Minority and Small Business Preferences in Procurement Auctions

Minority and Small Business Preferences in Procurement Auctions

Marketing, Society, and the Public Interest (MKTG 4644)

Mario Pandelaere

By Blake Nelson and Vaibhav Mummalaneni

Preferential treatment in the procurement process has only been in effect for just under 50 years. It started in 1968 when the small business association (SBA) reacted to the riots that took place in a minority dominated neighborhood located in Los Angeles, California. The SBA had an idea to help small businesses owned by “socially or economically disadvantaged individuals” (Bacchi, 2004). The original intention of this idea was to reserve business for only black individuals to help bring money into their communities. Congress liked the idea so much that they decided to enact the Public Works Employment Act (PWEA) of 1977. This piece of legislation authorized the spending of $4 billion dollars for local public works projects. Of the $4 billion dollars authorized for spending, 10% of the money was to be subcontracted to “minority business enterprises” (MBEs). The PWEA was the first act since 1854 that specifically identified the beneficiaries in terms of race or ethnicity. The eligible groups of minorities that were named in this act were “Negroes, Spanish-Speaking, Orientals, Indians, Eskimos, and Aleuts” (Agócs & Burr, 1996). Before the PWEA was enacted, in 1976, minority-owned businesses had won less than one percent of all federal procurement. Minorities, at the time, made up between 15 – 18 percent of the general population. Future programs adopted the PWEA’s idea of subcontracting 10% of the budget for MBEs including the 1998 highway program with a budget of $210 billion. The Clinton administration implemented 10% price preferences for MBEs on 76% of all federal procurement in October of 1998. Current day initiatives have been widely expanded to include many groups including businesses owned by racial minorities, women, LGBT people, disabled people, which, together, we will refer to as “minority owned businesses” and even small businesses.

        Preferential procurement processes and “supplier diversity” policies are essentially a form of affirmative action. They both share the similarity of essentially being labeled or considered as discriminatory towards the non-preferred groups in an attempt to help historically disenfranchised groups. However traditionally, affirmative action is applied to hiring or college application processes, but in this case, it is applied to procurement which results in some different effects. For example, when bid preference, a form of affirmative action, is applied to public contracting, there are different results that are produced versus the effects it has on college admissions. Bid preference, according to this study has the following effects: “While firms' bidding behavior matches theoretical predictions, procurement costs are 3.8 percent higher on auctions using preferences. The higher procurement cost in preference auctions is attributed to reduced participation by lower cost large firms” (Marion, “Are bid preferences benign? The effect of small business subsidies in highway procurement auctions”, 2007). What this study says is that large firms that operate with a high rate of efficiency do not participate in auctions that use bid preferences. The result of this action is driving up the cost for the purchaser causing an inefficiency. When affirmative action is used for college admission purposes, it provided different results when compared to the application of affirmative action on public contracting. According to this study of colleges in Texas and California, there was no effect on the number of minority or non-minority applications when affirmative action was present and when it was not present. “First, there is no relative trend in the number of applications sent by minorities relative to non-minorities after the end of affirmative action” (Card & Krueger, 2005). This is the major difference in effect between the two forms of affirmative action. In regular affirmative action, well-qualified but non-preferred applicants are usually not dis-incentivized enough to drop out of the process entirely. However, in procurement, large, efficient companies often choose not to even participate because of the negative incentive which results in large inefficiencies and cost increases for the buyer.