Reverse auctions are appropriate when:
• Supply consistently exceeds demand
• There is no need for a strategic relationship between buyer and seller
• The goods or services are easily described
• All potential suppliers meet common standards and service levels
• The financing of the contract is straightforward
• The decision about one commodity does not need to be seen as part of a broad
procurement portfolio.
Reverse auctions are less effective when:
• Demand consistently exceeds supply
• A strategic relationship is needed between buyer and seller
• Offers involve markedly different deliverables or service levels
• Deal financing is an integral part of the supplier selection
• Procurement decisions about one specific commodity need to be seen as part of a
broad portfolio of expenditure.
• Never make assumptions about the savings to be made from e-sourcing based on
extrapolations from early e-sourcing activities. Pilot auctions tend to yield spectacular
price reductions because procurement teams try the technique out on "unimportant"
categories of goods, which have usually had little attention for years. These items
have, after all, been selected as being unimportant.
• Be wary about creating wrong expectations by publicizing the lowest prices bid in
reverse auctions. Many procurement teams end up awarding contracts to suppliers
that were not the lowest bidders, for a variety of perfectly good reasons. No
organization should run a reverse auction under a set of rules that compels it to give
the contract to the lowest bidder.
• Remember that reverse auctions are not a panacea. And they are only one part of
what e-sourcing has to offer.
If the justification for an e-sourcing program has been based entirely on lowering prices
— and not on the consistency, efficiency and manageability it brings to the tendering
process — the team may lose heart and the sponsor will certainly lose confidence.
Program sponsors should see price reductions as a bonus, over and above the key
objective of improving procurement processes.
The real value of e-sourcing lies in its ability to provide an efficient, consistent and
manageable tendering process.
To achieve this, management teams should develop long-term change management
programs that focus on key business deliverables. Objectives should include a reduction
in the number of "roll-over" contracts and an increase in the number of tenders each
buyer can handle. It will probably take the program team at least four years to achieve
the transition from paper-based tendering to electronic tendering, and program sponsors
should be prepared for this. But the benefits are well worth fighting for, as the use of
electronic tendering for the exchange of information between buyers and potential
suppliers is significantly better, in every respect, than any paper-based mechanism.
Michael Inman, director of general purchasing, at Phoenix-based America West Airlines says America West
got a headstart in the cost-cutting race when it started looking into e-procurement initiatives in 2001 for its
indirect or "general" spend. In May 2001, it began doing some pilots with reverse auction provider
FreeMarkets Inc. (Pittsburgh, Pa.) and online airline exchange Aeroxchange.com. Eventually, the company
settled on MaterialNet.
The Opportunity. A key principle furthering professional purchasing is the use of
information to reduce uncertainty and thus reduce total cost. Purchasing
professionals have always had to manage the trade-off between limiting the
number of suppliers receiving an opportunity to quote to a manageable number
versus ensuring and maintaining a broad range of potential bidders to capture
the best total market price. The Internet offers the ability to fulfill both objectives
through the use of Internet-based reverse auctions. Reverse-Auctions are one of
the advanced tools enabling purchasing professionals to shift from “conducting
and administering” the procurement process, to “managing and monitoring”
e-tools that automate manually intensive processes quickly. It’s impressive to see
so many purchasing professionals use it for a variety of buys and receive
recognition for their results.
The Savings Potential. Firms that embrace Reverse-Auctions as a strategic
management technique are consistently enjoying a cost savings ranging from
10% to 20%, with some auctions resulting in substantially higher savings. Many
firms also achieve quality improvements along with cost savings either because
the current supplier, recognizing there may be a reason the buyer went out for
bid, decided to consciously look for improvement opportunities, or a new supplier
wants to earn follow-on business. Normally, most auctions result in some
savings, however even if an auction results in no savings, there is some benefit
in knowing that you are already at the best price while gaining additional market
information, in some cases free of charge. Reverse auctions are a painless way
to both improve the procurement process and to achieve a competitive cost
advantage.
The Higher Good . Reverse Auctions provide a proven and painless path to
strategic cost reduction. e-Procurement focuses on using Internet methods for
purchasing and offers significant advantages. The rationale is simple, in many
organizations purchased products and services are the most significant expense,
maybe 45% to 55% for the average firm. A five percent savings in those
purchases would result in up to a 50% profit improvement for a firm that has a
5% operating margin. To realize the same improvement might take up to a 50%
increase in sales. Tough for any firm regardless of it's market position. Any
reductions in purchases immediately translate into bottom line improvements;
and they preserve critical skills that would otherwise be lost in a reduction-in-
force. Only focusing on other items, such marketing, overhead and production,
can negatively affect sales efforts and might not result in true profit improvements
for several months.
The Choices. There are different Reverse-Auction models. Successful Reverse-
Auctions begin with two key ingredients; defining your criteria, then determining
which model will best meet your needs. Defining your criteria allows you to
segment your buys and will guide you to the appropriate model needed to
achieve your desired results. Buys vary from standard to highly specialized, low
to high risk, strategic to routine, small up to tens of millions of dollars. The
following chart depicts available models and their attributes.
The Benefits. The benefits are clear and can be summarized in the chart below.
Whether you are sourcing MRO items, direct materials, renewing annual
agreements, consolidating buys, purchasing capital equipment or one time buys,
there is a high probability that a Reverse-Auction can be applied.
By: Sandy Jap, associate professor of marketing at Emory University's Goizueta Business
School in Atlanta
Sealed-bid and open-bid auctions generated similar levels of potential savings, measured as the
percentage difference between the lowest bid and the buyer's historical cost.
sellers tended to see sealed-bid auctions as a more efficient way of doing business as usual,
participating in an open-bid auction led them to regard the buyer with a more jaundiced eye. For
example, suppliers in open-bid auctions were significantly more likely to agree with the statement,
"This process will reduce my chances of earning a fair margin on the business." Moreover,
suppliers in open-bid auctions often suspected the buyer of manipulating the process—by
bringing in unqualified sellers, for example, or by submitting its own bids in order to force prices
down.
In the short term, even if the auction process uncovers a new low-cost supplier, the process of
learning to work with an untested partner can push up the buyer's total cost of goods. Over the
longer term, if prices continue to fall, suppliers may merge to achieve economies of scale. That
could "tip the balance of power to the supply base," Jap explains.
Yet when used appropriately, online reverse auctions can still play a positive role, Jap believes.
Her surveys revealed that after participating in an auction, suppliers were more willing to make
investments in training, procedures, equipment and capacity that were tailored to the buyer's
specific needs. That was true even of open-bid participants, despite their higher levels of distrust.
Open-bid auctions also give sellers new information about their competitors' pricing, leading
some companies to make investments to lower their costs. In addition, some sellers hope to
avoid future auctions by creating a tighter relationship with the buyer.
