To aggregate, or not to aggregate, that is the question
As more and more budgets come under pressure in the public sector, those procuring goods and services are increasingly looking at novel ways to save money. The challenge is the same across the U.K. – ‘can we get more for less?’.
A starting point for many, is looking to derive savings via more efficient procurement.
However, this is easier said than done, as the very suppliers bidding on contracts are keen to ensure that they are not squeezed this time round (as in many instances their input costs are spiraling).
How does one reconcile these seemingly conflicting priorities?
A common solution currently in vogue is to look to aggregate. The argument goes something like this ‘by aggregating it means we have to only manage one supplier and we are likely to elicit significant savings as the supplier will secure greater economies of scale’.
“Rich gifts wax poor when givers prove unkind.”
Ophelia, scene i, The Tragedy of Hamlet, Prince of Denmark.
However, as any student of economics will observe there is an inherent flaw in this argument. One supplier equates to a monopoly and unless the RFP/RFQ is structured effectively, aggregation can lead to a single supplier winning who is incentivised to behave opportunistically. Of course, another issue with aggregation is that it favours the bigger players at the expense of SME’s. So much for economic development?
At Keelvar, we think the solution is pretty simple.
We believe that it is better to let the market decide on the best outcome. We would advocate breaking contracts up into smaller lots but with a clever twist so as to encourage competition. Bidders should have the freedom to bid on individual lots, bundles of lots, or even all lots. They will naturally be encouraged to offer conditional discounts which ratchet up as they win more business.
So bidder A may offer a 10% discount on winning 2 lots, a 20% discount on winning 3 lots and a 25% discount if the 3 lots were contiguous. Bidder B (an SME) can also bid aggressively on all lots while managing their risk by using what we call a side constraint i.e. they offer bids on all lots while advising they cannot win more than 2.
The results of this ‘expressive bidding’ is the market can offer a range of combinations and the large incumbent is ‘kept honest’ as they realise that the rules of the game have essentially changed and that they need to bid more aggressively as they are now competing against the sum of the smaller firms as well.
In many respects the arguments against managing a number of suppliers is a false economy as the savings resulting from a competitive procurement could easily trump the cost. (That said, with Keelvar’s procurement optimization software it is easy to stipulate a maximum number of suppliers at the evaluation stage of the process).
In short, we advocate that it is better to make a fully informed decision letting the market decide, rather than assuming aggregation is the best outcome.
Image Source: (Flickr – Kevin T. Houle)