Reverse auctions, digitally referred to as eAuctions, are where suppliers bid to fulfill a buyer’s requirement of goods or services. Unlike forward auctions, where buyers compete and bids keep increasing, reverse auctions have suppliers competing amongst themselves. In most cases, bidding starts from the highest price and the lowest overall bid wins.
Reverse auctions gained popularity with the emergence of online bidding technologies that connected multiple suppliers to the buyer on a real-time basis. The buying organization lists down the goods or services it wishes to buy and shares the exact specifications and other requirements. The suppliers then place the bids for the amount they’re willing to be compensated with, and the supplier with the lowest price at the end of the auction wins the contract.
Such auctions work best with products or services that can be detailed very clearly. An auction is only successful when the products or services that are being bid for are the same.
The main advantage of a reverse auction is that it allows the buyer to command the true market price of a product or service. Moreover, the negotiation and sourcing time is significantly lesser than what is spent in approaching suppliers individually. However, a high level of planning is required to prepare and conduct a reverse auction. Also, the process is characterized by the inflexibility of allowing novel or innovative responses from suppliers, and can also lead to apathy among some of them.
Types of Reverse Auctions
There are many types of auction. In teh main they can be split into 2 types:
- Price-led Auctions -> These are auctions that purely focus on the price of the auction and assumes the goods or services being provided are all exactly the same so that price is the only difference.
- Package-led Auction -> These are auctions that include the entire package to be delivered by the successful supplier. They cover more than just price and use some sort of scoring methodology to define the most advantageous supplier bid.
Price-led Auctions
Ranked Reverse Auction
In this auction, all suppliers are aware of their rank amongst other bids. Although price is a crucial factor, the buyers usually engage with all suppliers whose bids fall in a favorable price range.
Use Case
Auctions for goods or services where the specification is clear. Mostly relevant to specific part purchases where requirement is for market-wide part numbered goods.
English Reverse Auction
Also referred to as an open outcry auction, this auction transparently shows the leading bid to all bidders and results in a steady fall in prices. Such auction is designed for products where the key differentiator is price.
Use Case
When products offered by suppliers share similar characteristics and buyer wants to get the lowest price in the market.
Sealed Bid Auction
In these auctions, the process is carried out in a single round and the buyer cannot see the offers submitted by suppliers until the auction has ended. The supplier with the lowest overall bid wins.
Use Case
When products offered by suppliers share similar characteristics and buyer wants to get the lowest price in the market.
Japanese Reverse Auction
The buyer specifies the opening bid in this type of reverse auction and all participating suppliers must agree to this bid. As the auction continues, the price keeps declining and the last supplier in the auction wins the contract.
Use Case
When products offered by suppliers share similar characteristics and buyer wants to get the lowest price in the market.
Dutch Reverse Auction
This auction begins with a start price, which is often set as quite low, and a reserved price which is the highest bid possible. The start price increases with fixed intervals and goes up to the reserved price. The first supplier to make a bid wins.
When to use
When there are limited suppliers, and one or few of them possess notable cost advantage over the others.
Vickrey Reverse Auction
In Vickrey auctions, buyers indicate the maximum price they’re willing to pay for a product or service. The auction typically takes a single round in which the suppliers bid their best prices. The bidder with the lowest price wins, but the buyer pays him the amount bid by the winning bidder’s closest competitor, plus a small “step” that is usually $1 or less.
When to use
When buyer wants to drive the lowest price possible by encouraging suppliers to bid lower than usual in hope of securing business at the higher price bid by the closest competitor.
Package-led Auctions
Weighted Reverse Auction
These auctions work on the basis of a “merit score” determined using price and non-price factors such as delivery time, payment terms, etc. However, the suppliers can only change the price they’re willing to charge, and the bidder with the highest merit score wins.
When to use
When there is significant difference in product specifications and cost of doing business among suppliers.
Multi-attribute Reverse Auction
These auctions also use a “merit” score based on price and non-price factors but, unlike Weighted Reverse Auctions, the suppliers can change both price and non-price factors while competing with other bidders. The auction is won by the supplier with the highest merit score.
This type of auction requires significant planning to ensure the comparisons between suppliers are fair.
Benefits or Reverse Auctions
Reverse auctions offer the following advantages to the buyer:
- The process of bidding is transparent and real-time.
- Buyers can save a lot of time since these auctions are conducted live.
- Reverse auctions can provide significant leverage to the buyer.
- Reverse auctions normally ensure that buyers procure at current markets prices.
Caveats of Reverse Auctions
Despite its benefits to the buyer, reverse auctions pose some limitations as well:
- Reverse auctions only work for select goods and services that can be detailed clearly to ensure everyone is bidding for the same specification.
- Inconsistencies with the specification can lead to sellers with the lowest bid delivering sub-standard goods or services.
- Lack of planning, can result in the lack of accounting of additional costs like transportation, and buyer can end up choosing a supplier who is actually costlier than those who had bid higher.
- Reverse auctions do not work in a monopoly and generally have minimal effect in an oligopoly market.
Conclusion
Reverse auctions are essentially cost-cutting procurement tools that work best for very commoditized goods or services. In these auctions, the supplier aims to beat the competition by offering the required goods or services at the lowest price to the buyer.
Key Takeaways
- Planning, planning, planning… a successful auction is only as good as the planning that went into it. Ensuring a clear and transparent auction is only achieved through a well-organized and planned event, from goods and service specification to the IT being utilized to run the auction.
- The buying organization should place equal emphasis on reducing costs and maintaining optimal quality of procured goods and services when planning the auction.
- The buyer should ensure that the market has enough suppliers offering products at competent prices and quality.
- Procurement professionals should clearly state the requirements and specifications to avoid any mismatch.
- Before proceeding with the auction, the organization should conduct a mock auction to check the reliability of IT arrangements.