Competition and Cost Overruns in Procurement

Abstract

Most cases of cost overruns in public procurement are related to important changes in the initial project design. This paper deals with the problem of design speci¯cation in public procurement and provides a rationale for design misspeci¯cation. We propose a model in which the sponsor decides how much to invest in design speci¯cation and awards competitively the project to a contractor. After the project has been awarded the sponsor engages in bilateral renegotiation with the contractor, in order to accommodate changes in the initial project's design that new information makes desirable. When procurement takes place in the presence of horizontally di®erentiated contractors, the design's speci¯cation level is seen to a®ect the resulting degree of competition. The paper highlights this interaction between market competition and design speci¯cation and shows that the sponsor's optimal strategy, when facing an imperfectly competitive market supply, is to underinvest in design speci¯cation so as to make signi¯cant cost overruns likely. Since no such misspeci¯cation occurs in a perfectly competitive market, cost overruns are seen to arise as a consequence of lack of competition in the procurement market.

Procurement with Unenforceable Contract Time and the Law of Liquidated Damages

“…15 Courts, however, may refuse to enforce compensation if the amount established at the time of contract award appears that it is was intended to pressurize the contractor into performance.…”

“…Indeed, the empirical literature on public procurement suggests that, despite such provisions are routinely included in contract documents, delays are common and are not con…ned to inherently complex tasks, such as large infrastructure or military projects, where time overruns are often associated with important changes in the initial design (Ganuza, 2007). For example, using a sample including 894 projects, belonging to seventeen infrastructure sectors, completed in India during 1992-2009, Singh (2009) The ine¢ cacy of so called "penalty" clauses in stimulating compliance with contractual obligations might be generated by several circumstances.…”

Determinants of adaptation costs in procurement: an empirical estimation on Italian public works contracts

“…14 At the same time, in Italian public works delays are very striking: about two thirds of public works completed by 2005 involved delays higher than 20% of the completion time agreed upon in the contract. The determinants of such a phenomenon have been investigated by Guccio et al (2009b (Flyvbjerg and Skamris, 1997;Flyvbjerg et al, 2002Flyvbjerg et al, , 2003a show that construction costs are generally 15 Ganuza (2007) provides a rational explanation for what could be regarded as underinvestment in project design. A higher investment on a more accurate initial design lowers the probability of renegotiation and of awarding the project to the most efficient firm, but it increases its rents, when competition is not perfect.…”

The Simple Micro-Economics of Public-Private Partnerships

“…Denote t i (C i ) = α i − β i C i the cost-reimbursement rule used at date i. 34 Let us first consider the case where G can commit himself to such a two-period contract {t 1 (C 1 ), t 2 (C 2 )}. 31 In full generality, we could allow uncertainty on operating costs to be time-dependent.…”