Auctions vs. Negotiations: the role of long-term contracts
We show that there is an intrinsic value in the option to continue business without any consideration of competitive alternatives. We offer a new rationale for exclusive agreements in procurement and selling situations. The form of this agreement depends on two forces: ``Buyer power’’ (i.e. the ability to implement a revenue maximizing auction) and ``Information exchange’’. When both forces are at play a rent extraction mechanism à la Aghion and Bolton (1987) is best: competitors are pressured by the threat of dealing with the incumbent. The absence of information exchange prevents the implementation of such a mechanism. However, long-term business partners have a common interest to agree on an option to deal on an exclusive basis while keeping the possibility to revert to a competitive process (auction) should the surplus of an internal deal turn out to be low. Partial exclusivity occurs in equilibrium (with or without buyer power) in the sense that competition takes place with positive probability. Although there is no, such lock-up agreements harm competitors (and total welfare) by depriving them of business opportunities. Compared to Bulow and Klemperer (1996), the possibility of long-term contracting calls into question the efficacy of auctions relative to negotiations.