Competitive Bidding

Competitive bidding is a method for determining, by comparing rival offers, the price at which a good is sold. The need to win business against rivals forces participants to disclose their lowest acceptable price.

Competitive bidding can take many formats and can be used either to sell an item to many potential buyers or to buy an item from many potential sellers. A familiar example is an oral auction where the auctioneer asks if anyone will pay a certain amount to buy an item. If more than one person agrees to that price, the auctioneer suggests a higher price until only the winner is left. Another example is a sealed bid process, in which sellers are asked to submit their prices in writing so that their rivals will not see them. The seller offering the lowest price wins the sale if all other conditions, such as time of delivery and technical specifications, are met.

In “English” auctions, the auctioneer starts with a low price and progressively raises it until a winner is determined, whereas in a “Dutch” auction the price starts high and is lowered until someone agrees to that price. Both approaches are called “first price” auctions because the price named is the one at which the sale occurs. In a “second price” auction, the winner pays (or is paid) the price of the runner-up, that is, the next-to-highest (or next-to-lowest) bid. Which auction format yields the lowest price to a buyer, or highest price to a seller, is a matter of intense theoretical research.

Which format is used depends on the time available, the need to document the process, and whether bidders wish to keep some information private. A hospital seeking to buy a CT scanner may use a sealed bid auction, because it must weigh the technical merits of different machines against price. By agreeing not to publicly disclose the conditions offered by the sellers, the hospital hopes to secure a more favorable price.

Competitive bidding is frequently used by private health maintenance organizations to procure the services of clinical laboratories and other suppliers. It is not used routinely by the federal government to determine payment for services under Medicare. Studies by the federal General Accounting Office and the inspector general of the U.S. Department of Health and Human Services have found that Medicare payment rates are higher than those of many private insurers and are sometimes higher than prices offered to the public in retail stores. Under a demonstration project of competitive bidding for durable medical equipment in Polk County, Florida, in 2001, Medicare reports that it saved an average of 20% compared with its standard rates after selecting winners based on considerations of price, quality, and accessibility. The long-term use of competitive bidding in the Medicare program is a matter of intense controversy, because it has the potential to lower payment rates and possibly limit the number of suppliers who can participate in the program.