The role of cost modeling in competitive bid procurement
Date, Time, Venue
20th July 2012, Friday at 10.30 AM
Room 2.10
Engineering Front Building
University College London
Abstract
Many firms increasingly rely on suppliers for intermediate and
finished goods. Some companies (e.g., CISCO) even eliminated in-house
production capabilities. While production outsourcing is often cost-effective,
firms also lose some manufacturing and technical capabilities that are relevant
to estimate production cost. One way to address this is creating cost models to
estimate the costs of potential suppliers so that the firm can use the information
to negotiate an attractive price with suppliers. However, in settings where the
buyer wishes to negotiate a contract price by soliciting competitive bids from
multiple suppliers, the benefit of cost modeling is not clear since the bidding
competition among suppliers can itself reveal cost information. In this paper,
we examine this interplay, and examine if and when cost modeling should be used
prior to competitive bidding.
We show that although bid competition sometimes
duplicates the information gleaned by cost modeling, cost modeling can still be
benefit the buyer by helping the buyer to tighten a reserve price. We then
analyze under what situations the buyer can gain the most benefit through cost
modeling. Specifically, we characterize which supplier(s) to learn about, which
portion(s) of the costs to learn, and how deeply the buyer should learn.
We then apply these results to design the optimal learning strategy when the
buyer has multiple supply bases. Interestingly, learning about the supplier
whose cost is the most uncertain is not necessarily optimal, nor is learning
about the cost portion that contributes most to the total cost. We also show
that conventional intuition that the benefit of additional information has a
diminishing rate of return does not always apply when it comes to cost
modeling.
Bio
Hyun-soo Ahn is an associate professor of Operations Management
at the Ross School of Business at the University of Michigan. He received his
PhD in Industrial and Operations Engineering from University of Michigan at
2001. Prior to joining Michigan, he taught at the University of California at
Berkeley and worked at Intel. Hyun-soo’s research interests are in the design
and analysis of production and service systems, supply chain management, and
revenue management with operational considerations. His papers are published
in Operations Research, Manufacturing and Services Operations
Management, Journal of Applied Probability, Advances in Applied Probability,
and Queuing Systems. His research has been funded by multiple government
and private agencies including National Science Foundation. He has worked with
more than 20 companies including J&J, 3M, CISCO, Safeway, GE, Medtronic,
Ametek, and Boeing. At Ross, He has been teaching BBA, MBA, Global MBA, and
Executive MBA courses in Statistics and Supply Chain Analytics. He has
been awarded the Teaching Excellence Award (also known as Professor of the Year
voted by graduating class) at the Ross School (in 2006 for BBA, 2011 for MBA,
and 2012 for Exec MBA), and his teaching was featured in an article in Business
Week.
