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Procurement Perspectives: The reality of a world of ‘perfect information’

Stephen Bauld
Procurement Perspectives: The reality of a world of ‘perfect information’

In a world of perfect information, since all buyers and sellers know what price currently prevails in the market, any effort by a seller to secure more than the market price will fail.

Any effort by the buyer to get less than the market price will similarly fail.

The characteristics of the goods and services selected by the individual economic actors are perfectly understood in a similar manner by all actors.

The reality, of course, is that there is no world of perfect information, nor is there any world in which information is costless.

What markets must therefore do is adjust contracting practice so that contracting decisions can focus on some specific criteria that is universally understood and readily comparable.

Price is that criteria. Put another way, suppliers, who for the most part will draft the contracts, cut back on the risk that they are prepared to assume so that they can offer the most attractive cash price to prospective buyers. Hence, as a general rule, even markets where there is only a limited degree of concentration, over time the contractual terms offered to customers by suppliers both trend towards favouring supplier interests over those of customers and trend also towards uniformity from one supplier to another.

Government contracting departs from this norm, but the factors that influence government suppliers are nevertheless similar.

Although the world of municipal contracting might seem at first blush to stand a very good distance from the world of price theory, in fact price theory plays itself out every day in the world of municipal contracting in ways that are both predictable and almost uniform in consequence.

Thus, governments have a limited ability to dictate contract terms to the market, provided it is understood that in doing so, the effect will be to adjust the cash price that must be paid under the contract.

More generally, the consequence of departing from prevailing market practice and terms is that any departure will be reflected in a higher price.

The prevailing market price for goods and services will reflect the normal allocation of risk between supplier and customer, the normal customer’s service needs and delivery expectations.

It seems fairly obvious that when a customer insists upon delivery to some remote location, then the price charged by the supplier to that customer must necessarily increase by a corresponding amount to reflect the higher costs incurred by a supplier in dealing with that customer.

Similarly, any adjustment of risk that departs from the allocation of risk prevailing within the market will also result in a corresponding similar increase in price.

So long as the adjustment to price properly reflects the probability adjusted cost implications of the occurrence of a particular risk, such variations neither improves nor worsens the city’s position.

The city will pay a higher price for the supply it receives, but its overall cost (i.e., full-life cost) remains the same because the selling price increase will be balanced by the increase in a supplier’s anticipated cost in meeting the risk assigned to it by the municipality’s form contract. Problems arise, however, when a city seeks to push the envelope too far.

In many cases, the allocation may generate a disproportionate cost increase relative to the benefit that it affords.

For this reason, a number of terms of this sort that have appeared in recent municipal contracts across Ontario actually work against the municipality’s own interest.

Contract terms add “dead weight” to a customer’s final price, whenever the cost of meeting those terms exceeds the benefit derived by shifting risk to the supplier.

There are many different terms that do so. For instance, it is not uncommon for municipalities to stipulate a given level of warranty as one of the terms of a tender.

Stephen Bauld is a government procurement expert and can be reached at swbauld@purchasingci.com.

Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.

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