Optimal Procurement With Quality Concerns (joint with Nicola Persico)

Abstract

We characterize optimal procurement mechanisms in environments where each supplier is privately informed about both its cost and the quality of its product, and the suppliers' costs are affiliated. If the correlation between each supplier's quality and cost is high relative to the degree of affiliation among all suppliers' costs, it is optimal for the buyer to either buy from a randomly selected supplier and pay the highest possible cost, or do nothing, depending on whether the gains from trade are large enough. If instead the degree of affiliation among costs is large relative to the correlation between quality and cost, a standard second-price auction is optimal. In the remaining case where the affiliation among costs and the quality-cost correlation are both in an intermediate range, it is optimal to select the lowest-cost supplier if its cost is sufficiently lower than its competitors, and randomly select one supplier otherwise. We also show that the second-price auction is optimal, if there is sufficient uncertainty about the joint cost distribution.