Procurement Auction with Supplier Coalitions: Validity Requirements and Mechanism Design

We study the formation of supplier coalitions in the context of a buyer-centric procurement market. Considered under a second-price descending seal-bid auction, we propose a two-stage auction mechanism that allows suppliers to form coalitions with one another. Building on the foundations of core games and bidding-rings, we explore the idea of “managed collusion” which provides a means to enhancing bidder profitability. We identify six basic requirements for a valid coalition mechanism including characteristics such as individual rationality, welfare compatibility, maintaining competition, and financial balancedness. We show that such mechanism could be constructed so that the buyer does not loose the advantage from supplier competition, and that a stable coalition structure could be formed. We propose a profit distribution scheme among members in the supplier coalition and show that the proposed scheme provides proper incentive such that (1) the best strategy for a coalition member is to comply with the coalition agreement, and (2) bidding the true cost is the best strategy so long as the bids are uniformly distributed and the bidder’s cost is above a certain threshold. We also investigate the stable coalition structure under the proposed mechanism and show that under symmetric information there exists one unique strongly stable coalition structure.