Over-optimism in software development projects: "the winner's curse"

It is well known that software development projects tend to be based on over-optimistic cost estimates. Better knowledge of the sources of this over-optimism is necessary to improve realism in software development project bids and budgets. This paper analyses the effect of "the winner's curse". The winner's curse is a result of the selection of software providers among those with the lowest bid, i.e., those with a tendency towards the highest level of overoptimism. The winner's curse has not been extensively analyzed in software cost estimation studies, but is a well known phenomenon in domains such as auctioning. We exemplify the effect of the winner's curse with data from a real software development bidding round and simulate how increase in number of bidders and cost uncertainty impact the expected profit. We argue that the winners' curse is a problem for both clients and providers, and that it may lead to inefficient use of scarce resources. Possible remedies for reduction of negative effects of the winner's curse are discussed.