Auctions in Procurement

7/31/2019 Auctions in Procurement

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Auctions in procurementMadhur Shah Business Card Company: SAP Labs India Pvt LtdPosted on Oct. 11, 2010 07:14 AM in Procurement and SRM

1. Auctions - OverviewReverse auctions are hosted by single buyer and feature two or more suppliers competing for business. Such auctions arecommonly used by organizations in a tactical way to achieve sourcing objectives. It is called reverse because during theevent, the price is expected to go down due to competition.Usually in procurement, we deal with reverse auctions. Howeverin some selected cases, we also deal with forward auctions where the buyer is actually looking for buyers. This can happenif 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 forproposal) process followed by an auction. Here, the buyer gets a good sense of the market pricing and can determine theauction parameters with greater confidence. The table below lists in which scenario what combination of RFPs and Reverseauctions can be used:

Use of RFP process only Use of RFPprocess andReverse auctions

Use of Reverseauctions only

SpendCharacteristics

Complex Custom Generic

Specifications Developed jointly bysupplier and buyer (maybepatented)

Created by buyer

(maybe patented)

Defined by industry

standards

Market driver Value only Value and priceMostly Price andvolume

Industrycompetitiveness

Not very competitive(monopoly/oligopoly) Competitive Very competitive

Supplier availability Single or few ManyVery many(commoditized)

Riskiness of switching suppliers

Very high Medium Low

Supplierrelationship

Strategic Limited Transactional

Switching cost Very high Medium/low Negligible

Level of detail forsupplierqualification

High Medium Low

Supply lead time Long Medium Short/immediate
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Spend examples Patented carbon block filter;patented drug deliverysystem

Plastic enclosures;circuit boards;machine parts

Non-custompackaging; bulk chemicals; lab supplies

Table 1: Scenarios where reverse auctions can be used

3. Running a successful auctionThe following steps can help to ensure a successful running of auctions:

Determine category spend amounts and specifications: It always helps to collect comprehensive data annualconsumption, 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 theauction 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 fromRFQ/market research

Train suppliers: It is a good idea to invest in web based training to familiarize bidders with the auction tool. This reducesissues 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 chatwith buyer functionality, if available

Award business: Awarding should not be delayed for long. Barring exceptions, awarding should be done. Else the buyerloses credibility and it may be difficult to attract bidders for the next event

Capture savings: Document savings and publish to other buyers and s takeholders increases adaptability

4. Right setting for auctions4.1. Visibility rulesHow much information to disclose to bidders? The following list mentions the various options:

Visibilityrules What it is When to use it and why

Leading bidonly

Bidders can see only theirbid and the leading bid

Is most effective in auctions driven by market/priceshare

Is for a category that is commoditized andcompetitive

Has price as key factor in award decision

Can be used with as few as two bidders

Rank onlyBidders can only see theirbid and rank; they cannot seethe leading bid

Is most suitable when the bid values has a largespread

Features value-based categories

Has a supply market sensitive to price disclosure


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Has price as weighted factor in award decision

Needs at least six to eight suppliers for a successfulevent

Leading bidand rank

Bidders can see the leadingbid and their own rank

Is used in events with large number of bidders (30or more) and lotsIs used as a mechanism to establish a "preferredsupplier base" for subsequent auctions comprisingactual line item awards

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

Lineitemtype

What it is What is does and when to use it

Lineitem

A line item is an individual item on whichthe bidders can bid. Bidders can enter theprice per line item

Enables the buyer to cherry pick on line

item basis to come up with the lowest awardmix; however note that suppliers can thenalso cherry pick which items they want tobid on

Provides more visibility into pricing

Used when the buyer is unsure of volumedemand

Lot

A lot is a grouping of line items, based ondelivery location, raw materials,manufacturing process or awardingstrategy. Bidders enter price for each lineitem in the lot

Enables the buyer to get bids on low marginor low volume items on which the biddermight not bid if they were listedindividually

Enables the buyer to consolidate the supplybase

Used only if the volumes indicated forbidding are the actual volumes, not


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estimates, which will translate into awardvolumes

Table 3: Line item v/s lot

4.3. Bid decrementThe 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 sui table 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 andprocesses 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 focuson the currently open items and not get overwhelmed by the bidding activity

5. Benefit of auctions5.1. 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


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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 successfulauctioningBelow 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, itsbetter 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 theroad. 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. Thisintelligence 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 auctionis 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

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Documents

Auctions in Procurement