Fair Play

Online reverse auctions are helping buyers procure at the best total cost without favoring one supplier over another.


The Solution Enabled
In a reverse auction, one buyer invites multiple suppliers to bid on an RFQ. It is very much like a traditional RFQ, where the buyer sends out a document specifying their needs to pre-selected suppliers. The catch, however, is that all the suppliers can see the bids for the job, as they come in. Today the medium is the Internet, and a finite period of time is set for the bidding, say two hours. Each time a new bid is submitted, the buyer and all the suppliers can see that bid. So, until the time that the bid is slated to close, suppliers have the opportunity to submit new, lower bids.

The beauty of the reverse auction is the ability to completely circumvent the "meet comp," "best and final price" and the time-consuming multi-round approaches to supplier selection. Now, within two hours buyers can effectively let all bidding suppliers know what they need to do to win the business, so no money is left on the table. As a manager, this is especially important because you can know with much more confidence that the bidding process used by your buyers was both effective and fair.

I have heard some complaints recently that reverse auctions are a problem because suppliers that do not have appropriate capabilities end up undercutting incumbents but not delivering on the contracts they win. Just because buyers have a new arrow in their quiver doesn¹t mean they should discard important steps in the sourcing process - like pre-qualifying suppliers for strategic purchases. If buyers do get into trouble, they will learn from their mistakes. Buyers that source from suppliers who can't deliver don¹t last very long.

Preventing a Serious Problem
A more serious concern is that suppliers will use the reverse auction process to collude. It is quite possible as a supplier, when you know your opponent's pricing, to "signal" each other and work together to keep prices high. Take for example oil prices and OPEC. When all the players in OPEC decide to keep their prices steady, there is very little the buyer can do about it, since OPEC controls most of the supply. The key to this system is that the sellers are able to communicate with each other. If Saudi Arabia knows that Venezuela will not quote below $35 per barrel of light sweet crude, then they can also safely keep their price at $35 and not lose any business.

In fact, in two separate instances, I actually studied how to systematically collude with competition. At the Harvard University course on negotiating, we did exercises simulating multiple bidding rounds with other suppliers, and studied how to maximize profits under such situations. Then, in my MBA program, we learned a quantitative method for maximizing margins when you have to bid regularly for your work. So, don¹t think that suppliers won't try to do it. In fact, I'm certain that during my tenure as a purchasing manager, it happened right under my nose at least once, but I couldn't prove it.

Preventing collusion, however, is fortunately, relatively simple. All the systems I studied required a limited number of suppliers that continually and regularly bid against each other. The way they established communication was by monitoring the different responses to each other¹s bids. The way, to avoid problems is to regularly introduce new suppliers into your bidding, so there is always a new player to interfere. And of course, you should be willing to award business to that new player if they fairly win the auction.

I read recently that reverse auctions are bringing in such high levels of savings that senior managers are questioning whether purchasing has been doing its job. Just remember, buyers struggle every day with inefficient systems that don¹t help them get the lowest possible prices. So smile, help your procurement professionals learn about reverse auctions, and congratulate them (and yourself!) when the tool is effective.

Editor's Note:Deborah R. Wilson, C.P.M., is an analyst and consultant who specializes in purchasing automation strategies.

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