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.