Reverse Auctions: Quantifying the Savings Delta

September 17, 2008 5:02 AM | Categories: Spend Management

There's been quite a bit of discussion of late around the value of reverse auctions. Considering that CAPs says that their usage is down and anecdotally, I continue to hear more companies are using them as an exception and not the rule, it's logical to conclude that interest in them has peaked (at least for now). But as someone who has played a role in many bidding events over the years, I still believe they have a critical place in certain market environments, however difficult it can be to quantify their value.

Hopefully this task just got a bit easier . Over on E-Sourcing Forum, David Bush recently posted a case study which does as good a job as any at showing the incremental value an auction can bring on top of other negotiation techniques. David sets up the situation by describing a "control" environment that is not optimal from a supplier relationship perspective because of a case of supplier double bidding jeopardy. David notes that "a mid-level buyer had gone out to market with a formal RFP and finished negotiations with the vendors with some award recommendations. At this point, the VP decided he still wanted to test the reverse auction, despite the internal communication problem. After some smoothing over with disgruntled suppliers, the auction process started and submitted final bids were used as preliminary bids in the auction."

The results for this market which encompassed some $1.4 million in spend in a "highly specified operational indirect category" show that there's still savings to be had even after a multiple round manual negotiation. To wit, "after about an hour of activity, the final results were in and our client was able to implement an additional 4.7% in savings." So there you have it. Close to a five hundred basis point delta pre-auction negotiated to post-auction. Granted, this number might be significantly more -- or less -- in certain categories based on a variety of factors such as number of suppliers, capacity and the impact of underlying commodity price inflation, but it’s a good delta to keep in the back of your mind before deciding whether or not to take out the auction gavel.

- Jason Busch

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I do agree that this type of negotiation will yield a savings but on a shorter term. Thinking from a longer term perspective I doubt that this negotiation might not hold well across the supply chain and increase the total cost. Also this results in affecting the relationship with the suppliers. Measuring the impact on Supplier Relationship might become difficult and the organization might not get the best of the resources / goods they wanted to get. Supplier might tend to adjust the deliverables quality according to the price promised (if the contracts are vague!!!). If the contracts are perfect they tend to lose out on costs affecting future deliverables from the suppliers and finally increasing the total cost across the Supply chain. It would be better if the Buyer Organizations don’t practice this for “specialized” category goods / services. Demanding organizations with business volumes practice this in specialized service categories too say in Consulting Temp Labor procurement. Assumptions also should be put to the suppliers upfront during the RFP by the buying Organizations, that the RFP would be followed by an RA. The formula for the start price of an RA too can be shared (if not fully, at least the basis) with the suppliers. Especially in case of Public Sector Procurement, departments upfront inform the suppliers in the RFP process, that the L1 price from the RFP process will be the starting price for the RA. These days (or always!!!) suppliers become smart very fast than the Buying Organizations :)

# Posted By Senthil | 9/17/08 3:34 AM

Hello Jason!

I have truly enjoyed your blog for many years now. I have the pleasure myself of joining the blogging circuit once again!

Jason, you may or may not know that I have been a long-term fan of reverse auctions, for a variety of reasons. I concur however with the CAPS finding that usage of reverse auctions has peaked. We find continued interest in the methodology but also we find that many organizations are content to use their E-Sourcing tools for RFP only. I don't think its a knock on the technology. I think the decline is simply the next logical phase in the "hype" that most new technologies go through. And the good news is that the "trough of disillusionment" (to use Gartner terminology) is typically followed by enlightment and widespread adoption.

# Posted By Debbie Wilson, Gartner | 9/18/08 11:39 AM

I have seen some good examples that have had tremendously good results for the buyer. I know that in a Capitalistic environment it sort of rubs against the grain of the average seller but it inspires a sense of competition that limits largely inflated profits and streamlines the power of the consumer. I have no doubts on its longevity in a economy that needs some more spending and controlled costing.

# Posted By Reverse Auctions | 9/18/08 1:27 PM

Debbie,

Thanks for the kind words. Welcome back to the blogosphere!
I guess the question that I have in response to your concept of the Gartner Hype Cycle is whether or not the downward tick is being helped along in its Southward motion by changes in supply market conditions that favor producers over consumers (or suppliers over buyers). In other words, how much is fundamental to the Gartner core Hype Cycle structure vs. changes in supply market conditions? So much I feel these days we can attribute to the overall commodity market environment and general supply market conditions.

# Posted By Jason Busch | 9/18/08 2:12 PM

I suspect it's a combination of the Hype Cycle and the market conditions. Market conditions can sometimes be a cop-out.

# Posted By Barb Ardell | 9/18/08 7:20 PM

Jason,

We shown pretty clearly over the years that new technologies/application follow a predictable pattern of initial hype/overflated expectations, then a period of disappointment/disillusionment, followed by a balancing of expectation and capability. Many other factors can play into the speed of this movement, such as the presence of other strong competition. In this case I think you make an interesting point about rising prices curtailing the usefulness. But I wonder, if folks follow the best practice of completing an RFP before conducting a reverse auction, wouldn't this make reverse auctions doable, even in a market where prices are increasing? Or, couldn't you auction the formula for setting prices rather than the actual price?

# Posted By Debbie Wilson, Gartner | 9/20/08 11:14 AM

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