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Economic Considerations on Centralised Public Procurement

Gian Luigi Albano, Ph.D. Head of Research Italian Public Procurement Agency (Consip SpA) Email: gianluigi.albano@tesoro.it Beijing, 24-25 April 2008

Forces shaping Government Spending

Cost control Streamline processes

Better value for money!

Governments and private organizations have to tackle quite a similar problem.

Models of Public Procurement

Centralization

cost control streamline processes

Decentralization

Hybrid models

Centralization

Any evidence of a trend towards more centralized public procurement processes?


Examples (with some degree of differentiation) include, among others: GSA (United States) OGC Buying Solutions (United Kingdom); Consip (Italy); SKI (Denmark); Hansel (Finland); Satskontoret (Sweden); BBG (Austria)

Major forces affecting the degree of centralization


Efficiency/Savings Product Standardization Favoritism Strategic Procurement Network effects and Standards Markets Dynamics Emergencies Information Costs for Decision Making Bargaining Power Monitoring Contractors Performance E-procurement

Efficiency/Savings
Three main channels: 1. Higher volumes (demand side) Lower unit costs (supply side) + savings through competitive processes Lower Procurement organizational/transaction costs + savings Bigger risks of being out of the market for firms depending on public demand + savings through competitive processes

2. 3.

Specialization: Centralized procurement calls for more specialized expertise Knowledge and Information Sharing: collect, up-date and elaborate information from seemingly unrelated markets (e.g., printers and PCs; insurance and banking)

Product Standardization
Two main forces: 1. Better information gathering and processing 2. Standardized products go hand in hand with low degree of demand heterogeneity

Higher suppliers economies of scale Limits to centralization may arise owing to physical constraints (e.g., electricity purchased by local authorities that are scattered over a vast geographical area)

Favoritism
Local authorities can rely on better information on their needs (when products are not entirely standardized) and on suppliers characteristics. Repeated interaction (most purchases dont take place only once in a life time) may favor the emergence of a personal acquaintance between buyers and sellers, and thus some forms of favoritism (through lobbying, not necessarily corruption). Centralized competitive procurement processes may suffer less from favoritism, BUT generate a bigger pressure in terms of information gathering and processing.

Strategic Procurement
Core Procurement Sectors: 1. Defense (see Chinas National Defense white paper in 2004); in the US, the DoD recognizes some advantages of decentralized procurement processes (flexibility and innovation) Health: examples include, among others, the case of antimalaria drugs (benefits of centralization illustrated in a recent volume by the Board on Global Health); UNICEF for vaccines and WHO for tuberculosis Green Procurement: centralization enhances the positive externalities of imposing greener standards

2.

3.

Networks and Standards


Network industries account for a sizeable share of modern economies: e-markets (B2B, B2C, and B2G platforms), software (e.g., Operating Systems), banking (e.g., ATM networks) Network effect: the value to any member of the network increases with the size of the network. Coordination among users is paramount Centralized procurement may play a crucial role in expanding existing networks or, more crucially, in coordinating users switch from an old to a new network (in Sept 04, the Brazialian Government and IBM agreed to expand the LINUX operating system as an alternative to Microsoft Windows.)

Market Dynamics
In rapidly changing markets (e.g., hi-tech, biomedical), officers in local authorities may have access to local information (e.g., industrial districts). Officers of Central Procurement Agencies may, however, have access to better information about global trends.

Hybrid models appear best suited to solve such a tension

Emergencies
Urgent need for a commodity or service. Time too tight for the organization of a competitive tendering: first-aid goods after a natural disaster. Degree of centralization depends upon (i) whether the emergency occurs at local rather than national level; (ii) nature of commodity/service to be procured. GSA in the US. The agency is empowered to support government efforts by providing guidance on appropriate asset management (e.g., aircrafts, motor vehicles) in respose to hurricanes; selecting vendors from a special list, as sources for emergency procurement; assisting emergency acquisitions of goods and services with GSA Smart Pay, a special card allowing purchasers to procure at lower costs.

Decision Information Costs


Information-gathering costs tend to increase with the degree of centralization. Decision information costs depend on two main factors: 1. Degree of organizational fragmentation: the more highly fragmented an organization the higher information costs for decision taking. Nature of good/service: information costs are inversely related to the degree of product standardization

2.

Progress of ICT steadily reduces the cost of information gathering and processing. This should induce a positive correlation between e-procurement and centralization.

Monitoring Contractors Performance


When quality of contractual performance is soft (i.e., difficult to describe in a contract clause) centralized monitoring looks like an extremely hard task.

This may explain why centralized procurement processes can go hand in hand with decentralized monitoring activities (see US Federal Acquisition Regulation, 2005).

E-Procurement
Development of e-procurement: reduces the costs of information collection; standardizes the nature of information.

Higher centralization
Moreover, centralization magnifies the benefits of e-procurement. The value of web-based procurement system is the highest for organizations which, by introducing e-procurement systems, can undertake centralized procurement activities that they did not have before.

Bargaining Power
Demand aggregation raises buyers bargaining power via enhanced competition among suppliers (not necessarily via a higher number of participants, rather via bigger stakes, that is, bigger contracts). Higher bargaining power leads, in general, to higher savings even when economies of scale are mild. Large volumes may, however, discriminate against small and medium enterprises which do not have economic capacities to serve national contracts. Question: How do we cope with the crucial issue concerning fostering participation of SMEs in Public Procurement processes?

Fostering participation of SMEs


Feasible solutions (not mutually exclusive): Softening constraints on Joint Bidding. Bidding consortia provide a solution to barriers to entry for firms that do not satisfy the economic requirements to participate in large public tendering; Increasing the number of lots decreases their individual size/value hence facilitates participation of SMEs; on the other hand, more and smaller lots may facilitate collusive market-sharing agreements and make more difficult the exploitation of possible economies of scale; Combinatorial auctions where package bidding is allowed can be a way to allow the exploitation of possible economies of scale while facilitating participation of SMEs. Length of contract to avoid lock-in (but mind collusion!); Participation requirements should be as low as possible and should focus on aspects directly related to the contract.

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