Techniques for Protecting against Collusion in Sealed Bid Markets

• Author: Malcolm B. Coate
• DOI: 10.1177/0003603X8503000404
• Published date: 01 December 1985
• Date: 01 December 1985
• Subject Matter: Article

The Antitrust Bulletin/Winter 1985

Techniques for protecting against

collusion in sealed bid markets

BY MALCOLM B.

COATE*

I.

Introduction

897

The successful state and Department of Justice litigation attack-

ing price-fixing in sealed bid markets demonstrates that explicit

collusion is a major antitrust problem. Collusion occurs when

firms coordinate their pricing policies in an attempt to increase

their profits. For a given level of collusive profits, economic

theory posits that the likelihood of collusion depends on two

factors: the ease of reaching a consensus, and the ability to detect

cheating on the consensus (e.g., competitive behavior). IIn sealed

Staff Economist, Federal Trade Commission.

AUTHOR'S NOTE: The analyses and conclusions set forth in this article

are those

of

the author and do not necessarily reflect the views

of

other

members

of

the Bureau

of

Economics, other Commission staff, or the

Commission. I would like to thank Dave Pender and Paul Pautler

for

helpful comments on previous drafts

of

this article.

G. Stigler,

"A

Theory of Oligopoly," Journal

of

Political

Economy 72 (1964): 44-61.

Of

course, after the competitive behavior is

detected, it is necessary to punish the competitive firm for future

competitive behavior to be deterred. Punishment can be in the form of

retaliatory price reductions, refusals to cooperate in other matters (e.g.,

no exchange agreements for products or technology), or increased

marketing competition.

©1986 by Federal Legal Publications, Inc.

898 The antitrust bulletin

bid markets, the need to consider this second factor disappears,

because the ex post announcement

of

the winning bids (a normal

condition

of

such markets) guarantees the immediate detection

of

any competitive bidding. Consequently, to successfully collude in

a sealed bid market firms need only reach an explicit agreement

on price.' Thus, collusion can be a serious problem for govern-

ments and large businesses that use sealed bid auctions. Fortu-

nately, a purchaser can choose among a number

of

actions

designed to defend against collusion in sealed bid markets.'

In this article, we set forth and evaluate some

of

the existing

approaches that governments can use to improve their chances

of

receiving competitive bids. Since none

of

these strategies ad-

dresses the ability

of

collusive firms to detect competitive behav-

ior, we suggest a new scheme that occasionally randomizes the

winning bid to introduce uncertainty concerning the results

of

sealed bid auctions into the market. This method makes it more

difficult to detect competitive behavior, because collusive firms

cannot tell if the winner

of

the auction was the low bidder. We

conclude with a summary

of

the most effective defensive tactics

in the struggle against collusion.

2Firms could also collude through a tacit agreement, but this is

only feasible when there are few bidders and it is easy to arrive at a

collusive price (e.g., list prices are public).

3This article will concentrate on policies that governments can use

to avoid being the victim of collusion. Governments are the usual victim

of collusion in sealed bid markets, probably because the rewards of

government officials are not directly linked to cost control. On the other

hand, it is likely that competitive pressure will naturally force firms to

be alert to collusive bids, so corporate buyers will have a strong

incentive to detect collusive bids. However, the regulated sector of the

economy (e.g., utilities, hospitals) may not face strong competitive

pressures. These regulated businesses should consider some of the

suggestions contained in this article if they believe they are victims of

collusion. For a more detailed discussion of this issue, see A. Alchian,

ed., "Electrical Equipment Collusion: Why and How," in Economic

Forces at Work (Indianapolis: Liberty Press, 1977).