As I briefly touched on last week eAuction technology has
moved on somewhat in recent years and is now utilised to procure a whole
variety of goods and services outside of the stereotypical, and obligatory,
stationary re-tender. Auctions themselves are nothing new; the position of
Emperor of Rome was auctioned off in 193 AD, but these days there are so many
different parameters available to the procurement professional who is able, if
needs be, to run a whole array of multi-attributable and variable eAuctions.
Many procurement professionals however still remain
unenlightened to the vast toolkit at their disposal and are merely
preconditioned into persisting with the classic “English reverse” eAuction.
This standard approach is appropriate in a wide range of circumstances but may
not always be so. I would like to briefly describe the other forms of eAuctions
available, their respective mechanisms, strengths and weaknesses.
1.
Forward
English Auction
·
Mechanism
Anyone who has
attended a property auction or is familiar with eBay will be familiar with the
way this works. Essentially bidding starts at a low price and rises as participants
place progressively higher bids. This process continues until either the period
allowed for the auction of this item is closed or until no higher bids are
received. The seller is also able to set a minimum price for the sale (reserve
price) which if not met would result in the auction being aborted and no sale occurring.
·
Example
Numerous examples
to mention however the £22.5bn UK 3G auction is probably the most oft cited
procurement case study.
·
Strengths
Any English
auction has the advantage of price discovery which is particularly useful for
goods with an unknown or vague market value (art is a good example). The seller
in an English auction does not limit the maximum possible bid ex-ante which is
in contrast to other dynamic auction types
Exceptionally
useful when there a high number of very closely matched participants.
·
Weaknesses
There are a number of weaknesses levelled against English auctions
and I will try to summarise a few of them here. The first is that open auctions
such as the English format allow for potential collusion amongst bidders. There
are numerous papers on this subject and some high profile examples but it is a
definite watch out.
Secondly the so-called “winner’s curse” is
rampant in these auctions due to strong competition and
incomplete information about the product being sold. In the long run, and I am
writing this from the perspective of the procurement professional running the
auction, although a fantastic price may be achieved it may not be sustainable.
A third
disadvantage for both buyers
and sellers with the English auction is that everyone must be in communication
over the course of the auction, which can be expensive and difficult.
2.
Reverse
English Auction
·
Mechanism
Another one we are all familiar with. In a reverse auction the
bidding price goes down and the buyer award contract to the supplier who bid
the lowest price depending upon
the buyer's specific needs with regards to quality, lead-time, capacity or
other value-adding capabilities etc.
.
·
Example
Pretty much everything…including stationary.
·
Strengths
Transparency and
competition often yields exceptional results and also from a stakeholder
management perspective vibrant reverse eAuctions are actually quite exciting to
watch. A well-managed event, I will be doing a separate blog piece next week on
the process that needs to be followed, ensures that everyone is bidding on
exactly the same parameters. In markets which allow for multiple, reputable
participants the reverse eAuction is a valuable tool.
·
Weaknesses
I have glossed
passed the strengths somewhat because I am conscious that this article is more
about other eAuction types available however it would be remiss of me not to Segway
onto them by discussing some of the weaknesses of reverse English eAuctions.
There are three
distinct advantages that exist for buyers. The first and foremost is that, if
not managed correctly as per my previous post, that the ongoing relationship
between buyer and seller will be irrevocably damaged. Jap (2000) reports of one
instance where a supplier was so upset with their treatment they refused to bid
for another seven years. Positioning from the buyers’ perspective is most
definitely the key.
Related to this
lack of trust is the fear of commitment. Sellers fear that buyers are simply
awarding work based on the lowest price but will re-run the exercise (a la
office consumables) once the contract needs to be renewed. Why would anyone
commit any additional capital, tooling, training etc to such a relationship?
The third potential
disadvantage for buyers is that too few suppliers will respond to the reverse
auction announcement and a competitive environment will not develop. Although
in theory, only two competing firms are required to conduct an auction in
reality results are only really achieved when upwards of four or five suppliers
choose to actively participate.
There are also disadvantages
for the seller although I will only touch on them here. Primarily sellers are
suspicious that the possibility exists that the buyer is only using the reverse
auction as a negotiation ploy. The buyer may have identified a preferred supplier
before the auction and has no intention of awarding business to the lowest
bidder so any participant is really just time wasting. A second risk (and this
doesn't necessarily translate to an advantage for the buyer, is that the seller
may get caught up in the race. It is very easy to become exceptionally
competitive and offer unreasonably low prices that may actually be below cost.
It may also be true that a rogue bidder in the event has no intention on
actually completing on their bids but drags down the entire supplier cost base
as a result. Again this may or may not be seen as an advantage on behalf of the
buyer, depending on whether the outcome is sustainable or not. For those
wishing to see a nicely worked example of this last scenario I’d recommend the
auction scene from the ‘Dad’s Army’ Christmas episode ‘The love of three oranges’.
3.
Dutch
Reverse Auction
·
Mechanism
A Dutch auction involves an item being offered at a very
high price, well in excess of the amount the seller expects to receive. The
price is then lowered in decrements until a bidder accepts the price…one bid
will close the entire auction.
A slight reverse on this, and more common in a procurement
environment, is a reverse Dutch auction. Here the buyer specifies a starting
price, price change value, time interval between price changes, and the
reserved price. The auction opens with the first item with the specified start
price and increases by the specified price change value after a fixed interval.
The start price keeps on increasing until a supplier places a bid or the start
price reaches the reserved price. Once the bidding is closed for the item, the
auction moves to another item sequentially. The auction is closed when the
bidding for all items is completed.
·
Example
Dutch auctions emanated, unsurprisingly from flower markets
in Holland but in modern times the United States Department of the
Treasury also raises funds for the U.S. Government using a Dutch auction.
A variation on the theme has also been taken up by pricedrop.tv
·
Strengths
The primary advantage of Dutch auctions is speed. Since
there are never more bids than there are items being auctioned, the process
takes relatively little time to complete and actually from a buyer’s
perspective are quite easy to set up. They can also be used quite readily when
competition in the market is actually quite limited and traditional auction
techniques may not yield results.
·
Weaknesses
The prime weakness of Dutch auctions and in fact of all
non-traditional eAuction techniques is a lack of general understanding as to
how the process works and as such the level of training that is required to ensure
the smooth running of an event. Compounding this, although thankfully things
are improving, up until very recently few of the eAuction service providers
actually provided a Dutch auction solution and options are still less limited
than one would like.
It should also be noted that in an event a Dutch auction
would only see a single bid and as such the buyer would be blind as to how
others may have bid in the event and how they stand in relation to the single
bid received.
3.1. Yankee Auction
·
Mechanism
Firstly a caveat, this is not something I have ever run
myself however it is based quite heavily on the principles of a Dutch auction
so I thought I’d add in a little section on the Yankee auction. Quite simply
the buyer requests bids for a lot which consists of multiple units of the same
item. Each seller can bid on part of the lot at a fixed price and at the end of
the eAuction the buyer takes the lowest price bids, in ascending order, until a
full lot is reached. As a quick example assume there were 100 items in a lot
and bidder A offered to sell 50 items @ £100 each, B offered to sell 50 items @
£120 and C offered to sell 100 items @ £200 each then the buyer would allocate the
full lot in a split capacity to both bidders A and C. The best way to imagine
it would be a bit like ‘Dragon’s Den’ where they need to walk away with all the
money but can solicit bids from multiple Dragons. Well that helps me visualise
this anyway!
4.
Japanese
Reverse Auction
·
Mechanism
My personal favourite eAuction form but please excuse my
bias. The Japanese auction gives participants a few minutes to simply state
whether or not they can commit to a dictated price level. All those who
said ‘yes’ are allowed to progress and all those who said ‘no’ are
eliminated. The price level then drops by a certain amount and the
question is repeated to those who previously said ‘yes’. The eAuction
continues in this vein until all participants have ‘opted out’ of the auction.
Japanese Auction can be used in a forward, upward price
direction, such as the negotiation of rebates amongst a supply base. In
this example as it is fairly meaningless to give suppliers feedback on their
rebates in relation to the market (they could be providing different goods and
services at different spend levels) the forward Japanese auction allows the
buyer to negotiate with each supplier individually yet.
Since it is fairly meaningless to give suppliers market
feedback on their rebates, as each supplier could be contracted for different
goods and services and different spend levels, the Japanese Auction presents
itself as a superb way to negotiate with each supplier individually yet in parallel
and in a single auction.
Japanese Auctions lend themselves well to procurement
professionals who prefer a negotiation restricted to their handful of preferred
bidders as opposed to those who choose to proactively source from the wider
market, assuming such a market exists at all.
·
Strengths
Japanese auctions are particularly popular with retailers as
the approach can be a relatively successful one in markets dominated by a
handful of major players or where general market liquidity is low.
Although I am not totally on-board with the ethics of this a
Japanese eAuction can even be used for a single-source negotiation and has been
used in this way in the past; achieving benefits where other auction types
would obviously fail.
Other situations where the Japanese Auction can be used
effectively are when there are large cost differences between bidders, despite
both quoting for the same specifications. With your typical Ranked
Auction, the participant in first place is unlikely to be challenged, even
though they may have some residual margins to expend. However, utilise
the Japanese Auction and even that participant will be asked to improve their
offer.
It’s also often the case that whereas the winning bid in an
English reverse event is normally slightly lower than the second best bid (why
would they bid even lower when they know they are the winner?), in a Japanese,
the most competitive bidder can, and often does continue to bid lower. So the
buyer can benefit.
·
Weaknesses
The first problem, as is the case with Dutch auctions, they
are not broadly recognised, which means participants will require a greater
degree of hand-holding and reassuring. Secondly, they offer little to the
participants in the way of market feedback, although post-auction you can
certainly provide feedback at your own discretion and to whatever extent you
wish. Thirdly, they operate in a rigid manner with participants only able
to accept or decline each price level rather than to come in at their own price
level. It could mean that some participants have to wait a little longer
to submit their final offer, although the end goal of establishing the market
price is still achieved.
·
Example
Difficult to find examples and specific case studies but in
2008 a jumbo, black Densuke watermelon fetched a whopping £3,100
(650,000 yen) at a Japanese auction in 2008!
5.
Sealed
Bid
·
Mechanism
A type of auction process in which all bidders
simultaneously submit sealed bids to the auctioneer, so that no bidder knows
how much the other auction participants have bid. The highest (or lowest
depending on the auction form) bidder is usually declared the winner of the
bidding process.
·
Strengths
Sealed bids are also used to ensure a “fair and open
competition” where the buying organization does not have the opportunity to
influence the bidding process or steer the selection of a particular company by
sharing competitive bid information during the evaluation process.
·
Weaknesses
All the uncertainty related to the price of a product must
be translated into a single bid, which cannot be adjusted when more information
is revealed. Hence, if there is significant uncertainty about the price of the
product being procured, the potential for an inefficient outcome increases
since there is no price discovery.
Practical realities such as budget constraints and inter-dependency
in the products’ values, in the case of multiple products, can make bidding in
a sealed-bid auction exceedingly difficult unless the auctioneer allows the
bidders to express these constraints in their sealed bids, which in turn can
make it difficult to determine the winners.
·
Example
Often used for refinancing credit and foreign exchange,
among other (primarily financial) venues.
6.
Vickrey
Auction – Second price, sealed bid
·
Mechanism
Bidders submit sealed envelopes in one round of bid
submission. The highest bidder wins the item, but at the price offered by the
second-highest bidder (or, in a multiple-item case, the highest
unsuccessful bid).
·
Strengths
The Vickrey auction gives bidders an incentive to bid their
true value and allows for a focus on life cycle costing. The two-step approach
can balance price and value in a manner that does not complicate the process
and helps alleviate the practice of awarding business on the basis of the price
tag only.
·
Weaknesses
The approach does not allow for price discovery and
there is a risk that sellers use shill bids to increase profits – something that
the buyer will need to be aware of.
·
Example
This type of auction is rarely used aside from setting the
foreign exchange rates in some African countries.
7.
Elimination
(aka survival) Auction
·
Mechanism
Multi-round sealed-bid auctions in which low bids are
successively eliminated in every round with the low-bid price announced and
needing to be met or exceeded in subsequent rounds
In the first round, all bidders submit a sealed bid. As a
function of these bids, the auctioneer announces which bidders “survive” to the
second round, a minimum bid for the second round, and, most importantly, all
losing bids. In the final round of a survival auction the remaining bidders
have seen bids submitted by all of the others and as such have some sense of the
information possessed by the others.
·
Strengths
This approach combines the speed and predictability of
sealed-bid auctions with the desirable properties of ascending-bid auctions.
·
Weaknesses
This isn't really an event favoured by buyers or sellers
owing to the nature of the way the event is run.
-----------------------
It is always possible of course to run a series of or a “multi-phase”
auction, which may involve moving from a reverse English auction into a sealed
bid or vice-versa etc. There are also probably multiple auction formats that I
have not described in full detail here which I’d love to hear about!
I think the
principle though is that there is an opportunity amongst the procurement community
to vary their approach to the use of eAuctions and I hope this blog has provided
a rough overview of the events available. In the next blog I will be discussing
the ideal process to follow when setting up an eAuction and the potential pitfalls
to avoid for both buyers and sellers.
