Rethinking Government Supplier Decisions: The Economic Evaluation of Alternatives (EEoA)

Abstract

Public procurement is big business. The OECD reports member countries spent over $6 trillion on procurement in 2015. In 2018 the U.S. Department of Defense spent over $300 billion on procurement and research, development, test & evaluation, most of it sourced to the private sector. This exceeds the GDP of Ireland, Singapore, or South Africa. Perhaps the biggest challenge for governments is to conduct “source selections” when benefits cannot be monetized. The problem of ranking public investment alternatives when benefits cannot be monetized has spawned an extensive literature that underpins widely applied decision tools.

This technical research report highlights a key assumption made in the procurement process based on multi-criteria decision-making (MCDM) that guides public procurement decisions; it is crucial for practitioners and academics to recognize and understand the consequences of the standard technique prescribed and applied to guide public investments and evaluate vendors. Our research offers an economic model to assist public procurement officials to rank competing vendors when benefits cannot be monetized. An important defense application is “source selection” – choosing the most cost-effective vendor to supply military equipment, facilities, services or supplies. This project is designed to analyze the important military process of “source selection”—choosing the most cost-effective vendor to supply defense equipment.

The proposed methodology of “Economic Evaluation of Alternatives” (EEoA) addresses two assumptions in the conventional decision science (DS) model. DS “value” (utility) functions typically: a) normalize attributes, which risks losing valuable information; and b) Introduce costs alongside non-pecuniary attributes, which requires a weight assigned to cost. EEoA structures the procurement official’s decision as a two-stage problem: In the first stage, the official provides budget/funding guidance to competing vendors, along with desired characteristics or “attributes” of the product or service. Vendors engage in constrained optimizations based on their respective production technologies to generate proposals that satisfy projected budgets. Vendor proposals (bids) consist of bundles of non-monetary attributes. In the second stage, the procurement official ranks vendors according to the government’s utility function over the attributes. The bulk of the literature, and most government-mandated decision tools, focus on the demand side of a public procurement. The “Economic Evaluation of Alternatives” (EEoA) extends the analysis to the supply-side. A unique feature of EEoA is to model vendor decisions in response to government funding projections. Given a parsimonious set of continuously differentiable evaluation criteria, EEoA provides a new tool to rank vendors. In other cases, it offers a valuable consistency check to guide government supplier decisions.