Red Flags on Bid Rigging in Public Procurement

Red Flags on Bid Rigging in Public Procurement Elisabetta Iossa Elisabetta. iossa@uniroma 2. it Lear – Laboratorio di economia, antitrust, regolamentazione 1

Outline: 2 Detecting collusion in Procurement: red flags � Bid submission � Bid documents � Suspicious statements � Bidders’ behaviour � Bid analysis � Features of the product Policies and Practices to avoid collusion � Award criteria � Lot policies � Assessing quality in procurement � Participation � Leniency programs

Detecting Collusion Red flags 3 Although difficult to detect, there are many circumstances that signal the existence of some collusive behaviour in procurement. It is possible to define five categories of warning signs of occurring collusion, each of them referring to a particular moment or characteristic of the procurement mechanism. 1. Warning signs involving bid submission 2. Warning signs in documents submitted 3. Warning signs involving prices 4. Warning signs in suppliers’ statements 5. Warning signs in bidders’ behavior Even just one of the following “red flags” may be a signal of collusion!

Warning signs Bid submission 4 The same supplier is often the lowest bidder (i. e. the successful bidder). Each company seems to take a turn being the winning bidder There is a geographic allocation of winning tenders. Some firms submit tenders that win in only certain geographic area. Regular suppliers fail to bid on a tender they would normally be expected to bid for, but have continued to bid for other tenders. Some suppliers unexpectedly withdraw from bidding.

Warning signs Bid submission 5 The winning bidder does not accept the contract and is later found to be a subcontractor. The winning bidder repeatedly subcontracts work to unsuccessful bidders Competitors’ bids are received together Certain companies always submit bids but never win. Two or more businesses submit a joint bid even though one of them could have bid on its own. Competitors regularly socialize or hold meetings shortly before the tender deadline. *

Warning signs Documents 6 Identical mistakes in the bid documents or letters submitted by different companies, such as spelling errors (see case study Medical Equipment Procurement, India) Bids from different companies contain similar handwriting or typeface or use identical form or stationary. Bid documents from one company make express reference to competitors’ bids or use another bidder’s letterhead or fax number. Bids from different companies contain identical miscalculations. Bids from different companies contain a significant number of identical estimates of the cost of certain items.

Warning signs Case Study, India 7 Collusive agreement between three firms (MDD, PSE, MPS) in the procurement for medical equipments for the Safdarjung Hospital, New Delhi. Evidence: Common typographical errors: all three competitors miss-typed the word ‘of’ as ‘o’ at serial H, I, J, K, L. of a tabular form; Same spelling mistake: the word ‘over lapping’ was misspelled in all three bid documents as ‘overelapping’; Identical mistakes: all the items under price schedule XIA (used for domestic goods) were wrongly included under price schedule XIB (used foreign currency items); The font used for typing bids was also the same; Similar bidding patterns of these three firms in other similar contract works of hospital indicating for bid rotation.

Warning signs Documents 8 The packaging from different companies has similar postmarks or post metering machine marks. Bid documents from different companies indicate numerous last minute adjustments, such as the use of erasures or other physical alterations. Bids from different companies contain less details than would be necessary or expected, or give other indications of not being genuine. Competitors submit identical tenders or the prices submitted by the bidders increase in regular increments.

Warning signs U. S. Storm Damages Repair 9 Example. Let us take a look to these documents: Same typo in two different bid documentation !

Warning signs U. S. Storm Damages Repair 10 Previous slide shows identical typos in two bidders’ cover letters to repair damage done when a typhoon hit Guam. The letters both end with identical words: “Please give us a call us if you have any questions. Thank you very much. ” By noticing the extra “us” in both letters, the procurement official uncovered the cartel.

Warning signs Bidders’ behaviour 11 Sometimes potential suppliers act in a way that suggests past interaction with other suppliers. Suppliers meet privately before submitting bids, sometimes in the vicinity of the location where bids are to be submitted. Suppliers regularly socialize together or appear to hold regular meetings. A company requests a bid package for itself and a competitor. A company submits both its own and a competitor’s bid and bidding documents. Trade associations hold regular meetings.

Warning signs Bidders’ behaviour 12 A bid is submitted by a company that is incapable of successfully completing the contract (cover bid) A company brings multiple bids to a bid opening and chooses which bid to submit after determining (or trying to determine) who else is bidding. Several bidders make similar enquiries to the procurement agency or submit similar requests or materials. Financial transactions among bidders. Low participation in tenders characterized by high participation in the past

Warning signs Suppliers’ statements 13 Bid documents are made by statements, estimates and signatures. What we have to look at? Use of the same terminology when explaining price increases Statements that bidders justify their prices by looking at “industry suggested prices”, “standard market prices” or “industry price schedules”. Knowledge of competitor’s confidential bid.

Warning signs Suppliers’ statements 14 Spoken or written references to an agreement among bidders. Statements indicating that certain firms do not sell in a particular area or to particular customers. Statements indicating that a supplier submitted a courtesy, complementary, token, symbolic or cover bid.

Warning signs Bid analysis 15 Sudden and identical increases in price or price ranges by bidders that cannot be explained by cost increases. A certain supplier’s bid is much higher for a particular contract than that supplier's bid for another similar contract. Only one bidder contacts wholesalers for necessary pricing information prior to a bid submission A large difference between the price of a winning bid and other bids. Bids from local companies involve similar transportation costs as non-local bidders.

Warning signs Bid analysis 16 There are significant reductions from past price levels after a bid from a new or infrequent supplier, e. g. the new supplier may have disrupted an existing bidding cartel (see Case Study IMSS, Mexico). Similar (low) quality/price ratio offered by different firms. Abnormal high prices in tenders awarded via interdependent formulas. Anticipated discounts or rebates disappear unexpectedly. Identical (and high) bid amounts.

Case Study Case IMSS, Mexico 17 Consider the IMSS case, Mexico. Two collusive agreements in the Mexican pharmaceutical sector in the 2000 s. Procurement of Insulin for human use Contract-splitting rules: up to three firms may be awarded at the same time when the difference between their bids does not exceeds 1, 5%; Particular clause of the contract enables firms who have submitted similar bids to win a share of the contract facilitates coordination and collusion! Stable participation Cryopharma, Eli Lilly, PISA Laboratories, Probiomed (conspirators) were colluding by splitting the award of those tenders! High prices

Case Study Case IMSS, Mexico 18 Prices decrease sharply! Bids 2006 Time Table 2: Lowest bids for Insulin tenders, May 2003 -Dec 2007. Straight line indicates the entry of Dimesa. Source, OECD.

Warning signs Bid analysis 19 1. 2. 3. 4. Identical pricing can raise concerns especially when one of the following is true: Suppliers’ prices were the same for a long period of time. Suppliers’ prices were previously different from one another. Suppliers increased price and it is not justified by increased costs. Suppliers eliminated discounts, especially in a market where discounts were historically given.

Warning signs Bid analysis 20 Local suppliers are bidding higher prices for local delivery than for delivery to destinations farther away. Unexpected features of public bids in an auction, electronic or otherwise - such as offers including unusual numbers where one would expect a rounded number of hundreds or thousands - may indicate that bidders are using the bids themselves as a vehicle to collude by communicating information or signaling preferences.

Detecting Collusion Features of the product 21 Do the characteristics of the product to be procured facilitate collusion? Products or services sold are identical or very similar Few, if any, substitutes of the purchased product or service Little or no innovation in the product or service

Collusion prevention Award Criteria 22 A number of policies may be implemented so as to drastically reduce the risk of collusion in procurement. The most intuitive ones are those related to the tender design: Scoring rule. The choice of which scoring rule should be use is a critical one. Inter-dependent formulas may increase the risk of collusion (see Case Study Meal Tickets, Italy). No average-price bidding! Lowest price formulas makes coordination among firms easier! but they lower the risk of corruption! MEAT independent formulas work well for avoiding collusion bad for corruption! There is a trade-off between collusion and corruption in the choice for

Collusion prevention Award Criteria 23 Avg price = 4, 482 Remember the Meal Tickets case study! Average-price formulas (interdependent) encouraged firms to collude and to manipulate bids! Three cover-bids (Ristoservice, Sodexho and Gemeaz) helped the TJV to win the tender at a relatively high price!

Collusion prevention Award Criteria 24 The IMSS, Mexico case study also is interesting in this respect: Revision stage before final bidding: Technical requirements were publicly checked by the procurement agency before bids were definitely announced. This means that, at this stage, bidders may know the proposed bids of each other and eventually change their bids in case their prices were too high. Effect on bids? Deviations easily and promptly punished! more stable cartels Easier coordination

Case Study Insulin tenders 25 Sharp decrease of conspirators’ bids in the same moment in which Dimesa entered the market! Bids 2006 Time Table: Lowest bids for Insulin tenders, May 2003 -Dec 2007. Straight line indicates the entry of Dimesa. Source, OECD.

Collusion prevention Asymmetric lots 26 Lot size is another important variable for fighting collusion in procurement. It is important to understand the market structure so as to design lots to minimize the risk of collusion. Asymmetric lots. When lots are asymmetric, symmetric firms finds it more difficult to reach a collusive agreement. The firm assigned to get the smaller lot has high incentive to deviate! Of course this may not be valid when firms are asymmetric the lot sizes should not reflect the suppliers’ market structure (one big lot and one small lot favours collusion if there is one large firm and one small firm!).

Collusion prevention Assessing quality 28 Assessing quality offers. Sometimes the procurer uses discretionary methods to evaluate quality offers, say a panel of experts is called to give binding opinions on the quality bids submitted by bidders. This may create room for corruption, since firms may bribe experts in order to bias their evaluations, but it may make bid rigging more difficult. Trade-off corruption and collusion! Although, often they go together…

Collusion prevention Participation 29 By establishing certain procurement procedures, the procurement agency can discourage anti-competitive activity. Softening entry pre-requisites This increases participation rates, which naturally reduces the risk of collusion. However, this may also have a negative impact on the overall ‘quality’ of the procurement. Variable entry pre-requisites. Let entry pre-requisites vary according to the ex-ante perceived risk of collusion!

Collusion prevention Participation 30 It is important to maximize potential participation by genuinely competing bidders How to encourage participation? Lowering financial or technical prerequisites Increase number of lots Reduce their size! Prerequisites are important drivers for the efficiency of the procurement process! They trade-off the benefits of higher participation vs the bankruptcy risk of the

Collusion prevention Participation 31 Prerequisites are important drivers for the efficiency of the procurement process! But… Pros and cons They trade-off efficiency vs the risk of procurement failure. Low financial pre-requisites: higher participation (+efficiency) vs higher bankruptcy risk Low technical pre-requisites: higher participation (+efficiency) vs lower average quality of bids

Collusion prevention Secret process 32 In recurring procurements, knowing the identity of frequent suppliers may encourage coordination and collusion. Keep the process secret To help prevent competitors from knowing who to contact amongst potential competitors, the identity of potential bidders should not be disclosed! Consider also not disclosing an estimate of project’s costs so that bidders do not have an incentive to use that estimate as the floor for their tenders.

Collusion prevention Data recording and communication 33 Fast and prompt communication Suspected collusion, after an audit etc, should be communicated to the Competition Authority. The Competition Authority will determine if additional facts are needed. Encourage informal contact between the procurement agency and the Competition Authority whenever a potential collusive tendering situation is encountered.

Collusion prevention Data recording and communication 34 Fast and prompt communication Suspected collusion, after an audit etc, should be communicated to the Competition Authority. The Competition Authority will determine if additional facts are needed. Encourage informal contact between the procurement agency and the Competition Authority whenever a potential collusive tendering situation is encountered.

Collusion prevention Data recording and communication 35 Consider the Korean case: The Korean Federal Trade Commission (KFTC) uses a Bid Rigging Indicator Analysis System automatically and statistically analyzes the bids received during all the public procurement procedures. Makes the identification of collusive schemes easier! Speed-up the process for identifying a cartel. In the case examined: procurement of six sections (six lots) of the Korean Subway Line 7. Six large firms colluded by taking one lot each. KFTC found that winning bids were 80% above the estimated price. Participation was too low (one large company and two small companies on average for each lot)

Collusion prevention Leniency 36 There are instruments that help to discover anticompetitive behaviours once they have already taken place… Leniency programs. Frequent and successfully Antitrust policies. Usually Competition Authorities impose fines on firms that are found colluding. However, anticompetitive evidence is sometimes difficult to obtain so complete cartel deterrence is not feasible even if fines are very high. Leniency are programs that ‘automatically award immunity from fines to the first member of a cartel that spontaneously reports information before an investigation of the cartel is

Collusion prevention Leniency 37 How do they work? Cartels are sustainable if long-term gains from future collusion offset short-term gains from a deviation (i. e. , submitting a price that is lower than the collusive one!) With leniency, a deviating firm can report to the competition authority and protect itself! In exchange of hard information on a cartel, the deviating firm gets lower fines or complete immunity. As a consequence, deviator’s short-term gains increase while longterm gains remain stable higher incentive to report with respect to the status-quo!

Collusion prevention Leniency 38 Deterrence: Increasing amnesty (reducing the fine) destabilize collusion. If full leniency (complete immunity) is insufficient, offer a positive reward. Depending on the fine reduction and on the level of rewards, collusion becomes non-sustainable anymore. Concerns Program may be abused! (i. e. , companies may collude and then report!)

Collusion prevention Leniency 39 What if there are more than one deviators? First informant rule or more informants? No conclusive answer… Offering leniency to additional informants increases deterrence power. Drawback. This facilitates abusing the “collude and report” strategy. As a result, leniency becomes less effective It may reduce optimal amnesty rate (if all informants treated alike, then no leniency)