Reverse Auctions Find Niche in Marketplace
The move towards e-commerce and strategic sourcing topped public-and private-sector to-do lists in 2000. Many public entities dabbled in pilot programs. Specifically, there was a lot of interest in reverse auctions.
Depending on how astute entities were in choosing categories for online bidding events, uneven experiences were had throughout the public sector. Those with favorable outcomes consider reverse auctions a valuable negotiation tool. Whether self-service, fullservice (hosted), or someplace in between, online bidding events have become a mechanism for savings in a number of government entities.
The Commonwealth of Massachusetts began reviewing online bidding event vendors in March 2001. After awarding a pilot contract to a self-service reverse auction provider, the commonwealth held its first online event in November 2001. The successful bid for wash sand resulted in annual savings of $32,000 based on historical pricing ($128,000 to date).
Soon after the successful pilot auction, the commonwealth began a competitive procurement process to enlist a reverse auction provider. The procurement team included Marge MacEvitt and Ronald L. Whitaker, Procurement Team Leaders, Operational Services Division (OSD), Commonwealth of Massachusetts as well as representatives from user communities.
“With eight bidders, we had a lot of criteria to evaluate,” says Whitaker. “We were looking for a supplier to operate the online bidding events long term.”
Procuri was awarded the contract, and in January 2003, the commonwealth ran a second reverse auction. The online bidding event for reflective sheeting signs lowered costs by 27 percent.
“We knocked $127,000 off the price and ended up paying $349,000 for the same amount of material,” Whitaker says. “When the initial bid came in at $672,000, we realized that the companies had quite a large profit line.”
Recently in Massachusetts, 3M and Avery Denison competed in a reflective sheeting bid.
“We wondered if e-auctions were going to impact our business,” says Dennis Johnson, Contract Specialist, 3M. “Now, we look at reverse auctions as another way of doing business with different preparation involved.”
In the past three years, 3M has been involved in several reverse auctions with Wisconsin and Pennsylvania and a number of online auction firms.
“I think we are going to see more and more of the reverse auctions on select products at dollar values that are worthwhile for the agency,” Johnson says.
Ensuring that all suppliers are on equal footing in terms of quality, delivery, and service is a critical success factor for reverse auctions.
“We conduct a procurement ahead of time to qualify bidders,” MacEvitt says. “The only people who can participate in the reverse auction are those who have shown themselves to have met the mandatory requirements.”
When reverse auctions bring people together and create online markets, buyers gain insight, beyond savings, into the strengths and weaknesses of the vendors as they participate.
“From the buyers’ perspective, you get a sense of where everyone stacks up in the market,” says Alan Thomas, Director of Account Management, FreeMarkets, a provider of enterprise spend management solu-
tions. “In a sealed bid, everyone gets one shot, but it’s not as informative as when you create a marketplace and allow people to bid multiple times.”
In a reverse auction in which eight or more suppliers participate, purchasers will often see two to four suppliers grouped closely by price— so closely, in fact, that buyers will decide that price is actually not the determining factor. This allows buyers to take price out of the equation and review quality and technical merit.
“A buyer may have three vendors that are within one to two percent, which is not a material number in a large purchase,” Thomas says. “The marketplace you create allows that narrowing to take place, and allows suppliers to cluster very close together.”
Narrowing can present a buyer with more choices and alternatives than possible with a traditional negotiation for commodities. For suppliers, the reverse auction process can take some of the guesswork out of what price they should submit.
“With the reverse auction, suppliers have the opportunity to submit the best bid they can make and still be profitable for their shareholders,” MacEvitt says.
Though identities are not disclosed, reverse auctions can provide bidders with additional insight. “The events are anonymous as far as who is submitting a price during the
auction,” Johnson says, “but from the general marketplace, we would have an idea of who we are bidding against.”
Likewise, depending on what type of feedback they receive, suppliers gain some awareness of their ability to compete, which at times, can be a real eye-opener. By entering an online marketplace, vendors may find that their competitors are 10 or 15 percent better on cost. According to Thomas, post-event analysis can lead vendors to review internal processes for greater cost efficiencies.
Online bidding event providers mainly focus on savings that, in reality, are not sustainable. In simple economic terms, competition brings supply and demand into an alignment that establishes a market price.
“Although everyone talks about reverse auctions in terms of savings, that’s really only to be expected the first or first few times through,” says Mickey Rathers, Consultant, eBizITPA, a nonprofit resource center for Pennsylvania businesses. “After that, it’s about maintaining the best market price.”
Due to market fluctuations, an effective reverse auction might actually result in a price increase.
“When health insurance rates are expected to go up 20 percent, if you were able to keep your inflation to
10 percent, your net gain is 10 percent,” Rathers says. “Even though you are paying more than you used to, the reverse auction has established the best market price.”
The first time a buyer uses a reverse auction to acquire a commodity or service, significant savings are realized only because there existed a large margin. When the contract expires and the entity goes back to auction, a successful event will garner the same price or one that is slightly increased.
Large organizations with buying power can continue to ask for deflation round after round, but that has less to do with the competitive bidding characteristics of a reverse auction and more to do with the size of entities’ orders.
“The vendor community, of course, wants to hold on to as much profit as possible,” Whitaker says. “Now that we are aware of the large profit lines in so many of the companies, the idea is to reduce costs.”
Critics of reverse auctions within the public sector maintain that large cost reductions will not continue, and they are right. Logic suggests that entities cannot expect big savings on repeated buys for the same product or service from the same supplier and have the supplier, or even the supply base, stay in business.
What entities, such as Massachusetts, will continue to benefit from is market transparency and market price definition.
Reduced margins can often be offset by increased volume. Suppliers must carefully evaluate online bidding events in terms of capability, capacity, and cost.
Employing a strategic approach to reverse auctions is key for both buyers and suppliers. As in any negotiation, buyers must proceed with caution and ensure-that all invited vendors are qualified-to provide the goods or service to the required levels of quality, delivery, and service.
Business Practices Determine Sustainability
By Katherine Frisch, Editor
Reverse auctions are nothing more than automated competitive bidding processes, and competitive bidding has been around as long as procurement has been around.
“Online competitive bidding doesn’t do anything to compromise business processes in and of itself,” says Mickey Rathers, Consultant, eBizITPA. “It comes down to how the buyers and the sellers choose to participate, especially on the buyers’ side.”
In the sourcing process, procurement professionals analyze data, collaborate with multi-disciplinary team members and suppliers, collect information, leverage volume across locations, capitalize on the buyer’s strengths, and utilize appropriate competition in the market to get best value.
According to John Madrid, Senior Vice President, Strategic Sourcing Service, Procuri, “In developing sourcing strategies, procurement teams need to carefully consider the nature of the market and its suppliers.
“The uniqueness of the category, the number of available suppliers, and the degree of competition among suppliers are all factors that drive the desired supplier relationship,” Madrid says.
Marty Barclay (left), Dynaquote Program Manager and Doug Luthringer, Dynaquote Support Specialist, monitor a reverse auction for eBizITPA.
Best Business Practices
Assure suppliers that you value their participation in the new process and will give them a fair chance to win your business.
Communicate all the criteria that formulate the award decision. Clear item specifications and unambiguous auction rules are essential.
Explain how the auction process will progress—from the RFI posting to contract award. If applicable, explain how suppliers can collaborate in developing the RFQ. Also explain how you will determine which suppliers will participate in bidding.
Provide details on the logistics of the reverse auction process.
Explain how you will determine the winner of the event and which non-price factors will weigh in the decision.
Encourage suppliers to participate in the practice event.
Reluctant suppliers? Encourage them to submit at least one bid—their best.
Emphasize that you do value supplier relationships, and you want to have long-term relationships with those suppliers who deliver the best value for your requirements.
In terms of best practices, buyers must apply the same procurement processes and due diligence efforts to the reverse auction process. Specifically, buyers must complete a very thorough supplier qualification process to ensure that all participants are qualified. Due diligence ensures that the winning bidder is someone with whom the buyer is willing to do business.
Binding vs. Non-Binding
Non-binding events are seen more often than not in the private sector. The buyer chooses based on criteria other than price. Though not necessarily a bad practice, nonbinding events may make suppliers very wary of the process.
Due to purchasing codes and policies, public sector tends to hold binding auctions, in which the buyer is forced to award to the lowest qualified bidder. Nevertheless, those qualification criteria must be very clearly stated.
“During public-sector events where anyone can bid, it is up to the buyer to make a selection of who is qualified,” Rathers says.
The best way to mitigate the risk of the suppliers choosing not to participate, or not participate effectively, is to communicate exactly what the selection criteria will include. By minimizing the fears and answering suppliers’ questions,
buyers vastly improve the suppliers’ chances of competing effectively.
“Nobody likes surprises,” Madrid says. “When a supplier, incumbent or not, doesn’t know what to expect, anxiety is a natural consequence.”
According to Rathers, “By alerting suppliers to all criteria, you have continued to cultivate a relationship with those suppliers even though you are putting them in a very competitive process that most people think is counter productive to a relationship.”
“Once you explain all of this, it should be clear to your suppliers that the process will be fair and smooth,” Madrid says.
The number one supplier complaint is lack of post event follow-up. Suppliers must be notified if they have won and will get the business.
“Many times you will see a supplier who has taken first place in a reverse auction never get any feedback, win, lose, or otherwise,” says Rathers.
A best practice is simple followup to let the suppliers know when the decision is going to be made and if possible, alert them as to how the decision will be made.
The attitude towards reverse auc-
Auctions Identifying Suppliers
Shortly after eBizITPA opened its doors, the nonprofit resource center for Pennsylvania businesses held a reverse auction for marketing services, including logo design and support materials.
“Without an existing relationship with any of the local creative agencies, we thought that the reverse auction would be a great place to start,” says Mickey Rathers, Consultant, eBizITPA.
After a very thorough prequalification process and online event, the group selected the low bidder. A year and a half later, eBizITPA continues
to work with the winning bidder.
“We used a reverse auction to identify a vendor and start a relationship,” says Rathers.
Reverse auctions can help identify suppliers of products or services that an entity has never before bought.
“If you know what you need, and you know what is important to you in terms of quality delivery and service, then you can create qualification criteria,” Rathers says.
Pre-qualification should provide buyers with a significant level of comfort with all participants and begin
a supplier relationship.
“Once you have started a good relationship, you do not necessarily want to continually option that relationship off,” Rathers says.
tions has not been positive on all fronts, but there is evidence to suggest that the online events are sharpening the relationships between buyers and suppliers.
“The Role of Reverse Auctions in Strategic Sourcing,” a study conducted by CAPS Research, finds that by removing some of the market price ambiguity, reverse auctions force buyers to provide better specifications. At the same time, the events force suppliers to be clearer about what they are supplying.
Online events have allowed suppliers to use their time differently. Prior to reverse auctions, suppliers spent a great deal of time in negotiations. Likewise, buyers are able to adjust their work days.
For a standalone, desktop procurement tool that is relatively low in cost to install and use, reverse auctions provide an efficient means to get a final best offer from a group of suppliers. The success of reverse auctions has overcome some early resistance, but it will be up to procurement professionals to maintain the trust and mutual interdependence between buyers and key suppliers.
—Visit the Commonwealth of Massachusetts at: www.state.ma.us.
—eBizITPA, Center for eBusiness and Advanced IT, www.ebizitpa.org, is a Ben Franklin Technology Development Authority Initiative.
The non-profit organization provides education and training programs in e-business and advanced IT processes to Pennsylvania companies, as well as access to online supplychain management solutions, including DynaQuote electronic quoting and bidding tool.
The organization recruits, attracts, and establishes viable businesses, leading to job creation and Pennsylvania “brain gain.”
—Freemarkets, www.freemarkets.com, is a provider of software and services for global supply management.
—Procuri, Inc., www.procuri.com, is a provider of online strategic sourcing solutions that enable enterprises to make best value sourcing decisions.