Sourcing from the Enemy: Horizontal Subcontracting in Highway Procurement

This paper empirically considers the effect of horizontal subcontracting on firm bidding strategies in highway construction auctions. In this industry, subcontractors are hired by prime contractors prior to the auction, and the hired subcontractor may also be a competitor in the primary auction. While the practice of horizontal subcontracting may improve productive efficiency, serving as a horizontal subcontractor softens a firm's bid strategy, since winning the auction may entail losing subcontracting business. To separately identify the effect of horizontal subcontracting on bid strategies from its correlation with firm costs, I use detailed item-level unit prices charged for the same items by the bidder and the firms to which it supplies those items. Each additional competitor supplied by the firm is estimated to increase its bid by 1.4 percent, consistent with horizontal subcontracting softening bid strategies. Despite this, the winning bid is virtually identical between auctions with and without horizontal subcontracting. This result, along with the characteristics of firms chosen as horizontal subcontractors, points toward an efficiency motive for cross-supply rather than an attempt to soften competition.