Same product, different price: Experimental evidence on the transaction cost expenditures of selling to governments and firms

• Published date: 01 May 2023
• Author: Matthew Potoski,Ole Helby Petersen,Trevor L. Brown
• Date: 01 May 2023
• DOI: http://doi.org/10.1111/puar.13551

RESEARCH ARTICLE

Same product, different price: Experimental evidence

on the transaction cost expenditures of selling to

governments and firms

Matthew Potoski

1

| Ole Helby Petersen

2

| Trevor L. Brown

3

1

Bren School of Environmental Science and

Management, University of California, Santa

Barbara, Santa Barbara, California, USA

2

Department of Social Sciences and Business,

Centre for Research on Public-Private

Collaboration, Roskilde University, Roskilde,

Denmark

3

John Glenn College of Public Affairs, The Ohio

State University, Columbus, Ohio, USA

Correspondence

Matthew Potoski, Bren School of Environmental

Science and Management, University of

California, Santa Barbara, 2400 Bren Hall, Santa

Barbara, CA 93106-5131, USA.

Email: mpotoski@bren.ucsb.edu

Abstract

Whether governments pay more than firms when contracting has been an

important and stubbornly vexing question in public management. One challenge

has been finding ways to credibly compare the costs of engaging in market trans-

actions with governments versus firms. In this paper, we systematically compare

the costs of contracting when governments and firms buy the same product

under the same circumstances. Using data from a randomized experiment of

Danish firms, we examine selling firms’transaction cost expenditures when selling

the same product to governments and other firms. We find that firms estimate

spending about 34 percent more on transaction cost expenditures when selling to

governments than when selling the same product to firms. Experience in selling to

governments is associated with lower transaction cost expenditures, suggesting

that learning can reduce firms’costs of selling to governments and firms.

Evidence for Practice

•Sellers’estimate their transaction cost expenditures to be 8 to 10 percent of the

contract value.

•Sellers’estimated transaction cost expenditures are significantly higher when

selling to governments than to other firms, likely due to sellers’higher costs of

complying with contract monitoring and enforcement requirements.

•Sellers’experience with public sector contracting lowers their transaction costs

expenditures when selling to governments and other firms.

INTRODUCTION

Improving public sector contracting is an important pub-

lic management challenge, in large part due to the

amounts governments around the world spend on pur-

chased products

1

: government purchasing represents

from 5 to 20 percent of national GDP and from 20 to

45 percent of public sector expenditures among the

OECD countries (OECD, 2019, pp. 172–173). As govern-

ments become increasingly reliant on complex supply

chains to fulfill their missions and deliver value to

stakeholders (Abonyi & Van Slyke, 2010), some suggest

that governments often pay above-market prices for com-

monly available products (Marion, 2007; Ohashi, 2009).

For example, news reports in Denmark claimed that local

governments were paying 40 percen t more for goods

routinely available in grocery stores (Rasmussen, 2010).

Stories from the United States showed the federal gov-

ernment apparently paying $10,000 for a toilet seat cover

and $435 for a common hammer (Freedberg, 1998).

As it turned out, these media stories were deceptive.

Claims that governments purchase inefficiently and

pay inordinately higher prices often fail to account for

the effects of government purchasing regulations and the

unique features of products that governments buy. The

This research was supported by the Independent Research Fund Denmark [Grant

no.: 9061-00020B].

Received: 19 July 2021 Revised: 20 July 2022 Accepted: 19 August 2022

DOI: 10.1111/puar.13551

This is an open access article under the terms of the Creative Commons Attribution-NonCommercial License, which permits use, distribution and reproduction in any

medium, provided the original work is properly cited and is not used for commercial purposes.

© 2022 The Authors. Public Administration Review published by Wiley Periodicals LLC on behalf of American Society for Public Administration.

Public Admin Rev. 2023;83:623–638. wileyonlinelibrary.com/journal/puar 623

seemingly exorbitant prices paid for groceries by Danish

local governments included daily delivery to the doorsteps

of thousands of public schools, nurseries and retirement

homes (Rasmussen, 2010). The U.S. Air Force’s toilet seat

cost $10,000 because the seller needed to design and build

it from scratch to fit a few aging tanker planes (Gregg,

2018). No firms bought these parts because only the Air

Force owned such tankers. The U.S. Department of Defense

did list a $435 price tag for a construction hammer, but the

hammer was part of a bulk spare parts purchase where the

price covered $15 for the hammer and $420 in research

and development costs for other goods in the bulk pur-

chase, including jet engines (Mothershed, 2012).

Inefficient government contracting could have many

unfortunate consequences: wasted public sector budgets,

higher taxation, and calls for internalization of formerly con-

tracted products (Clifton et al., 2019; Warner & Aldag, 2021;

Warner & Hebdon, 2001). The efficiency of public sector con-

tracting also informs the long-standing research inquiry into

how and when different organizational forms perform more

or less effectively, one of the most important topics in the

social sciences (Koning & Heinrich, 2013; Ostrom, 2007;

Perry & Rainey, 1988;Shleifer,1998; Williamson, 1996). Con-

tracting and purchasing provides a window into the relative

performance of different institutional arrangements because

it is a function common to all organizations, both public and

private (Brown, 2013; Rainey & Bozeman, 2000;Tadelis,2012).

Identifying whether firms offer products to govern-

ments at higher prices than they charge other firms for the

same products is an important step in examining and

explaining the relative performance of alternative organiza-

tional forms. Firms may charge higher prices to govern-

ments because of insufficient incentives for governments

to simplify the purchasing process, the costs of public sec-

tor purchasing regulations intended to promote social

values, or the inexperience of some firms who have not yet

adapted their business practices for selling to governments.

Academic research has struggled to systematically compare

purchasing between governments and firms because they

often buy different products and use different accounting

practices (Bel et al., 2010; Bel & Rosell, 2016; Savas, 1987).

The strategy we pursue in this study measures the costs

firms bear when selling to governments compared to when

they sell the same products to other firms.

Analyses of the costs of executing an exchange

between two parties have used several related theoretical

approaches, including transaction costs, coordination

costs, and management costs (Bowen & Jones, 1986;

Geyskens et al., 2006; Mohr, 2017b; Romzek &

Johnston, 2002; Sclar, 2000; Williamson, 1979,1991). Our

approach builds on analyses that examine the cost drivers

in public sector contracting (e.g., Petersen et al., 2019,

2021). We use the term “transaction cost expenditures”

to capture the actual financial costs buyers and sellers

experience to execute market exchanges (De Schepper

et al., 2015; Petersen et al., 2019). Private firms may

charge higher prices to governments because sellers

incur higher transaction cost expenditures when selling

the same products to governments than when selling to

other firms (Purchase et al., 2009). If private firms are sell-

ing the same products to a government as they are to

another firm, the sellers’production costs should be identi-

cal regardless of the buyer’s organizational form. The costs

of organizing and governing the exchange is therefore

where cost differences to the buyer are likely to emerge,

and therefore also where our analytical focus lies.

In this paper, we develop an approach to systemati-

cally compare a firm’s transaction cost expenditures when

selling the same product to governments and other firms.

In doing so, we keep the product characteristics and

the seller’s organizational form constant and only vary

whether the buyer is a government or another firm. We

draw on data from a randomized experiment of contract

managers in 177 Danish firms in three major industries

that commonly sell to both governments and other firms:

the construction, information, and communication tech-

nology, and consulting and advisory industry. We pro-

vided contract managers with a vignette describing a

product that their firm typically sells to both governments

and other firms. Respondents were randomly assigned to

a scenario where the buyer was a government or a firm,

with all other circumstances of the exchange being iden-

tical. The vignette included a description of the product

along with the total price of the contract and asked

respondents to provide precise estimates of the costs

their firm would spend to complete the exchange.

Respondents were provided with detailed guidelines on

how to calculate their firm’s estimated transaction cost

expenditures and on how to assign that spending into

different ex ante (before contract signature) and ex post

(after contract signature) exchange activities.

Our analysis provides evidence that selling firms esti-

mate transaction cost expenditures that are 10.36 percent

of the contract value when selling to governments and

7.74 percent when selling the same product to other firms,

an additional cost of selling to governments of 34 percent.

To further explore the sources of the additional transaction

cost expenditures, we break down selling firms’exchange

activities into subsets of ex ante and ex post categories

and find that selling firms’transaction cost expenditures

are particularly higher for monitoring and enforcement

activities when selling to governments. Our findings pro-

vide evidence to help answer the question of whether

firms offer products to governments at higher prices than

the same product than firms. To the best of our knowl-

edge, these are the first empirical estimates of private

firms’transaction cost expenditures when selling identical

products to governments and to other firms, under the

same circumstances,and in similar market conditions.

The credibility of our findings is bolstered by the

experimental features of our research design. Moreover,

because Denmark’s public sector is known for its regular-

ity and low corruption in purchasing, the effects we

report are likely to be smaller than what would occur

624 THE TRANSACTION COST EXPENDITURES OF SELLING TO GOVERNMENTS AND FIRMS