Auctions for Split-Award Contracts

The buyer of a homogeneous input employs split-award contracting to divide his input requirements into two contracts that are awarded to different suppliers. The buyer uses a sequential second-price auction to award a larger primary contract and a smaller secondary contract. With a fixed number of suppliers participating in the auctions, we find that the buyer pays a higher expected price than with a sole-source auction. The premium paid to the winner of the secondary contract must also be paid to the winner of the primary contract as an opportunity cost of not winning the secondary contract. With fixed costs of participating in the auction, we identify the conditions under which a secondary contract can increase the number of suppliers and lower the expected price paid by the buyer. An optimal secondary contract can internalize the cost reductions from the new industry capacity and extract the rents of the suppliers. An optimal secondary contract can be particularly beneficial when the number of suppliers is limited by high fixed costs.