Second Sourcing and the Experience Curve: Price Competition in Defense Procurement

We examine a dynamic model of price competition in defense procurement that incorporates the experience curve, asymmetric cost information, and the availability of a higher cost alternative system. We model acquisition as a two-stage process in which initial production is governed by a contract betw...

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Bibliographic Details
Published in:The Rand journal of economics 1987-04, Vol.18 (1), p.57-76
Main Authors: Anton, James J., Yao, Dennis A.
Format: Article
Language:English
Subjects:
Auctions
Capital costs
Cost efficiency
Cost incentives
Economic competition
Economic costs
Fees
Military expenditure
Price competition
Procurement
Production costs
Unit costs
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Summary:We examine a dynamic model of price competition in defense procurement that incorporates the experience curve, asymmetric cost information, and the availability of a higher cost alternative system. We model acquisition as a two-stage process in which initial production is governed by a contract between the government and the developer. Competition is then introduced by an auction in which a second source bids against the developer for remaining production. We characterize the class of production contracts that are cost minimizing for the government and that induce the developer to reveal private cost information. When high costs are revealed, these contracts result in a credible cutoff of new system production in favor of the still higher cost alternative system.
ISSN:0741-6261
1756-2171
DOI:10.2307/2555535