Strategic Sourcing Through Reverse Auctions

A PurchasePro Inc. White Paper

As a buyer, wouldn't you like to get the best deal possible when you purchase products and services; have suppliers compete for your business; and discover the optimum terms the market is willing to offer? Thanks to reverse auctions, your purchasing organization can control costs, gain efficiencies and maximize the total value received from purchases.

At every company, the purchasing function is central to controlling costs and extracting value. With corporate spending exceeding $20 trillion annually, representing about 80% of revenues, it's easy to understand why purchasing organizations have tremendous influence over the cost of doing business, and ultimately, profit levels. If a purchasing organization can secure even modestly better deals -- in price alone or total value -- the savings go straight to the bottom line. Industry experts figure that even a 5 to 10% savings in purchasing costs increases profit margins by 28 to 50%.

The concept of trying to get great deals on purchases isn’t exactly new for purchasing organizations. For years, they have sought ways to source products and services more strategically. But their efforts have met with mixed success, as cumbersome, time-consuming and largely manual sourcing processes have held them back. With few tools to help them discover new sources of supply, and no easy way to encourage competitive bidding among potential suppliers, purchasing organizations have struggled to take their strategic sourcing efforts to the next level.

Thankfully, times are changing. New tools and technologies can help you modernize the sourcing process and make it more competitive. One of the most accessible and affordable solutions, offering some of the most dramatic returns, is the reverse auction.

Reverse auctions are bidding events sponsored by a buyer. The buyer identifies a pool of qualified suppliers, shares information about its product or service needs, and hosts an auction where suppliers make dynamic bids to win the business. Using an auction platform, buyers and suppliers connect, exchange information, negotiate and participate in auctions, all in real time.

What’s more, reverse auctions are within the reach of every buying organization, thanks to a variety of cost-effective, hosted auction solutions that are intuitive, easy to implement and require no technical expertise. Moreover, they produce phenomenal returns – averaging up to 17% savings on the cost of goods purchased. That's why Forrester Research expects more than $52 billion in goods and services to be sold through auctions by 2002.

This paper makes the case for incorporating reverse auctions into your sourcing strategy. It gives an overview of a reverse auction, highlights the benefits you can expect to receive by using reverse auctions, discusses important buyer considerations, and closes with guidelines for choosing auction solutions and partners.

Understanding Reverse Auctions

Everyone is familiar with the auction concept. Sotheby's and Christie's are well-known establishments that auction luxury items to well-heeled buyers. eBay is a successful example of an online, consumer-oriented auction site.

Auctions are timed bidding events. One party puts something of value up for bid and other parties compete, in a fixed window of time, for the right to buy the auctioned item. Each bidder tries to edge out the others with an offer sufficiently attractive to win, yet calculated to cost the bidder the least.

There are several types of auctions. The best known is the "forward" auction where a seller puts up goods or services for sale. Flip the roles of the participants and you have a reverse auction where the buyer initiates the auction, publicizing its desire to buy specific goods or services to a community of suppliers. Whereas in a forward auction, bid prices go up over time, in a reverse auction bids get progressively lower until the lowest bid wins.

How a Reverse Auction Works

A reverse auction starts with a buyer seeking to purchase products or services from a group of suppliers. But before the auction gets underway, the buyer must decide which suppliers to invite to the auction, and inform them in detail of the products or services it wishes to buy. The buyer must also choose the attributes of the auction itself -- the mechanics as to how the auction will be run -- and circulate these rules to the bidders. These rules may address:

Privacy -- The identity of the buyer and/or suppliers may be kept secret.

Sealed/unsealed bids -- Bid contents may or may not be published for all to see. If bids are sealed, bidders learn only the relative rank of their bid.

Time windows -- Definite start and end times are established, with buyers often reserving the right to extend the window in competitive bidding situations.

Starting bid -- Buyers usually establish a starting bid, which is the ceiling for opening bids.

Bid formats -- Bids are submitted in a set format to enable quick evaluation and comparison.

Notification -- The time period for evaluating bids after the auction closes, and the method of notifying the winner, may vary.

The day of the auction, auction participants connect to the event via the Internet. A variety of security and authorization features, including user ids and passwords, secure the auction. During the event, all parties have real-time, graphical access so they can monitor the proceedings.

PurchasePro's e-Source Auction Process

The auction starts with suppliers submitting opening bids. The auction platform evaluates each bid using a pre-determined mathematical formula and, in open bidding situations, shows the relative position of each bid. Although many auctions have one-dimensional bids -- bids that focus on price alone -- they may also support multi-dimensional and multi-criteria bids that cover a variety of objective and subjective factors. For example, a buyer may want a supplier with a track record of on-time delivery, or the financial stability to perform over a long-term contract. According to a Purchasing Magazine article, the four most important criteria to purchasing managers when sourcing goods and services are quality, price, delivery and lead-time requirements.

To evaluate complex bids accurately, the auction platform relies on a mathematical, weighted formula. Formulas must be applied in real time during the auction so that suppliers receive immediate feedback on the rank of their bid and can formulate their next bid strategy.

After a round of bids are evaluated, successive rounds of bidding follow, with suppliers either submitting more competitive bids or dropping out of the contest. As the auction proceeds, bidding drops to progressively lower levels as suppliers compete with each other to win the business. The auction usually remains open until one supplier outbids the others by quoting a price that is so low, or offering a set of terms so valuable, that no other supplier is willing to compete. The auction terminates at its pre-set time, unless extended by the buyer, and the winner is notified. The buyer and winning supplier then finalize any terms and conditions, and ink the deal.

 

The Benefits Offered by Reverse Auctions

For a nominal investment, very company can benefit from using reverse auctions. The most tangible benefits come from reducing the cost, and enhancing the value, of purchased goods and services. Secondary benefits come from automating parts of the sourcing process, and increasing the efficiency of the purchasing organization. Making reverse auctions even more attractive are the hosted solutions offered by service providers such as PurchasePro. These solutions allow companies to sponsor auctions for a reasonable cost, with little set-up effort, and no maintenance or support burdens. By keeping the cost of entry low, PurchasePro keeps its customers’ ROI high.

Here are some of the benefits you can expect to receive by using reverse auctions.

Reduced Costs

• Using an auction format -- putting business out to bid and allowing suppliers to compete against each other -- allows a company to discover and obtain the most favorable market prices.
• Automating the sourcing process reduces administrative overhead and the cost of finding and securing products and services.
• Aggregating and directing corporate purchasing through auctions gives a company greater leverage with suppliers and a stronger position for negotiating favorable financial contract terms including unit price, delivery charges, insurance and other types of fees.

Maximized Value

• Auction formats elicit the best offers from suppliers, maximizing the overall value received by buyers where value is measured by all contract terms -- not just financial ones -- including quality, lead times, location, customer service, etc.
• Auctions allow buyers to discover new and optimal sources of supply beyond their existing base of suppliers.
• Auction analysis and decision-making tools help buyers evaluate competing bids based on weighted criteria that include both "hard" (price) and "soft" (quality) attributes to discern the most value-maximizing offer.

Increased Efficiency

• Auctions streamline the sourcing process, greatly decreasing the time it takes to accomplish a single sourcing cycle and freeing staff for other work.
• Automating the sourcing process, by eliminating manual processes and paperwork, reduces the opportunity for human errors, inaccuracies and reworks.
• Sophisticated analysis and decision-making tools allow buyers to evaluate and compare competing bids, in multiple dimensions and based on multiple criteria, more quickly, easily and effectively.

Buyer Considerations

For a buyer, conducting a reverse auction isn't terribly complex, especially if an experienced auction provider lends a hand. Integrating reverse auctions into a well conceived and comprehensive sourcing strategy is the real challenge. Most organizations are already performing many of the tasks involved in a reverse auction, but are using manual rather than automated techniques, and achieving only a fraction of the results. Adopting reverse auctions gives companies an opportunity to add best practices to their sourcing process, making it more formal, consistent and repeatable. When approaching reverse auctions, important buyer considerations include:

• Type of spend

Buyers can use reverse auctions to purchase both direct and indirect materials. The type of item sourced directly affects the effort spent qualifying suppliers and preparing requests for quotes (RFQs). For vital products or services, buyers must investigate and weigh subjective factors such as supplier reliability, dependability and financial stability. Complicated or specialized products require complex and lengthy RFQs. In contrast, sourcing ordinary, widely available goods usually takes less preparatory time.

• Supplier identification and recruitment

Buyers can spend a significant amount of time identifying and screening eligible suppliers to participate in the auction. The pool may include the buyer's existing vendors, but invariably will include others to encourage competitive bidding. Buyers screen suppliers using multiple criteria, such as financial stability, location, product quality, etc. and decide how to weigh these criteria when it comes time to evaluate bids. Buyers typically research and screen suppliers using requests for information (RFIs) and surveys.

• Developing RFQs

Buyers convey their product or service needs in detail to suppliers to enable them to formulate accurate and responsive bids. These specifications are contained within RFQs, comprehensive documents that precisely define the product or service desired and any required criteria or performance attributes. Developing an RFQ may require substantial intra-company coordination, and companies are likely to need collaboration tools (often supplied by the auction provider) to facilitate RFQ development. Buyers should also hold extensive question-and-answer periods with suppliers to clarify any information.

• Incorporating auction metrics into sourcing strategy

Auctions yield valuable insight into how the market evaluates, prices and packages products and services. Buyers can use this information to fine tune their sourcing strategies, and package and time their purchases in ways that will elicit favorable terms from suppliers. For example, timing an auction at the end of a quarter may induce suppliers trying to meet quotas to offer better deals. Or, if product reject rates are high, a buyer may need to give more weight to product quality in future auctions.

Getting Started with Reverse Auctions

Getting started with reverse auctions is easy thanks to hosted, yet customizable, auction platforms like PurchasePro’s e-Source solution. Depending on the breadth and depth of contacts the service provider has with the supplier community, you could have instant access to a global marketplace of suppliers simply by signing on with the right provider.

If you join forces with a competent service provider, preparing for and running a reverse auction is straightforward. Researching and qualifying suppliers, and preparing RFQs, take time, but these are tasks that you already perform. Automating them will alleviate much of your burden. Service providers offer tools and templates to automate these tasks, and may also provide consulting assistance for many facets of the sourcing cycle.

Choosing the Right Auction Solution

Reverse auction platforms have a full range of features. Security features to ensure authorized access and the integrity and privacy of data are common. Other features, like collaboration tools, RFQ templates and bid evaluation formulas, vary among solutions. Nevertheless, every auction platform must have attributes that encourage usage, make it easy for suppliers to participate, and permit auctions, bids and other events to complete successfully. Key characteristics for success include:

• Easy to use so that buyers can concentrate on honing their sourcing strategies rather than mastering platform and technology details
• Intuitive so that buyers and suppliers can quickly come up to speed and realize benefits
• Flexible enough to accommodate a variety of auction formats and bidding situations
• Minimal set-up required, so that IT resources aren’t needed and buyers and sellers don’t need technical training
• Interaction with other commercial forums to give buyers access to a broader choice of suppliers, as desired
• Cost-effective to justify holding a reverse auction in the first place.

Besides these general characteristics, auction platforms must have specific features that allow buyers and suppliers to perform all of the tasks involved in a typical sourcing/reverse auction cycle. Look for an auction platform that offers the following minimum set of capabilities.

• Research and qualify suppliers – the ability to locate eligible suppliers through yellow pages and listings, screen their product/service offerings, issue and review RFIs, and perform surveys.
• Administer the auction – the ability to determine the rules and mechanics of the auction, create groups of supplier participants, notify suppliers and interact with the auction host.
• Create and distribute RFQs – the ability to develop comprehensive RFQ documents (optionally from templates), including attachments, and to collaborate with internal employees and external partners.
• Conduct the auction – the ability to run an auction, monitor and evaluate bids, terminate or extend the auction, and notify the winning bidder.
• Support complex bidding – the ability to support bids along multiple dimensions and criteria, whether objective or subjective, and transform bid information into adjusted evaluation prices using customizable mathematical algorithms, including net present value calculations, weighted average calculations, currency conversions, etc.
• Perform post-auction negotiations – the ability to negotiate and finalize terms with the winning bidder.
• Make purchases – the ability to generate purchase orders and send them electronically to winning suppliers.
• Manage settlement and logistics – the ability to coordinate and finalize shipping and logistics terms, and manage payment and collection.
• Report and track – the ability to track and analyze the performance of auctions and suppliers through decision-making and analysis tools.

Choosing the Right Auction Partner

The party that provides and powers the auction platform will have great influence over your success in using it. It is important to consider the qualities of the service provider as part of your research. As more auction providers and sourcing partners emerge, it is critical to perform your own diligence to assess the viability of your partner and its solution. Essential characteristics for an auction provider include:

• Proven track record

A partner with a history of prosperous engagements and satisfied customers is likely to repeat its successes and perform well in the future.

• Successful business model

A partner with a winning business model will be financially successful and able to weather market fluctuations.

• Marketplace connections

Reverse auctions derive their greatest benefits when bidding is competitive, which requires participation by a number of suppliers. A partner that sponsors other forums, such as global marketplaces or exchanges, can give buyers access to a built-in, large pool of potential bidders.

• Supplier outreach

Recruiting and training suppliers to participate in online events takes effort. Partners that already sponsor online forums are adept at these tasks. They can help buyers research and screen suppliers, and create RFIs and templates. In turn, they can help train and support suppliers through tutorials and practice auction sessions.

• RFQ/RFI development

By leveraging the sourcing experience gained from its client base, a partner can help jumpstart buyers’ efforts at developing RFQs, RFIs and other sourcing documentation through consulting assistance and templates.

• Full auction administration

Buyers should be free to focus on sourcing strategies, not the details of running an auction. Partners must be skilled at administering auctions on behalf of buyers, developing and circulating auction rules, educating participants through Q&A sessions, operating and monitoring the auction, and dealing with any service and support issues.

• Broad value-added services

To extract the full benefits of their sourcing solution, buyers should look for a partner that offers a range of value-added services, from wireless support to financial services, settlement, logistics and more.

• Superior customer service

Partners that provide responsive and proactive customer service resolve issues quickly, disperse needed information in a timely manner and ensure the success of each participant in using the auction platform.

In Conclusion

As a buyer, how can you know for certain that you are getting a good deal when purchasing products and services? There’s only one way – to have suppliers compete for your business. Competition is the key to unlocking favorable deals, letting you discover and capitalize on the best terms the market is willing to offer. Competition is exactly what reverse auctions provide.

Reverse auctions deserve a place in any well developed sourcing strategy. They allow companies to minimize the cost of goods and services while maximizing the value received. Now within the grasp of every company, thanks to cost-effective, hosted auction platforms, reverse auctions are producing spectacular returns – an average 17% cost savings on purchases. That’s why companies like Owens Corning, Lexmark, Lennox International, Unisys and Arch Coal are using reverse auctions today. That’s why you should be using them too.

This paper is owned by PurchasePro Inc.  Copyright 2001 PurchasePro Inc.  All rights reserved.   For more information on PurchasePro, visit www.purchasepro.com.