Over the past 20 years, cities have tended to subcontract more and more activities like
street maintenance and office cleaning. A new study by Veronique Flambard and Isabelle
Perrigne, published in the October 2006 Economic Journal, looks at an example – snow
removal contracts in the city of Montreal in Canada – and finds that differences in the costs
faced by potential subcontractors can lower the benefits to the city of having a competitive
procurement process.
Montreal allocates a large part of the street snow removal contracts to private firms through
‘first-price’ procurement auctions. Because of winter weather conditions, firms located far
from the job location need to rent storage space for their heavy equipment. This additional
cost, which introduces some differences among firms, is substantial, especially in the most
urbanised part of the city.
Contracts are for five years. Firms submit a price per meter of street and are awarded this
price times the meters of streets included in the contract. Snow removal is frequently a
secondary activity for firms as their main activity is in paving, landscaping, etc. Sixty-one
procurements for a total of 457 bids submitted by 60 firms were held between 1990 and
1998.
Montreal is located on an island between two rivers. The west half is highly urbanised while
the east half is more industrialised, where firms are mostly located. For the contracts
located in west Montreal, firms have a disadvantage because of costly storage space.
Bidding data show that participation in western tracts is 17% less on average than on
eastern tracts and that eastern firms win only 38% of procurements while their bids
represent 59% of the submitted bids.
New methods enable the researchers to recover the firms' costs from bidding data. The
recovered costs show a difference of Can $0.69 per meter or 6.5% on western tracts
between a firm located in western Montreal relative to a firm that is not. For the firms that
won the contracts, profits computed as the firms' bid minus cost are smaller by Can $0.30
per meter or 41% for eastern firms than for western firms. So to win the procurement, the
former need to bid aggressively, thereby reducing their profits.
For eastern tracts, the differences are not as important because rental space can be found
at low cost.
For western tracts, 24% of the procurements result in inefficient allocations. The difference
between the winning firm's cost and the most efficient firm's cost is equal to Can $0.607 or
6.58%. This inefficiency could be reduced by changing the procurement rules thereby
lowering total procurement costs.
In this situation, economists recommend using price preference policies. The idea is simple.
If some bidders have a cost disadvantage, they should receive special treatment consisting
of either a discount on their bids or a subsidy to cover their cost disadvantage. Such
practices are widely used in defence procurements in which national firms may enjoy a bid
discount up to 50%. Other examples include affirmative action policies for firms owned by
minorities.
The difference between eastern and western firms' costs varies from zero to Can $1.06 per
meter depending on the distance to the snow dump and the street length. If such a
difference among firms can be eliminated, 61% of western auctions would be won by
eastern firms.
The researchers consider three possible scenarios: