Local Cost Synergies in Reverse Auctions: An Application to Road Salt Procurement

Abstract

We develop a structural model of firms' bidding behavior in simultaneous first-price auctions with linkages across items, and apply the model to procurement auctions held by Minnesota's Department of Transportation (MnDOT). Each year, MnDOT holds simultaneous first-price auctions to procure road salt for each of its depots (storage facilities) located throughout the state. We find strong evidence for economies of scope: large firms' bids reflect a preference for winning co-located depots. Counterfactual simulations indicate that, on average, large firms' bids are 6 to 8 percent lower than they would have been absent the estimated economies of scope. While these lower bids are beneficial to the state, they also reduce the competitiveness of small firms – for which we do not detect economies of scope. MnDOT therefore faces a tradeoff when taking actions that may either enhance or diminish economies of scope.