The Problem of Predatory Bidding

1
The Problem of Predatory Bidding in Competitive
Tenders a Swedish Case Study Paper prepared
for the 1st Conference on Railroad Industry
Structure, Competition and Investment Toulouse,
November 7-8, 2003 Gunnar Alexandersson
Staffan Hultén EFI / Stockholm School of
Economics P.O. Box 6501 SE-113 83
Stockholm SWEDEN phone [phone] fax 46
8 33 43 22 e-mail Gunnar.Alexandersson_at_hhs.se St
affan.Hulten_at_hhs.se
2
1. Introduction 2. Low bids in tenders is
there a problem? 3. The legislators view on
low bids in tenders 4. A recent case the
tender of the train services to Northern
Sweden Costs, revenues and subsidies in
detail What do previous tenders of train
services show? 5. Discussion and conclusions
3

• Why do firms place low bids in tenders?
• The desirable case
• Unique competence
• Innovative ideas on production methods
• Economies of scale/scope

4
Why do firms place low bids in tenders? Three
different types of less desirable
explanations 1. To force competitors to leave
the market 2. A subsidiary to the procuring
organisation places a bid that, if it turns
out to be impossible to fulfil, presupposes
more money from the owner 3. Carelessness or
ignorance
5
Predatory Pricing A firm, usually an incumbent,
is dumping prices with a consciously calculated
loss, or is able to use profits gained in other
branches of its business through
cross subsidisation Hits competitors first,
making them exit the particular market. Then
consumers are affected, facing higher prices and
worsened supply. Difficult to separate predatory
pricing from fierce but healthy price competition
6

• Predatory pricing - does it exist?
• Industrial economists looking at historical
  evidence
• The Chicago School Predatory pricing is rare if
  existing at all since
• it is seldom or never rational. This is because
• a) it is costly
• b) it is difficult to recoup by future monopoly
  profits
• Later theory development, e.g. decision and game
  theory
• Strategy may be rational in the presence of
  asymmetric information
• Aggressive pricing has a strong signalling
  effect, deterring entry
• Irrational from a profit-maximising perspective
  may be rational when
• other objectives are taken into account.

7

• Public procurement
• some special circumstances
• Procuring entity has a strong position as a
  buyer,
• sometimes close to a monopsonist
• The winning bidder enjoys a monopoly-like
  position during
• the contract period, but its actual powers are
  often very
• restricted in terms of pricing and supply
  levels
• End consumers (when present), are bound to use
  the
• supplier chosen by the procuring entity
• Bids that imply low profitability create a risk
  that the
• supplier will not be able to fulfil the
  conditions of the
• contract, causing interruptions in delivery
• If problems arise, shifting to another supplier
  is seldom an
• option in the short run, not even for the
  procuring entity

8

• The legislators view on predatory pricing
• America (U.S. and Canada)
• Key question is recoupment possible?
• Market structure is crucial
• If entry barriers are low dont investigate
  further

9

• The legislators view on predatory pricing
• European Union
• Does not consider predatory pricing as such
• instead, focus is on price reductions as one of
  several
• practices related to abuse of dominant position
• Price reductions considered serious whenever
• practised by dominant firms and aimed at
  specific
• competitors
• Successful strategy or not does not really
  matter
• Relevant market is an important issue

10

• The tender of the trains to Northern Sweden
• Background
• Passenger train services (mainly night trains)
  running from Gothenburg
• and Stockholm to the very north of Sweden
• Tendered seven times since 1992
• Net cost contract
• New tendering authority, Rikstrafiken,
  established in 1999-2000
• SJ (former monopolist) won the first five
  tenders
• Tågkompaniet won the 6th tender, entering in
  January 2000
• Implied a reduction in subsidies from 122
  million SEK/year to 114 million SEK/year (on
  average)
• Connex won the 7th tender, entering in June 2003
• Implies a reduction in subsidies to
• 62 million SEK/year (on average)

11
Table 1 The bids of Connex and Tågkompaniet
in Rikstrafikens tender of the Northern trains
(million SEK)
12
(No Transcript)
13
(No Transcript)
14
(No Transcript)
15

• Conclusions
• Likely case of predatory bidding
• Procuring authority has not investigated bids
  thoroughly
• Costly legal aftermath likely
• Need for reformation of procurement and
  competition regulation
• 1. Alternative forms of procurement?
• 2. Measures for determining when bids are too
  low
• 3. Take into account the size of firms
  entering new markets
• 4. Consider the problems related to fulfilment
  of low bids
• in the service sector