RTM: Reverse auctions have really taken off.  Having started with the automakers and Boeing, they are now being used by Kraft, Nestle, Dell and Intel and are even being adopted by small and medium businesses.  What is the appeal?

SJ: Huge price savings!  Compared to the traditional process where a buyer goes round, gets quotes and then tries to bring suppliers down on price, they lead to price reductions as high as 40%, although more typically 15-20%.  That leaves the purchasing director looking like a hero!

But I would guess that 60%-80% of the time the buyer doesn’t even go with the lowest bid, so what finally hits the books is significantly less. There is also a big saving in time for the buyer.

RTM: Why does it have such a huge impact on price?

SJ: The suppliers can see that there is no bluffing.  They can see the real quotes put in by competitors – in real-time pressure!

RTM: All this must have had some impact on relationships between suppliers and buyers.

SJ:  Yes, it does.  Actually, I got involved in this area after betting a guy who runs reverse auctions that all this would affect relationships with suppliers!

RTM: I take it you won…

SJ: Oh yes.  We researched supplier attitude before and after the reverse auction. Full price visibility auctions left suppliers feeling vulnerable and forced to expose their pricing mechanism.
 
RTM: Did suppliers trust the process?

SJ: No. They often felt that buyers were putting in phantom bidders to cut the price.  As an insider, I knew that this was not true, but the mere perception caused them to be increasingly suspicious of the buyer.

But I found that reverse auctions were a pretty effective wake up call to complacent suppliers!  It makes some think hard about how they can differentiate and add value.

RTM: So are there rules which buyers should follow when they hold reverse auctions?

SJ: Yes. Build the trust back in. Make it very clear whether you will legally commit to award the contract as a result.  Often, suppliers fear that reverse auctions are simply a way of viewing prices.  Buyers should also state whether the the lowest bidder will win. 

Buyers should also be very clear that they are only going to allow qualified bidders into the auction.  In most industries, there are only 3 or 4 suppliers who are capable of delivering.  If bidders see a dozen competitors, they feel that the buyer has let  in Joe & Bill’s startup, just to reduce the price.

RTM: What about the losers?  I mean how do you handle it if one of the losers is a strategic supplier?

SJ: Well, if the product is unique and comes from a strategically important supplier then don’t hold an auction!  But if it is an indirect product, not used directly in manufacturing such as office supplies, PCs or paper towels, then reverse auctions really come into their own. In companies where buyers have good relationships with suppliers they will tell them why their bid failed and look at the problems.

RTM: I gather that you have a mathematical modelling tool, Bidanalyzer, which you believe can accurately forecast not only the final bids, but also the optimal bids from established suppliers.  How does that work?

SJ:  We are still testing it, but the early trials have been successful.  We take the first few bids and we can accurately forecast what the final bid will be, no matter which industry and no matter what size the contract.  On four trials so far we have achieved 97% to 98% accuracy. We can also model the optimum bids from each supplier.

RTM: Can you explain what you mean by that?

SJ: Yes, we can use the model to come up with the price from each supplier which should provide them with a reasonable, but not extortionate profit.  This is extremely important for the buyer.  BidAnalyzer enables buyers to identify which suppliers might have held back in the bidding process and stopped bidding prematurely.  And it also identifies the suppliers that may have bid too much and might experience a "winner’s curse."  You probably don’t want a good supplier to put in a bid on which it will definitely lose money.

The optimum prices and the forecast can all be made from the initial bids placed in the auctions.

RTM: Given that reverse auctions have now been around for 3-4 years has the behaviour of suppliers and buyers changed?

SJ: My sense is that both sides are getting smarter.  Suppliers are making fewer mistakes and buyers are clearer about their expectations and intentions from these auctions.

For a detailed report on reverse auctions, view The Role of Reverse Auctions in Strategic Sourcing from Center for Advanced Purchasing.  This free 88 page report can be found at CAPSresearch.org.