Status Quo of Reverse Auctions
Dr Bernd Huber, Manager Sourcing Center of Excellence, Google
Over the last decade, reverse auctions in procurement have have gained significant credibility and momentum both in the private and public sector. This is not surprising as the word ‘auction’ is derived from the Latin verb ‘augere’, which means to increase. It is of course also due to the significant benefits, such as cycle time reduction and fair market pricing, that are regularly achieved across an ever wider range of categories.
With the reverse auction capability in the Fortune 500 approaching 100 percent, it is clearly a business practice that is here to stay.1 The increase in adoption is also visible in a study among UK firms of various sizes in different industry sectors: 61% responded in 2009 that they were using eSourcing tools. Of these, 65% were using reverse auctions. 8% of the organisations have implemented them within less than one year, 47% within one to three years, and 45% in more than three years.2
Having exhausted low hanging fruit such as stationary supplies, complex services and supply markets have become the focus of reverse auctions. With more advanced technology and knowledge in place these days, hardly any service or product is exempt from their reach. The average reverse auction contract in the Fortune 500 is valued at $2.2 million.3 A common saying became: if you can specify it, you can auction it.
Organisations experienced in reverse auctions run them with even just two suppliers. A common approach is that price is an important element in the total value proposition from a supplier, but the lowest price bidder in the auction does not necessarily win the business. Weighted evaluation criteria in terms of best value like customer service or delivery quality are taken into consideration for the final selection as well.
Internal eSourcing Excellence Center as Adoption Driver
Many organisations successfully using reverse auctions have centralized their eSourcing efforts under a small team of experts who manage all online sourcing projects. This is to fully support procurement and stakeholder teams in eSourcing best practice, so that all users are trained to the latest technologies / strategies and have access to the best available automated templates and tools to maximise sourcing value.
With this internal eSourcing excellence center in place, reverse auction implementation is often evenly split between a top–down (in which the organization’s top management directs the use) and a bottom–up implementation approach (in which the implementation originates from managers within the procurement function).
However, complex auctions are not, and can never be, fully predictable and without any risk due to parameters such as supplier market intelligence, their objectives, perceptions and level of expertise, etc. Nonetheless, the learning curve with an increasing auction number helps spot trends and successful strategies.
Therefore, a well-planned strategy developed with eSourcing experts prior to the event is one of the most important predictors of success. To rely on the technical helpline alone from the eSourcing provider is in many cases not sufficient.
Sourcing managers continue to specify requirements and conduct supplier and market analyses, while the internal eSourcing team will take this intelligence and give support in the following areas:
Knowledge base in eSourcing: training of sourcing group and suppliers, up to date keeping on new features, handling of ad hoc training questions.
Institutionalization of best practice, e.g. promoting reverse auctions as the primary tool for competitive bidding to stakeholders.
Ensure that activities measure up to the highest ethical and legal standards (no phantom bidding, no rabbits, no acceptance of offline private bids, no bird watching, etc).
Ranging from full set-up of eSourcing projects to second set of eyes to monitor / ensure set-up as required.
Help stakeholders define project strategy, scope, requirements, lotting, etc.
Establish / review project timelines.
Troubleshooting in all eSourcing stages, ranging from “quick and dirty” to complex multi-phase projects.
Serving as focal point for all operations and set-up issues, e.g. access control.
Ensuring best available tools from eSourcing technology providers.
Decrease cycle times by creating a “library” of category-specific reverse auctions and develop supporting tools.
Automate supplier training.
Document / audit results to learn from successive eSourcing projects.
Drive fact-based sourcing decisions by e.g. analyzing cross-event data.
The centralized reverse auction knowledge can also be used where the organization participates as a supplier in reverse auctions.
Select and Prepare the Right People
In many organisations, there is a widely variable skill set in procurement with eSourcing being inconsistently applied by multiple users. A critical factor is therefore to hire / train truly collaborative sourcing professionals who are open minded about auctions. Most resistance comes actually often from within the procurement function, not necessarily from stakeholders. Procurement professionals may see reverse auctions as a threat to their own negotiation skills and value add.
At the same time, they may only have a limited number of big spend sourcing projects per year and shy away from using the eSourcing system as they tend to forget over time what they learnt in their initial training. This also emphasises the need for a core team of eSourcing experts who are fully trained and ensure the use of consistent best practices approaches.
It is important to reassure that procurement professionals and stakeholders will not lose control and to show how they can win from using auctions, e.g. that they are not blamed if the auction generates better results than the previously face to face negotiated pricing.
In promoting the concept, it is also vital to emphasize the benefits that will resonate specifically with them. For example, the focus can be first on like-minded professionals that are receptive to auctions or on low risk areas. Even low spend items may be accepted for an auction (e.g. threshold $30k) to gain some trust that the auction process adds real value. Once there is a first win in one category, the auction concept can be marketed very readily to other categories or higher spend.
Auction adoption also increases when senior leaders are invited to come in and witness the auction event. The appreciation they gain from watching procurement manage live auctions is typically very beneficial in marketing. Team or functional meetings can also be used to give tech talks demos and mock auctions.
Another motivation strategy is to reward key individuals / teams on successful or early adoption of auctions by small bonuses, peer rewards, tokens, etc (e.g. a monthly award for the best auction of the month). Key milestones achieved and successes should be also celebrated and communicated (100th auction, spend taken out to bid, etc). Everyone in the organization should be informed of the reverse auction initiatives undertaken and their measurable results.
These approaches help develop executive sponsors and self-starters within the enterprise. At the same time, building up some strong documentation of the auction benefits and how they are used within the organisation is very beneficial (well linked site at Intranet with new stories, results summary of each auction performed sorted by category, videos, specific group eMails, etc).
In some companies a more mandated approach may be also necessary to ensure adoption, for example that business owners who claim targeted spend over a certain threshold (e.g. $100k) cannot be competitively bid will need an appropriate reason (i.e. supply market monopoly etc.) and a waiver from senior management.
All these measures are aimed to create a can-auction culture and mentality where the auction is a natural part of the negotiation process.
Have the Right Tool in Place
Having the right eSourcing tool is also a crucial part of the success. The tool should have a sophisticated, yet intuitive and easy to use interface, while it should be still capable of complex price negotiations with multiple suppliers. This compromise between user interface and functionality is often not easy to reach, but drives adoption significantly. For example, while the tool should have a deep level of set up functionality for the eSourcing expert team, suppliers and stakeholders put a lot of focus on easy access and transparent auction dashboards.
Sophisticated auction tools should provide a number of different visibility rules (e.g. traffic lights, rank only, best bid, open bid) and auction formats (apart from the English reverse auction). For example, multidirectional auctions allow some items to be bid downwards and others upwards at the same time. These are particularly useful where suppliers can bid a unit price downwards and a rebate upwards. Multi-attribute auctions also incorporate non-price factors and come up with a weighted supplier evaluation. The tool should be flexible in creating total cost of ownership calculations and in defining the level of access at am item level for suppliers.
Other examples include Japanese auctions, which can be beneficial when supplier competition is limited, where market pricing is confidential, or where cost structures differ widely across suppliers. In a Japanese auction, the procurement professional sets the starting price level and the appropriate bid and time decrements (e.g. the auction will decrease in price by $5 every 2 minutes). Suppliers have to accept to supply at that specific price level or to withdraw from the auction. The winning supplier(s) is the last accepted offer remaining.
Reverse Dutch auctions follow the opposite direction, whereby the procurement professional sets an initial too low price for any supplier to supply at. The price is then gradually increased in defined bid steps and time steps. The first supplier to accept the stated price wins and the auction ends.
These are just some examples the tool should provide to support complex price negotiations and to further drive auction adoption.
Reverse auctions are here to stay. There are several factors that go into the decision on whether to use reverse auctions. These factors include the product or service specifications, the characteristics of the supply base, the market pricing structure, or the size of the sourcing project. They may not always be the best approach for some specific negotiations (e.g. sole source negotiations, preferred vendor not challenged by other competitors in the auction, etc).
Suppliers are also getting more and more advanced in auction participation. For example, there is evidence from 14,188 auctions performed that 34% of suppliers place a single best bid (=low ball) in the auction and do not bid any further.4 Research evidence also shows that procurements professionals are often very communicative up until the auction, but do not provide adequate feedback to suppliers after the event, which can lead to supplier burn-out.
However, all in all reverse auctions tend to produce measureable results in achieving a fair market price and a significant reduction in negotiation cycle times. Organisations that gain auction competence do so by setting aggressive throughput targets and by the volume of auction activity. By employing auctions in the right format, at the right time, and in combination with other best practice sourcing tools, companies are able to increase the benefits that arise from their sourcing efforts.
1 Aberdeen, 2009. 2 Academic Research into the adoption of eSourcing tools/techniques within the UK Procurement community. Undertaken by Professor Mohammed Saad, Dr. Peter James, Visiting Professor Andrew Douglas, Bristol Business School. Interim report March 10th, 2010. 3 CAPS Research, 2007. 4 Millet, I., Parente, D.H., Fizel, J.L., Venkataraman, R.R., 2004, “Metrics for Managing Online Procurement Auctions”, Interfaces, 34:3, pp. 171-179.