As reverse auction gains popularity globally as a sourcing and negotiation tool, I am constantly asked the question whether these auctions do more harm than good. Before answering this question, let’s first understand what reverse auctions are and how they work.
As the name suggests, reverse auctions are the exact opposite of a traditional auction. In a traditional auction, there is a Seller who wants to sell a product or service and there are Buyers who bid for the same. The objective of the Seller is to increase the price. In a reverse auction, the exact opposite happens wherein a Buyer wants to procure a product or service and invites Suppliers to bid for his/her business with the objective of pushing prices down. Unlike traditional auctions that occur at physical locations, reverse auctions are accessed online, through web browsers, or via private software companies. That is why they are also known as eAuctions. The software company facilitates the auction process and provides support, training, and all necessary software to suppliers participating in the bidding process.
Reverse auctions can be either open or sealed-bid. In a sealed-bid auction, after the buyer posts the RFQ, suppliers submit a bid within a stipulated time. Only the supplier and the buyer are aware of the details of the bid. The buyer reviews all the bids and either decides to award the contract or, if not satisfied, proceeds with another round of bidding. Most reverse auctions are of open-bid format. In an open-bid auction, once the RFQ is posted, a designated date and time is communicated to the Suppliers of when the reverse auction will take place. On the designated date and time, Suppliers log in to the software platform and start posting their bids. The bidding process has a fixed duration typically ranging from 2 hours to 6 hours. In this format, all the Suppliers can see the current lowest bid, and this creates a more competitive environment that encourages suppliers to outbid their competition.
Benefits of Reverse Auctions
Some of the key benefits of reverse auctions include reduction in purchase price, more efficient procurement process, fair and transparent process, and access to a global supplier base.
· Reduction in Purchase Price – as stated above, reverse auctions create an extremely competitive environment that encourages Suppliers to outbid their competition. This subsequent reduction in the purchase price results in procurement cost savings for the Buyer. Additionally, typically companies that use reverse auctions buy in volume and can take even greater advantage of cost savings. Lastly, because the reverse auctions are conducted at a much faster pace than traditional sourcing and negotiations, savings are realized much more quickly.
· Increased Efficiency in Procurement Process – Another significant benefit for both buyers and sellers is the improved smoothness and speed of the procurement process. Reverse auctions eliminate the multiple rounds of negotiations that typically take place in a traditional sourcing process. This also results in saving significant time of all the people involved in the process, leading to additional cost savings for buyers and sellers.
· Fair and Transparent Process – Open-bid reverse auctions are a very fair and transparent process as all the information and data is visible to all participants real-time during the auction. This is one of the key reasons why many Government Contracts and Tenders are awarded using reverse auctions.
· Access to a Larger Supply Base – With reverse auctions, bidding is not limited to those physically present as the technological capabilities removes geographical limitations and leads to global searches for the best price. It can also potentially increase the supplier base by providing an opportunity for small and new companies to compete.
Critical Success Factors for using Reverse Auctions
While reverse auctions have several benefits that have been explained above, it is critical to understand when the use of reverse auctions is beneficial. Following are some of the critical factors for the successful implementation of reverse auctions:
· Selecting the Right Product/Service - Reverse auctions are not suitable for all products and services procured by an organization. It is very important to select the “right” product and service that is appropriate for a reverse auction. We use the Kraljic matrix (developed by Peter Kraljic) to segment all the products and services in to one of the four quadrants (as illustrated below) based on two criteria – Risk of Supply and Business Impact. Reverse auctions can be conducted on Products and Services that are “Transactional / Routine”. These are typically “commodity” type items where Price is the only differentiating variable. Reverse auctions can also be conducted on some of the “Leverage” items on a case-by-case basis. Reverse auctions should never be conducted on “Strategic” and “Bottleneck” items. This is because when we do a reverse auction, we are basically telling the supply base that all we care about is the Price. However, for “Strategic” items the relationship with the supplier is very critical and for “Bottleneck” items assurance of supply is crucial.
· Prequalification of Suppliers – When we conduct reverse auctions, price should be the only differentiating factor amongst competing firms. Therefore, it is very important to prequalify the suppliers and only invite those suppliers to participate who meet all the other standards and requirements towards attributes as Delivery, Quality, HSE, Technology, etc.
· Have a Target Price – Before starting the reverse auction, the Buyer should have a target price in mind that they would like to achieve that is fair and reasonable to both parties. The target price can be established through either benchmarking or cost estimation. In many cases, suppliers underbid either to obtain the business at any cost or because they have not understood the buyer’s requirements. Awarding the contract to such suppliers is very risky because in most cases they are unable to execute the contract. The target price can help the buyer identify those suppliers that are underbidding and call them in for further discussions before deciding whether to award the contract.
· Fixed Specifications / Statement of Work (SOW) – Reverse auctions should only be conducted for products where the Design and Specification is fixed and for services where the Statement of Work is fixed. This is because the suppliers are quoting a price based on certain Specifications/SOW and if these change in the future, then the price is no longer valid and we get into discussions/negotiations regarding Variations to Contract, Price Revisions, etc. which can be very messy and time consuming.
In conclusion, application of reverse auctions has several benefits such as cost savings through reduction in purchase price, increased efficiency and greater transparency in the procurement process, and access to a larger supply base. However, if used incorrectly, it can reduce the suppliers’ trust and cooperation thereby jeopardizing long-term relationships. It can also have a negative impact on the other attributes such as quality, delivery, technology, and HSE.
Therefore, to get the maximum value and benefit out of reverse auctions it is very important to follow the Critical Success Factors highlighted above. This will ensure that we can reap the benefits of reverse auctions while minimizing the risks associated with it.
For more on Reverse Auctions and expert advise and guidance on how to conduct one successfully, kindly write to us at firstname.lastname@example.org and for more exciting updates on Cost Management, be sure to follow our Linkedin Page The Anklesaria Group .
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