A
reverse auction is a type of
auctionAn auction is a process of buying and selling goods or services by offering them up for bid, taking bids, and then selling the item to the highest bidder...
in which the roles of buyers and sellers are reversed. In an ordinary auction (also known as a forward auction), buyers compete to obtain a good or service, and the price typically increases over time. In a reverse auction, sellers compete to obtain business, and prices typically decrease over time.
In business, the term most commonly refers to a specific type of auction process (also called
procurement auction,
e-auction,
sourcing event,
e-sourcing or
eRA, eRFP, e-RFO, e-procurement, B2B Auction) used in government or private sector procurement.
In consumer auctions, the term is often used to refer to sales process that share some characteristics with auctions, but are not necessarily auctions.
Introduction
This article focuses on the "e-procurement" definition of the term, as this is the most commonly found application of reverse auctions and the term "Reverse Auction" has become synonymous for most people with this type of auction.
Reverse auction is a strategy used by many purchasing and supply management organizations for
spend managementSpend management is the way in which companies control and optimize the money they spend. It involves cutting operating and other costs associated with doing business...
, as part of
strategic sourcingStrategic sourcing is an institutional procurement process that continuously improves and re-evaluates the purchasing activities of a company. In a production environment, it is often considered one component of supply chain management...
and overall supply management activities.
In a typical auction, the seller puts an item up for sale. Multiple buyers bid for the item, and one or more of the highest bidders buy the goods at a price determined at the conclusion of the bidding.
In a reverse auction, a buyer puts a contract out for bid, either using specialized software or through an online marketplace. Multiple sellers offer bids on the item, competing to offer the lowest price that meets all of the specifications of the bid. As the auction progresses, the price decreases as sellers compete to offer lower bids than their competitors.
Bidding performed in real-time via the Internet results in a dynamic, competitive process. This helps achieve rapid downward price pressure that is not normally attainable using traditional static paper-based bidding processes.
The buyer may award the contract to the seller who bid the lowest price. Or, a buyer may award contracts to suppliers who bid higher prices depending upon the buyer's specific needs with regards to quality, lead-time, capacity, or other value-adding capabilities.
The use of
OptimizationIn mathematics, computational science, or management science, mathematical optimization refers to the selection of a best element from some set of available alternatives....
software has become popular since about 2002 to help buyers determine which supplier is likely to provide the best value in providing goods or services. It includes relevant buyer and seller business data, including constraints.
Reverse auctions are used to fill both large and small value contracts for both public sector and private commercial organizations. In addition to items traditionally thought of as commodities, reverse auctions are also used to source buyer-designed goods and services, and they have even been used to source reverse auction providers. The first time this occurred was in August 2001, when America West Airlines (now
US AirwaysUS Airways, Inc. is a major airline based in the U.S. city of Tempe, Arizona. The airline is an operating unit of US Airways Group and is the sixth largest airline by traffic and eighth largest by market value in the country....
) used FreeMarkets software and awarded the contract to MaterialNet.
In 2003, researchers claimed an average of 5% of total corporate spending was sourced using reverse auctions.
The whole point of a reverse online auction is to bid on auctions where the lowest unique bid wins.
History
Reverse auctions gained popularity in the late 1990s as a result of the emergence of Internet-based online auction tools. Pioneer of online reverse auctions, FreeMarkets, was founded in 1995 by former McKinsey consultant and
General ElectricGeneral Electric Company , or GE, is an American multinational conglomerate corporation incorporated in Schenectady, New York and headquartered in Fairfield, Connecticut, United States...
executive
Glen MeakemGlen Meakem is a venture capitalist and American conservative radio host based in Pittsburgh, PA.-Early life and education:...
after he failed to find internal backing for the idea of a reverse auction division at
GEGeneral Electric Company , or GE, is an American multinational conglomerate corporation incorporated in Schenectady, New York and headquartered in Fairfield, Connecticut, United States...
. Meakem hired McKinsey colleague Sam Kinney who developed much of the intellectual property behind FreeMarkets. Headquartered in Pittsburgh, PA, FreeMarkets built teams of "market makers" and "commodity managers" to manage the process of running the online tender process and set up market operations to manage auctions on a global basis.
The company's growth was aided greatly by the hype of the dot-com boom era. FreeMarkets customers included
BPBP p.l.c. is a global oil and gas company headquartered in London, United Kingdom. It is the third-largest energy company and fourth-largest company in the world measured by revenues and one of the six oil and gas "supermajors"...
plc, United Technologies,
VisteonVisteon is one of the world's largest suppliers of automotive parts. The company formed in 1997 and spun off from the Ford Motor Company in 2000. In 2005, Visteon moved to new headquarters in Van Buren Township, Michigan...
, H.J. Heinz,
Phelps DodgePhelps Dodge Corporation was an American mining company founded in 1834 by Anson Greene Phelps and William Earle Dodge, Sr.. On March 19, 2007, it was acquired by Freeport-McMoRan and now operates under the name Freeport-McMoRan Copper & Gold Inc.-History:...
, Exxon Mobil, and
Royal Dutch ShellRoyal Dutch Shell plc , commonly known as Shell, is a global oil and gas company headquartered in The Hague, Netherlands and with its registered office in London, United Kingdom. It is the fifth-largest company in the world according to a composite measure by Forbes magazine and one of the six...
, to name a few. Dozens of competing start-up reverse auction service providers and established companies such as
General MotorsGeneral Motors Company , commonly known as GM, formerly incorporated as General Motors Corporation, is an American multinational automotive corporation headquartered in Detroit, Michigan and the world's second-largest automaker in 2010...
(an early FreeMarkets customer) and
SAPSAP AG is a German software corporation that makes enterprise software to manage business operations and customer relations. Headquartered in Walldorf, Baden-Württemberg, with regional offices around the world, SAP is the market leader in enterprise application software...
, rushed to join the reverse auction marketspace.
Although FreeMarkets survived the winding down of the dot-com boom, by the early 2000s it was apparent that its business model was really like an old-economy consulting firm with some sophisticated proprietary software. Online reverse auctions started to become mainstream and the prices that FreeMarkets had commanded for its services dropped significantly. This led to a consolidation of the reverse auction service marketplace. In January 2004,
AribaAriba is a software and information technology services company located in Sunnyvale, California.- Early life :Ariba was founded in 1996 by Bobby Lent, Boris Putanec, Paul Touw, Rob Desantis, Ed Kinsey, Paul Hegarty, and Keith Krach on the idea of using the Internet to enable companies to...
announced its purchase of FreeMarkets for $493 million.
Fortune magazine published an article in March 2000 describing the early days of reverse auctions.
In the past few years mobile reverse auction have evolved. Unlike
business-to-businessBusiness-to-business describes commerce transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer...
(B2B) reverse auctions, mobile reverse auctions are business-to-consumer (B2C) and allow consumers to bid on products for pennies. The lowest unique bid wins.
Very recently business-to-consumer (B2C) auctions with a twist have started to evolve - they are more similar to the original
business-to-businessBusiness-to-business describes commerce transactions between businesses, such as between a manufacturer and a wholesaler, or between a wholesaler and a retailer...
(B2B) auctions than mobile reverse auctions in that they offer consumers the option of placing a specification before retailers or resellers and allowing them to publicly bid for their business.
In Congressional testimony on the 2008 proposed legislative package to use federal funds to buy toxic assets from troubled financial firms, Federal Reserve chairman Ben Bernanke proposed that a reverse auction could be used to price the assets.
Current State
Reverse auctions (also becoming known as service auctions) are undergoing a resurgence at present, as evidenced by a number of service auction sites that are doing a significant volume of business both in number of projects and amount of money spent. There are narrow scope sites, such as those specializing in programming, technical writing and other professional, desk-based work or in home improvement and construction work.
In 2004, the White House Office of Federal Procurement Policy (OFPP) issued a memorandum encouraging increased use of commercially available online procurement tools, including reverse auctions. In 2005, both the Government Accountability Office and Court of Federal Claims upheld the legality of Federal agency use of online reverse auctions. In 2008, OFPP issued a governmentwide memorandum encouraging agencies to improve and increase competitive procurement and included specific examples of competition best practices, including reverse auctions. In 2010, The White House Office of Management and Budget cited “continued implementation of innovative procurement methods, such as the use of web-based electronic reverse auctions” as one of the contracting reforms helping agencies meet acquisition savings goals.
Keys to success as a supplier in reverse auctions are: (a) Thorough preparation – it's essential to know your costs, your suppliers, your requirements, and your market to the greatest extent possible – tiny details can make the difference between winning and losing, and between being profitable or not; (b) Reverse auctions should be largely kept to the supply of commodity products rather than proprietary ones; and (c) Having a strong, competent bidder leading your effort at the time of the auction, with clear guidelines on when to bid and when to fold is essential.
See also
- Tendering
- Request for Quotation
A request for quotation is a standard business process whose purpose is to invite suppliers into a bidding process to bid on specific products or services. RFQ, generally means the same thing as IFB ....
- Request For Tender
A request for tender, commonly abbreviated to RFT, is a formal, structured invitation to suppliers for the supply of products or services. In the public sector, such a process may be required and determined in detail by law to ensure that such competition for the use of public money is open, fair...
- Request For Information
A request for information is a standard business process whose purpose is to collect written information about the capabilities of various suppliers. Normally it follows a format that can be used for comparative purposes....
- Request For Proposal
A request for proposal is issued at an early stage in a procurement process, where an invitation is presented for suppliers, often through a bidding process, to submit a proposal on a specific commodity or service. The RFP process brings structure to the procurement decision and is meant to...
- Optimization (mathematics)
In mathematics, computational science, or management science, mathematical optimization refers to the selection of a best element from some set of available alternatives....
- Operations research
Operations research is an interdisciplinary mathematical science that focuses on the effective use of technology by organizations...
Further reading
- Bounds G., "Toyota Supplier Development", in Cases in Quality, G. Bounds, Editor, R.D. Irwin Co., Chicago, IL, 1996, pp. 3–25
- Shalev, E. Moshe and Asbjornsen, S., "Electronic Reverse Auctions and the Public Sector – Factors of Success", Journal of Public Procurement, 10(3) 428-452.
- Bounds G., Shaw, A., and Gillard, J., "Partnering the Honda Way", in Cases in Quality, G. Bounds, Editor, R.D. Irwin Co., Chicago, IL, 1996, pp. 26–56
- Dyer, J. and Nobeoka, K., "Creating and Managing a High-Performance Knowledge Sharing Network: The Toyota Case," Strategic Management Journal, Vol. 21, 2000, pp. 345–367
- Liker, J. and Choi, T., “Building Deep Supplier Relationships,” Harvard Business Review, Vol. 82, No. 12, December 2004, pp. 104–113
- Womack, J., Jones, D., and Roos, D., The Machine that Changed the World, Rawson Associates, New York, NY, 1990, Chapter 6
- Jap, Sandy D. (2007), The Impact of Online Reverse Auction Design on Buyer-Supplier Relationships, Journal of Marketing, 71(1), 146-50
External links