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).

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.

(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.

Reverse Auction Types – SCM Digest

SCM Digest recently summarised a piece of mine from ISM magazine here: Procurement and Sourcing News: Understanding the Options for E-Auctions. In it I describe the main reverse auction variants.

In the first draft I used the standard names I was always taught: English, Dutch, Japanese. But ISM were uncomfortable with these names because of possible racial overtones and so I chose something far more dry: Bid Auctions and Clock Auctions.

At first I put this down to Political Correctness Gone Mad. But on reflection I think there is some value to the duller names.

1. I didn’t make these terms up. (Ascending/Descending) Bid  and (Ascending/Descending) Clock auctions have as credible a pedigree as English and Dutch auctions – certainly in the wider world outside of procurement. For example, when I was talking about possible auction formats with the UK government department tasked with auctioning Carbon Emission permits, the language we used was all about ascending/descending bid auctions and ascending/descending clock auctions.
2. Bid and Clock auctions don’t suffer from the ambiguity of terms like English and Dutch.  I come across many people who confuse Dutch and Japanese auctions. And even some who confuse Dutch and English.
3. This terminology does not run the risk of inflaming national prejudices. This is a very real issue – for example TradingPartners China is not comfortable talking to Chinese buyers and suppliers about “Japanese” auctions because of historical tensions between the two countries.

So I am definitely now increasingly in favour of the drier terms. To summarise the auction format types:

Reverse English = Descending Bid. Each supplier places a bid; these bids decrease over time.

Reverse Japanese = Descending Clock(*). The clock ticks down the price and suppliers must accept each tick to stay in the auction.

Reverse Dutch = Ascending Clock(*). The clock ticks up the price until a supplier accepts the price and wins.
(*) Clock auctions: Imagine a clock face that, instead of hours and minutes, has prices written on it. Apparently the original Dutch flower auctions did actually use a clock face with prices instead of hours and minutes.