Why Aren’t Reverse Auctions More Commonly Used?

A recent blog post over on Procurement Excellence asked why aren’t reverse auctions used more by procurement people? According to the article, it’s usually because:

  • procurement people sometimes lack the confidence to run them
  • procurement people are often scared of running auctions because they might expose how badly they are currently buying

Fair enough. They do require confidence and if you’re really doing poorly, they’ll expose that. But these aren’t the only reasons, and, I’d bet, not even the most common reasons. What about:

  • procurement people are scared suppliers won’t participate

Suppliers can be as scared of, or more scared, of an auction as a buyer. And for many reasons. They might be the incumbent with a history of overcharging. They might be a first-time invitee and have the perception it is only being run to drive down incumbent pricing. They might feel that it won’t capture the full value of their offering. And so on.

And these reasons only really apply to procurement people who probably haven’t run reverse auctions (or at least those who haven’t run a reverse auction successfully). There’s also:

  • experienced procurement people know that sometimes a reverse auction can increase prices and
  • smart procurement people know that it’s not always the right option

For a reverse auction to be successful, a number of conditions have to be right. There have to be enough suppliers willing to participate who want the business. The current pricing has to be above market average. The buyer has to be willing to award to the bidder with the lowest (weighted) bid and the suppliers have to perceive that. Either the majority of the cost has to be landed cost or the true cost needs to be easily defined as a weighted multiple of a (supplier’s) bid. If these conditions aren’t met, not only could costs not decrease, but they could increase. For example, if there were only three suppliers, in collusion, in a supplier’s market where demand exceeded supply and the current market price exceeded the price the buyer was currently paying, costs might increase substantially!

Furthermore, a truly smart buyer knows that reverse auctions aren’t always the answer, especially for strategic materials, components, or services. Not only are there some things that you can’t auction, but there are some things you shouldn’t auction, especially if your spend is high enough where you have leverage with your preferred suppliers. If you do a spend analysis and find out you’re spending 50M with your preferred temp labor supplier, it’s pretty easy to get at least 10%, if not 20%, savings if you show them the numbers and threaten to take your business elsewhere. Who’s going to give up 30M to 40M worth of business in a down economy? And if you’re primarily contracting security guards, janitorial services, and seasonal warehouse packers, should there really be a salary bell curve? In these situations, someone making above the mean is not going to be more effective than someone making below the mean.

Finally, a good procurement pro knows that there are only two technologies in the tool-kit that consistently give double digit returns on average, regardless of the economy — and those tools are spend analysis (which can enable leveraged negotiations) and decision optimization. While it’s true that a reverse auction can generate double digit savings in the right situation, that situation is not nearly as common as some vendors will have you believe. And that’s why more procurement pros aren’t running reverse auctions. They’re not always the right choice.

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