Understanding Reverse Auctions in Procurement: Part One
History of Reverse Auctions
Because of their immense success at generating cost savings and their ability to increase efficiency, reverse auctions rapidly gained popularity in the late 1990s and early 2000s. However, their use waned over time due to tight markets, especially during the COVID-19 pandemic, and due to misconceptions about their use.
Because of the pressure to do more with less and prices rapidly declining in 2023, reverse auctions have made a remarkable comeback. There is a renewed focus on cost-effective procurement strategies and many professionals are now rediscovering the benefits of reverse auctions. They have become a crucial tool in modern procurement.
This article delves into what reverse auctions are, a little about the process, and lastly where they fit into your strategic sourcing process.
What is a Reverse Auction?
Unlike traditional auctions, where buyers compete to purchase goods or services by bidding higher amounts, a reverse auction flips this process on its head. Here, sellers compete to offer their goods or services at the lowest total cost. The reverse auction is predominantly used in business-to-business (B2B) procurement, particularly for negotiating goods and services that are clearly definable.
The reverse auction process begins with the buyer selecting a group of items or a service that is needed. Usually driving this selection is seeing changes in market pricing, receiving an increase notice from the supplier, looking for options for a poor performing supplier, or simply looking to maximize savings. In an increasing market, reverse auctions are frequently used on a quarterly basis to ensure prices increase slower than the market does.
Detailed specifications, requirements, statements of work, and quality standards are outlined to ensure that all supplier submissions meet the necessary criteria. Once the specifications are set, the buyer invites qualified suppliers to participate in the auction. The best auctions utilize a pre-qualification process to ensure that only capable and credible suppliers are included.
An online platform, such as K2 Sourcing’s, is used to conduct the reverse auction. The buyer establishes the duration, participation criteria, extensions, and bidding rules on this platform. During the auction, suppliers submit their bids in real-time, competing to offer the lowest total cost. Because the negotiation is completely automated, it becomes extremely efficient. Additionally, the reverse auction software continuously updates with the current lowest offer, allowing all participants to see the most competitive offer. This transparency drives suppliers to submit their best prices, fostering a highly competitive environment.
Reverse Auctions and Strategic Sourcing
When you run an RFQ or RFP do you typically negotiate with suppliers? Most procurement professionals would answer yes. After suppliers provide responses to your RFQ or RFP, it is common to shortlist suppliers and begin negotiations. It is also common for these negotiations to occur via meetings and email and take several weeks.
This is where the reverse auction fits in. Rather than manually conducting the negotiation through email and meetings, reverse auction technology enables one to automate the negotiation process. You are simply augmenting one step, the negotiation step, of your strategic sourcing process.
Conclusion
Reverse auctions have revolutionized the procurement landscape by leveraging competition among suppliers to achieve cost savings and efficiency. Years of independent research show reverse auctions average savings greater than 14% and the several week negotiation process is completed in about an hour.
When used appropriately, reverse auctions are a powerful tool in a procurement professional's arsenal. In future articles, we will delve into the benefits of reverse auctions, how to select commodities or categories for reverse auction, reveal details about running exceptionally successful reverse auctions, and review misconceptions about their use.