Does Procurement eAuction Design Matter? (part 3)

I’ve used 2 slides so far introducing e-auctions in general and outlining why you would want to run an e-auction and how different e-auction types will

The next 5 posts (including this one) will outline 5 different tips that buyers should consider when running their sourcing projects to maximise the benefits from e-auctions:

One of the highest savings I have ever seen in an eAuction was the one we achieved for waterproof matches for an arm of the UK’s Ministry of Defence. They had been spending about £1.5million a year on these. The eAuction identified savings of just over 75%.

Is this because eAuctions are some kind of magical system to achieve ludicrously low prices which are probably then going to be unsustainable by the suppliers?

No. Well not in this case anyway. Why will become clear later on.

In this case the buyer was strategically sourcing this category for the first time in a long time. During the process he discovered that his organisation was buying matches in boxes of 17. It turned out that manufacturers these days make them in boxes of 25. So they buying organisation was paying for someone to unwrap the boxes of 25, take out 8 matches and then wrap them back up again.

The buyer did some investigation: Was there a particular army regulation that stipulated that a squaddie can only have 17 waterproof matches in a box at a time? Are more than 17 matches in a box likely to light themselves spontaneously, and

So this is the first tip out of my five tips is: Revisit your specs, talk to the suppliers about the specs, make sure the specs make sense and make sure the suppliers are clear on the specs.

This is arguably a strategic sourcing issue as much as an eAuction issue. But there are two reasons why this issue relates particularly to eAuctions:

1. For an eAuction to be successful, all suppliers need to be bidding on a level playing field. One element of having a level playing field is having clear specificiations. While strategic sourcing best practice might be to have clear specs when you go to market, an eAuction forces you to adhere to this practice.

2. If you make such a fundamental change to the specifications as happened in this case, then how do you know what the market price really is? You don’t, and the only way you will find out is by running an eAuction. Without an eAuction in this case you could almost guarantee that the suppliers would offer some level of discount, but would not have offered anything like the 75% achieved in the eAuction.

I know that there are some buyers who are afraid of running eAuctions because they don’t want to generate “too many savings”. They want to “save some for next year” and/or are afraid of being asked by their boss to explain a large saving: “so what have you been doing for the past 2 years?” Both of these may make sense from an individual buyer’s perspective, depending on their individual targets. But they are not the way to achieve real game changing results for the buying organisation. So double praise to the buyer in this instance for challenging old assumptions, engaging with suppliers and achieving such a tremendous saving as a result.

For completeness, here is the slide I used for this story. This one did bring me back in line with the 10/20/30 rule.

Auction Tip Specifications

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Does Procurement eAuction Design Matter? (part 2)

You’ll be glad to know that this post is shorter than part 1. On this slide of the presentation I broke the 10/20/30 rule by using bullet points and font sizes of 14 – 16. Oh never mind.

Not all eAuction designs are created equal. Choosing the right eAuction type is an important step in maximising the benefits you can achieve from the event. Here are 3 examples I often use:

Hygiene Services

  • Saving from RFI only: 17%
  • Suppliers did not know there was going to be an auction involved
  • Saving from RFI + Auction: 39%

In this case a potential client had already run their own sourcing exercise, achieving a 17% saving for Hygiene Services. TradingPartners was challenged to see if an eAuction would do better. To cut a long story short, the eAuction did much better, increasing the 17% saving to 39%. Now, in theory the buyer may ,have been able to negotiate some slight increase in savings beyond the 17%, but would not have been able to get to the 39% saving level without an eAuction.

We see this time and again with eAuctions: With open competition you get a better result than through doing your sourcing offline.

Consultancy Services

  • Saving from a normal Reverse English Auction would have been about 12%
  • Run as a Weighted Auction and so delivered saving of 18%

This auction was the first one run in the UK under the 2006 procurement regulations. These regulations state that, if an eAuction is used in the public sector, then the winner of the auction must win the contract (with certain caveats). These regulations have driven increased adoption of weighted auctions. Interestingly enough, weighted auctions often achieve greater savings than would be possible under simple English price-only auctions. This is because they do a very good job of levelling the playing field amongst higher price/quality and lower price/quality suppliers. And is another reason why weighted auctions should be used far more by buyers than what is currently the case.

Levelling the playing field amongst suppliers by using weightings improves the results for both buyers and suppliers

Dairy Products

  • Saving from a normal Reverse English Auction would have been at most 5 – 6%
  • Run as a Japanese Auction and so delivered saving of 12%

I still remember fondly the first Japanese eAuction we ran in the back end of 2005. The market place for this category at the time was very tight. So an English eAuction wouldn’t have been a great choice. So we ran it as a Japanese eAuction and got a dramatically improved result. Again, you can speculate that with judicious messaging, for example, you might have been able to achieve more than the 5-6% savings we calculated would have been achieved under an English auction. But again, an English eAuction would never have been able to achieve this increased level of saving.

Use particular auction types (e.g. Japanese or Multi Directional) when the market conditions dictate

Does Procurement eAuction Design Matter? (part 1)

In my last post I outlined the presentation I gave at eWorld in Feb, which went down very well, and so for the next few posts I will be posting up some of the main slides with some commentary.

Procurement eAuctions, as we know them today, really took off in the mid 90s. Back in those early days, behind the sales and marketing spin, reverse auctions were pretty basic tools most suited to simple commodity items for which price was the most important (if not the only relevant) factor. eAuctions have moved on dramatically over the past decade and are now capable of delivering significant benefits to buyers across an ever wider range of categories.

Reverse eAuction Family Tree

(click to enlarge)

The Reverse eAuction Family tree shows how eAuctions have evolved over the past decade.

Before I dive into the different types of eAuction shown, a word on terminology. The vast majority of academic study and thinking about auctions has been based around auctions used for selling goods or services. In these auctions a seller puts something up for auction and potential buyers place bids, with one buyer being awarded the goods or services at the conclusion of the auction. The same theories and practices could apply equally well in procurement auctions. But in these auctions a buyer puts something up for auction and potential suppliers place bids. In other words the roles of buyer and seller are reversed in a procurement auction. Hence the name reverse auction. As you’ll see, the term “reverse” does not apply to the price going down, because under some reverse  auctions the price can actually go up!

To return to the evolution of eAuctions. A decade ago almost all “reverse auctions” used the same broad format. This has now come to be known as the Reverse English eAuction. In a Reverse English eAuction the price starts at a particular agreed level and then potential suppliers place lower and lower bids to drive the price down. This is still the most popular type of auction format today, but it does rely on 4 or more suppliers who share a similar cost base in order to be successful. About 90% of TradingPartners’  eAuctions in the private sector are English eAuctions. The buyer is careful not to guarantee awarding the contract to the lowest priced supplier because the lowest priced supplier may not offer the best value for money overall.

There is another offshoot of Reverse English eAuctions called Multi Directional eAuctions. Multi Directional auctions allow some elements to be bid downwards and others upwards at the same time. These are particularly useful where suppliers can bid a unit price downwards and a rebate upwards. Many TradingPartners’ auctions for office supplies use the multi directional format because rebates are a common feature in this category.

Where competition amongst suppliers is likely to be limited, or where cost bases differ dramatically across suppliers, or where the buyer does not want to share market pricing information amongst suppliers, Japanese eAuctions are a good alternative. In a Japanese eAuction buyers set a price level and suppliers have to accept to supply at that price level or to withdraw from the auction. As long as one supplier has accepted a certain price level the buyer then decreases the price level, inviting suppliers again to accept or withdraw. Suppliers do not know how many other companies they are competing against. At TradingPartners about 10% of auctions use the Japanese format.

Reverse Dutch eAuctions follow the opposite method compared to Japanese eAuctions. In a Dutch eAuction the buyer sets an initial price that is very low, too low for any supplier to supply at. The buyer then gradually increases the price until one supplier agrees to supply at the stated price. The auction then ends. Forwards Dutch Auctions work well for selling (in particular, some successful IPOs have used a variant of a dutch auction). But Reverse Dutch eAuctions don’t work well in procurement. One main reason is that the buyer only ever sees the price from the lowest priced supplier, so if there are any issues with that supplier’s quality (for example), the buyer does not have an alternative source of supply to hand. In fact, I recall talking to a major retailer who had updated their Reverse Dutch eAuction software so that it acted the same way as a Sealed Bid: accepting price proposals from suppliers and then revealing them all to the buyer. In practice this is the way to go: don’t do Reverse Dutch eAuctions on the internet. You will be better off doing either a Sealed Bid or a Japanese auction, depending on the circumstances.

In the EU public sector, regulations came into force in January 2006 that stated that: if a buyer was to run a reverse eAuction, the buyer would need to award the contract to the supplier who came first. This left public sector buyers with two choices:
(a) Qualify out all but a tiny minority of identical suppliers amongst whom price is really the only differentiator, and then award the contract to the one of these who comes in with the lowest price during the eAuction, or
(b) Calculate weightings and incorporate those into the eAuction so the supplier who comes first is not necessarily the one with the lowest price, but is the one with the best value for money.

Enter Weighted and Multi Attribute eAuctions. These auction types incorporate non-price factors into the auction so that the buyer can award a contract, say 60% on price and 40% on quality and see the real positions of the different suppliers, on a total value for money basis, in real time during the auction. About 60% of the UK public sector eAuctions facilitated by TradingPartners have used these kinds of weighting. The rest tend to be English auctions.

Unfortunately, traction for weighted auctions outside of the EU public sector is very low, perhaps because it forces buyers to think through their award process up front rather than waiting until after the auction.

This is already a long post for a blog, but I hope it has given you an overview of the richness of the contemporary eAuction landscape. In my next post I will discuss how judicious use of these different auction types has helped buyers achieve better results in their sourcing projects.

eWorld reprise: eAuction Design Introduction

Thanks for all of you who came to the TradingPartners talk at eWorld last month. I’ve just seen the feedback and was blown away by the response. 5th out of the 21 “particularly good” presentations (not sure how many presentations there were in total). Obviously the big names Hackett came first, trailed by Oracle and CIPS. CombineNet did just marginally better than us. Which is all very cool. Good to see eAuctions becoming a topic of interest again. So thanks again to everyone who came and who left feedback.

With this in mind I figured I’ll post up here some of the key pieces from the talk over the next few days which will hopefully help you to some degree with your own sourcing (and auction) exercises.

Incidentally, for the presentation geeks amongst you: This was my first attempt at using Guy Kawasaki’s 10/20/30 rule. Briefly this says: only use 10 slides, talk for 20 minutes and don’t use any font size smaller than 30. How did I do? Well, I did use 9 slides. I talked for a little over 20 minutes. And most of the time I used massive fonts. It was a lot of fun to do it this way – I think I’ll carry on aiming for this approach because it forced my to be more interesting. One more thing that I did, which I heartily recommend: give your talk to your wife/husband/etc. Until you get it right.

Go Go Ninja Dinosaur

The friday before Easter (good Friday) is a national holiday in the UK. Seeing as I’m awake anyway and on my laptop, here’s a completely non-work-related post.

It’s great having a friend with good taste in music. Mine came to visit recently and gave us a copy of Colours Are Brighter . This is an album of music for children, but by “proper” bands. With profits going to charidee. It makes a refreshing change from Noddy etc.

It’s got the likes of Four Tet doing a great track called Go Go Ninja Dinosaur. And Belle and Sebastian doing a song about monkeys breaking out of a zoo. And a song about tidying up. And an epic Divine Comedy track about Winnie The Pooh.

Particularly poignantly for me (as I am sure will be for any fathers who work away from home from time to) is Snow Patrol doing a song called “I am an astronaut” which goes like this:

I am an astronaut
I am an astronaut
Daddy’s away and Mum’s asleep and
I am an astronaut

Lucian (coming up to 2 years old) isn’t too keen on Snow Patrol but is a sucker for the Franz Ferdinand track on there, Jackie Jackson.

For those of you who can’t wait to check out the album here is the cute animation for (a shortened version of) Go Go Ninja Dinosaur.

(On a slightly more adult note, he also got me Burial’s 2nd album which is also excellent – like DJ Shadow does UK Garage)

Bubble 2.0 investment advice from The Undercover Economist

Tim Harford’s book “The Undercover Economist” is a great read for those interested in everyday economics: from how the price of a cappuccino is set to why some aid projects in developing countries work and others fail and even dedicates a very readable chapter to one of my favourite topics: The 3G license auctions carried out in 2000-2001. But it’s his insights into the economics of transformational industries (like the internet) that I want to talk about here.

He talks about a particular transformational technology: the train, and about a bet he had with a fellow economist about the merits of investing in one of the major UK railway companies, Great Western Railways, when they went public in 1835. Tim thought you’d make more than a 10% annual return over the long term. The other economist believed the return would be lower than 10%. Tim lost the bet.

Not long after the Great Western Railway shares were put on sale for £100 a share in 1835, there was a tremendous burst of speculation in rail shares. Great Western shares peaked at £224 in 1845, ten years after the company was formed. Then they crashed and never reached that level again in the century-long life of the company.

Turns out you’d have got a 5% annual return over the long term. And this was in one of the successful companies.

So even the best rail companies weren’t great investments and the worst were financial disasters. But nobody disputes the fact that the railways completely transformed developed economies. Conservative estimates are that they added 5 – 15 per cent to the total value of the US economy by 1890 – a staggering amount when you think about it. But competition to build and operate railway lines kept profits modest. As long as competition is strong, the railways had little scarcity power.

Fast forward nearly 200 years and Tim goes on to ask 

whether, as [internet 1.0] bubble valuations suggested, company profits will really be so dramatically much higher in the next few years. It’s tempting to think that this is an argument about the power of the internet, mobile phones, computers and other recent technological advances. Many internet fans did indeed argue that it was reasonable to pay an enormous amount of money for a company like Amazon because the internet was ‘transforming everything.’

Unfortunately, that is not the point. Maybe the internet really is a transformational technology like electricity, mass chemical production or the railways. The answer will emerge over time but that answer does not actually matter much for the stock market. The hidden premise is that if we are in an economic revolution, shares should be valuable. This premise is wrong. Shares should rise in price only if there’s good reason to think that  future profits will be high. As we know, profits derive from scarcity; for instance, ownership of scarce land (protected by legal title), a scarce brand (protected by trademark) or an organisation with unique capabilities (protected by nothing more than the fact that most effective organisations are hard to copy). So share prices should rise only if economic transformation increases the degree to which organisations control scarce resources.”

The attempt to control scarce resources is why so many internet companies’ business plans revolve around getting as much market share as possible. Build the user base first and then figure out how to monetise it. (PayPal apparently used to pay $10 for each new member who signed up; their main competitor $5). This policy has worked for some companies but not for all. Business history is littered with usurpers taking over the crowns of previous incumbents. In 1996, Yahoo looked unassailable as the leading search provider. No-one could have foreseen Google eating their lunch. In more recent times MySpace was also a poster child for some time only to be eclipsed by Facebook.

Tim does make one concession to the tech space: eBay. A marketplace like eBay can only be successful if it collects many buyers and suppliers together in one place at the same time. That fact might make it very sticky as a business model. But even that should not be taken as read. Look at the eBay backlash going on at the moment  with former PowerSellers looking for alternatives like http://www.onlineauction.com/ and http://www.ecrater.com/ and http://www.amazon.com or even just relying on their own web presence and hoping for shopping search engines like Froogle and price comparison sites to send traffic their way.

Which brings me back to Tim’s analysis. The internet is transformational. Broadband is transformational. Web 2.0 is transformative. Web 3.0, 4.0, 5.0 and 94.0 will all doubtless be transformational. But that does not mean that the companies providing the transformational technology are themselves valuable. It might even mean that all investment in these transformational companies is  speculative and symptomatic of a bubble. That each new iteration of Web Something Point Zero will be accompanied with its own rapid boom and bust. That the real value is not going to be realised by the companies providing the transformational technologies. That the real value is going to be realised by the economy as a whole: By the freight company able to route trucks more efficiently; by the retailer able to source products faster and cheaper; by the bank that is able to target services better to its customers. Not by the company building the website technologies. Oh lookee here at Jeff from Venture Chronicles on VCs losing interest in Web 2.0 companies.  (An aside. Ariba:  The 800lb gorilla of “my” space – the B2B procurement space – have they ever actually been profitable?). 

This doesn’t make comfortable reading (or writing) for someone who works in the technology space. But I do think that Tim Harford’s analysis is worth taking the time to understand, rather than brushing it under the carpet because it is uncomfortable. Certainly it helps focus the mind that any company in the technology space that wants to be around for the long haul needs to figure out where the scarcity is in what it is doing, and how it is going to profit from that scarcity. Look at the list of exciting startups here and here and figure whether there really is some control of scarce resources behind the crazy names.

Enough doom-mongering for one day. Till next time.
 

Multi Attribute For The Masses

Now this is cool.

Taking the Expedia/Kayak thing to a whole new level is InsideTrip.

It is a travel site that uses non-price attributes to work out the overall quality of your plane trip, including such elements as leg room, travel duration, gate location etc. Read more at TechCrunch.

OK, so there’s no dynamic negotiation going on amongst the airlines on the site (yet). But the idea of factoring in non-price attributes into an online shopping site is the same thing we do in the B2B space with factoring non-price attributes into sourcing decisions. Though we don’t do enough of it.

I tried out the site with my next Chicago trip. It gives British Airways a higher score than American (definitely agree on that). But gives Virgin the same kind of score as American – though I have heard that Virgin is better than BA. As it happens I’m breaking a long-time BA habit to go with Virgin this time round so will see for myself whether their rating algorithm works for me.

But even if it doesn’t – that’s not a big deal. This is only the second such application I’ve come across. The other one was a hotel-booking site (which I can’t unfortunately find my reference for). The hotel application struck me as overly academic. But InsideTrip is a more exciting consumer-driven usage of multi attribute concepts, and demonstrates how straightforward and intuitive multi attribute buying can be made. More consumer-driven lessons for the B2B industry.