Auctions in procurement

Madhur Shah Business Card Company: SAP Labs India Pvt Ltd Posted on Oct. 11, 2010 07:14 AM in Procurement and SRM

1. Auctions - Overview

Reverse auctions are hosted by single buyer and feature two or more suppliers competing for business. Such auctions are commonly used by organizations in a tactical way to achieve sourcing objectives. It is called reverse because during the event, the price is expected to go down due to competition.Usually in procurement, we deal with reverse auctions. However in some selected cases, we also deal with forward auctions where the buyer is actually looking for buyers. This can happen if the procurement department wants to sell out scrap, etc.

2. When to use reverse auctions?

For companies that are just starting to conduct reverse auctions, the best practice would be to use an RFP (request for proposal) process followed by an auction. Here, the buyer gets a good sense of the market pricing and can determine the auction parameters with greater confidence. The table below lists in which scenario what combination of RFPs and Reverse auctions can be used:

Use of RFP process only Spend Characteristics Specifications Market driver Industry competitiveness Complex Developed jointly by supplier and buyer (maybe patented) Value only Not very competitive (monopoly/oligopoly)

Use of RFP process and Reverse auctions Custom Created by buyer (maybe patented) Value and price Competitive Many Medium Limited Medium/low Medium Medium

Use of Reverse auctions only Generic Defined by industry standards Mostly Price and volume Very competitive Very many (commoditized) Low Transactional Negligible Low Short/immediate

Supplier availability Single or few Riskiness of Very high switching suppliers Supplier relationship Switching cost Level of detail for supplier qualification Supply lead time Strategic Very high High Long

Spend examples

Patented carbon block filter; Plastic enclosures; Non-custom patented drug delivery circuit boards; packaging; bulk system machine parts chemicals; lab supplies

Table 1: Scenarios where reverse auctions can be used

3. Running a successful auction

The following steps can help to ensure a successful running of auctions:

Determine category spend amounts and specifications: It always helps to collect comprehensive data annual consumption, pricing trends, commercial terms, etc so that the buyer can confidently float the auction document Identify suppliers and get initial quote: Usually a RFI/RFP or RFQ processes as suitable is conducted before the auction is floated. This helps the buyer to get a fair idea of the market price Determine the auction strategy and rules and then build the event: As discussed above, get information from RFQ/market research Train suppliers: It is a good idea to invest in web based training to familiarize bidders with the auction tool. This reduces issues during the auction event Conduct live auction: It is recommended to make a buyer hotline available for bidders. This should be on top of any chat with buyer functionality, if available Award business: Awarding should not be delayed for long. Barring exceptions, awarding should be done. Else the buyer loses credibility and it may be difficult to attract bidders for the next event Capture savings: Document savings and publish to other buyers and stakeholders increases adaptability

4. Right setting for auctions

4.1. Visibility rules
How much information to disclose to bidders? The following list mentions the various options:

Visibility rules

What it is

When to use it and why Is most effective in auctions driven by market/price share Is for a category that is commoditized and competitive Has price as key factor in award decision Can be used with as few as two bidders Is most suitable when the bid values has a large spread

Leading bid only

Bidders can see only their bid and the leading bid

Rank only

Bidders can only see their bid and rank; they cannot see Features value-based categories the leading bid Has a supply market sensitive to price disclosure

Has price as weighted factor in award decision Needs at least six to eight suppliers for a successful event Is used in events with large number of bidders (30 or more) and lots Is used as a mechanism to establish a "preferred supplier base" for subsequent auctions comprising actual line item awards

Leading bid and rank

Bidders can see the leading bid and their own rank

Table 2: Visibility rules during auction

4.2. Line items v/s lot

Buyer can decide whether bidding happens on each line item or a group of line items, called lot. If buyer unsure of supplier capabilities in the market, best not to create lots. Market basket approach if large number of line items contribute to the total spend, buyer selects a cross section of line items based on delivery location, product category, etc to create a market basket and conduct auction events: Goal is to identify and establish contracts with a group of preferred suppliers Each subsidiary of the procuring organization conducts auctions with these suppliers to make the final award

Line item type

What it is

What is does and when to use it Enables the buyer to cherry pick on line item basis to come up with the lowest award mix; however note that suppliers can then also cherry pick which items they want to bid on Provides more visibility into pricing Used when the buyer is unsure of volume demand Enables the buyer to get bids on low margin or low volume items on which the bidder might not bid if they were listed individually Enables the buyer to consolidate the supply base Used only if the volumes indicated for bidding are the actual volumes, not

Line item

A line item is an individual item on which the bidders can bid. Bidders can enter the price per line item

Lot

A lot is a grouping of line items, based on delivery location, raw materials, manufacturing process or awarding strategy. Bidders enter price for each line item in the lot

estimates, which will translate into award volumes

Table 3: Line item v/s lot

4.3. Bid decrement

The following factors should be borne in mind while deciding the decrement values:

Two types of bid decrement values: Percentage and Monetary value (dollar/rupee) Determining right bid decrement is very important: Too large or too small bid decrement will discourage bidders and reduce competition and if there is a wide range in price of line items, percentage decrement is recommended

4.4. Beating leading bid v/s beating own bid

Beating leading bid is suitable for forward auctions where suppliers solicit buyers For reverse auctions, beating own bid should be used. This allows supplier to give the best price based on his cost and processes Often the lowest bidder does not meet the quality and service grades and thus the buyer goes for the second lowest bidder. It should be ensured that the second best bidder has given his best possible price

4.5. Duration and use of extensions

Duration of the auction event depends on number of line items and participating suppliers For auctions with 15-20 line items and 4-8 suppliers, recommended minimum time is 20 minutes Usually bidders place their bids in the last few minutes. Here extensions can be used to ensure an even playing field For events with more than 20 line items, buyer should use a staggered open and close. This would enable bidders to focus on the currently open items and not get overwhelmed by the bidding activity

5. Benefit of auctions
5.1. Benefits to buyers

Removes human factor from price negotiation Not all buyers are good negotiators Increased efficiency Earlier bidding process would run into months while with auctions, award can be done in weeks Transparent purchasing process All auction data can be made available to internal stakeholders. This goes a big way in winning confidence of stakeholders as well as useful for auditing purposes Transparency to bidders Bidders have visibility on where they stand in the competition

Supplier development Instrumental in building trust with the bidder on a fair process. Since the bidder knows where he stands in competition, he is motivated to participate next time with improved pricing

5.2. Benefits to bidders

Fair and competitive environment Bidders appreciate providing them a level playing field Collaborative bidding environment It allows the bidders to have real time questions and answers during bidding Market intelligence Even if they lose, they get good insight into pricing intelligence of competitors Transparency to bidders Bidders have visibility on where they stand in the competition Ability to react to competitor pricing They can react instantly to competitor bids which is not possible in traditional negotiations Time efficiency Supplier can focus time to other RFQs since the decision is almost instantaneous

6. Best practices for successful auctioning

Below listed are some best practices for successful auctioning:

Select items that exist in a naturally competitive environment - If there are only few suppliers available for auction, its better to go for supplier development first. Ensure that all available contracts are expiring - Bidders generally do not want to win business one or two years down the road. Buyer should ensure that the accepted bid gets awarded in recent future Identify relevant non-price factors - It would disqualify some suppliers and help in better decision making for the buyer. This intelligence can be gathered from the RFP process preceding the auction or even some analytics can be used here Do not use auctions as benchmarking or price discovery - We could use other sources or use RFP for that. Once an auction is conducted, the bidders expect an award to happen Set realistic starting prices - Buyer should do proper research before the auction Allow adequate time to train and support bidders - This would apply especially right before the auction and also helps in fostering a level-playing field feeling among bidders Intend to award business - Else it would be unethical as well as bidders would not participate next time Contact all participants after the auction, especially losing ones - It might be a good idea to explain for 5-10 minutes on why they lost. It helps in supplier development and also building a rapport for future interactions

Most of these features and many more are available in SAP Supplier Relationship Management offering