Reverse Auction: Friend or Foe?
Procurement organizations have been using reverse auctions in sourcing events for decades as a means to reduce spend, introduce new vendors into the supply base and remain competitive in the market. While reverse auctions have flourished since the mid 1990’s, they have also been heavily scrutinized. Trends such as these have forced suppliers to adapt to competitive business practices or become inconsequential. As procurement tools become more streamlined, practices like reverse auctions are more commonplace in sourcing events; however, they continue to harbor negative connotations. Amidst this controversy, buyers and suppliers continue to see benefits, but the myths surrounding this mode of buying power prevail:
Myth 1 – Reverse auctions damage the buyer-supplier relationship.
Traditional stigmas surrounding reverse auctions often portray the buying organization as a villain preying on the competitive nature of suppliers vying for contention to successfully bid on a sourcing event. While this may have been the case in the early stages of reverse auction sourcing events, suppliers and buyers alike have become increasingly comfortable with the technology. Buying organizations will often alleviate any apprehensions a supplier is having about participating in the reverse auction environment by fostering communication between the firms, educating suppliers on the methods and tools used before a sourcing event takes place, and using 3rd party hosts to administer the event. Once the auction is complete, firms will publish results and ask for feedback to continue perfecting the process.
Myth 2 – Buying services are not suitable in a reverse auction platform.
Service providers often provide services that are more personal and more difficult to define than industries that sell goods, which elicits the idea that reverse auctions may be more challenging to define and potentially offend service providers. While reverse auctions are primarily used to procure commodities, with proper parameters and preparations in place prior to the opening of a sourcing event, savings on services can be achieved. The most successfully executed reverse auctions for services place a greater emphasis on the meticulous creation of the RFx and clearly define the details and scope of the buyer’s requirements. The service industries that often see the most positive outcomes using this platform include 3rd party logistics, marketing and advertising and warehousing. For a real time look at how the reverse auction process can benefit a services firm, see the graph below highlighting an actual sourcing event for a Travel and Expense Automated Software Solution. (Note that suppliers of this event were given a very comprehensive 100 question survey prior to the auction):
Myth 3: Reverse auctions only allow for a one-time cost savings.
Although historical data shows that the highest cost savings are realized when a buying firm enters a reverse auction for a particular good or service for the first time, there is incremental value to be gained beyond a first event. Over subsequent events, the firm will typically see their cost savings yields diminish. While this trend appears to negatively impact the buying party, the reverse auction process actually allows firms to discover the true current market price of goods and services. Not only does this type of procurement by buying parties influence future sourcing events in a positive way, it is an incredibly creative way to keep suppliers honest.
Myth 4: Price is paramount.
As with most sourcing events, the incentives associated with cost reduction and cost avoidance seem obvious. However, other motivational factors are buried in the notion that reverse auctions are all about the price. Champions of reverse auctions know that successes can be realized and measured in the relationships gained from quality suppliers that have not been identified prior to the sourcing event. Allowing competitive suppliers to participate opens the door for vendors that have not been considered before. Other non-price attributes leading to a successful reverse auction include building buyer-supplier relationships, reliability of delivery and discovering higher quality products and services. To highlight this idea, one buyer was quoted saying, “For me, a mere price reduction does not mean a successful auction. A successful auction entails that we have, besides some type of cost reduction, a good vendor that can service our needs, quality of service, and a vendor that is willing to work with us in order to have a relationship with us; for example, using electronic capabilities to enhance our relationship.” This argument is confirmed as we see buyers including terms in the RFx that explicitly state that the lowest bid will not necessarily be awarded the business.
The future of reverse auctions
Reverse auctions are here to stay. We continue to see an increase in the number of firms using 3rd party reverse auction hosting companies to add value to sourcing projects. There will continue to be use for this tool that is not primarily based around cost savings for purchasing organizations. In fact, buyers are using this tool in more sophisticated ways, ensuring that a larger supplier base is considered, the quality of goods and services are highly scrutinized and overall value is continually added to a firm’s purchasing power. This is being accomplished through detailed analysis and research preparation before an RFx is delivered to maintain consistently positive results. In fact, a former director of government affairs for a leading medical supplies firm, was quoted saying “Unless the requirements are extremely detailed and specific as to what they’re looking for, the [buying firm] is going to get a cheap price and probably a cheap-quality product.”
Reverse auctions will continue to benefit both buyers and suppliers alike, and will remain a prevalent option for a sourcing strategy of both goods and services. Reluctance to use reverse auctions could mean your firm will quickly fall behind. Organizations must continue to ask themselves, are reverse auctions a friend, or a foe?
Phil Przeklas is a Functional Implementation Business Analyst with Nitor Partners. Prior to joining Nitor, Phil held positions in sales, purchasing, logistics and materials control in the retail and automotive industries. He applies his experience and knowledge across the Source-to-Pay spectrum to help clients implement technology solutions, while maintaining business continuity and driving process improvements. Phil holds a Bachelors of Science in Fisheries and Wildlife and a Masters Certificate in Supply Chain Management specializing in Global Procurement, both from Michigan State University.