Issues with the centralisation of procurement
Interview with Ignacio Herrera Anchustegui, Ph.D candidate at University of Bergen and member of the Bergen Centre for Competition Law and Economics. Ignacio has been awarded a coveted international Scholar-in-Residence program from the American Bar and significant funding from Statoil for a post-doc. His research interests are related to the interaction of public procurement and competition law in particular buyer power in centralised purchasing.
Hello, Pedro, thank you very much for the invitation, I’m a big fan of the series and it’s a great honour for me to be here and have a word with you and hopefully say something interesting about the interaction between public procurement and competition law, also especially in centralised purchasing which is the area that I’m most interested in.
It’s a pleasure because I had you in the list for a long time and I was just waiting until you’ve actually submitted your PhD to do the invitation.
Yes, thank you, that actually was last week so looking forward to the evaluation and see if I pass or not but we will see.
Most of your research and most of your work is actually in competition law or in competition in economics so how did you end up looking at centralisation of public procurement?
Well, that’s a very good question because originally my PhD topic was going to be centralisation in public procurement or buyer power in public procurement settings and originally that was the starting point but it actually faded away because my supervisors thought that the topic was very complicated which I think it is, and it ended up being purely buyer power and anti-trusts or EU competition law. So then the main reason why I ended up in this question was because I come from a country, that is Venezuela, probably linked to the fact that we have a lot of money but the money’s probably not well spent in the public procurement markets and then I was thinking, ok, what do we do from the perspective of a public buyer when we have a lot of capacity and resources to enter into a market and how does this public buyer, or buyer in general, behaves in the market and can create problems but at the same time can do things that are a positive outcome. So the way that I ended up doing also centralisation of procurement has to do with the fact that the University of Bergen, I am the person that is in charge of the course on EU and EA public procurement law so it seemed like a natural fit and then as I delved into the analysis of buyer power economics and buyer power anti-trust regulations or EU competition law regulation. Then it shifted away from being the centre of my PhD thesis to kind of like my pet topic on the side and what I do on my free time, so to speak.
Yes, that’s make very much sense but if you’re doing it on the side and it’s a more complex topic, what have you been able to achieve so far in terms of research on it?
Well, quite a few things actually because I’ve been looking at what is the situation, I mean, firstly I’ve been looking at what buyer power is from a general perspective and that doesn’t change too much between what happens in a public market and what happens in a private market. But when it comes to centralised purchasing and when it comes to public procurement, my interest was seeing how is public buyer power created and how has it been integrated or enhanced, for example, in the EU directives and one of the things I saw is that when I started my project, the EU public procurement directives were not yet in force and weren’t even still a project, they were not even approved and I could follow a little bit that there was a transition from, “Well, we’re creating centralised purchasing agencies,” and this is like a pilot project that happened in 2004, forwards now to 2014-24, centralised procurement seems to be a very in-fashion tool to generate a lot of savings. So it ended up being kind of a side project but at the same time very important project for me because I was able to, at the same time that I worked on my anti-trust regulation, I could also see the similar issues that happen in private markets tend to replicate in public markets. Although, at the same time, public markets are slightly different because the buyer doesn’t behave in the same way as it does in a private setting. So it ended up being a very interesting and enriching situation in which what I learned from a setting that is purely private in the terms of competition law, retro activated or helped me understanding what was going on in the public side and vice versa. So I think the combination is there and some of the problems and some of the benefits, you can see them replicated. Of course it’s like modifications depending on what kind of sector you’re talking about and what kind of buyer power is being exercised.
Can you give us an example of those similarities and differences between the private sector and the public sector?
Yes, of course I can give you, what is the most important similarity? The most important similarity is buyer power; it is the ability of a buyer that wants to acquire something to reduce the purchasing price he pays for whatever he wants to acquire. And this happens both in the public sector and this happens in the private sector and one of the main reasons why this happens and this is very clear in centralised purchasing in public procurement is that you’re able to generate economies of scale and economies of scale in very simple terms, not to be very jargon, means that the more things I buy, the cheaper is the price that I’m going to get, right? And this happens both in the private setting or in a public setting. In a public setting a centralised purchasing agency is going to pool the demand of different contracting authorities and it’s going to buy either for all of them or on behalf of all of them in order to increase the amount of buying ability that it has and, therefore, by purchasing more, it’s able to obtain a lower final price for each of the units and the same will happen as well in a setting of a private sector. That will be the logic that is used to say why buyer power is a positive thing in both the public sector and both the private sector, so it is seen as efficiency enhancing because it allows to decrease the purchasing price of something without necessarily having an adverse impact when it comes to the amount of goods that you buy because when the price that you pay is being reduced by reducing the quantity that you buy, that seems a bit counter-intuitive, you enter into something that is called monopsony power and monopsony power is the negative aspect of buyer power because in monopsony power, you pay less for the goods that you buy because you buy less. It’s because the way that the supply curve exists, it’s that the more that you buy, the higher the price, so you can drop the price by purchasing less but when you purchase less, you generate inefficiency in the market because you’re not buying the optimal amount of goods that are required.
So this is what is portrayed as the negative side of buyer power in simple terms, it’s a bit more complicated in abstract, I think it’s difficult to grasp, but the problems exist in both markets. And let me give you another example, Pedro. For example, in the case of centralised purchasing in public procurement, the centralised purchasing is said to be positive because you manage to carry out a lot of different procedures into a single one. So you pull them together into, instead of 10 municipalities buying, each of them, their own goods, they just entrust that activity to the one central purchasing body that is going to carry out a single tender instead of 10 tenders at the same time. So not only do you obtain a lower purchasing price because you’re pooling the demand of all of this but at the same time, you’re reducing your administrative costs because you only have one tender to do instead of 10 separate tenders and that is seen as a positive thing because it reduces costs and that is something that the directive explicitly says, “Well, it is good because we’re going to obtain cheaper prices and also cheaper costs.” But at the same time, that can be also negative because what you’re doing there is creating a lot of concentration in the market where there’s only one buyer buying everything for all these other buyers so this buyer has a lot of market power and therefore makes it more difficult to, for example, I know it’s one of your topics of interest, to small, medium undertakings or enterprises to have access to those contracts because they probably don’t have the capacity or they cannot compete in pure terms of price with a larger seller.
So the contract can be very efficient in the short term because you obtain a lower, cheaper price but, in the long term, you can have a problem of market concentration because the smaller suppliers cannot compete any more. And this is something that also might happen in the case of private sector and in the private sector you see that in some areas there is not conclusive data but there is some claims that buyer power, for example, in the supermarket sector creates problems because the smaller suppliers, in this case, farmers, are being pushed out of the market and I guess that’s something that we all see in the newspapers, that there’s problems between the buyer power of retail stores and small suppliers that are being squeezed outside of the market and I think that same negative side exists, may also exist in the public procurement setting, although in the public procurement setting we have different ways of doing things, especially because we can, for example, divide lots, we can divide the contract into different lots. So if we do that, we kind of put away, aside this problem or at least make it less complicated or less difficult or less prone that concentration in the market arises. I don’t know if I am being too technical or…
No, no, it’s perfect. Actually, you have pre-empted my next question which is if centralisation can have that negative effect on the market, and that is certainly my view and my opinion as well, what about lots? Because lots have been bandied around as being a solution for all evils of centralised purchasing but personally I’m not entirely sure because, on the one hand, you’re effectively creating, again, the same transaction costs as you would if you had just different procedures. That’s the first one, and the second one is if the lots are not done well, you’re actually facilitating the collusion in the market.
Yes and I fully agree with you and it’s a little bit of self-advertisement but last week a book came out in which I wrote about this, I wrote about what happens when you try to centralise and at the same time you try to divide into lots and those things don’t make any sense because either you do one thing or you do the other thing. And the problem with lot division is that lot division, I think, is actually a positive thing but firstly is not mandatory, member states can decide whether they want to let contracting authorities to do it or not while in some contracts I think lot division should be actually said, “In this case, you should, in 99% of the circumstances, divide into lots.” But at the same time, as you say, when you divide into lots, you end up in a problem that the cost saving that you managed to do when it comes to the tender, it’s gone or maybe it’s going to be reduced, because now you’re going to incur into a lot of expenses when it comes to contract administration because instead of having one single contract, you have maybe five or six depending on how many lots you have, and all this is going to be more contracts that you have to administer. So tender wise, it’s going to be cheaper if you centralise because you might say there’s only one procedure in which you have different lots but once you enter into the contract execution then you have the problem that you have to administer more contracts so that is also expensive for the contracting authority. The difficulty here lies in determining which of the effects is better? I mean, do we save more money by centralising the procurement and is it an efficient saving and we’re not hurting the market when we have a centralised purchasing body that carries out a lot of tenders and is this cheaper than administering five or six or eight lots? That’s one question and I think that we don’t have conclusive data on that area so it’s difficult to say which effect prevails.
And then you have the other problem that you mentioned, that is the issue of it’s not only about dividing into lots, it’s knowing how to divide into lots because if you divide into lots in a way that this just makes easy or facilitates collusion among suppliers, among economic operators, then the lot division is going to carry out a negative effect in the sense that for the contracting authority, it’s not going to get a cheaper price, it’s going to get a higher price because the tenders are entering into a bid-rigging agreement because they can’t seem to distribute the lots. So, for example, if you know that you’re going to have probably three economic operators submitting a tender, you should never divide the contract into three lots because then you know they’re going to split the market. So lot division has to be done in a smart way and that is a bit difficult to know because you have to have understanding of competition economics and you have to know how the market is going to react and that is a difficult exercise for a contracting authority.
So yes, I am more positive than you in a sense that I think lot division is positive if done correctly, the thing is that there’s very little indication how it’s to be done correctly according to the directive and that’s why I think that in these cases, when it comes to centralising and when it comes to lot division, what is really important is some kind of best practices. People in the central administration and people in the European Commission or different bodies in Europe should tell the contracting authorities, “We have these different tools to maximise public buyer power in an efficient way. We should be aware that you can exercise buyer power that is exploitative or exclusionary and is anti-competitive, that creates inefficiency in the market and you should use it in a positive way. And on top of that, you know that there is exists something called lot division and lot division is positive in certain times and you should consider using lot division in these kinds of ways.” So my suggestion would be we need to train people when it comes to how to carry out centralisation of purchases, what kind of things we’re going to buy and if we should use lots or not because I think lots are positive but, as you say, not always.
One of the problems I have with lots is that, as you said, it’s very hard to get well but it’s also very hard to forecast in advance, let’s say, a simple solution that would work in most cases and you’ve indicated one basic idea which is if you know more or less the number of tenders are going to come up, you should always have a number of lots that is smaller than the number of tenders.
But that’s pretty much and, from then onwards, it effectively implies that you know the market really well and it implies that you know or you’re going to be able to find a way to divide whatever you’re going to be doing into lots that actually increment competition and do not affect it. And personally I don’t see people in the field having that capacity to be able to do that kind of analysis.
No and I agree with you. I think for the contracting authority, it’s not because the administrative personnel or the civil servant is not smart enough to know this, it’s because he’s not trained to do it and I think that’s a problem because it’s not straightforward, you need to have knowledge on what you’re buying, you need to have knowledge on, at the same time, the market that is out there, that is going to supply you the goods, you need to understand how private operators operate which is very difficult because sometimes there’s a lot of information asymmetry that the one that buys doesn’t know that much of the market and the one that sells knows it much more. So it is very tricky and that’s why I think contracting authorities need some kind of counselling, they need some kind of training on how to carry out lot division in an efficient way because carrying out lot division for carrying out lot division is not a smart tactic, it’s just going to create an unnecessary amount of contracts and maybe you won’t even need to, it might not be a very efficient choice and then you might be sacrificing efficiency for the sake of having more players.
But at the same time, having more players sometimes is justified and sometimes it is not, so it also very case sensitive and it’s difficult to give a straightforward answer. I think one of the bits, one of the challenges of public procurement is that it’s so case by case analysis because our markets are special because what we buy is different because the rules are complicated and because the needs of every contracting authority are as well different. So it’s difficult to give a very clear cut answer when it comes to this. I think the answer is training, I think the answer is telling the buyers out there, “What should we do about this? How should we do it?” And explain the pros and cons of centralisation and lot division that are two issues that seem to go in opposite directions even though the directive wants them both to come together in the same place. So I think that’s also a deficiency of the directive because the directive tries to do probably too many things that I think are well intended but when you try to put them into practice, they probably are not going to be able to be compatible with each other and that’s one of the problems that I see when it comes to the policy regarding centralisation of purchases but at the same time promoting small, medium undertakings. Either we do one or we do the other one or if we want to try to do both then we need to really know what we’re doing.
Well, about the directive, I mean it’s important for us to understand that it’s a text of compromise, it’s a compromise achieved between 28 member states and also the European Parliament. So it’s always going to be trying to achieve everything without actually hitting the sweet spot for anyone at any given time. And also the directive, it’s supposed to harmonise the legislation, it’s then up for the member states to transpose it into the national legislations and what we’ve seen is that, more often than not, the member states like to use the directive as an excuse for any mistakes and any failures of the system without them taking into consideration that their own responsibility into actually weaving the directive into national law. That is certainly the case here in the UK over the last 10 year that I’ve been here. Now moving on the ball a little bit further, I was listening to you and listening to your critique about centralised procurement and possibly the creation of a monopsony by the contracting authorities but the fact is, from a public sector perspective, the logic when we, or when they go for centralised purchasing, the logic that they want to achieve is actually the savings that can be the end result of that process. There’s no real consideration about the impact it’s going to have in the market because, effectively, they’re externalising the cost either to the market itself or either to the future and not to themselves today.
Yes, and one thing that I want to clarify is that I think monopsony power, both in the public sector and in the private sector is very rare and with monopsony power I have to be very specific with what I mean with it because the literature is a bit tricky when it comes to the use of terms, especially in the US. In the US they use monopsony power to refer to buyer power in general which I think it gives the wrong impression because monopsony power is one very specific model of purchasing that, to decrease the price that you pay, you buy less quantity. That’s one way of buying, there’s many ways of buying and I think in the public sector, exerting monopsony power is even more difficult because your demand in this condition, by the demand of the end user, that is the one that obtains the benefits of the public service that the contracting authority gives. At the same time, as you say, the public buyer has different interests than, for example, a private buyer and the public buyer has a different interest, it’s not profit maximising necessarily, what it wants is to obtain good quality products, what it wants is to satisfy a social need and might not necessarily enter into the situations in which it might abuse its power as a monopsonist would do.
So I don’t think, in the public setting, I think monopsony power is not the main problem. What I think the main problem in the public setting would be the use of inefficient bargaining power in the sense that we obtain a discount but that discount either is being eroded by the cost of running the process or we don’t really use it or we don’t pass the benefit to the end consumer in a positive way. And this is one of the differences that I see between the public buyer power and the private buyer power because the public buyer has different interests than when it comes to a private buyer. The private buyer wants to maximise profit while the public buyer needs to satisfy social needs and that is a crucial difference between the two of them and I think that’s something we have to keep in mind. So I would say in a public sector setting, the case of monopsony power is going to be very rare, if likely impossible, and the same happens in the private sector. In the private sector, monopsony power, it’s no longer in fashion among the economists, now we speak about efficient bargaining and then we speak about different types of contracts that we can do, we can use to make as efficient as possible the contract and therefore reduce the prices without having a negative impact on welfare when it comes to study welfare.
So the ability to buy something without reducing purchases and not hurting the market as such. And, as you say, the public buyer is not aware or is not interested in hurting the market but it can do it as well and that’s why I think it’s important to understand that the public market should be disciplined in some way because, yes, public buyer power might be efficiency enhancing and might be positive if we use it right. And then we have two problems. We have problem number one, most purchasing by contracting authorities, it’s not covered by EU competition law rules, that will depend on whether the activity carried out with those purchases constitutes an economic activity and that’s the problem that Albert Sanchez-Graells and I, we have been working a little bit on this, Albert being the first one to put it out. And then, not only that we’re not, the public buyer’s not conditioned by competition law, which I think it should be, but the other problem is that sometimes we are a bit too naïve in the way that we buy and we don’t know exactly what is going to be the repercussion in the market of the way that we carry out the purchases and this is another factor that I think contracting authorities should be more aware of. That whatever the contracting authority carries out in the market, it can have a substantial impact, especially in sectors that are very dominated by public buying. For example in Norway we have the case of the health department, we have something that’s called Helsenorge and Helsenorge is the central buyer of absolutely everything that is carried out when it comes to healthcare in Norway and public healthcare in Norway is about 97% of the market. So whenever Helsenorge carries out a tender and buys goods, its activities as a buyer has a repercussion on the suppliers but, at the same time, on the end consumer as well because the end consumer is going to be either beneficiated or is going to be harmed depending on how the buyer behaves in the short, but more importantly, in the medium and long-run term. Because I think the key is using buyer power in a way that it is efficiency enhancing, it can reduce prices but at the same time, is used as a tool to maximise dynamic efficiency which basically means, in simpler terms, to make sure that we obtain the best outcome when it comes to innovation and equality as well in the long run.
So I’ve got two final questions for you before we finish and I’ll ask you to be brief on those. You see that intersection between law and economics, what methods are you using in your research, especially when you’re looking at centralised procurement and what challenges do you face?
Well, the very short on this, I am not an economist myself so that’s the first challenge because we’re talking about very complex micro economics and industrial organisation. So what I’ve done is I’ve not used a full-fledged law and economic analysis which is what most economists tend to do when they do law but I’ve done something that I’ve labelled an economically-informed legal analysis which basically means I do a literature review, I try to understand what the economists are putting up, then I try to see if there is a consensus in the area and most of the time, there’s no consensus between the economists and then I try to say, “Well, this is the outcome and we don’t have a clear-cut answer because all the models by the economists are highly dependent on assumptions.” If assumption A does not exist then the model crumbles and falls and you don’t have the model working anymore and that is one of the main challenges. The main challenge, for me as a lawyer is that economists work with fiction and lawyers work with reality and I work in a centre that we mix competition lawyers and economists and when I speak with them, they tell me, “Well, this is my assumption,” and I tell them, “Well, but the world doesn’t work like that,” and they say yes, and they tell me, “Yes, I know it doesn’t work like that but that’s the only way that I can simplify the model so I can make assumptions and I can have reliable results.” So of course, I think economics is fundamental and very important but at the same time, we have to be aware that both our disciplines have limitations.
I mean, that’s a very important point because I’m always very well aware of the limitations of our discipline and how we usually are interested in, yes, analysing reality as a lawyer but we’re interested in a binary answer which is, “Yes, it’s legal,” or, “No, it’s not legal.” Whereas we usually do not look at the wider implications of any decision and that’s certainly the issue I’ve had with law in the long run which is if we just look at yes or no, legal or illegal kind of dichotomy, we are enabled to actually help whatever area of the law we’re studying, actually developing into achieving whatever goals the law is supposed to achieve.
Yes, I agree with you. I think we have to skip out of a yes or no answer because a lot of our answers, as a lawyer, are in a grey area. So whilst I say all the time, the answer is, “It depends.” It is very difficult for me to, especially in the field of anti-trust to say this is right or wrong. Well, it depends, it depends on what is the situation, it depends on the variables at hand, it depends on, as you said, what are the goals that you’re trying to give? Because this is another point, what are we looking for? And depending on what are we looking for, our answer’s going to be tailored in a different way because we try to adjust the way that we interpret the law to fit our result that we desire. So it has to do a lot with also the political goals or the social goals that the rules try to achieve and that’s how we also use our interpretation or our way of applying the law to achieve those end results which is also a highly sensitive topic. And the economists also do the same even though they say they don’t but I think economics is also value-laden in the sense that economics are based on a specific set of beliefs so, for example, if you believe the market is the right thing to do and that will be the Chicago School of Economics, everything is about end consumer efficiency. Or you maybe believe that the market should not be left alone, there has to be some kind of regulation on it and then you have to have some strong rules that are going to tell you how to behave and that would be maybe the Ordoliberal school which is a school that I am more interested on or maybe you say, “Well, you know what? The market doesn’t work at all and we have to have a state plan control,” and then you end up in the situation like as a socialist or a communist state.
Or Venezuela in which we don’t know what’s going but something is going on and there’s probably more like a capitalism of state which is a different thing.
OK, one final question which has to be really, really brief because we’ve gone over the allotted time that we had for the interview. What future work are you planning in this area?
Well, in the area, I’m going to be working mostly now, my postural project on utilities and regulation of electricity and gas. So I’ll be looking into the utilities regulation of gas and electricity and particularly to see what happens when the activities are exposed to sufficient competition, that they get a waiver from the application of utilities directive and see how this waiver process is being carried out and how the practice is done because what I’ve seen is that we have very little information on it. And then I will continue working on purely competition law, anti-trust law, also in the field of electricity and gas when it comes to access to distribution networks and non-discrimination for third-party access.
Looks fascinating. Ignacio, thank you very much for taking the time to be with us today.
No, thank you, Pedro, and I’m sorry for speaking way too much, that’s what happens when you get a Latin American in your show. I mean, we speak way too much but it has been a real pleasure for me, thank you very much.