Lemon Problem: A Procurement & Supply-Chain Risk

In the world of procurement and supply chain management, decision-makers often face a dilemma when purchasing goods or services: How can you be sure you’re getting what you pay for ? This is where the “lemon problem” comes into play – a classic concept in economics that has major implications for both public and private procurement.

This article explores the lemon problem in procurement, its implications, and strategies to mitigate its effects.

What is the Lemon Problem ?

The “lemon problem” was first introduced by economist George Akerlof in his 1970 paper “The Market for Lemons.” He used the term to describe how markets can fail when buyers and sellers have access to different levels of information. Specifically, in the used car market, sellers know whether a car is a “lemon” (defective) or not, but buyers don’t. This asymmetry of information leads to distrust, lower prices, and an eventual breakdown of the market.

In procurement and supply chain management, this problem arises when buyers cannot fully assess the quality of goods or services before making a purchase.

The lemon problem can occur in many markets, including: Used cars, Labor markets, Health insurance, Investing, and Credit markets.

How Does the Lemon Problem Affect Procurement?

In both public and private procurement, the lemon problem can take several forms:

Low-Quality Bidders Win the Tender

When tenders are awarded based mostly on the lowest price, suppliers offering substandard goods or services may underbid to win contracts. These suppliers might cut corners on quality, materials, or labor—leading to long-term losses for the buyer.

Example from Bangladesh: In public procurement, especially in infrastructure or construction, we’ve seen cases where a contractor delivers poor-quality work to stay within their low bid. This can lead to frequent maintenance issues, increased lifecycle costs, and even safety hazards.

New or Honest Suppliers Get Crowded Out

High-quality suppliers who offer fair pricing may lose out to those selling “lemons.” As a result, competent vendors may choose not to participate in tenders they view as rigged or biased towards cost-cutting. This reduces competition and innovation in the market.

Increased Oversight and Transaction Costs

To manage the risk of getting a lemon, buyers introduce complex compliance requirements, excessive documentation, and multi-layered approvals. While meant to protect against fraud, this slows down the procurement process and increases administrative burden.

Signs of the Lemon Problem in Supply Chains

• Disproportionate focus on lowest price, ignoring quality, warranty, or after-sales service.
• Lack of supplier transparency or performance data.
• High supplier turnover—frequent changes in vendors due to dissatisfaction.
• Reliance on informal networks or intermediaries instead of open competition.

Solutions: How to Overcome the Lemon Problem

Move Beyond Price-Only Evaluation
Use Most Economically Advantageous Tender (MEAT) criteria that consider quality, delivery, warranty, technical merit, and after-sales support alongside price.

Pre-Qualification and Vetting
Implement robust supplier pre-qualification, including track record, financial strength, and references. In Bangladesh, the e-GP system already supports some of these features.

Contract Performance Tracking
Introduce a performance evaluation system and publish vendor ratings. Transparency creates accountability and helps buyers make informed decisions.

Support New and Local Suppliers
Provide training and onboarding support to help new suppliers meet technical and compliance standards. This builds a more diverse and competitive market.

Use Technology for Monitoring
Digital tools like e-GP, blockchain, or AI-powered analytics can help track delivery and flag quality issues early.

Consumer Protection Laws
In many countries, governments have enacted laws to allow buyers to receive compensation for products that fail to meet the promised standards of quality and performance.

Final Thoughts

The lemon problem is not just a theoretical issue – it has real-world consequences for efficiency, cost, and trust in the procurement system. By acknowledging and addressing information asymmetries, both public and private procurement entities in Bangladesh can protect themselves from “lemons” and ensure better outcomes for taxpayers, customers, and suppliers alike.