Reverse auctions, also referred to as procurement auctions, is where the role of the buyer and seller are reversed. In a reverse auction, multiple sellers compete concurrently to sell goods to the buyer and / or provide services to the buyer, with prices dropping as the sellers out-bid each other to win the contract.
As the Internet emerged, reverse auctions were popular as a buyer’s strategy to drive down the prices on widely distributed homogeneous goods. Auto makers saw reverse auctions as another level of competition for automotive parts suppliers. Initially, the reverse auctions did reduce the prices on parts – once. The second generation of reverse auctions found fewer suppliers wanting to sacrifice their profitability. It was the big bang theory which had a limited life span as a price tactic. Once a new bottom was found on the lowest cost, subsequent price reductions had to be designed out of the products.
Incumbent sources often found themselves competing against their own price model to retain the business. Reverse auctions are effective only where there is an adequate number of qualified suppliers, who want the business – with quality being a lesser concern to the buyer.
The e-Bay online model uses the traditional auction format with a fixed-time period. The highest bidder takes the lot. Many public organizations use this type of e-auction service to sell surplus goods. One municipality found a ten-fold increase in potential bidders using traditional e-auctions to maximize the return when disposing of its fleet of police motorcycles. The power of the online format efficiently allows a seller to make contact with global bidders.
ERAs are now being used to acquire goods and services.
Preparing for ERAs
Third party ERA service providers are widely available in the market to facilitate transactions. Reverse auctions may require some training to develop effective techniques for buyers and sellers involved in the online process. Due to the current infrequency of ERAs, third party service providers could be a viable option to stage an event.
Market intelligence on the part of the buyer needs to ensure there is a pool of competitors among the potential bidders. A puddle of competitors favours the sellers or will result in few, if any, bids – similar to most conventional RFX events. Again, third party service providers already have online presence to expedite the events and have services to target specific sectors and build competitive tension.
Reported savings on ERAs (per US-based eBridge)
Southern California Casino reported savings of 42% off their budgeted spend. In a 1 hour and 6-minute event, 234 bids were submitted with the lowest bid changing 59 times. The winning bid was 1.96% less than the 2nd place bid.
A South Carolina school district reported a 10% savings on a $5M annual food services RFP. The lowest bid changed 34 times over the event.
A North Carolina hospital and affiliated university reported $900K savings over 5-years for records management services. The ERA involved (3) bidders which were pre-screened and took 1 hour with 27 changes to determine the lowest price. The spread between the lowest and next lowest bid was 1%.
An Arkansas college reported a $300K savings (17%) for an RFP on custodial services through an ERA event. It took less than 1 hour involving 10 suppliers and 186 bids. The spread between the lowest and the next highest was 0.65%.
One Canadian niche market for the use of ERAs is the Police Auctions Canada. PAC sells goods on behalf of several Ontario police services, Toronto Transit Commission, and (3) universities. ERAs run 24/7.
Electronic auctions are permitted conditionally under the CFTA: Chapter 5: Article 514; CETA Chapter 19.13. The United Nations, under its Model Law on Public Procurement conditionally allows ERAs under Electronic Reverse Auctions: Chapter VI.
Various other international organizations recognize ERAs as tools for government procurement agencies to increase value for its stakeholders. As more international trade agreements emerge, standards of practice for the rules of engagement become more relevant for all parties to adopt.
In Canada in February 2018, the Ontario General Contractors Association went on record as saying that ERAs are a form of bid shopping and contravene Canadian procurement laws; ERAs provide no real return on investment; the OGCA cited a US-based study which also refuted construction cost savings through ERAs.
However, construction materials as a category are regularly purchased through ERAs.
Caveats with Electronic Reverse Auctions
- Know your market
- Know your lead time
- Ensure you have the expertise
- Use prequalified suppliers wherever possible
- Lowest cost is the objective – not better quality
- Don’t over use the practice
- Specifications should be explicit yet easily conveyed
- Be cognizant of supplier relationships
- An ERA often produces better results than other competitive options such as negotiations
- Can be effective within a centralized reporting structure
In summary, it is time to revisit the use of auctions and ERAs specifically. They are a tool which should be used judiciously – as we know, not every tool is a hammer. Used strategically, ERAs have their place in the market as another competitive tool to complement traditional bidding practices.
Larry Berglund | SCMP | MBA | FSCMA
Larry has been in the supply chain management field as an author, manager, business trainer, academia, and consultant for many years. Larry has worked in both the private and public sectors. Recently he has been co-facilitating NECI eSeminars, classroom sessions, and online modules. His new book, Good Planets are Hard to Buy is now available on Amazon.
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Readers are cautioned not to rely upon this article as legal advice nor as an exhaustive discussion of the topic or case. For any particular legal problem, seek advice directly from your lawyer or in-house counsel. All dates, contact information and website addresses were current at the time of original publication.