A mixed integer model of bidding strategies for outsourcing

An emerging phenomenon in the management of information systems is outsourcing. Outsourcing is the contracting of various system management functions by user-firms to vendors. This paper focuses on the outsourcing bidding process pertinent to the selection of one contractor by a user-firm. The paper explores bidding situations where the vendors have different levels of expertise and cost structures. Truth-revealing mechanisms that induce the vendors to bid competitively in line with their costs are utilized and a mixed integer programming model is presented. The model allows the user-firm to obtain the optimal expected contract cost. Some interesting conclusions emerge from the analysis of representative examples used in the paper. First, the results clearly show that truth revealing strategies always result in lower contract costs for the user-firm than if the user-firm were to follow the straightforward strategy of always choosing the lowest bid. Second, the user-firm can reduce contract costs by deploying a discriminatory selection policy vis à vis the different vendors. Third, subsidies need to be given in order to ensure truth-revealing behavior of the vendors. Thus the qualitative interpretations of the model parallel bidding behavior practices observed in the real world.