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Which Type of Reverse Auction Should You Be Using?

Posted by David Wadler on Jul 26, 2018 10:15:00 AM

Advancements in technology have allowed procurement teams to introduce new sourcing strategies and practices. A reverse auction, for example, can automate and streamline the sourcing process to increase cost efficiency without requiring months of negotiation. Before going further, we want to acknowledge that cost should not, in the vast majority of situations, be the sole driving factor in choosing a supplier. Indeed, sometimes cost and quality can be inversely correlated. Taking a holistic approach where cost is a key consideration will deliver better outcomes. But that’s for another blog post….

While you might be keen to start saving money in record time, a little homework—a tiny bit, really—is helpful. There are numerous reverse auction types and formats from which you can choose. And selecting the right one could help you reap the most benefits from this tool.

Let’s take a look at some of the most popular auction types to help you decide which one best suits your needs:

1. Ranked Auction

Ranked auctions are arguably the most popular auction type given how they can be effective for multiple industries and project types. Most companies choose ranked auctions when they want to engage numerous potential bidders that they expect would be bidding at similar price points.

The key information provided to the suppliers in ranked auctions is their position or rank against the other bids. At any point, the supplier with the leading bid is the only one who has knows what the current best price is.

One potential disadvantage of ranked auctions, however, is that participants who are in the second or third position might get the impression that they won’t have a shot at winning the bid. For that reason, you want to communicate that price is an important consideration, but that a contract won’t automatically be awarded to the low bidder. One benefit to consider regarding ranked auctions is that suppliers tend to prefer them over other auction types since it’s not a pure “race to the bottom” in terms of price. If suppliers feel strongly about the overall strength of their offerings, they will make competitive bids and expect that cost will be one factor in how total value is evaluated.

2. Open Auction (also known as an Open Outcry or English Auction)

In an Open Auction, everyone who has submitted the bid will have full knowledge of the value of the leading bid. Bidding typically starts high—or at a buyer-defined maximum—and falls steadily. This means that all the participants start with a level playing field and all have an equal shot to compete for the winning bid.

A supplier can only submit a bid if its numbers beat the current best price. The process works best when the buyer is comfortable with attaching a value to their project, allowing them to quickly settle negotiations. Bear in mind that this kind of reverse auction is designed for commodity items where price is likely the key differentiator.

One common misconception is that buyers are obliged to award the contract to the low bidder. While that is frequently the case, it’s not always so. Even with commodity goods, there can be considerations beyond price that influence the outcomes of these events.

3. Dutch Auction

Dating back to Tulip Mania in the 17th century, Dutch auctions have made their way beyond The Netherlands and out of flower markets. In fact, they’ve been used for public stock offerings.

In a reverse Dutch auction, the buyer will list a product, a quantity and price that it would like to pay. Suppliers can elect to opt in or out for some or all of the quantity. For example, if a buyer wants to buy 10,000 widgets at $10 per widget, suppliers have three choices:

  1. Place a bid to provide all 10,000 widgets at $10/widget.
  2. Decide not to provide any widgets at that price.
  3. Place a bid to provide some portion of the widgets for $10/widget.

Prices increase at a predetermined interval as long as there is outstanding supply. And in many cases, multiple suppliers can combine to meet the needs of a single buyer. Imagine, for example, multiple rounds of bidding with our widget example.

reverse_dutch_auction_table

In this scenario, four suppliers combine to meet the needs of the buyer. The market clearing price, i.e., the price at which the buyer can be fully supplied, is $14. In the above example, even though Supplier A, B, and C were all willing to sell their widgets for less, each would receiving the market clearing price of $14. Buyers should take care to set a reserve price, which acts as a ceiling.

(Fun Facts: If you’re wondering if the buyer can buy the specified quantities at the bid prices rather than at the reserve price, they can...just not in reverse Dutch auction. Rather, this would be the result of a reverse Yankee auction. In that scenario, Supplier A would be providing widgets at two price points and delivering at an average price of $11.33. And while the buyer would pay between $10 and $14/widget, the blended cost of all the widgets to the buyer would be $11.40.)

Although a Dutch auction offers loads of flexibility and can drive down prices, it can also introduce complexity into the supply chain. That complexity can, in some cases, undermine any savings realized in the sourcing process. It’s a useful tool for a buyer to have, but should be considered carefully before implementation.

4. Japanese Auction

Reverse Japanese auctions begin with the buyer’s sending an opening price to suppliers. To participate, suppliers must accept the opening price, signifying that they agree to the requirements defined.

As more bidders agree to participate, the bid price goes down at specific intervals—usually time contingent—with bidders being asked to accept or reject the new price. The whole process continues until there is only one bidder left. A Japanese auction is, in effect, a process of elimination.

A reverse Japanese auction type is ideal when the buyer wants to limit information available to potential bidders. In addition, a buyer can run it even if there is only one participant on the supplier side. Note, however, that this is also the least popular method of eSourcing among suppliers as it gives them very little feedback. It’s also considered one of the more difficult auction formats for businesses given that it’s challenging to set-up and requires more attention to execute.

Keep in mind that each type of reverse auction will have its own strengths and weaknesses. Choosing the right one depends on what your objectives are and what you need to address. However, regardless of what type you choose, this process will ultimately help you get the most value for your budget, allow you to source suppliers easily, and simplify the complex process of procurement.

Take advantage of Vendorful’s eSourcing platform and find out how we can help improve your procurement process, get in touch with us today.

Topics: Reverse Auctions