Auction procedures and competition in public services The

Auction procedures and competition in public services The case of urban public transport in France and London Miguel Amaral, Stephane Saussier, Anne Yvrande-Billon 2008

Summary Competition in public services is needed to lead private operators to operate public services at a competitive price without loss of quality. One instrument to introduce competition tendering in public services is public auctions. Two ways to bypass competition are collusion and corruption >> competition has to be organized. Two instruments to organize competition for the field are transparency and discretionary power of public bodies, smart combination of which will not allow the defecting strategies. Another factor to keep in mind is competitiveness of the field. This hypothesis is tested through the exploration of London and French bus tendering systems.

1. Theoretical framework Introduction; Transparency of procedure; Discretionary power of public bodies; Competition levels.

1. Introduction • Recent trend is introduction of competition in organization of public services and public procurement, is competitive tendering through public auctions • The objective of using auction procedures is to replace competition in the field by competition for the field, leading private operators to operate public services at a competitive price without loss of quality. • However, there are two way to bypass competition: • Corruption • Collusion • When the number of competitors increases, the incentive to corrupt the public authorities is greater so that there is no certainty that competition ‘‘kills’’ corruption and collusion. >> competition for the field must be organized.

1. Factors of Effectiveness of Auction Procedures: Level of Transparency -- ability of bidders to know and understand the actual processes by which contracts are awarded: - award criteria are clearly and objectively defined ; - a record of the award process is easily accessible. Opacity (lack of transparency) regarding selection criteria and attribution rules : - is a source of great uncertainty for potential new entrants >> may be discouraging; - increases risks of capture and favouritism and therefore facilitates corruption; - fully opaque disclosure policy, which hides all information from bidders, would make collusion difficult to sustain, but procurement agencies operate on behalf of public and can not afford that; - partial disclosure is reported to be practically equivalent to a fully transparent one; Transparency of procurement processes: - may facilitate collusion (partners can promptly identify and punish defecting firms); - a fully transparent one may be a good way to prevent corruption. Thus, measures aimed at combating favouritism can facilitate collusion and vice versa.

1. Factors of Effectiveness of Auction Procedures: Discretionary Power of Public Bodies “hold-up” problem: a situation where two parties may be able to work most efficiently by cooperating but refrain from doing so because of concerns that they may give the other party increased bargaining power, and thereby reduce their own profits; • Auctioning leads selecting firms to produce goods at the lowest cost but with the lowest level of non-contractible quality >> allowing a public buyer to exercise his discretion to exclude dubious providers ex ante and/or punish opportunistic suppliers ex post is seen as desirable and efficient, especially in repeated procurement >> Discretion facilitates the enforcement of non-contractible quality standards as mentioned above • adverse effects of discretion: • likely to induce collusion between selected suppliers • inefficiency cost of corruption increases with the auctioneer’s discretionary power, resulting in: • Favouritism • Or making collusion sustainable • These drawbacks might be reduced with fully transparent auction procedures and ex post evaluations of the performance of private operators >> transparency and discretionary power of public bodies are complementary instruments to organize competition for the field.

1. Factors of Effectiveness of Auction Procedures: Degree of Competitiveness of the Environment - as the number of bidders increases, prices decrease towards efficiency prices; - degree of competitiveness of the environment affects the probability of collusion and corruption: - The higher number of bidders, the lower risk of collusion; - For corruption: - increased competition leads to lower corruption since it reduces rents; (no bribes can occur in markets where perfect competition prevails, that is where there are no excess profits from which to pay the bribes) - But less competition also means that it is more valuable for the public to avoid corruption and therefore that there is a greater incentive for a regulatory response (Higher rents indeed imply that the public would be more apt to rewrite the bureaucrat’s contracts and spend resources trying to control them). >> a way to structure competitive tendering for public services to foster competition and prevent anticompetitive behaviours is yet to be found, but it should be an efficient combination of: - transparency of procedure; - discretionary power of public bodies; - and competition levels.

Hypothesis of the study a transparent procedure, coupled with the discretionary power of the public bodies, could be an efficient way to organize competition for the field and prevent collusion and corruption behaviours as much as possible. .

2. London Model of Bus Tendering Introduction; Procedure; Role of regulator.

2. London Model of Bus Tendering: Introduction • 800 routes, 1630 km sq, 3. 5 mln passengers a day • 1984 reform: • government regulation remains, but tendering regime is introduced: • London Buses Limited (operational subsidiary), split to 13 local subsidiaries; • required to compete against operators for individual bus routes; • Tendered Bus Division with discretionary power is set up. • By 2001 all routes supplied through tender contracts.

2. London Model of Bus Tendering: Procedure 1) Invitation to tender issued by the regulator every 2 -3 weeks >> 20% of network is tendered each year. • Contract includes route details, vehicle type, etc, lasts 5 years with possible extention to 7 yrs basing on performance 2) Regulator selects set of pre-qualified bidders, who are authorized to submit sealed (opaque) bids 3) Contract is signed basing on "best economic value" (lowest price bidder), but quality might be considered too (e. g Sunday services). *** • The system attempts to reach both: • Small companies: • unbundling of the network encourages participation of small bus operators, and consequently fosters competition • Large operators: • possibility of bidding for packages of routes should make it possible to benefit from coordination synergies and economies of scale and scope.

2. London Model of Bus Tendering: Role of Regulator (Tender Bus Division) • Ensures proper execution of contracts • Collects data on many different aspects of the service (time schedule, driving quality, cleaning of the buses, etc. ) • Enjoys strong discretionary power that takes the following forms: • bidders can be automatically disqualified if, should they win the bid, their market share is too high • Incumbent (current holders) bidders are explicitly preferred. (might be asked a second offer) >> the Regulator is shaped to foster competition

3. French Model of Bus Tendering Introduction; Procedure; Inefficiency Indicators.

3. French Model of Bus Tendering: Introduction • Since 1982 management of public urban transport decentralized to local authorities(LA), which means no national regulator; • In each urban area, the urban public transport services are supplied by a single operator and for a given period of time; • Local Operator defines routes, amount of subsidies given to the sector, schedules and fares; • LOs operate: • Directly; • Or delegate to a mixedprivate company 70% of operators are private and are owned by 3 large companies(2 xprivate, 1 xsemi-public) + association of small local firms (11%) • 70% of operators are private and are owned by 3 large companies(2 xprivate, 1 xsemi-public) + association of small local firms (11%) >> Little competition for the field and a great discretionary power of the authorities (tacit prolongation of contracts, contracts via negitiation, etc) • 1993 law against corruption: compulsory competitive tendering, automatic prolongation forbidden, which resulted in the following auction procedure: . .

3. French Model of Bus Tendering: Procedure 1) Pre-qualification of bidders: call for candidates with rough description of the service, forming a pool from those who ale to provide financial and professional guarantees 2) Bids: principle conditions, technical details and description are communicated to the bidders, as well as pricing conditions and type of contractual agreement indicators 3) Negotiation and selection of final provider: separate negotiations with the finalists re contractual terms *** • Local authorities are bound to periodically launch an invitation to tender • But are not bound to select the final set of bidders or the ultimate winner according to objective and precisely predefined criteria: • local authorities are not obliged to adopt the rule of the lowest or even the best bid • selection criteria can therefore include subjective elements such as the reputation of the bidder or the confidence he inspires. • justification of the choices is not made public, the motives behind the choice are hardly verifiable ex post. • Attribution mechanism combines two substitute modes of selection: competitive bidding and negotiation: • CB selects lowest bidder, but may have undesirable self-selection consequences and fail to respond to ex-post adaptation >> good for simpler services • N may lead to corruption and favouritism, but more time spent on contract discussion redces risk of post-hoc opportunistic haggling >> good for more complex services >>This results in few bidders and a decreasing number of bidders

3. French Model of Bus Tendering: Indicators of Inefficiency • Low level of competition: 88% of existing contracts have led to the renewal of the incumbent. Might be result of: • Extention of bus networks? • Renewal among incumbent bidders? (making better offers) • Or simply ineffectiveness of new procedure? • low number of bidders and the increasing number of procedures with only one bidder >> probable inefficiency of the tendering procedure • French local authorities organize larger-size auctions, but London operates more routes • Investment responsibilities higher - but London's entry barriers are higher (investments in rolling stock are private) • Hence, it's rather the way local authorities combine transparency and discretion over the selection process. • Indirect facilitation of collusive behaviors: • Cartel bw 3 leading operators revealed in 2005 (market division, bidding offers sharing, threatening potential entrants) • Absence of cost reductions

4. Comparison of the Models Analysis of Cost Dynamics; Evolution of Contractual Design; Results Conclusion

4. Analysis of Costs Dynamics Introduction of a tendering process in London has been followed by a decrease in operating costs until 2001, but in France, introduction of the anti-corruption law has changed nothing as regards the costs. This may be due to the fact that, in London, the period 1990– 2001 corresponds to the progressive replacement of the former public firms by private operators, while in France operators were already private before the promulgation of the Law. This might also explain why, since 2001 (when nearly all the London network started being operated by private operators) costs have started to rise in London case. >> introduction of competitive tendering is leads to cost reductions if it is coupled with private operators’ entry.

4. Evolution of Contractual Design Competitive tendering is not the only device to incite operators to be efficient, but also: • contractual schemes • distribution of property rights *** • France: from cost-plus (i. e. management) contracts to more high-powered incentives contracts (i. e. fixed-price contracts) • The latter are recognized as leading to higher cost-efficiency • London: from net cost contracts to quality incentive contracts • mainly gross cost contracts with bonuses and penalties depending on the observed quality • which led to increase in quality of services

4. Insight into Bus Contract Issues • Cost-plus contract - also termed a cost reimbursement contract, is a contract where a contractor is paid for all of its allowed expenses to a set limit plus additional payment to allow for a profit; • It contrasts with fixed-price contracts, in which the contractor is paid a negotiated amount regardless of incurred expenses. • Under a net-cost contract the operator provides a specified service for a specified period and retains all revenue. The authority pays a subsidy to the operator if the bus services in an area are unprofitable. If the services are profitable, the authority pays the operator a royalty. Under a net-cost contract the operator has to forecast both his costs and his revenues. • A gross-cost contract pays the operator a specified sum to provide a specified service for a specified period. All revenue collected is for the authority.

4. General Results - London organization: • based on the existence of a regulator with a discretionary power • it is counterbalanced by the transparency of selection process with an emphasis on competition development: • through the use of both ‘‘small size’’ • and ‘‘package’’ tendering processes. - The French organization: • • based on a bilateral agreement with no regulator, is characterized by important discretionary power of the local governments. . and low level of transparency emphasis on scale economies through the use of a ‘‘big size’’ tendering process

4. Results: Comparison of the Instruments

4. Conclusion Few competitors, with increasing costs and collusive behaviours, characterize the French model, while the London model exhibits better results by using the transparency of auction procedures and the discretionary power of the regulator as two complementary instruments to foster competition and prevent anti-competitive behaviours.

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