Reverse Auction e-Procurement: A Suppliers Viewpoint

Andrew Stein, Lecturer, School of Information Systems, Faculty of Business Victoria University, PO Box 14428, MC8001, Australia, Andrew.stein@vu.edu.au

Paul Hawking, Lecturer, School of Information Systems, Faculty of Business Victoria University, PO Box 14428, MC8001, Australia,Paul.Hawking@vu.edu.au

Abstract

Procurement has been the latest process to get the “e” treatment. It is also the process of choice now for organisations seeking increased efficiencies and reduced bottom lines. E-procurement is one of the shining lights in the evolving e-business story and this paper will look at a case study of an online reverse auction where a major Australian manufacturer sources logistics services for most of its commodities. The paper presents the case of the reverse auction from the viewpoint of one supplier and looks to present the insight of a losing bidder. Small and large businesses, global organisations, Australian and multi-national business, greed, fear and avarice are all themes explored in the paper giving the “real business” perspective to a topic that often is simplified into “techno-business” jargon.

Keywords

e-Business, e-Commerce, B2B Commerce, e-Procurement, Case Study Research

INTRODUCTION

The increasing trends towards globalisation and increased competitiveness across markets have meant that most businesses are looking to increase efficiency. Increasing efficiency by addressing workforce levels and streamlining internal operations has been a favourite of many organisations. Businesses (Minahan & Degnan, 2000: p.3) are now looking at the supply chain and procurement to provide additional efficiencies. Strategically (Minahan & Degnan, 2000: p.3) a superior supply chain increasing business responsiveness and competitive advantage. Anderson and Lee [HREF7] see the supply chain as crucial to organisations:

"The winners in the internet enabled supply chain competition will be those companies that discard the traditional rules of doing business while working collaboratively with customers and supply chain partners to create the future".

Integrating supply chains can yield substantial benefits for enterprises, from a 20-30% reduction in bottom line goods and services costs (Smock, 2001) to a 35% increase in market share (Copacino & Byrnes, 2001). This paper looks at the use of online reverse auctions and uses the case study methodology with an analysis from the viewpoint of a supplier company.

e-Procurement Research Framework

Organisations have been selling products and services to each other as long as recorded history. Organisations spend (Minahan & Degnan, 2001, p.3) over US$20 trillion on external goods and services and the supply chain is now the focus in cost reduction and efficiency increase. The Internet age has coined new terminology describing many existing business processes. Diba (Diba, 2000) refers to the need for using newer terms for old processes. B2B is the accepted term for describing a whole range of procurement type functions. Many research organisations predict massive growth in the B2B market. Bowles sees the global B2B market growing to US$968 million in 2002 and then US$1551 million in 2004. Whilst these predictions should be accepted with caution there does seem to be a "sea change" in how procurement is operating in organisations. B2B promises (McGarvey, 2000) to drive costs down and streamline procurement operations. Electronic commerce has increasingly adopted a wider and wider definition and can be defined as any application of information and communication technology to enable business functions. This could include phone, fax, edi-networks and the Internet. This broad definition covers the use of information technologies within the procurement function. Another definition is:

"any electronic communication that facilitates the exchange of goods, services or other assets between suppliers and buyers." [HREF3]

Hemond-Wilson [HREF6], classified B2B as including sell-side (e-catalogues), e-marketplaces, trading partner agreements and buy-side (e-procurement). Another definition moves closer to the business process of procurement and defines e-Procurement as:
"The use of electronic technologies to streamline and enable procurement activities of an organisation." [HREF3]

Minhan [HREF4] has a definition that interchanges e-sourcing and e-Procurement:
"…is the process of utilising Web-based technologies to support the identification, evaluation, negotiation, and configuration of optimal groupings of trading partners into a supply chain network, which can then respond to changing market demands with greater efficiency."

Activities that could be applied to the e-Procurement process include: advertising tenders; electronic submission of tenders; electronic ordering; internet sourcing via third-parties; electronic mail between buyers & sellers; electronic mail in contract management; research into supplier markets and integration of procurement within the financial and inventory systems.

e-Procurement Implementation Model

David Wyld (as quoted in [HREF1], p.4) developed an e-Procurement implementation model that looked at the e-Procurement process from drivers through impact to imperatives. The model is presented below.

Figure 1. e-Procurement Model [HREF 1, p.4]

Drivers

Impacts

Imperatives

Fast pace of tech innovation Shift of power from suppliers to buyers Internal linkage between supply chain & portal
Economic Globalisation Develop online supplier qualification
Rapid growth of eBus portal sector Market makers increasing competition Leverage suppliers into e-portal marketplaces
Large orgs become market makers Develop vertical markets to force B2B and lower costs
Vertical trading communities New product & services requirements Build strategic alliances e-comm players

The model above demonstrates some changes that are affecting the e-procurement value chain. Organisations on the buying and selling side will need to address these challenges to capture both the tactical cost control and more strategic market developments. The Aberdeen report (Minahan & Degnan, 2001, p.4) divides procurement and e-Procurement technologies into three categories:



Most e-Procurement solutions addressing the three categories above strive to achieve the following benefits (Minahan & Degnan, 2001, p.5):

Table 1. e-Procurement Benefits by category (Minahan & Degnan, 2001: p5)

Indirect

Direct

Sourcing

Price reduction Visibility of customer demand Unit cost reduction
Improved contract compliance Visibility of supply chain capacity Enhanced decision making
Shortened cycle times Accuracy of production capacity Improved market intelligence
Reduced admin costs Reduced inv/op costs
Enhanced inventory management Shortened proc cycle times

The Auction Economy

In the late 1990’s the Internet was being used increasingly for bidding in auction based sales. O’Malley (1998) saw the Web being “a giant bidding war” and Queree (2000) commented that online auctions were becoming mainstream business models. The auction model was settling into the B2B marketplace and also being developed for various e-Government applications. Wyld (2001, p.7) saw the auction model being used in procurement, disposition of used assets and internal management. Batsone (1999) asked the question whether the price of everything is negotiable. At the heart of the auction economy is the concept of pricing and more directly dynamic pricing. Dynamic pricing simply means that a good or service is priced according to what the market determines. The Web introduces a real-time perspective to dynamic pricing. Wyld (2001, p.12) presents a dynamic pricing model developed from Opensite. [HREF2]

Table 2. Dynamic Pricing Categories [HREF 2, p.12]

many Auction(1s:Mb) Exchange(Mb:Ms)

Buyers

Haggle(1b:1s) Bidding(1b:Ms)
one one

Sellers

many

At the heart of the auction model and dynamic pricing is the concept of personal price elasticity. Customers will determine the price depending upon the price/value trade-off. No longer is the supply/demand model determining price, a more complicated customer centric price/value trade-off determines pricing. Airlines use this principle when they have multiple price points for the one product. There are several differing auction formats used in online auctions (Wyld, 2001, pp.17). English, Yankee, Dutch, Sealed bid, Vickrey and the reverse auction are some formats used. The reverse format is the basis for this paper. Other formats include the Vickrey where the winner is the highest bidder and the winning price is determined by the second highest bidder. The Yankee auction allows for multi-item bidding with the winner being determined firstly by price, secondly by quantity and then by time bid. Freemarkets [HREF4] promote the ability of their auction format to decrease services prices by 16-18% and goods by 2-3%. These cost reductions are very attractive to buyer markets [HREF8] but it is unrealistic to expect repeated annual reductions of 20% per year. The auction format is not perfect, problems such as collusion and “winners curse” do present problems for buyers and sellers. The other pitfall of the online auction is the ability of the auction to connect buyers and sellers and therefore destroy the role of the traditional intermediary. Bowles (2000) sees this as a driving force in the development of B2B e-Marketplaces, where the e-Marketplace is replacing the function of the traditional “middleman”.

Reverse Auction Process

The reverse auction process involves intensive work on behalf of the buyer and market maker to structure the bidding process and prepare suppliers for qualification. The process is represented below. [HREF1]

Table 3. Reverse Auction Format [HREF1]

1. Make Market (specs)
2. Identify Suppliers
3. Pre-Award Review
4. Approved Suppliers Listing
5. Identify Specific Terms & Conditions
6. Invite Suppliers
7. Set Up Auction
8. Conduct Auction
9. Contract Write-up

Wyld (2001, pp.26-28) lists some 60 B2B exchanges or e-marketplaces globally. Some of these including Covisint (Automotives), Chemwatch (Chemicals) and Neoforma (Medical Goods) use an auction format [HREF8] to develop pricing. Globally Ariba Inc., Freemarkets Inc., iPlanet, and Commerce One among others are leading vendors in e-Procurement applications. In Australia Freemakets.com is the leading vendor in online auctions. In June 2000, Mayne Nickless (Gettler, 2000), a diversified organisation with major interests in health-care and logistics, signed a three-year deal with Freemarkets.com to manage procurement and operate an online auction. Freemarkets [HREF5] have also operated procurement operations for gas, aviation fuel and casual labour.

METHODOLOGY

Case study research methodology was used as the paper presents an exploratory look at implications of reverse online auctions. Yin(1994, p. 35) emphasises the importance of asking “what” when analysing information systems. Yin goes further and emphasises the need to study contempory phenomena within real life contexts. Walsham (2000, p.204) supports case study methodology and sees a need for a move away from traditional information systems research methods such as survey toward more interpretative case studies, ethnographies and action research projects. Several works have used case studies (Chan, 2001; Lee, 1989; Benbasat et al., 1987) in presenting information systems case-study research. Cavaye (1995) used case study research to analyse inter-organisational systems and the complexity of information systems. The data collection process included examination of existing documentation, content analysis of email, interview of actors and direct observations. The auction event was analysed from the supplier organisation viewpoint with particular emphasis on the participants and outcomes of the event. In April 2001 AusBuyer commissioned Auction.Com to make a market for the logistics component of their manufacturing activities. The market was broken down into 19 channels both state and nationally based. AusSupplier received notification that a contract that it had partially carried out for three years was to be auctioned on the Internet. AusSupplier started a six-month exploration into online auctions and B2B procurement. Considerable time and financial resources were expended in firstly learning and then secondly participating in the reverse online auction. The three participants in the auction event were AusSupplier, Auction.Com and AusBuyer.

AUCTION CASE STUDY

AusSupplier is a micro-business with 2 full time and 5 part time consultants. It is an “infomediary” or in older language a “middleman”. AusSupplier turns over $AUD 10 million and has a small client base. The role of the “infomediary” is to win a contract for packing and exporting commodities into the Asian marketplace. AusSupplier wins a contract from a large manufacturer and then negotiates transport and shipping rates. The commodity that was to be auctioned was worth about $AUD1.6 million/year and AusSupplier was responsible for about 20% of the contract. A major transport company was responsible for the other 80%. Auction.Com is a multi-national market leading e-Commerce company specialising in e-Procurement and auctions. They have about 1000 employees worldwide and operate with about 140 large multi-national clients. They have conducted about $US21 billion in auctions resulting in savings of about $US 6 billion. It is obvious when looking at Auction.Com and AusSupplier the difference in size, technology and more importantly the chasm in understanding e-Business. The Australian manufacturer (AusBuyer) was the Australian arm of a global organisation based in US. The global organisation was undergoing financial strain due to the poor commodities market worldwide. In order to reduce costs AusBuyer turned to Auction.Com to conduct an auction event. Once again we see a major difference between the globally based Auction.Com and AusBuyer and the micro-business AusSupplier. The auction event was an Australia wide procurement exercise focussing on logistics & transport. The entire procurement operation of AusBuyer was placed in 19 lots with each lot undergoing a 1.5 hour auction. For AusSupplier the auction event went through 5 stages; market-made(client), pre-qualification(supplier), pre-auction planning(supplier), auction-strategy(supplier) and post-auction(client).

Market Made

Shortly after the initial notification AusSupplier undertook research into the reverse auction process, then received a CD containing Web based bidding software and documentation from the manufacturer. This documentation consisted of over 50 files including tender documents, quote spreadsheets, specifications and information. It was updated 4 times before the final auction. Initially the deluge of information was overwhelming.


“I have spent hours retrieving, printing, reading and just trying to make sense of the process.”
Managing Director, May 2001.

At this stage considerable effort was expended in determining if AusSupplier could participate in more than one channel. It was felt that other channels, including some interstate, could be attempted but a more conservative approach was adopted due to uncertainty in the process.

Pre-Qualification

This is the stage where Auction.Com and AusBuyer weed out non-performing suppliers but try to ensure an adequate number of bidders to create the auction dynamic. AusSupplier had no idea how many other companies had pre-qualified, it only learnt of the number at the auction event. Pre-qualification also introduces some financial parameters for the event. Auction.Com set the switching cost at $AUD1.3million, that is, the price when AusBuyer would consider awarding the contract away from the existing supplier. Market research by AusSupplier showed the existing contract was worth $AUD1.6million. The difference between the switching and existing contract price was about 18%. This figure is very important as much of the advertising material by Auction.Com quotes savings of 18%. AusSupplier again expended considerable resources at this stage; two site visits, 4 sub-contractor meetings, 200 phone calls, 45 emails out, 15 emails in, 30 hours of managing director time and 20 hours of consultants time. The bill for participating in the reverse auction was climbing. Summarising the financial details thus far:


The high AusSuppliers market entry price was formulated on the basis of entry into an unknown scenario. It was formulated on the rate of moving the commodity by the tonnages quoted by AusBuyer with a margin built in. At this stage it became apparent that the auction format was introducing an element of incredulity to the quoting process.
“We are flying in the dark, some cowboy could underbid us and have no real idea of what is involved in the job….” Managing Director, June 2001.

For AusSupplier this new foray into B2B was daunting, no idea of how many others bidders, no idea of their market entry point and only one Auction.Com tutorial on a simulated auction to guide them.

Auction Strategy

Being pre-qualified and waiting for the auction became quite stressful. What strategy should be adopted? What would happen if the power failed, or the ISP went down? What would be the lowest position AusSupplier would take in the auction, would they be swept up in the auction dynamic? Who would press the buttons, would they hold their nerve. Auction.Com conducted a training session from their Asian headquarters and AusSupplier soon mastered the auction interface. They had three strategies for the auction, entry, middle and end-strategy. The entry-strategy was to come in at our high pre-qualification bid after about 3 minutes and then watch the market develop. The middle-strategy was to maintain control on the screen and drive the bids down in a controlled manner. It is important to understand that in the auction event you only see bids and do not know where they come from. The only strategy for the end was to be in the end game and if AusSupplier did not win they wanted to be under the switching cost at the end. This would show AusBuyer that AusSupplier was a serious bidder. AusSupplier had seen sample auction events where the end game was frantic.

The Auction Event

The auction was delayed a week and with a late flurry of updates and clarifications AusSupplier waited until 10.33 to press the bid accept button. In 5 seconds the early and middle strategies were destroyed. There were three other bidders and one bidder came in right on the switching price. This was felt to be a ploy to scare off other bidders, it was felt that this was the existing contractor.

Early Action (Where did that bid come from? See Figure 2.)

Middle Game(A Sinking Feeling, See Figure 3.) After about half an hour another bidder entered and soon started to drive down. AusSuppliers strategy was to drive down to the reserve price.

End Game (A Dog fight, See Figure 4.) At this stage it is fair to say that the phones were put on hold. As the scheduled auction time elapsed the bidding intensified. A bid in the last minute extends the auction by one minute. There were three bidders left. The original button presser passed to the managing director when the low position previously agreed upon was passed. The auction entered the phase that Auction.Com call the auction dynamic, the dynamic that drives the price down. The reserve was driven down $90000 in 7 minutes. The number of bids in the last 7 minutes tripled all bids in the previous 1.5 hours. The managing director started to lose some semblance of control as he did not want to lose to the other bidders. The agreed low margin of 12% was reduced to 5%. AusSupplier did not win the auction, they were in the game at the end and drove the market down to inflict some pain on the other bidders.

Post Auction

After the auction AusSupplier were told they would have to wait 5 weeks for the result, it came much earlier. AusSupplier lost the 20% of the contract they had at the start. The managing director took about two weeks to get over losing to the competition. There are several issues that need to be discussed concerning the reverse auction.

ANALYSIS

A six-month process costing thousands of dollars, resulted in the loss of an existing part contract. This was not a desirable outcome. The winner was a transport company that bypassed the “infomediary” in winning the contract. AusBuyer received a 20% reduction in their logistics in one channel. In another channel where only one supplier pre-qualified the existing contract price was inflated by 5%. In this case the auction dynamic was missing and therefore no savings were made. For the supplier there are many issues to consider. Firstly, the web auction format is able to link buyers and suppliers directly thereby cutting out any middle operators. Traditional suppliers will need to engage the e-Markeplace channel to access the growing number of organisations moving towards e-Sourcing. Secondly, the cost to participate is considerable when we consider the size of the participating supplier. Australia has a high proportion of small and micro-business, will the nature and scope of reverse auction suit the current Australian business landscape? Thirdly, the whole issue of driving costs down at the possible expense of contract servicing is crucial. This is demonstrated when we see the auction format not favoured in Asian markets where service is considered paramount. Finally the ability of the auction to drive dynamic pricing produces an ethical dilemma. Wyld (2001, p. 18) refers to the auction principle where there is always another group willing to lower your bid. Do we want business run only on the bottom line? AusSupplier had prided itself on providing a service second to none. Any glitches in the previous contract like variability of supply of the commodity or problems in logistics or shipping never presented a problem. In this case AusBuyer was under pressure to drive down prices due to the global marketplace, but will there be a price to pay if the contract lapses and a premium needs to be paid to bring in another supplier to complete the contract. This scenario occurred three year prior to the online auction being adopted. Much of the literature comments on the popularity (Wyld, 2001, pp. 55-77) of reverse auctions for private industry to drive pricing whereas government use it to source suppliers based on other criteria. For the client who received the 20% reduction in costs all is rosy. Questions remain about the service quality they will receive, whether contracts are adhered to and what sort of supplier relationship they enjoy in the contract period. Verga (2001) reported the importance of the need to maintain a strong relationship between buyers and sellers in Dell Computers move to e-Sourcing. Oracle supply chain manager [HREF8] referred to the need to look after suppliers:

“..no point in driving your suppliers out of business. You would be out of business yourself”.

DISCUSSION

Wyld (2001, pp. 40-45) describes three main implications of the use of online reverse auctions; merging of online and regular business, cultural and attitudinal change and technological change. The merging of regular and online business has the potential to propel B2B e-commerce into every organisation. Verga (2001) emphasises the difficulty for suppliers who have perfected the “regular” supply chain and the undeniable imperative that they must move online or be obliterated. Wyld (2001, p. 42) saw this as leveraging suppliers into the marketspace. AusSupplier’s first foray into the online procurement world heralded the need to create a new type of relationship management. Dynamic pricing will be the driving vision (Hof, 2000) and suppliers will need to carve out their business relationships around this reality. The reverse auction changes the buyer-supplier relationship from one of negotiation often in a one-on-one situation into a more dynamic and removed dialogue. Time frames are collapsed and the art and culture of traditional business negotiation is pancaked into a dialogue with a web auction application. Tapscott (2000) referred to the elevation of price as the single criteria for winning reverse auctions as being flawed. He felt the price only model will be replaced by a more mature model, where quality, customer service, credit terms and shipping reliability were often as important as price. AusSupplier realise only too well the importance of other factors in contract adherence but must obey the absolute nature of dynamic pricing. Technology in the form of “bots” (Bayers, 2000) may provide the answer to the price only dilemma. It is conceivable that smart “bots” will allow buyers and sellers to bid on a range of variables not just on price alone.

CONCLUSION

Whether we consider the evolving nature of business, cultural changes or technological changes the online e-Procurement auction and e-Marketplace promises to change forever the way business is transacted. For AusSupplier, a micro-business located in Melbourne, the next foray into reverse auctions will be undertaken with less fear and more hope.

Images

Figure 2 Start of Auction

Figure 3 One Hour into the Auction

Figure 4 All Over

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Hypermedia References


HREF1. www.buyersgov.gsa.gov

HREF2. www.opensite.com

HREF3. www.dcita.gov.au/pub/reports/emarketplaces

HREF4. www.aberdeen.com/ab_company/hottopics/esourcing/

HREF5. www.freemarkets.com/benfits/case_studies/

HREF6 http://www.as400.ibm.com/developer/ebiz/documents/ecommerce.html#2

HREF7. http://www.manufacturing.net/scm/contents/pdf/anderson_lee_wp.pdf

HREF8. http://globalarchive.ft.com/globalarchive/article.html?id=020313001689&query=freemarkets

Copyright

Andrew Stein & Paul Hawking, © 2002. The authors assign to Southern Cross University and other educational and non-profit institutions a non-exclusive licence to use this document for personal use and in courses of instruction provided that the article is used in full and this copyright statement is reproduced. The authors also grant a non-exclusive licence to Southern Cross University to publish this document in full on the World Wide Web and on CD-ROM and in printed form with the conference papers and for the document to be published on mirrors on the World Wide Web.