Benefits Of Reverse Auctions

Published Date: 02 Nov 2017

After providing a high-level overview to procurement managers at our New York headquarters in January, the project team arranged a half-day of buyer training in early February. By then, some divisions had already identified their own "high potentials" list of spend categories to be included in the pilot phase. As part of their participation in these pilots, representatives from each of our divisions worked with suppliers to coordinate the training suppliers would need in order to participate in the test auctions.

We planned and conducted seven pilot auctions, which were completed by June 2001. Conducting seven test events enabled us to hold at least one auction within each of our procurement organizations (manufacturing and research, for example) and then to gauge results both across these different organizations and across different spend categories.

Following our extensive preparation, the pilots proceeded smoothly. The technology tool we used worked well with Pfizer's different procurement groups and geographical locations, and the upfront training we provided to suppliers enabled them to participate fully with no technical difficulties.

Online reverse auctions proved to be a good fit with our existing strategic sourcing process. This ties back to our overall approach of selecting technology that integrates and adds value to our current procurement processes. The reverse auction tool that we chose did not require us to change our existing process. Instead, it supports and optimizes our seven-step strategic sourcing process, which includes determining our procurement requirements for a particular item, distributing those requirements to our suppliers, and evaluating the response we receive from our suppliers. The reverse auction tool has allowed us to take some of the manual parts of that process and automate them, making them more efficient. Requirements for a bid are now distributed to suppliers electronically. We also receive questions from suppliers electronically and answer and post them in one location so that all suppliers can benefit from that information. Finally, the bidding process occurs online at a set date and time and serves to establish a true market price for the commodity. In essence, the reverse auction tool works to expedite the price Following our extensive preparation, the pilots proceeded smoothly. The technology tool we used worked well with Pfizer's different procurement groups and geographical locations, and the upfront training we provided to suppliers enabled them to participate fully with no technical difficulties.

Online reverse auctions proved to be a good fit with our existing strategic sourcing process. This ties back to our overall approach of selecting technology that integrates and adds value to our current procurement processes. The reverse auction tool that we chose did not require us to change our existing process. Instead, it supports and optimizes our seven-step strategic sourcing process, which includes determining our procurement requirements for a particular item, distributing those requirements to our suppliers, and evaluating the response we receive from our suppliers. The reverse auction tool has allowed us to take some of the manual parts of that process and automate them, making them more efficient. Requirements for a bid are now distributed to suppliers electronically. We also receive questions from suppliers electronically and answer and post them in one location so that all suppliers can benefit from that information. Finally, the bidding process occurs online at a set date and time and serves to establish a true market price for the commodity. In essence, the reverse auction tool works to expedite the price comparison and review process. All other key parts of the process, such as supplier qualification, requirement and bid clarification, and other contractual elements are still taking place offline. (Exhibit 3 shows the reverse auction process and its results.)

Benefits Of Reverse Auctions

Now that the results are in and our analysis is complete, our project team has given the reverse auction process high marks when measured against its stated objectives. Against the objective of making an impact on indirect and direct material costs, we achieved an average savings of 11 percent across our seven pilot events. Perhaps that should not surprise anyone given the structure of reverse auctions, which allow one buyer to receive bids from several competing sellers. Still, it was encouraging to see the theory translated into cost savings over a wide variety of indirect and direct materials.

Against the secondary objective of educating Pfizer procurement professionals, we observed real-world confirmation of that old saying: To do is to learn. Not only did the work of preparing for and participating in these events train our people in the use and benefits of reverse auction technology, but it also initiated several productive exchanges among procurement professionals working at different Pfizer locations. These exchanges helped us make meaningful progress on important issues such as improving communication among our different locations, standardizing contracts where appropriate, and dealing with poorly performing suppliers.

Additionally, we discovered several ancillary benefits that make reverse auctions an even more attractive proposition for the correct categories. The reverse auction tool enables us to better plan our request for proposal (RFP) process. It helps us make sure that we involve the right parties, and it shortens the price review cycle time. The reduction in cycle time from RFP to implementation has proven to be among the most significant benefits of the new process. The real-time nature of the electronic bid process can reduce cycle time from months or weeks to days. This translates into further cost savings measurable in reduced administrative and processing time.

Other benefits include providing an opportunity for new suppliers to participate, removing the emotional component from the initial evaluation of suppliers, establishing an objective and fair negotiation tool, helping to quickly identify opportunities for regional or national "lotting" from appropriate suppliers, and achieving true market pricing for commodities. One of our project team leaders predicted this last point well before the first test auction. "Reverse auctions," he told our newsletter writer, "are analogous to a stock market; the visibility of real-time information should enable a buyer and multiple sellers to determine an efficient market price."

Challenges of Reverse Auctions

With benefits, of course, come challenges, and reverse auctions are no different. The good news is that most of the challenges relate to the process of planning and conducting an auction. Our team was unanimous in its conclusion that the logic and the technology of reverse auctions are both sound. Instead, most of the suggested improvements involve qualification and preparation of suppliers in advance of the bidding event.

It is not difficult to understand why some suppliers will see reverse auctions as a threat and be reluctant to participate if a company does not stress a total cost of ownership model and only focuses on price. In this era of interdependent supplier/customer relationships, we, as customers, must help our suppliers see the value in reverse auctions. Among the beneficial outcomes we have begun discussing with our key suppliers are increased efficiency within their businesses and early familiarity with a technology and a process that more and more of their important customers will soon be using.

Another project team leader summarized this challenge neatly. "One of our goals is to achieve cost savings across several areas of our spend," she said, "but we must balance that goal against our number one priority of valuing relationships with strategic suppliers and ensuring the steady flow of the direct and indirect materials we need." Participating suppliers must also be prepared to take full advantage of the process. For example, supplier representatives must be able to react quickly during an auction, whether that means having the authority to adjust a quote quickly or being able to reach their management for prompt approval of a new bid.

The Internet also enhances revenues by offering information aggregation and a wider product portfolio from many sources. For example, Yahoo! Shopping provides product information from a large number of retailers. This information aggregation enhances revenues because it attracts customers who know they are likely to find the product they are seeking. Physical retail store chains could similarly aggregate product availability information from all their stores on the Internet and direct interested customers to the appropriate location. In contrast to direct sales and "eliminating the middle man," it has become popular to create hubs or portals to link customers to other companies and their products. These hubs and portals improve shopping and fulfillment through a one-stop method with the hosting firm receiving revenues through commission fees and advertising. For example, Amazon announced that it earned $606.5 million from renting some of its Web site to other e-tailers.

Facility costs (including both site and processing costs). e-Businesses can centralize facilities because online sales allow the separation of order placement and order fulfillment. Site costs may decrease as direct customer-manufacturer contact and geographical centralization eliminate or reduce retail sites. For example, Amazon supplies its customers from a few warehouses, while Borders and Barnes & Noble must incur facility costs for all their retail stores. In addition, bookstores have a higher space cost per square foot and lower asset utilization than warehouses do.

On the cost side, however, e-grocers have several disadvantages compared with their bricks-and-mortar counterparts. Although the virtual store reduces facility costs by eliminating retail sites and checkout clerks, it incurs processing costs for activities such as picking, packing, and handling. In a traditional supermarket, customers do their own pick and pack, while handling is done in high-volume pallets instead of "eaches." The inventory savings resulting from centralization also prove marginal because supermarkets already achieve sufficient forecast accuracy from their large size. Inventory benefits from aggregation are higher, however, for e-grocers such as EthnicGrocer.com that focus primarily on slower-moving specialty items.