Analysis of an e-Auction

It’s often worth having a look at particular cases of reverse auction design and see what was done well and what could have been done to improve the result further. In this post I will look at an auction for a couple million $ of packaging materials.

Some key aspects of the auction design were done exceptionally well, credit to the CPO and the buyer:

  1. All bidders were credible potential suppliers. They were all known suppliers who the buyer would do business with.
  2. Switching costs had already been factored in so the suppliers were all bidding on a completely level playing field.
  3. What if scenarios were used, in other words bidders were able to offer pricing against different specifications.
  4. The buyer was clear that no post-auction price negotiation would be entered into. In other words, bidders had to put their best price in the e-auction rather than hold back for further haggling after the e-auction.

In summary, the buyer had done all his homework up front and run a well managed process, and so is now well placed to award the contract quickly and start achieving the savings identified in the auction.

However, an even better result could have been achieved if the buyer had managed to address some of the following items:

  • Invite more suppliers from low cost countries. In this case there was one Chinese supplier taking part in the auction plus a handful from Eastern Europe. The Chinese supplier was not faced with much competition, even on a TCO basis. This is an important point to remember and is a much more general point than one specifically about Chinese suppliers. While some believe that all you need is 3 or 4 suppliers to get enough competition going, the reality, as I keep repeating, is that you need 3 or 4 suppliers who share a similar cost base in order to stimulate the competition. The challenge, obviously, is to make sure that new suppliers from low cost countries are pre-qualified rigourously.
  • Start the auction at a pre determined entry bid level rather than having suppliers offer their own pre bids. Auction professionals are very aware of “killer bids” in which one supplier makes an extremely low bid in order to put the other suppliers off competing. Better to have all bidders make regular, small bids to keep the competition going.
  • Show suppliers the current best bid rather than their rank. This is only practical where all suppliers are starting from the same entry bid level, but when it is used, suppliers have something to aim at and encourages more aggressive bidding activity.
  • Play a more active role during the auction itself to encourage bidders to bid to the best of their activity during the auction. Some people believe that an auction is a purely technical exercise that magically makes suppliers bid to the best of their abilities. However, the reality is that human interaction is key:
    • Bidders are humans too and prefer to deal with a human being rather than with a machine.
    • Bidders often make incorrect assumptions in their bidding (e.g. if I am competitive in lots 1 and 2 then I don’t need to be competitive in lot 3 because the buyer is bound to single source). Skilled auction managers can spot trends in bidding behaviour and encourage more aggressive bidding across all items in an auction – just like their counterparts in traditional sales auctions.
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