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.

Can e-auctions help with … ?

I was visiting a client recently who was asking the usual questions about reverse auctions: I can understand that they work for a very commoditised category which I have a high spend for, but how can they help with this more strategic strategy?

I hear this question so here are some brief thoughts.

Reverse auctions are helpful if you want to achieve a better price than what you can achieve otherwise. If you don’t care about getting a better price, don’t consider a reverse auction.

Of course auctions these days are far more sophisticated than the old price-based systems. Weighted and Multi Attribute auctions are capable of incorporating all kinds of non-price attributes into the competitive dynamic. With this in mind I’ll revise what I just said:

e-auctions are helpful if you want to achieve better value for money than what you can achieve otherwise. If you don’t care about value for money, don’t consider an e-auction.

Once you consider an e-auction there are some factors that could rule it out:
(a) Monopoly. If what you are buying can genuinely only be got from one source then, sorry, you can’t do much about it. But I wonder whether, with a little imagination, you can change the specs to some degree to allow competition? Just a thought.
(b) Unable to specify what you want. The EU directive on public procurement puts it well: You can’t auction the result of intellectual endeavour. In English, this means that you couldn’t auction the design of a building. But guess what, you can auction architect day rates. So, again, with a bit of imagination you might be able to specify what you want in such a way that it does become auctionable.
(c) You know and love your favourite supplier too much. Fair enough. But bear in mind that despite all the talk about “win win” that is in vogue these days, the supplier might just be taking a teensy bit of advantage

A personal perspective: I have been negotiating two contracts recently – one for software development and one for hosting. I used a weighted e-auction for the software development but elected to source my hosting offline. The offline negotiation has been much more of a pain in the arse for me than the online e-auction. I dare say that the suppliers feel likewise. Next time I will use an e-auction, if I can.

Reverse auction: it really doesn’t have to be just about price

I’ve seen a lot of auctions that take into account price and non price factors in the uk public sector. This is because since January 2006 public sector buyers who use auctions must award the contract to the person who comes first in the auction.

Whether it’s Consultancy workers on a 35% price / 65% non-price basis, or electricity on a 90% price / 10% non-price or temporary workers on a 60% price / 40% non-price, these kinds of auction have become pretty much business as usual in the UK public sector.

The private sector has been very slow to adopt this kind of methodology. Private sector buyers prefer to run auctions just on price and then to work out the details of how to make the award afterwards.

There are strong arguments on both sides of considering non price attributes during an e-auction. The significant benefit is that it levels the playing field amongst suppliers, letting them compete at what they are best at and producing a result that (in theory at least) is more easily implementable. Yet it is more work up front. And there does seem to be a perceived “lack of control” amongst some buyers of letting suppliers know this much information.

So it’s noteworthy when a private sector buyer chooses to build in non price factors. We had one such example a few weeks ago, for rental cars.

The potential suppliers were adamant that they would not take part in a reverse auction because they felt competing purely on price was not appropriate.

So the buyer built a dynamic rfp that weighted the participants 80% on price and 20% on non price.

In contrast to a price only auction that typically lasts about 1.5 to 2 hours, this was left open over a 24 hour period.

The potential suppliers could log in at any time to see their overall ranking, taking overall value for money into account. Value for money included other elements of the suppliers’ offers, for example: the percentage of hybrid vehicles in the fleet, the number of on-airport locations, reporting capability, percentage of cars with GPS, number of VIP memberships available, etc.

The result: the openness generated sufficient competition to achieve greater savings than the buyer had thought possible.  Don’t be surprised with this result. Many of this kind of auction I’ve seen have helped the buyer achieve increased savings.

The benefits of weighted auctions

Readers of this blog will have seen a few posts about the impact of new public procurement rules on the use of auctions.

Over the past year I have seen some pretty interesting results and I want to share a couple of illustrative examples. On the one hand these auctions can deliver increased savings (sounds counter-intuitive, I know, but it’s true). On the other hand these auctions can let higher quality suppliers win, even if they can’t compete purely on price.

Generalising, suppliers are either high quality/high price or low quality/low price. In your common or garden online reverse auction the high quality/high price supplier can’t compete on price with the low quality/low price supplier. This means that the low quality/low price supplier doesn’t have to work so hard to get into first place.

In a multi attribute or weighted auction, the quality is fed into the auction mechanism to produce a comparator score – this compares the total value of each offer. The winner of the auction is the one with the best comparator score, not necessarily the one with the lowest price.

The high quality/high price supplier ends up with good overall value for money, even if their price is relatively high. So a lower quality/lower price supplier has to bid far more aggressively on price than they would have done in a price only auction.

Two real-world anecdotes I’ve seen recently highlight what can happen when you start running these auctions:

1. An auction where the winner of the auction was the supplier with the highest price: Best value for money overall but highest price. The winner of the auction had a price about 10% above the lowest price in the auction, but because of their higher quality and better delivery they were able to win on a total value for money basis.

2. An auction where the winner of the auction was the supplier with the lowest price, but they had to compete very aggressively to match the overall value for money of the higher priced suppliers. The savings generated through the auction were 18% but if non-price factors had not been included into the auction then the saving would only have been about 12%.

Caveat: If this all sounds too good to be true, then that is because this kind of auction is hard work to set up. Additionally it is not appropriate in all situations. For example, if I want a 2 day lead time and I really don’t care if you offer me a 1 day lead time instead, or if I want trainers with 2 years experience at least and I really don’t care if you offer me trainers with 5 years experience then building in weightings for these attributes would be a waste of time.

EU Bureaucrats in sourcing innovation shock

So there I was last week having an email conversation with a client about the algorithm needed to relected the split of 70% price/30% non-price they were applying in their sourcing decision for IT hardware, and how this split would be reflected in their e-auction.

This was all being driven thanks to the EU Directive on Public Procurement, written into English law as the Public Contracts Regulations 2006. They state that, if non-price elements are to be used in the decision-making process then a precise weighting (i.e. a number) must be assigned to those elements. No room for fuzzy subjectivity – a sourcing decision under these regulations has to be fully transparent and objective.

This is particularly relevant where e-auctions are concerned because the final contract award decision should be made immediately after the e-auction, with the supplier who comes first in the e-auction being the supplier to whom the contract is awarded. So supplier bids may need to be modified to take into account different quality/ethical/delivery etc attributes amongst bidders.

It’s great news for competition because it means that all suppliers are bidding on a level playing field – coming first in the auction is a prize worth competing for, and coming first means you have the best overall offer (as distinct from having the lowest price).

It does mean buyers have to become more sophisticated than perhaps they were in the past, to be able to make decisions like the 70/30 split this post started with – this will come as good news to some and bad news to other. Though the expectation is that once they get over the initial learning curve, buyers will see that this kind of approach to an e-auction is no more and no less than best practice in procurement.

So far indications are that suppliers prefer e-auctions that take into account non-price factors – see an article I wrote for Industrial Distribution about multi attribute auctions earlier this year. I’ll post more about experiences with these kinds of auctions, but in the meantime let’s raise a glass to those unlikely innovators and implementors of best procurement practice: the suits in Brussels!