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Home : Articles : Reverse Auctions

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REVERSE AUCTIONS

Government Reverse Auctions

by Glenn Wheaton, July 27, 2010

Introduction

Today, buyers for federal agencies, state and local governments, and municipalities are under increasing pressure to do more with fewer staff and resources. This often involves fulfilling their missions and purchasing required goods and services using the most effective and efficient manner possible. To accomplish this, many government buyers are turning to new buying processes and technologies. One technology that has become increasingly popular with government buyers is the use of reverse auctions. Many government buyers have been able to realize large savings using reverse auctions on purchases for commodities, indirect goods, and services. These savings have enabled these governments to apply the money saved to other budget line items and programs and has mitigated the impact of tight economic conditions.

Reverse auctions are a structured competitive bidding event where two or more suppliers place bids to supply goods or services that drive the price lower over the course of the event. There are many variations and business rules that can be set for reverse auctions and there is also some overlap with other sourcing tools like RFPs, RFIs, and RFQs. This article will focus on the impact of reverse auctions on the public sector. It will provide some of the reasons for the growth of reverse auctions and their increasing use by government entities. It will also outline some of the issues that government buyers face when they are contemplating the adoption of reverse auctions. In addition, the article will also provide details on some things that the government buyer can do to increase the chances of successfully implementing reverse auctions and maximizing savings.

Reasons for Adoption

There are many compelling reasons for governments to adopt reverse auctions. Many of the benefits of adopting reverse auctions were established by the private sector and were then confirmed by the experiences of states and government agencies. The use of reverse auction technology has become more widespread in response to the growth of the Internet and its value as a tool for finding and exchanging information. As the Internet has grown, reverse auctions have evolved as an efficient and structured way to conduct online negotiations with suppliers. In fact, reverse auctions have completely revolutionized the way that many government buyers conduct business. Reverse auctions offer governments significant cost savings benefits, result in lower cycle times, increase compliance, enhance transparency, increase collaboration, boost supplier participation, and provide feedback for participants. The reasons for adoption are described in further detail in the sections below.

Compliance

Many governments have decided to implement reverse auctions to fight corruption, reduce back room negotiations, and bring transparency to the government purchasing process. By facilitating a structured and automated negotiation, reverse auctions provide a clear and documented process for reaching an agreement on pricing for many different types of goods and services. Moreover, the process is open since a reverse auction preserves bidder anonymity and provides suppliers with real time pricing feedback. This means that suppliers will instantly have an understanding of where they stand in relation to other bidders. Moreover, buyers, auditors, management, or other personnel can have real time visibility into the negotiation. Due to their unique structure and the transparent process, reverse auctions are an excellent way to comply with fair purchasing policies, laws, or regulations.

Price

One obvious benefit of reverse auctions for government buyers is their effectiveness as a means of negotiating price for purchases. As long as the government buyer has a pool of qualified suppliers that are willing to participate in a reverse auction, the power of competitive bidding and price disclosure will drive the price lower. It is important to remember that in a reverse auction, it is the power of the market and competitive bidding, not the buyer bullying the vendor that drives the pricing lower. Vendors then respond to these market price signals and adjust their pricing lower accordingly. Reverse auctions are most effective for lowering purchase prices when they are used for purchases that are more transactional in nature rather than for more strategic purchases. Some government buyers have been able to realize savings in the range of 10% to 30% on some of the items that they purchase. This savings results in additional money that can be used for other, more productive purposes.

Cycle Times

The traditional buying process for many good includes locating qualified suppliers, contacting each of these suppliers, obtaining pricing, negotiating with these suppliers and then awarding the business. Negotiating with suppliers can be quite time consuming and labor intensive for the government buyer. Reverse auctions offer a way to reduce the complexity and obtain pricing in a quick and structured format that encourages lower bids from suppliers within a designated period of time. The time element of reverse auctions along with a well defined start and end date make the negotiation efficient and helps complete the price negotiation by the end of the event. This save a lot of time and effort that can then be used for other productive activities. The bottom line is that reverse auctions and processes like them reduce the time from solicitation announcement to award.

Transparency

For government buyers, transparency in the buying process is very important to build taxpayer trust. In some areas, reverse auctions have been implemented as a means of reducing corruption and leveling the playing field. When implemented correctly, the reverse auction process does not lend itself to bid rigging or other corrupt practices since the price is determined by the market. It is also easy for the government organization to maintain control over the process, see what is happening, and understand the bids that were placed. The price disclosure aspect of reverse auctions brings clarity to the bidding process, discloses pricing while preserving bidder anonymity, and keeps the whole process above board. It is also easy to document and the reverse auction process produces data that can be used to support award decisions or provide documentation in the event of an audit.

Collaboration

Reverse auctions also provide an environment that makes it easy for 2 or more buyers to collaborate on a purchase. Buyers can work together online to develop specifications, business rules, and set other important parameters for the reverse auction. This collaboration boosts the overall effectiveness of the event and can help pool together purchasing, technical, or other expertise for a sourcing project. Other personnel like managers and auditors can also view the reverse auction and accompanying documentation as well. Reverse auction also boosts collaboration with suppliers for many types of commodities as well. Supplier can ask questions and can respond quickly to specifications and negotiations.

Participation

When done well, reverse auctions should boost participation in the buying process. Reverse auctions make it easier for qualified suppliers to participate in the buying process by making it more convenient, giving them real time feedback, and shortening the cycle times for the purchase. This saves supplier time and lowers costs by eliminating an otherwise lengthy and time consuming negotiation. Moreover, the fact that the reverse auction is available over the web makes it more accessible to a larger pool of vendors and provides global access for suppliers. These factors can increase the number of suppliers that are involved in the buying process.

Feedback

Reverse auctions provide real-time pricing feedback for participants. This means that right after a supplier bid has been placed, the supplier will know whether his/her bid was good enough to win the business. This real time pricing feedback, unlike traditional purchasing methods or sealed bidding sends suppliers feedback on what they need to bid in order to win the reverse auction. This gives suppliers the information that they need to remain competitive and can help them to adjust their business processes and procedures quickly in order to remain competitive in the future. In this way, reverse auctions provide a real-time measurement of where the supplier stands in relation to other suppliers. If a supplier loses the reverse auction, the supplier has the opportunity to refine its operations to reduce costs, produce better products, or otherwise meet the buyer requirements better.

Issues for Government Buyers

While reverse auctions clearly provide significant and measurable benefits for government buyers, there are some issues that public sector buyers should consider when they are thinking about reverse auctions. With these issues in mind, governments can successfully adopt reverse auctions and avoid some important pitfalls. Some of the issues that buyers should be aware of include: the legality of reverse auctions, the process adjustments to the buying process needed, the need to have the backing of leadership, an understanding of when to use reverse auctions, and the costs associated with using them. The sections below will outline some of these issues in additional detail and provide government buyers with a framework to use when approaching these issues and applying them to reverse auctions at the federal, state, and local level.

Legality of Reverse Auctions

Every government agency whether federal, state, local, or other municipality needs to make sure that reverse auctions are legal as a purchasing methodology. For federal government agencies, Federal Acquisition Regulations (FAR) are no longer contain any ambiguities about whether or not reverse auctions are prohibited. Instead, the Federal government is actively working to implement advanced purchasing techniques like reverse auctions that have been used effectively in the private sector for years. This is apparent in some of the more recent federal regulations like the E-Government Act of 2002 (PL 107-347) and policies like the May 12, 2004 memo, from the Office of Procurement Policy that encourages agencies to use commercially available procurement tools like reverse auctions. In July of 2009, the OMB released a memo that states that agencies should focus on "developing more strategic acquisition approaches to leverage buying power and achieve best value for the taxpayer." In addition, the courts have also rejected challenges that claim that reverse auctions "knowingly disclosing contractor quotation or proposal information before award" (MTB Group, Inc. v. United States) as long as bidder anonymity is preserved. These laws, regulations, policies, and court decisions have provided the impetus for the federal government to adopt reverse auctions.

Many states are also adopting reverse auctions as a means of conducting certain kinds of purchases. In some cases the states have laws and rules that mandate open competition and the use of advanced sourcing and buying technologies like reverse auctions. For example, the State of Texas Office of State Purchasing and General Services has rules and policies that require the use of certain approved purchasing methodologies. Reverse auctions are one of these approved methodologies. Other states have been slower to adopt reverse auctions because state law is not clear about the use of reverse auctions or may prohibit them altogether. These states will likely wait to use reverse auctions until the purchasing laws and policies are changed or until rulings and precedents provide additional clarity regarding the legality of reverse auctions. Many municipalities like large cities and counties that conduct many, high dollar purchases have reverse auction processes in place; other municipalities do not. It is important for any municipality that is seeking to conduct reverse auctions to check on the laws, rules, and policies in effect to make sure that they are updated to accommodate reverse auctions.

Process Adjustments

Adopting a new technology involves some effort and also requires rethinking the way things are done in order to make use of the new technology or process. This is sometimes difficult to do if the organization or agency already has established policies, procedures, and ways of doing things. Implementing reverse auctions often means rethinking the entire purchasing process where reverse auctions and Internet based sourcing methods are concerned. Some areas that will need to be adjusted include per-qualification procedures, how solicitation and requirement documents are generated, new procedures to accommodate the reverse auction, new bid analysis procedures, and procedures for managing and monitoring the reverse auction. Other parts of the process include changes to the award process and alterations to the process of event documentation and preparation for audits.

It can take a little time for buying personnel to gain the knowledge needed to conduct a reverse auction and to get used to the new process. This means that managers or people within the organization seeking to adopt reverse auctions need to have a plan in place that can bring buyers up to speed. For some organizations, this will involve meetings, planning sessions, and running test auctions. For other organizations, this might involve training or bringing in a staff member or outside expert with reverse auction expertise. For other organizations, this will mean bringing in a "full service" reverse auction company or consultant to run a couple of events. The purpose of this would be to show internal buyers how to conduct and event and also to transfer knowledge from the reverse auction expert to the rest of the buying department. Many organizations go with a combination of these options.

Leadership Support

In order to successfully implement reverse auctions, it can be extremely helpful to have the support of upper management. With the backing of upper management, it can be easier to make the changes to the buying process that need to take place since it is supported from the top and are part of the organization's goals. In order to obtain upper management support for reverse auctions, it is often helpful to have some data and to demonstrate the business case for reverse auctions. There are many published studies that outline the cost savings that organizations in the private and public sector have been able to achieve. Additionally, it can also be helpful to obtain some sample data from a pilot or single reverse auction that was used to purchase a suitable commodity.

Upper management for buying organizations often set specific goals and targets for the purchasing group. Reverse auctions can be an important part of achieving those targets and generating the cost savings or value that management seeks to realize. For this reason, it is important to have a way to measure cost savings. Additionally, when a reverse auction is a success, it is important that upper management is aware of the success and is able to quantify the value delivered from the auction or event. This will encourage upper management to adopt reverse auctions for more purchasing events, provide additional support for the adoption, and will help the department to adopt best practices for purchasing.

When to Use

Reverse auctions should not be used for all purchases. It is important to remember that reverse auctions are only one of many tools available to buyers. Reverse auctions should only be used when their use would deliver more value than the use of other available purchasing tools. When do reverse auctions deliver more value? Reverse auctions tend to deliver more value when the following conditions occur: common specifications, competitive supply base, competitive market pricing structure, long lead times, low costs of switching suppliers, low distribution complexity, high savings opportunity, large purchase size, and a purchase that would result in a non-strategic relationship with the vendor. If many of these conditions describe the purchase, reverse auctions are likely the best option. Examples of items that government agencies have successfully purchased using reverse auctions include raw materials, processed goods, travel, printing services, capital equipment, components, and many other items. Reverse auctions also work best when price is a key point of negotiation for the buying organization. For some purchases, it might make sense to use more than one strategic sourcing tool (RFI, RFP, reverse auction, etc) to conduct a purchase.

Clear Specifications

One important issue that applies to both reverse auctions and other purchasing methods is the importance of clear specifications and definition of requirements. Without a clear definition of what the buying organization requires, the supplier may not understand what they are bidding on. This is highly problematic for the buying process in general. However, for a reverse auction, not having clear requirements is disastrous. If the suppliers do not have a clear idea of what they are bidding on, it is impossible for them to bid their lowest price or even the correct price. Moreover, with an unclear definition of requirements, suppliers may think they are bidding to supply different products. Consequently, it will be impossible to negotiate on price since there is not common agreement on the specifications that will be used by the suppliers to develop the pricing. Without a clear specification or definition of requirements, the government entity should not attempt to use a reverse auction, but rather should spend more time defining the requirements or submit an RFP instead.

Costs

There are real costs for conducting a reverse auction. One of the largest costs for reverse auctions is associated with acquiring the technology required to conduct the reverse auction. This technology is owned by companies that have developed software to perform and conduct reverse auctions. These companies make money in one of two ways. The first way is by selling a license to use the software to the organization seeking to conduct a reverse auction. This license can be an one time license fee or a periodic charge depending on how the contract with the technology provider is structured. The second way that technology providers make money from their technology is by providing services to conduct the reverse auction on behalf of company making the purchase. These "full service" or "managed service" vendors often charge a percentage of the transaction or a higher hourly rate to provide these services. There is also a time commitment required from buyers and suppliers. In order to provide incentives for suppliers to participate, the purchase conducted using reverse auctions should be a high enough dollar value so that it is worthwhile for the suppliers to participate. It is important that the cost savings from the event will more than make up for the costs of conducting the reverse auction.

Conclusion

For government buyers, reverse auctions can be more complex to implement than they first appear. As long as government buyers understand some of the issues involved in implementing reverse auctions, they can successfully adopt this important purchasing technology. By implementing reverse auctions correctly and effectively, government entities can realize large cost savings along with other benefits. Despite the issues government buyers may face, the benefits that can be realized by selectively implementing reverse auctions far outweigh any arguments against not using them.

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