E-auctions – a useful purchasing tool?

Electronic auctions or e-auctions as they are generally referred to are becoming a widely used tactical procurement technique and in this article a basic outline of the technique and some of the issues surrounding it will be discussed.

E-auctions are generally the reverse formof auction whereby the buying organisation specifies a particular requirement and allows suppliers to bid for it. Typically the lowest bid wins in a reverse auction. The buying firm can determine what information will be made available to potential bidders.Historically the common form of auction that most purchasers are familiar with is theforward auction in which there is one seller and two or more potential buyers and is more frequently referred to a merely an “auction”. The auction usually starts with low price and the buyers will bid the price up until either a stated period of time has expired or no other buyer wants to put in a higher bid.

There are now several producers of web-based auction facilities and the use of such facilities is becoming more widespread. The auction itself may be typically between four to eight bidders and there is a reserve price which if the bidders cannot achieve the contract is not placed. The bidders may or may not be provided with the prices bid by the other players and may only be provided with their relative position in the bidding process, and there is generally a time limit placed on the auction.

One of the arguments sometimes made against the e-auction process is that they are adversarial and narrow as they focus on price to thedetriment of other factors. This is however not really the case as the auction generally follows an exhaustive process of discussion of the non-price factors and the specification, which must of course be completely understood by all of the parties. When these issues have been fully clarified the issue of price alone can be dealt with in the auction. From this perspective e-auctionsdiffer little from other forms of procurement apart from the fact that a strong competitive element has been introduced on the issue of price, and I can see little wrong with that.

Where there are differences in the products the contenders are offering it is possible to factor or weight the prices according to the none-price differences. One example of that I saw recently was an auction for batteries. The life of the batteries differed as did the base prices so the prices were weighted by the forecast battery life to give the adjusted price and the auction was held using the adjusted prices.

The important issue is of course do they work? There is much evidence that the competitive e-auction process can provide substantial savings. In one auction I witnessed recently almost £800,000 was saved on a contract for mechanical handling equipment and servicing on the original contract price of £4millon. Another example is the nineteen universities and colleges in the London Universities Purchasing Consortium who collectively shaved 10% from their £10 million annual electricity bill. One institution saved up to 24% in the event, which saw eight suppliers make bids on contracts covering 156 education sites Twelve suppliers showed interest in the auction but after two-hour interviews with each prospective supplier four of them dropped out. In another example the NHS Purchasing and Supply Agency reported saving £12.7 m (31%) in an auction involving 8 suppliers in a 43/4 hour auction.

The OGC website provides a useful list of “first principles” for those considering e-auctions.

  • e-auctions are an appropriate tool in many competitive procurements
  • e-auctions are not about price alone
  • The contract needs to be of a value that will attract competition
  • e-auctions require a clear and concise statement of requirements
  • Initial price proposals are needed
  • Commercial sensitivities must be respected.

I would add to this list the condition that there must be an adequate number of potential suppliers, ideally 5 or more.

For those in the public sector there is no general prohibition on the use of e-auctions for the Open and Restricted Procedures that are in accordance with the EC Directives on Supplies and Service, Utilities and Works.

The issue as to whether e-auctions are conducive to the development of good buyer supplier relationships is an issue that has been the centre of considerable debate, and the tendency has been towards the view that they were adversarial and therefore damaging to relationships. However new research undertaken by CIPS and the University of the West of England, supported by Oracle and BT, published under the title I-Adapt was re reported by Andrew Douglas, senior purchasing specialist at Oracle UK in Supply Management May 2003, comes to some rather surprising conclusions. Besides showing, not surprisingly, that buyers enjoyed the benefit of lower prices, most surprising was the finding that buyers who had used an online auction to buy commodities and services they had previously purchased using traditional methods, reported a dramatic improvement in their supplier’s performance in the five key performance factors: account management, flexibility, quality, of product or service, delivery and reliability, and dependability. The research appears to contract the conventional purchasing wisdom that auctions damage the supplier-buyer relationship.

The suggested reasons for this apparent contradiction appear to be as follows:

  • Auctions tend to be run at the end of an exhaustive purchasing process with only rigorously evaluated suppliers being included in the auction. This process centres on a strong specification which leads to better supplier selection. Hence the process itself prior to the auction tends to be more exhaustive.
  • The auction process tends to marginalise the issue of price within the buyer-seller relationship and the parties can then focus on contract execution. In particular the supplier may take the view that it is much cheaper to retain a customer through good service and support than to go to the expense of wining a replacement.

The author suggests that even incumbent suppliers, who win about 60% of auctions but at significantly reduced margins seem to accept the situation and then get on with building the relationship.

The author gives five key messages to purchasing practitioners. First, auctions are here to stay. Second, they are not a threat to buyer’s professional skills. Third, they do not degrade and can even enhance your supplier’s performance. Fourth, they are gaining acceptance within the supplier community. Lastly e-auctions should be one of the tools the purchasing professional’s toolbox.

E-auctions are therefore a useful tool amongst many others for the procurement professional. However they do have the advantage of bringing a competitive element into play with the possibility of the important issue of price coming back into the equation.

Sources

OGC Website

CIPS Website

CIPS Tactics and Operations Study Guide

I-Adapt report

Damage Limited by Andrew Douglas Supply Management May 2003

Neil Fuller 2004