On Reverse Japanese Auctions

Paul Ferraro recently left a comment asking about reverse Japanese auctions.

I can only scratch the surface in a single blog post, so if you’d like to discuss this more then please leave a comment and we can continue the conversation. Also – I run workshops at TradingPartners every month (and also occasionally at CIPS) so if you want to dig further into different types of reverse auctions feel free to drop me a mail.

In brief the question was: “Are reverse Japanese auctions only appropriate when there is a small number of suppliers bidding?”.

Briefly the answer is “In theory a reverse Japanese auction will work just fine, all the time. But in practice you’re best off keeping to Japanese auctions where there are fewer suppliers.”

Some initial comments regarding reverse Japanese auctions:

1. I once saw an eAuction manager just after he’d run a reverse Japanese auction with 8 suppliers in. Haggard is a good way to describe him. The reason is that you have to collect up to 8 bids at each price level before decreasing the price. What with internet connections, technical issues at the supplier side etc you can pretty much guarantee that one supplier will need additional coaxing and assistance to prevent them from missing a price decrement. A reverse Japanese auction can be pretty hard work for the eAuction manager to run because it relies on the eAuction manager to drive the competitive element.
2. I was talking to a UK body recently who are intending to run a reverse Japanese auction on a supply base of 200 suppliers (due to the vagaries of the category). I hope that with a bit of investigation a better way of running this auction as a reverse English auction will transpire.
3. We are seeing a lot of success with reverse Japanese auctions at TradingPartners but I do wonder sometimes whether weighted auctions would be better in some of the cases where a Japanese auction was used. (e.g. in my example below where you could apply a weighting to reflect switching costs).

But to get back to Paul’s questions. I’ll use a highly simplified example to illustrate what I mean when I say that reverse Japanese auctions are most appropriate when there are fewer suppliers:

Suppose you have 2 potential suppliers, Incumbent Supplier and New Supplier. You are currently buying from Incumbent Supplier and she knows full well that it is going to cost you about €30,000 to switch supplier, not to mention the hassle factor involved from your side of things if you have to switch. New Supplier, on the other hand has no idea of what these numbers are.

First let’s run this as a reverse English auction, with an opening price of €400,000.

New Supplier wants to win the business so places a bid of €390,000 early on in the auction. What happens next? Incumbent Supplier won’t bid – she knows the business is still safe with her. Nor will New Supplier bid more aggressively – he thinks he’s in the lead. So the auction ends, Incumbent Supplier keeps the business and New Supplier is left with a bitter taste in his mouth about this whole auctions business.

Now let’s run this is a reverse Japanese auction, again with an opening price of €400,000.

Buyer drops the price to €390,000. New Supplier and Incumbent Supplier both have to accept this price level, without waiting to see who else accepts first. And they both know that they need to accept the price level to stay in the auction. They both accept. The buyer then drops the price to €390,000. etc etc.

Now let’s change the scenario. Instead of 2 potential suppliers there are 20 potential suppliers. Even in a reverse English auction you’ve now got sufficient competition amongst all the suppliers to encourage competition and to bring the incumbent into that competition

Obviously the example above is a trivial but I hope it gets the general point across – that reverse Japanese auctions are most use when you have a small-ish number of bidders. (In reality you might use messaging, for example, to stimulate competition even with only a small number of suppliers).

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