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Reverse auctions:
Are they worth a second look?
Lisa Wichmann
Reverse auctions were dealt a mighty blow this past fall. The federal Public Works department—the largest buyer in Canada—finally bent to supplier pressure and announced it would not use the auctions as planned.
It’s little wonder, considering reverse auctions—which invite suppliers to bid against each other in a live Internet event—have garnered a bad reputation over the past several years.
Buyers and suppliers have said they damage relationships, incur hidden costs, and fail to take non-price factors into account.
And yet, companies such as Bell Canada use reverse auctions regularly, and find them to be a worthy tool, not only for getting the best price, but for making sourcing more efficient.
Phenomenal savings
Bell Canada—with the help of Ariba Inc.—has held reverse auctions for categories such as office equipment, legal services and fuel. "Some of the reverse auctions have delivered phenomenal savings," says David Annett, general manager of procurement with Bell Canada in Montreal.
"It really doesn’t apply to every category, but for the ones it applies to, it's really beneficial and I think people just need to be convinced of it, just by seeing the results."
Those results are impressive. Bell did an inventory of its printing equipment recently, and decided to replace older standalone machines with new multifunctional devices.
An RFP was issued, and from the first round off bids, several vendors were chosen as finalists. Those vendors were invited to participate in a reverse auction. During the live bidding 25 per cent was shaved of the price—in just half an hour.
The company has conducted a reverse auction for fuel too, a commodity it had never issued an RFP for before. Savings from that event were substantial as well.
"We [also] did one for legal, and it's not that intuitive to me that a lawyer's office would know exactly what to do on an electronic RFP or auction, but it went very well."
In fact, even the smallest supplier can participate in reverse auctions these days, as long as they have an Internet connection. Training before the event ensures the auctions run smoothly.
"The vendors would log in a week ahead of time for online training, and it wasn’t as problematic as I thought it would have been," Annett says, adding there was some initial resistance within his own purchasing department.
"There's a hurdle to get over for the knowledge base at the beginning, but I think people see the benefits in the end because it frees up time for them."
For instance, with traditional RFPs, buyers typically take calls from numerous suppliers asking for clarification. With reverse auctions, "there's an electronic answers board where you can post questions and answers, instead of picking up the phone and going through the same thing 15 different times," Annett says.
Moving forward, Bell Canada—which is in the midst of an extensive strategic sourcing project encompassing scorecarding, category management and contract compliance—aims to conduct more reverse auctions.
Suppliers say…
That might not be welcome news to John Reid, president of CATAAlliance, an IT industry group in Ottawa. Reid spearheaded the opposition campaign to convince Public Works to climb down from the idea of reverse auctions.
"It's not only negative to vendors, it’s negative to the taxpayer because the reverse auction focuses only on best price or lowest cost, as opposed to the best value," Reid says.
"So you can provide a commodity or a computer service at the lowest cost, but if you strip away some of the...onsite support and logistics, you then leave the client with a lower-cost item, but without access to some of those other resources that would really make it more efficient in the long run," he added. "It's a mindset and methodology that is much too narrow and unworkable."
The argument probably stems from the early attempts at reverse auctions, which saw dissimilar suppliers pitted against each other like apples and oranges. But since then, a few lessons have been learned, says Marty Barclay, program manager with eDynaQuote, an online reverse auction provider in Erie, Penn.
"Smart buyers will make sure they don't use reverse auctions whenever they have differently-qualified vendors...where one company simply has better expertise, better service, or better technical help."
Barclay has more than 20 years experience in purchasing and supply chain management. He teaches courses on reverse auctions, to try to dispel some of the lingering opposition.
"When there are problems with them, it's all about poor communication, poor item selection, and poor definition of what the buyer needs, and possibly, poor pre-qualification. Has it happened a lot in the past? Well certainly, and that’s why a lot of vendors have a jaundiced view of reverse auctions.”
Knowing the limit
Buyers have been burned too. Typically, reverse auctions encourage aggressive, heat-of-the-moment bidding, and later, the winning supplier—realizing he bid too low—refuses to honour the auction.
But through education, and a discerning eye to what suppliers can be trusted to behave professionally, those occurrences are far less frequent, Barclay explains.
"One of the things we teach the supplier side is make sure you know what your best price is before you go, and then don’t go below it," he says. "I would consider it an unethical process for the seller not to know how low they can realistically go."
Purchasers have their limits too, of course. The initial RFP to pre-qualify vendors should give buyers a ballpark figure of the bids. But to be safe, they might want to set a reserve price, or a threshold. If the reserve isn't met, the buyers can cancel the auction, and redo their specs to invite cheaper bids.
Buyers can also tell suppliers ahead of time that other factors, such as service, will weigh in the evaluation, and the final decision will be made after the auction is over.
Having been in the business for years, Barclay can provide examples of both successful, and doomed, reverse auctions.
One client set out to buy 2,000 computers. They pre-qualified vendors and narrowed them down to two manufacturers, who were invited to outbid each other in a reverse auction.
"There was a total of 115 bids placed in that event," Barclay recalls. "So it was a very lively competition and the buyer had an expectation of a certain price level they thought they could get to, and they got 20 per cent lower than what they had even hoped…From the start price to the end price, over a million dollars [was saved]." The auction lasted about an hour and 20 minutes.
On the flip side, he relates a story of a purchaser trying to buy $10 million worth of "office supplies." The problem was, the term included computers, furniture, and various other products. "Only national, very large distributors could compete and the little guys...could not even participate because it was set up as one big package deal."
In another case, the buyer pre-qualified six vendors of photocopiers. The buyer needed next-day delivery, but failed to screen the vendors accordingly. Three suppliers were able to provide next-day shipping; but three weren’t.
After the auction was over, the vendor balked at the next-day delivery commitment, saying he hadn’t noticed it. Diligent screening and pre-evaluation on the buyer's part would have prevented that vendor from participating in the first place, Barclay says.
David Morgenstern, managing director of Ariba Sourcing (Mississauga, Ont.) can relay even more astounding behavior. "The worse case scenario is when you have buyers running an auction and they receive prices from the auction and then go back and try to negotiate," he says.
"It’s that kind of behavior that kills the company the next time they try to run an auction; their reputation in the market is completely ruined. But it also hurts the whole space. That is the sort of ultimate bad behavior."
No more paper
Though reverse auctions are getting a lot of attention again these days, Morgenstern says they're just one element in a bigger e-procurement picture.
"We're not saying that every category is suitable for an auction type of bid environment…But that doesn't [mean] the sourcing process should still be done paper-based and manually in Excel and e-mail. The benefits of electronic sourcing are very clear, both to buyers and suppliers."
For one thing, documents are created and stored digitally. The next time that category is sourced, all the documents are on hand at one keystroke. It’s also easier to shoot a draft RFP around by e-mail to get supervisor approval and feedback before sending it out.
The same applies to receiving bids electronically. "They're no longer drowning under Purolator packages coming in," Morgenstern says.
For suppliers, e-bidding puts an end to the hassles of compiling huge packages of paper and scrambling to postmark it by deadline. Once e-tendering is well established, buyers might consider the next step of reverse auctions.
"Auctions should really be viewed as the very last step of an electronic sourcing process. Not a necessary step, but only a suitable step when the supply market conditions are right."
Though opinions differ, the general consensus is the contract should be high enough dollars to draw the interest of vendors, ensuring the participation of at least two or three.
In the past, buyers stuck to simple, commodity-based purchases for reverse auctions, but are now venturing into more complicated contracts, such as services. Morgenstern says there are algorithms and software programs available to accurately weigh non-price factors.
Clearly, there's a lot of work on the front end, before the auction is even set up. But this due diligence serves to put suppliers more at ease, says Jemin Patel, CEO and president of e-procurement company, HedgeHog Inc. (Carmel, Ind.).
"A successful auction happens only when all the pre-work is done properly and the supplier has all the information needed before the event, so there’s no question about what he bids on."
HedgeHog provides three different models of reverse auctions. The first is a hosted event, in which HedgeHog runs the event from start to finish, including supplier discovery, if requested. With the hosted model, the supplier who wins the auction pays a small percent to HedgeHog. But there's no charge to the buyer.
In the second model, HedgeHog leases the software, at a monthly fee, to companies who want to run their own auctions. The third model offers one-off events, for customers who use auctions less frequently. Other companies prefer to have their IT department design an in-house application.
It's difficult to ascertain what model is best. But suppliers who are nervous of reverse auctions might be more amenable to taking part in an event run by a "neutral" party.
"For companies that have their own internally-designed and operated reverse auction system, vendors are somewhat skeptical about the controls in place...on fake bids or fake suppliers to drive the price down," Barclay says.
Purchasers should also point out the efficiency benefits of reverse auctions, which take a lot of cost out of doing business, Patel adds. "The biggest benefit is the wait time for the supplier," he says. "For example, if I'm bidding on a project, I get the RFP, I send in my quote, and I don’t know when these quotes are going to be evaluated. On the reverse auction, I know, right in front of me, what my rank is…So there's a lot of information that I get by participating in the reverse auction, which I’m generally not able to get as a supplier when I'm [mailing] in my bids."
When there are numerous suppliers participating, Patel recommends a 'plain' auction, meaning suppliers can see how many vendors they’re up against, the competing bids, and their own rank (specific company names are not disclosed). It typically engenders more aggressive bidding.
In auctions with just two or three vendors, Patel suggests letting suppliers see only their own bid and rank. So they don't know how many vendors they're competing against, but they can always see if they’re winning or not.
Suppliers go through a demo first, to make sure they know how to use the auction. If technical difficulties arise—such as a frozen screen or lost Internet connection—they can call a live help line to ask for proxy bidding. The auction can also be paused until technical problems are resolved. The events usually run just over an hour, though large buys sometimes require an extended auction of two hours or more.
Buyers should come to the auction with complete visibility as to what each vendor is offering. They should have communicated the exact specifications, service levels, delivery times and other value-added requirements beforehand, and confirmed that each supplier can compete on those terms. On a broader level, they shouldn't just be looking for rock-bottom discounts.
"Two or three years ago, it was all about 'how much can I save?' Well, what you see on the screen is not what you’re really going to save," Patel says. The more impressive savings come from the faster speed and accuracy of conducting procurement, for both the buyer and supplier.
For the first auction, it’s not unusual to see savings of 20 per cent. But on subsequent auctions for the same commodity, the price cuts won’t be that dramatic, simply because suppliers can't feasibly go much lower.
But the efficiencies will still be there. Suppliers can track the results of their bids instantly, and cut the price even lower if they slip out of first place; something they couldn’t do with traditional sealed bids.
For purchasers, it brings the whole process into the electronic realm. Bids are no longer locked in someone’s drawer at the office. Getting rid of the paper—while getting the best possible price—are undeniable advantages to reverse auctions. They might be controversial, but if properly governed, they work just fine.
Contact the editor with your comments at lisa.wichmann@pb2b.rogers.com
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