Erasmus University Rotterdam Erasmus School of Economics Master Thesis Msc Economics Of

ERASMUS UNIVERSITY ROTTERDAM

ERASMUS SCHOOL OF ECONOMICS

The Effect of Electronic Auctions on Competition: In Public Procurements

for Pharmaceutical and Medicinal Products in European Union

Abstract

This research makes an inquiry abouthow electronic auctions affect the competitiveness in public procurements. It was conducted by observing the number of offers and the ratio of contract value over estimated value in procurements. Using data from the European Union Open Data Portal (Tenders Electronic Daily (TED)) for the time period between the years 2012 and 2014 about the public procurements for the Pharmaceutical and Medicinal Products, two empirical models are designed. First model is about the total effect of the electronic auction method on competitiveness and shows that it increases the competitiveness of public procurements about 6.67 percent. On the other hand, second model presents that electronic auction method decreases the number of offers in procurements by 1.21. It is observed that this method boosts the attractiveness of procurements; however, it extends the process. This extension is one of the main reasons for why contracting entities use electronic auction method in procurements very rarely.

1.Introduction

2.Related Literatures and Legislation

2.1 Literature Review

2.2 Electronic Auctions in European Union

The Definition of Electronic Auctions

The Mechanism

2.3 Main Concerns about Electronic Auctions

3. Methodology and Data

3.1 The Data

3.2 Hypothesis Development

3.3 The Model

Explanatory Variable

Control Variables

Total Effect

Indirect Effect

3.4 Robustness Checks

Contracting Entities Attitude

Potential Suppliers Attitude

4. Results

4.1 Total (Net) Effect

4.2 Indirect Effect

4.3 Attractiveness of Procurement

4.4 The Effect of Electronic Auctions on the Time Lengths

5.Discussion

6.Conclusion

References

Appendix

Appendix 1

Appendix 2

Appendix 3

Appendix 4

Appendix 5

Appendix 6

Appendix 7

Appendix 8

Appendix 9

Appendix 10

Appendix 11

Appendix 12

1

1. Introduction

Electronic auction method was opened-up for use of member states in the European Union with the Directives 2004/EC/17 and 2004/EC/18 for contracting entities.In 2004, electronic auction method promised a great future by offering lower transaction costs, more transparency, greater access to new suppliers and time savings for awarding authorities; reduced costs, access for new buyers and markets and increased sales for suppliers (Arrowsmith 2005; Bovis 2005; Trepte 2007). In 2014, the European Union published a new Directive, 2014/24/EU, in this Directive, certain features of the provisions about electronic auctions remained unchanged in general. While the European Union has encouraged public entities and governments in all member states to use electronic auctions in public procurements for years, usage rates of this method are still lower than expected (Hur et al. 2007).

During 12 years, the use of electronic auction methods has remained relatively small, between the years 2012 and 2014 the ratio for the usage of that method in public procurements for pharmaceutical and medicinal products is only 7.34%. Potential reasons like bureaucratic matters, insufficient electronic infrastructures, and conservative policies of the member states made the effect of electronic auction methods on competition questioned.

Interestingly, in public procurements for purchasing identical goods, electronic auction methodis very relevant in some member states while public entities in other states hesitate to use electronic auctions. The purpose of this research is to examine the relationship between electronic auctions and competition in public procurements in the European Union. This research also investigates the consequences of using electronic auction method in public procurements on competition and finally attempts to answer the following research question:

What is the impact of electronic auctions on competition in public procurements? And what are the main reasons of not using electronic auctions frequently for the member states?

This research examines the consequences of using or not using an electronic auction method in procurement and compares the competition levels in all public procurements for identical goods in the member states of European Union for the same time period.

Electronic auctions can be defined simply as a dynamic process in which potential suppliers compete against each other by offering lower bids, on an electronic platform, to win a public contract. It is suggested that, by improving accessibility, electronic procedures attract much more tenders than standard paper-based procurements and the increased competitive pressure in auctions forces the potential tenders to submit their best offers which would improve value for money.Furthermore, electronic auctions contribute to transparency and provide significant savings in costs and time. That is why the EU encourages the contracting authorities in member states to use electronic auctions.

A basic example about electronic auction is presented in Table.1. In the example, it is suggested that three tenderers submitted an admissible initial tender and were invited to participate in the online auction which will be conducted in three phases and solely on prices. All tenderers could observe their own ranking and the value of the winning offer at any time during the auction. They could revise their offers downwards at any time in the auction without any cost. The estimated value of the productand the minimum difference between the offers determined by the entity equals to € 1000 and € 20 respectively. The outcomes of the auction and each phase are as follows:

Table.1 A Basic Example for Electronic Auction

Throughout the auction (and in each phase), all bidders know their own rankings and the amount of the winning bid. They revised their offers downwards to win the auction. And finally, bidder B won the auction. The contracting entity will award the contract to bidder B if B meets the contract award criteria.If it happens,final value (contract value) will be equal to € 800. This basic example presents the expected process in price competition.

The results of the thesis should be of relevance to public entities and governments that need information about when they should use an electronic auction in public procurements and what are the consequences of electronic auctions, in order to provide competition at a high level. The paper is organized as follows. Section two gives a brief overview of the existing literature and process of electronic auctions. Section three addresses the data and methodology used for this research. Section four presents the results and finally section fiveand six offeringpoints of discussion and concluding remarks as well as points of discussion.

2.Related Literatureand Legislation

2.1 Literature Review

The thesis is related to two streams of literature. First, it relates to the literature on the characteristics of auctions and the effect of auctions on competition. In that literature, four basic types of auctions are widely mentioned: ascending-bid auction (also called open or English auction), descending-bid auction (Dutch auction), first-price sealed-bid auction, and second-price sealed-bid auction (also called the Vickrey auction) (Klemperer 1999). These standard typesof auctions have been generally used to sell items or services throughout history. Before the Internet, auctions were not prevalent because of the necessity of being available at the same place for both auctioneer and bidders. By providing an important platform for e-commerce, the Internet enables people and firms to conduct auctions for a wide range of items at rather low transaction costs (Müller 2001). This new type of auctionis called as electronic auction (also called online auctions or internet auctions). While recent literature about auctions focuses largely on the private sector transactions, electronic auctions are also used by the public entities or governments to meet their needs.

The auctions which are used to purchase products and services are called reverse auctions (Müller 2001).The use of electronic (reverse) auctions by buyer public entities provides a number of advantages; significant price reductions, a number of administrative benefits, and finally enhanced transparency about the whole procurement process (Shalev et al. 2010). On the other hand, electronic reverse auctions limit the competition to price negotiations instead of quality of the products, and this restriction could damage the long term relationships between the public entities and suppliers (Shalev et al. 2010) and also they are slightly more costly for authorities (Strand et al. 2011). This research aims to contribute to the literature on auctions in public sector by examining the consequences of using electronic (reverse) auctions in public procurements.

Second, the thesis relates to the literature about the European Union legislation on the electronic (reverse) auctions. The European Union has started to use electronic auctions in public procurements since the year 2004 (Arrowsmith 2004; Caranta 2015; Soudry 2004). At articles 1(7) and 54 of the Directive 2004/EC/18 and 35 of the Directive 2014/24/EU, the European Union makes a definition of electronic auctions and sets up the rules about the electronic auction process. An ‘electronic auction’ is a repetitive process with an electronic device for the submission and the revision of the offers; this device ranks the tenders and determines the awarding process of procurements (Strand et al. 2011). In these Directives of the European Union, member states were encouraged to use electronic (reverse) auctions in their public procurements for the award of public works contracts, public supply contracts and public service contracts. However, it is also expressed that certain service and work contracts which requires intellectual performance could not be the object of electronic auctions as their “subject-matter design”. This research aims to contribute to the European Union legislation on the electronic (reverse) auctions by examining the effects of electronic auctions on public procurements and the relationship between these auctions and public implications.

2.2 Electronic Auctions in European Union

Auctions have been used for the exchange of goods such as works of arts, products or services throughout history (McCabe et al. 1990). The main idea of auctions is to increase the value for money with the possible lowest price in an online competition. It provides tenderers to revise their bids downwards to underbid the bids of other tenderers.By the help of improvements in information and communication technology, it is suggested that electronic auctions reduce searching costs and operational costs and as a consequence attract more firms to offer a bid and make the markets more competitive. Electronic reverse auctions have been more prevalent in the last years because these auctions can lower purchase prices (Shaull 2011, Carter et al. 2007). One of the most important aspects of implementing an electronic auction is the remote bidding access which implies that distant potential buyers can participate in the bidding process (Guillotreau et al. 2006). Despite the fact that public entities have performed auctions for a long time to meet their needs, they have used more commonly sealed bid auctions instead of electronic auctions (Carter et al. 2007).

In 2004, the European Union provided an opportunity for member states to use electronic auctions in their public procurement processes as use of the technique of electronic auctions is likely to increase (Directive 2004/EC/18). In open, restricted or negotiated procedures, the public entities and contracting authorities may decide to execute the awarding process of a public contract by the help of an electronic auction technique. It was expected that electronic auctions will reduce searching costs and operational costs,enable most of the firms in the Union to make a bid for public procurements in other member countries by the help of this cost reduction and make public procurements more competitive (Arrowsmith 2004). After passing more than a decade, use of electronic auctions in member states of the European Union has remained lower than expected (Strand et al. 2011). As a consequence, although electronic auctions reduce time, transaction costs and bureaucracy and have a pressure on offers downwards, contracting authorities havehesitated about using electronic auctions in their public procurements. This thesis aims to examine the validity of the hesitation of contracting authorities.

In order to derive benefits from electronic public procurement tools, the European Union had published new regulations to enable the use of electronic methods before setting new electronic procurement procedures namely dynamic purchasing systems, electronic (reverse) auctions etc., in 2004. The following directives and proposals generated the legal background for electronic auctions:

• E-Commerce Directive - On certain legal aspects of information society services, in particular electronic commerce, in the Internal Market, Directive 2000/31/EC.
• Electronic Signatures Directive - On a Community framework for electronic signatures, Directive 1999/93/EC.
• Data Protection Directive - On the protection of individuals with regard to the processing of personal data and on the free movement of such data, Directive 95/46/EC.
• Copyright Directive - On the harmonisation of certain aspects of copyright and related rights in the information society, Directive 2001/29/EC.
• Public Sector Information Proposal – On the re-use and commercial exploitation of public sector documents, COM/2002/207.

After these regulations, the European Union published Public Sector Directive (2004/18/EC) in 2004 for the award of public works, public supply and public service contracts, made a definition of electronic (reverse) auctionsat Article 1(7) and defined clear rules for the process at Article 54. Public Sector Directive 2004/EC/18 was repealed with effect from 18th April 2016. European Union published a new Directive, 2014/24/EU, on 26th February 2014 however certain features of the provisions about electronic auctions remained unchanged in general. As our sample in this research covers the period between the years 2012 and 2014, we will focus on the provisions in former Public Sector Directive (2004/EC/18) which are also consistent with the latter Directive.

The Definition of Electronic Auctions

In the Public Sector Directive (2004/18/EC), the European Union clearly authorised member states to use electronic auctions in their procurements. At Article 1 (7) of the Public Sector Directive, electronic (reverse) auction is defined as “a repetitive process involving an electronic device for the presentation of new prices, revised downwards, and/or new values concerning certain elements of tenders, which occurs after an initial full evaluation of the tenders, enabling them to be ranked using automatic evaluation methods”. We can infer certain features of this process from the definition.

• An electronic device must be used in the process.
• The technique is to be used for the presentation of new, revised downwards, prices and/or new values. Non-price elements of the contract can be revised as well as prices.
• Only downward revision of the price or value is permitted.
• The auction will be operated after an initial full evaluation of tenders.

It is worth to note that electronic auction is not a new separate procedure and can be used only as an awarding technique within other procurement procedures.

It is reported that some provisions in Directives could cause uncertainties to discourage contracting entities to use electronic auctions in procurements. For instance, about the availability of electronic auctions in terms of what will be procured, it is stated at the article “certain service contracts and certain works contracts having as their subject-matter intellectual performances, such as the design of works, may not be the object of electronic auctions”.This provision could be interpreted as a restriction on using electronic auctions in public procurements about “subject-matter intellectual performances” such as the design of works. Another possible explanation for the provision might be that it states only a caution instead of a prohibition. Arrowsmith (2005) stated that this provision causes an uncertainty about the availability of the contracts for electronic auctions because of these contradictory interpretations. At last in the new Public Sector Directive (2014/24/EU), at Preamble(67) it is clarified that only the quantifiable elements which can be expressed in figures or percentages and which are suitable for automatic evaluation by electronic means, without any intervention or appreciation may be the object of electronic auctions. It is also stated that in a procurement procedure for the purchase of a specific intellectual property right electronic auctions may be used.

In Public Sector Directive, the use of electronic auctions is explained at Article 54, this provision determines detailed rules of the mechanism.

Certain features of the provision at Article 54 are as follows:

• (1) Member states are clearly authorised to use electronic auctions.
• (2) In open, restricted or negotiated(with a notice/call for competition)procedures and in framework agreements and dynamic purchasing system, the contracting authorities may use an electronic auction at the stage of the award of a public contract when the contract specifications can beestablished with precision. The electronic auction shall be based solely on prices or on prices and/or on the new values of the features of offers.

• (3) Contracting authorities who decide to hold an electronicauction,must state that fact in the contract notice.The noticeshall includethe relevant information concerning the electronic auction process, the electronic equipment used and the arrangements and technical specifications for connection. The conditions under which the tenderers will be able to bid and, in particular, the minimum amount of price revisions which will, where appropriate, be required during bidding should be stated in the contract notice.

• (4) Before commencing an electronic auction, contracting authorities must make a full initial evaluation of the tenders received from potential suppliers according to the rules of selected procurement procedure. All tenderers who have submitted admissible tenders shall be invited simultaneously by electronic means to submit new offers. And the electronic auction may not start sooner than two working days after the date on which invitations are sent out.

• (6) Throughout each phase of the auction, contracting authorities shall instantaneously enable all tenderers at least toascertain their relative rankings at any moment. If stated in the specifications, authorities may also provide other information about other prices orvalues submitted and at any time announce the number ofparticipants in that phase of the auction. In no case, however, may they disclose the identities of the tenderers.
• (7) Contracting authorities shall close an electronic auction in one or more of the following manners:

(a) On the date and time fixed in advance in the invitation;