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November 14, 2008

A Value-Based Alternative to Reverse Auctions

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Jeff Cochran

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As the reverse auction increases in popularity as a way for buyers to drive vendor costs down, more suppliers are choosing not to participate in them. Suppliers are resisting the pressure to reduce profitability and commoditize their products and services. However, a strategy to avoid reverse auctions is not the best or only way to prevent erosion of profits.

As in any “negotiation” the best way to get what you want is to help the other side get what they want. And today’s buyers are certainly interested in more than simply cutting costs (although in this economy, it is a primary interest). Suppliers need to find a way to provide customers with the benefits of reverse auctions without succumbing to the pitfalls of the strategy.

The figure below shows the existing model for a typical reverse auction.

Arthur D Little, a management consulting company based in the UK, developed a process that meets the needs of buyers, while protecting the interests of suppliers. In this process, the buyer takes the additional step of defining key criteria that increase the value of each proposal to the buyer. Buyers would indicate which value-added products or services would be most important to meeting their needs.

Suppliers would then assess the willingness of the buyer to pay extra for various value-adds. This gives the supplier a chance to adjust pricing based on real criteria, instead of having to guess at these options and hope to make the “final” round and then negotiate in a needs-based manner.

Buyers would then accept the lowest adjusted price bid, and save the time and trouble of the post-auction negotiation. The figure below reflects this basic process:

The buyer benefits from an increased array of goods and services that will be capable of auction; a decreasing the number of bidders who fail to deliver value; and an award based on total value. Suppliers have price transparency, but the real value of their bid is concealed in the details and it minimizes the “final round” of negotiations after the auction by reducing buyer discretion to change specs or to demand discounts. In short, it provides for negotiation in a controlled and structured manner.

Source: Arthur D Little is the world’s oldest management consultancy, founded in 1886. This process was originally defined in Dr. Daniel Deneffe’s research paper titled “How to Design Reverse e-Auctions to Realize Their Full Potential.”

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