Affirmative action as a cost cutting tool in procurement markets

Abstract We study the effect of a procurement market affirmative action program where buyers can provide bid discounts to preferred (small, women-owned, and minority-owned) vendors, thereby enabling them to win contracts even if they are not the cheapest option. These programs are typically framed as an exercise in social responsibility, since buyers will pay slightly more in order to support traditionally disadvantaged businesses. Using data from business-to-government procurement auctions in Virginia and a structural model of vendors’ bidding behavior, we demonstrate that preferred vendors generally have higher costs than their non-preferred counterparts. As a consequence, the affirmative action program can reduce buyers’ procurement expenditures in this context through intensifying competition and forcing large, low-cost vendors to significantly reduce their prices. The magnitude of these savings is over four times larger when buyers strategically use a variable bid discount policy rather than committing to a fixed bid discount ahead of time. Our findings demonstrate that these affirmative action programs need not be a financial burden for buyers. Instead, affirmative action programs that improve societal outcomes can also improve other key metrics like procurement spending.