Entry and R & D Costs in Competitive Procurements and Contracting

Abstract

A model of competitive procurements and contracting is presented. The key features of the model include pre-contract R&D, an endogenous number of symmetric firms, and a first-price sealed-bid procurement auction. The unique symmetric perfect free-entry equilibrium is characterized. If the R&D technology is variable scale with constant marginal returns, it is socially optimal for one firm to do all of the R&D and production. However, since the buyer considers only his own cost of procurement, the buyer will prefer to allow free entry, and the number of firms will usually be larger than is socially optimal. If the R&D technology is fixed-scale, the buyer's choices will be socially optimal if the buyer's opportunity cost of an alternative procurement is high. On the other hand, if the opportunity cost is low the buyer will choose a reservation price lower than the socially optimal value and a number of firms no larger than the socially optimal number. Certainly, the type of R&D technology plays an important role in determining optimal R&D and procurement policies for the buyer and for society.