Why Bidders Stay Away

Attracting a sufficient number of bidders has become an increasing challenge for procurement. Because capacity utilisation is close to the maximum in many industries, suppliers have little interest in taking part in tenders that demand a great deal of effort and promise too little profit.

Anyone who, as a buyer, wants to understand how participation can be increased again must first understand bidders' motives: under what circumstances is it rational for them to decline to take part? For this analysis we use simulations based on auction theory, since the negotiation formats examined can be approximated as auctions.

The Bidder's Calculus

A common procedure is the first-price sealed-bid auction (FPSB): each supplier submits a single, sealed offer, all offers are opened simultaneously, and the contract goes to the bidder with the lowest price. Setting non-monetary differences aside, the cheapest offer simply wins. In regulated industries, tenders are usually awarded according to this pattern; for the purposes of analysis, other negotiation formats can be approximated well by an FPSB negotiation.

A bidder decides whether to take part on the basis of its expected payoff:

Expected payoff = probability of winning x payout if winning − cost of participation

If the cost of participation is higher than the probability-weighted payout, the bidder stays away from the tender. It is precisely this calculation that can be systematically influenced with the tools of game theory in procurement.

Fear, Greed, and the Optimal Bid

When setting prices, bidders add a strategic margin to their costs. Two opposing forces – bluntly put, fear and greed – determine its size. A bold participant chooses a large margin, a cautious supplier only a small mark-up. A higher bid means more profit if the contract is won, but at the same time lowers the probability of winning it. The optimal bid lies where the expected payoff reaches its maximum.

A central role is played by risk aversion – the degree to which someone prefers certain over uncertain outcomes. Most people prefer a certain payment of 500 euros to a 50 percent chance of 1,000 euros, even though both have the same expected value. Risk-averse bidders concentrate on winning the contract at all, and care less about the margin. Risk-seeking bidders pay more attention to their profit margin and worry less about winning the contract.

Two Levers for More Participation

The bidder's calculus points to two fundamental levers for increasing participation:

  • Lower the cost of participation.
  • Increase the expected profit – either through a higher estimated probability of winning or through a higher profit in the event of a contract award.

Both levers also work in mirror image when you are not procuring but divesting assets through auctions – here, too, the other side's participation calculus determines success.

Lowering the Cost of Participation

Taking part in a tender is often needlessly complicated and time-consuming: tender documents not infrequently run to several hundred, sometimes even several thousand pages. Anyone who reduces the bureaucratic effort and other preparatory work lowers suppliers' cost of participation and raises the participation rate. Opportunity costs are particularly high when a company is already working at the limit of its capacity and could deploy its resources productively elsewhere.

One direct option is to compensate bidders for taking part. In doing so, however, it is important to avoid signals that point to weak competition – because then bidders demand higher prices. Since the compensation itself can already be read as such a signal, it makes sense only when the cost of participation is substantial.

Raising Expected Profit and Steering the Number of Bidders

Two factors influence the expected profit particularly strongly. First, greater risk aversion among bidders lowers prices – beyond a certain point, however, participation becomes unprofitable and the bidder withdraws. Second, with each additional competitor the chance of winning the contract falls, and with it the expected profit. When bidders know that many competitors are entering, they decline to take part more often – above all weaker suppliers with a low probability of winning.

A worst-case scenario arises when the bidders assess themselves as similar and at the same time expect many participants: it can then happen that everyone declines. The remedy is to limit the number of admitted bidders and to communicate this limit openly. In regulated procurement, the number of bidders cannot initially be capped directly because of the procedure – but the goal can be achieved indirectly, for example through staged shortlisting.

Recommendations for Procurement

If you expect a low number of bidders for a tender, four measures suggest themselves:

  • Reduce the complexity and the effort required to take part.
  • If the bidders assess themselves as very similar and expect many competitors: limit the number of bidders and inform the invited bidders of this limit.
  • For very high participation costs: compensate bidders for preparing offers.
  • Set targeted incentives that raise the expected profit for bidders with the desired characteristics.

Competitio has implemented such tender and negotiation designs in 16 industries for an award volume of more than EUR 35 billion – scientifically grounded in the game theory of Prof. Dr. Christian Rieck. Talk to us if you want to design your next tender for sufficient bidder participation from the outset.