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November 11, 2008

Reverse Auctions – Strategies for Suppliers

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Jeff Cochran

1

A reverse auction (also called procurement auction, e-auction, sourcing event, e-sourcing or eRA) is a tool used in business-to-business procurement. It is a type of auction in which the role of the buyer and seller are reversed, with the primary objective to drive purchase prices downward. In an ordinary auction (also known as a forward auction), buyers compete to obtain a good or service. In a reverse auction, sellers compete to obtain business.

According to recent research, the number of companies purchasing goods via online auctions is increasing by 5% annually. Large organizations (>$100M U.S. in goods purchased) use the reverse auction more often than smaller companies.

The risks for suppliers are clear – reduced pricing on auctions won, future price reductions in face-to-face negotiations (due to the bad precedent), inability to differentiate on value, a removal of the direct relationship with buyers and constraints on the terms and conditions of the contracts associated with reverse auctions.

There are some benefits to a supplier too. Reverse auctions give you the time to effectively prepare a strong bid. Suppliers can also develop a new channel for excess inventory and reduce the costs of acquiring new customers. Transaction costs are reduced in a reverse auction and suppliers can improve the standards for specifications (creating a more level competitive playing field).

Here are some key strategies to try when participating in a reverse auction:

1. Use Precedents to Your Advantage

If a customer is thinking about using the reverse auction for the first time, you should share the following common complaints about the strategy:

  • It is slower and ultimately more expensive than a face to face transaction. Time spent drawing up the specs, qualifying applicants, identifying bidders, and choosing the winner all contribute to a longer, more drawn out process.
  • Reverse auctions drive out competition. Some suppliers cannot compete on price alone, which, over time, erodes the competitive advantage by consolidating the supplier base. Eventually, bargaining power will shift back to the supplier.
  • Sometimes the winner cannot meet the demands of the buyer at that low price. As a result, the buyer has to start the process all over again.
  • Reverse auctions carry the risk of exposing sensitive information that can be shared among bidders and buyers.

2. Establish a Walkaway

By setting a reserve price (a price at which you will not accept a penny less) and establishing strong, non-negotiable evaluation criteria, suppliers can play the same game as buyers. One example is to set an “exploding deadline.” Set a limit to the amount of time your bid is valid. Do not let the auction end then wait for a “final” decision. Reserve the right to close your bid if a contract is not in place within a reasonable amount of time.

3. Use Pricing Software

Prevent unprofitable bids by investing in pricing software to quickly analyze profitability, especially if you participate in multi-offer reverse auctions where you can see who is winning the business during the auction. Vendavo, MapInfo, Visstar and Zilliant all provide different types of software that can protect your bids from becoming losses.

In the next entry, I will outline some alternatives to reverse auctions that can help both supplier and buyer get the most of what they want from their deal.

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