Weird and wonderful traditional auction types

I’ve always thought that auctions work best if they carry on while bidders are happy to bid. Most offline (and online) auctions I am familiar continue until no more bids are received – just like the way the standard procurement reverse auction works.

On the other hand eBay is notable for always finishing an auction at a predefined time. This encourages bid sniping where potential buyers tactically try to wait for the last possible moment to get their best bid in. So I was fascinated and entertained to read in “The English Year” by Steve Roud about traditional buying auctions which rely on a fixed time to end rather than continuing indefinitely.

In a candle auction a candle was lit and bids were accepted until the candle went out. Or a pin would be put in a candle and bids would be taken until the candle burned down far enough for the pin to drop out. Apparently this was an officially sanctioned way of running auctions in the 17th century and Steven cites examples where candle auctions still take place in England (on the 6th of April at Tatwell, 13th December at Aldermaston).

Other weird and wonderful (to modern readers) auction types Steven cites are

• The Running Auction that takes place in Bourne, Lincolnshire on the Monday before Easter. This is to auction grazing rights on a piece of land, and bids are accepted for as long as it takes for 2 children to complete a 200 yard race, and
• An auction at Wishford in Wiltshire that takes place on Rogation Monday, also for grazing rights, in which “[b]uyers are summoned by the church bell, about fifteen minutes before sunset, and the parish clerk walks up and down between the church porch and gate while the bidding takes place. As soon as the sun dips below the horizon, he strikes the church key on the gate, and the auction is over”.

Looks like eBay’s approach has a good historical pedigree

The serious point, though, is that these types of auctions that tried to fix a specific end time eventually died out to be replaced by open-ended auctions.

Using auctions to save the world

Reading The Economist’s leader on Hank Paulson’s plan to save the US finance system.

Guess what – they’re planning to use auctions.

EU Carbon Emissions Scheme “isn’t working”

So claims a report by Open Europe just out and available here.

It’s a pretty hefty report – but here’s a quote for those with an interest in auctions:

[T]he ETS in phase one was not a real market – instead of auctioning off permits to pollute, member states allocated them free of charge to companies based on how many the government believed they needed. This created severe distortions. Large companies which lobbied for more permits than they needed were able to sell them on at a profit. Other institutions – particularly smaller institutions like hospital trusts – proved less effective at lobbying. They got too few permits and therefore had to pay into the system.

In other words, you would have got a much better result from the scheme if it had harnessed the power of a (well-designed) auction to create the market.

Whether buying or selling, (well-designed) auctions are the best way to allocate goods and services.

See also:

See also EU emissions trading scheme an ‘embarrassing failure’, think tank says
Source: www.edie.net.

Savings from Reverse Auctions

Aberdeen recently published (27 July 2007) a Sector Insight on the state of savings being generated across EMEA through the use of eSourcing technologies: EMEA: Advanced Sourcing Leads to Tangible Results.

This report quotes an average saving of 11.5% in North America vs 12.4% for EMEA. To me these figures look a bit on the low side, but hidden away on page 3 is an innocuous sentence that helps explain:

EMEA organizations are interested in e-sourcing event managed services (27%), supplier performance management programs (22%) and collaborative sourcing (21%); these technologies should further improve the realized cost savings.

 In other words, the single greatest factor for increasing savings is to invest in event managed services. Obviously that comes at a price – so organisations need to weigh up the value of managed services against the costs – but it is gratifying to see Aberdeen recognising that not all electronic reverse auctions are created equal, and that managed services increase the benefits of electronic reverse auctions.

Small plug: Coincidentally, this report from Aberdeen is out in the same week as my new White Paper: “Does Procurement eAuction Design Matter?” which gives a number of examples for improving the results from eAuctions. 

The Winner’s Curse and Reverse Auctions

The winner’s curse is an interesting (certainly it sounds interesting) feature usually discussed in relation to forward auctions – i.e. selling auctions. Basically it says that the winner of an auction is the one who has over-estimated the value of the item being auctioned.

This is how it works. It’s a very theoretical example but the point is not to be accurate, it is to illustrate a point:

5 companies want to buy an oilfield. They all have roughly the same technology at their disposal for estimating the amount of oil in the oilfield. They can all generate roughly the same amount of income from the oil. Theoretically some companies will under-estimate the value of the oilfield, and some will over-estimate.

Let’s say the oilfield is worth 100 units. Let’s say, that the oil companies have estimated the oilfield’s worth at 80, 90, 100, 110 and 120 units respectively.

Let’s now say that these 5 companies have been invited to submit sealed bids for the oilfield. And let’s say that they all bid 10 units less than the price they think it’s worth to them (so that they can make some profit), then you would get bids of 70, 80, 90, 100 and 110.

I know that this is a very simplified example – and I’m not going to go into digressions about net present value and the rates of return et al.

The point is that, when you are selling something that is worth roughly the same to everyone who is buying it, and you sell via a sealed bid, then the person who wins it is the one who over-estimated its value. In this example the company who estimated the value at 120 bids 110 and finds that the oilfield is worth 100.

That is the winner’s curse. Similar logic goes for normal “english” auctions as well.

But what about reverse auctions?

In a reverse auction, bidders (suppliers) are bidding down their margin. You would hope that bidders understand their cost structures, so would be unlikely to bid below their cost due to having under-estimated their cost. Of course, there are other reasons why bidders might bid below cost if they have particular strategic reasons for trying to win a particular contract. They would do this with their eyes wide open, though, so you can’t really talk of a curse.

If this is true (and I haven’t seen any serious studies on the subject) then it would mean that reverse auctions are even more efficient at allocating resources optimally than forward auctions.

Jargon

Was my father in law’s 65th birthday celebration over the weekend. I was hoping to go for a whole weekend without getting dragged into anything computer-related, and nearly did, except for the fact that he had a new digital camera for his birthday and needed to install the software on his PC for it.

The main thing that threw him was that the CD you have to install is called the Solutions disk. He had filed the CD away because he assumed it was for trouble shooting: He had assumed that the Solutions disk was for Solving problems.

Whereas any techie will tell you that solution is just a piece of meaningless jargon which can mean almost anything, but only very rarely does it actually solve anything. When a techie means solution, in the sense that everyone else understands it, they will more likely use the word resolution.

Don’t blame me, I didn’t invent the culture. I am convinced that the plethora of jargon is invented for the benefit of sales people – so they have something with a distinct name that they can sell.

However, from the buyer’s or user’s point of view the jargon is usually irrelevant, even misleading. SOA is an example doing the rounds right now (and I still don’t really understand it myself, or even particularly care). Web 2.0 is another.

Even in my own industry – the electronic reverse auction industry – the term auction has become a confusing jargon term. Sometimes it can mean a piece of software capable of running auctions, sometimes it can mean an event complete with suppliers, some times it can mean the whole process of negotiating a contract – from designing the specifications through to finally awarding the contract to the chosen supplier.

I suppose some of this is inevitable, and thankfully it’s not as bad as using obviously misleading language or meaningless neologisms. But it goes to show that even phrases that people can assume are commonly understood can have wildly different interpretations.

In other words: If the jargon doesn’t make sense, don’t think you’re dumb – it’s the jargon that’s dumb, not you. And also, even if the jargon does make sense – beware – because even common words can have very different meanings depending on who you are hearing them from!

How to run a bad electronic reverse auction

So  much seems to be written about how best to run an electronic reverse auction (including by yours truly) that I thought it would be entertaining to share some tips on what not to do.

The benefits electronic reverse auctions bring (clarity, rapid price discovery, low-cost sales channels for suppliers, etc) can be neutralised by managing them badly. Perhaps the simplest example is post-auction negotiations. It may sound counter-intuitive to recommend that buyers do not negotiate further on price after the auction finishes. After all, if there are a few $$ left on the table then why should the buyer leave them there? From a short-term perspective this is probably right. But from a long-term, economically sustainable perspective, this doesn’t work. As soon as suppliers wise up to this tactic they either refuse to take part in future auctions or they hold back in the expectation of post-auction negotiation. Bang, auction benefits neutralised for many years to come for that buyer.

Even eBay offers some basic advice to sellers on how to produce a listing and how to behave during and after an auction, so how much more important must it be for participants in $000,000 electronic reverse auctions to think carefully about their strategies in order to get the best result?

With that in mind, here are some top tips on how not to run an electronic reverse auction:

For the buyer (i.e. auction manager) 

1. Make sure the Invitation To Auction (or whatever you call it) is as vague as possible. Fit it onto 1 sheet of paper, max.
2. If any bidders ask for clarifications then don’t answer them. After all, it will be more fun if all the bidders think they are bidding for something different.
3. Don’t waste your time qualifying suppliers before the auction. You want to leave as much work for yourself after the auction as possible. And, hell, chances are you want to stay with your incumbent anyway so there’s even less point finding out if the other bidders are serious.
4. Don’t communicate with the suppliers during the auction. You wouldn’t want any good old fashioned negotiation to get in the way of the technology, would you?
5. Obviously you have no intention of changing suppliers, you are just running the auction with the intention of beating down your current incumbent’s price. So why not call the incumbent up after the auction asking them to match the leading supplier’s bid?
6. Or, if you have fallen out with your incumbent, then treat the final bid from the auction as a starting point for negotiations with your preferred supplier.
7. Don’t tell the bidder who came first in the auction that she hasn’t been awarded the business until at least 3 months have passed. Until then don’t answer any calls from the bidder asking for updates on the contract award process.

For the supplier (i.e. the bidder)

Remember that the buyer is only running the auction as an information-gathering exercise and has no serious intention to award the contract based on the auction results.

1. Turn up on time to show some willing and place a few bids if prompted, but otherwise just sit tight and watch the other guys. If you’re lucky you might not have to bid at all and you’ll end up finding out your competitors’ pricing. 
2. Make sure you wait until the auction is running before you ask any questions about the specifications or auction rules. Whatever you do, make sure that your interpretation of what you are bidding for is different to what the other bidders are bidding on. 
3. Whatever you do, make sure you don’t come first. After all, what’s the point?
4. Wait until after the auction then call up the buyer offering to negotiate offline, perhaps even matching the leading price. This way other bidders won’t be able to respond to your offer - isn’t that great?

The benefits of weighted auctions

Readers of this blog will have seen a few posts about the impact of new public procurement rules on the use of auctions.

Over the past year I have seen some pretty interesting results and I want to share a couple of illustrative examples. On the one hand these auctions can deliver increased savings (sounds counter-intuitive, I know, but it’s true). On the other hand these auctions can let higher quality suppliers win, even if they can’t compete purely on price.

Generalising, suppliers are either high quality/high price or low quality/low price. In your common or garden online reverse auction the high quality/high price supplier can’t compete on price with the low quality/low price supplier. This means that the low quality/low price supplier doesn’t have to work so hard to get into first place.

In a multi attribute or weighted auction, the quality is fed into the auction mechanism to produce a comparator score – this compares the total value of each offer. The winner of the auction is the one with the best comparator score, not necessarily the one with the lowest price.

The high quality/high price supplier ends up with good overall value for money, even if their price is relatively high. So a lower quality/lower price supplier has to bid far more aggressively on price than they would have done in a price only auction.

Two real-world anecdotes I’ve seen recently highlight what can happen when you start running these auctions:

1. An auction where the winner of the auction was the supplier with the highest price: Best value for money overall but highest price. The winner of the auction had a price about 10% above the lowest price in the auction, but because of their higher quality and better delivery they were able to win on a total value for money basis.

2. An auction where the winner of the auction was the supplier with the lowest price, but they had to compete very aggressively to match the overall value for money of the higher priced suppliers. The savings generated through the auction were 18% but if non-price factors had not been included into the auction then the saving would only have been about 12%.

Caveat: If this all sounds too good to be true, then that is because this kind of auction is hard work to set up. Additionally it is not appropriate in all situations. For example, if I want a 2 day lead time and I really don’t care if you offer me a 1 day lead time instead, or if I want trainers with 2 years experience at least and I really don’t care if you offer me trainers with 5 years experience then building in weightings for these attributes would be a waste of time.

The Trouble With Dutch Auctions

I am not a big fan of reverse Dutch auctions on the internet, from either the buyer’s or the seller’s point of view.

Dutch auctions were initially invented and adopted to speed up the sale of flowers in Amsterdam. Potential flower buyers would sit in a room which contained a clock. The clock would initially show a very high price – much higher than any flower buyer would be prepared to pay. The price shown on the clock would then tick downwards until it reached a price that one buyer was happy with. The buyer would press a button to “stop the clock” and could buy as many lots of flowers as they wanted at the price shown on the clock. If more flowers remained to be sold then the clock would continue downwards until all the flowers had been sold.

Software providers have adapted this kind of auction to internet procurement auctions, but the practical implementation leads a lot to be desired.

In a reverse dutch auction the price starts very low and gradually increases until a supplier “stops the clock” and offers to supply at the price shown on the clock. Apparently, the faster the clock, the more excitement and the higher prices would be (i.e. better for the auctioneer).

Of course, on the internet, you can’t legislate for the speed of bidders’ internet connections. So all implementations of online reverse Dutch auction that I have seen allow the bidder to place their best bid before the auction starts and then have the system work out when to stop the clock. The system gradually ticks upwards and eventually reveals the winning supplier’s bid to the buyer.

In other words, they aren’t auctions at all. There is no competition, no unleashing of those “animal spirits”, no nervous energy. In short, nothing of what makes auctions the best tool for allocating goods and services in a market.

As if that isn’t bad enough, the buyer only ever gets to see one supplier’s bid – so if there are any quality or other issues with that supplier the buyer is not able to switch to another supplier.

In fact, I am aware of one major retailer which has been updating its Dutch auction software to reveal all the suppliers’ bids. In other words they are turning Dutch auction software into Sealed Bid software.

The moral of the story – think carefully before running a Dutch auction on the internet. You’ll be running a second-class sealed bid. 9 times out of 10 the real solution would be to use a Japanese auction …. but that is a different story post.

eBay and auction integrity

Following on from my previous post bidancient’s eBay account is showing as “no longer registered”.

Very right of eBay to do this. Granted, despite bidancient‘s “Titanium Power Seller” size, he only ever contributed an imperceptible fraction of a percentage to eBay’s revenue, and so eBay are hardly going to be crying about his loss. But given the enormity of the allegations (shill bidding and fake goods, as alleged by The Sunday Times, are little short of fraud) it was right for eBay to take the opportunity to stamp out dodgy behaviour when it came to their attention.

Cynics might say that this behaviour definitely happens with other sellers, who no doubt also have excellent feedback scores, so why make such a fuss over bidancient? But that is to miss the point. It’s like saying “Theft happens, so there’s no point in punishing it when it’s discovered”.

The point is that eBay works because if you want to sell something, it’s worth doing it on eBay. Why is that? Because that’s where the buyers are. And why are the buyers there? Because they have faith in the integrity of the auction. Challenge the integrity of the auction and the market eventually falls to pieces. “Eventually” might be a long time for a company with a $44bn market cap – but it is heartening to see eBay taking this issue seriously.

This applies similarly to procurement auctions (subtle differences in legal definition of a sales and a procurement auction notwithstanding) because procurement auctions rely on suppliers taking part and competing and smart suppliers are not above walking away from an auction that they perceive to be dodgy.