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.

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