A reverse auction (also known as buyer-determined auction or procurement auction) is a type of auction in which the traditional roles of buyer and seller are reversed.[1] Thus, there is one buyer and many potential sellers. In an ordinary auction also known as a forward auction, buyers compete to obtain goods or services by offering increasingly higher prices. In contrast, in a reverse auction, the sellers compete to obtain business from the buyer and prices will typically decrease as the sellers underbid each other.
A reverse auction is similar to a unique bid auction because the basic principle remains the same; however, a unique bid auction follows the traditional auction format more closely as each bid is kept confidential and one clear winner is defined after the auction finishes.
For business auctions, the term refers to a specific type of auction process (also called e-auction, sourcing event, e-sourcing or eRA, eRFP, e-RFO, e-procurement, B2B Auction). Open procurement processes, which are a form of reverse auction, have been commonly used in government procurement and in the private sector in many countries for many decades.
For consumer auctions, the term is often used to refer to sales processes that share some characteristics with auctions, but are not necessarily auctions in the traditional sense.
Context
One common example of reverse auctions is, in many countries, the procurement process in the public sector. Governments often purchase goods or services through an open procurement process by issuing a public tender. Public procurement arrangements for large projects or service programs are often quite complex, frequently involving dozens of individual procurement activities. Reverse auctions can also be used to reveal private opportunity cost information, which can be useful in the design of incentive programs to correct market failures and promote the provisioning of public goods, common-pool resources, and non-market ecosystem services, for example.[2][3]
Another common application of reverse auctions is for e-procurement, a purchasing strategy used for strategic sourcing and other supply management activities. E-procurement arrangements enable suppliers to compete online in real time and is changing the way firms and their consortia select and behave with their suppliers worldwide. It can help improve the effectiveness of the sourcing process and facilitate access to new suppliers. This may in the future lead to a standardization of sourcing procedures, reduced order cycle, which can enable businesses to reduce prices and generally provide a higher level of service.[4]
In a traditional auction, the seller offers an item for sale. Potential buyers are then free to bid on the item until the time period expires. The buyer with the highest offer wins the right to purchase the item for the price determined at the end of the auction.
A reverse auction is different in that a single buyer offers a contract out for bidding. (In an e-procurement arrangement this is done either by using specialized software or through an on-line marketplace.) Multiple sellers are invited to offer bids on the contract. In public procurement, time limits for the receipt of bids apply.[5]
E-procurement
In the case of e-procurement, When real-time e-bidding is permitted, the price decreases as sellers compete to offer lower bids than their competitors whilst still meeting all of the specifications of the original contract.
Bidding performed in real-time via the Internet results in a dynamic, competitive process. This helps achieve rapid downward price pressure that is not normally attainable using traditional static paper-based bidding processes. Many reverse auction software companies or service providers report an average price reduction of 18–20 percent following the initial auction's completion.[6]
The buyer may award the contract to the seller who bid the lowest price. Or, a buyer may award contracts to suppliers who bid higher prices depending on the buyer's specific needs with regard to quality, lead-time, capacity, or other value-adding capabilities.
The use of optimization software has become popular since 2002[clarification needed] to help buyers determine which supplier is likely to provide the best value in providing goods or services. The software includes relevant buyer and seller business data, including constraints.[citation needed]
Reverse auctions are used to fill both large and small value contracts for both public sector and private commercial organizations. In addition to items traditionally thought of as commodities, reverse auctions are also used to source buyer-designed goods and services; and they have even been used to source reverse auction providers. The first time this occurred was in August 2001, when America West Airlines (which later became US Airways) used FreeMarkets software and awarded the contract to MaterialNet.[citation needed]
One form of reverse auction is static auction (RFQ or tender). Static auction is alternative to dynamic auction and regular negotiation process in commerce especially on B2B electronic marketplace.
In 2003, researchers claimed an average of five percent of total corporate spending was sourced using reverse auctions.[7] They have been found to be more appropriate and suitable in industries and sectors like advertising, auto components, bulk chemicals, consumer durables, computers and peripherals, contract manufacturing, courier services, FMCG, healthcare, hospitality, insurance, leasing, logistics, maritime shipping, MRO, retail, software licensing, textiles, tourism, transport and warehousing.[4]
History of internet-based reverse auctions
The pioneer of online e-procurement reverse auctions in the United States, FreeMarkets, was founded in 1995 by former McKinsey & Company consultant and General Electric executive Glen Meakem after he failed to find internal backing for the idea of a reverse auction division at General Electric. Meakem hired McKinsey colleague Sam Kinney, who developed much of the intellectual property behind FreeMarkets. Headquartered in Pittsburgh, FreeMarkets built teams of "market makers" and "commodity managers" to manage the process of running the online tender process and set up market operations to manage auctions on a global basis.[citation needed]
The company's growth was aided greatly by the hype of the dot-com boom era. FreeMarkets customers included BP, United Technologies, Visteon, Heinz, Phelps Dodge, ExxonMobil, and Royal Dutch Shell, to name a few. Dozens of competing start-up reverse auction service providers and established companies such as General Motors (an early FreeMarkets customer) and SAP, rushed to join the reverse auction marketspace.[citation needed]
Although FreeMarkets survived the winding down of the dot-com boom, by the early-2000s, it was apparent that its business model was really like an old-economy consulting firm with some sophisticated proprietary software. Online reverse auctions started to become mainstream and the prices that FreeMarkets had commanded for its services dropped significantly. This led to a consolidation of the reverse auction service marketplace. In January 2004, Ariba announced its purchase of FreeMarkets for US$493 million.[8]
Fortune published an article in March 2000, describing the early days of internet-based reverse auctions.[9]
Very recently business-to-consumer auctions with a twist have started to evolve; they are more similar to the original business-to-business auctions than mobile reverse auctions in that they offer consumers the option of placing a specification before retailers or resellers and allowing them to publicly bid for their business.[citation needed]
In congressional testimony on the 2008 proposed legislative package to use federal funds to buy toxic assets from troubled financial firms, Federal Reserve Chairman Ben Bernanke proposed that a reverse auction could be used to price the assets.[citation needed]
In 2004, the White House Office of Federal Procurement Policy (OFPP) issued a memorandum encouraging increased use of commercially available online procurement tools, including reverse auctions.[11] In 2005, both the Government Accountability Office and Court of Federal Claims upheld the legality of federal agency use of online reverse auctions.[12] In 2008, OFPP issued a government-wide memorandum encouraging agencies to improve and increase competitive procurement and included specific examples of competition best practices, including reverse auctions.[13] In 2010, The White House Office of Management and Budget cited "continued implementation of innovative procurement methods, such as the use of web-based electronic reverse auctions" as one of the contracting reforms helping agencies meet acquisition savings goals.[14]
Scoring Auctions
A common form of procurement auction is known as a scoring auction. In that auction form, the score that the buyer gives each bidder depends on well-defined attributes of the offer and the bidder. This scoring function is formulated and announced prior to the start of the auction.[15]
Buyer Determined Auctions
Many procurement auctions are "buyer determined" in that the buyer reserves the right to select the winner on any basis following the conclusion of the auction. The literature on buyer-determined auctions is often empirical in nature and is concerned with identifying the unannounced implicit scoring function the buyer uses. This is typically done through a discrete choice model, wherein the econometrician uses the observed attributes, including price, and maps them to the probability of being chosen as the winner. This allows the econometrician to identify the weight on each attribute. [16] Conceptually and theoretically, the effect of this format on buyer-supplier relationships is of paramount importance.[17] Instead of each bidder as submitting a price and the lowest price bidder winning the contract, here each bidder can be perceived as submitting a total "score" involving a price + nonprice attributes. The winner is the bidder who has the highest score. Unlike scoring auctions, there is no pre-announced or binding weight on each quality attribute that will determine the winner in a formal fashion. Rather, bidders operate in an uncertain environment in which only the buyer knows its own considerations. Given the uncertainty regarding other bidders’ nonprice qualities, it may be that bidders learn about the competition by observing other bidders’ bids. One can therefore expect systematic differences in their response patterns to competitive bids. [18] Likewise, the provision of information on other bidders in such auctions is generally known to affect prices [19] Pre-existing relationships are known to be the key driver in the buyer’s selection and therefore bidding aggressiveness in the auction-- in terms of the number of bids submitted, the rate at which the bids are submitted, and the price concessions offered—are related to these relationships. [20] Theoretically, the factors that determine under what circumstances a buyer would prefer this format over a price-based format have been explored. [21][22]
Demsetz auction
A Demsetz auction is a system which awards an exclusive contract to the agent bidding the lowest price named after Harold Demsetz.[23] This is sometimes referred to "competition for the field." It is in contrast to "competition in the field," which calls for two or more agents to be granted the contract and provide the good or service competitively. Martin Ricketts writes that "under competitive conditions, the bid prices should fall until they just enable firms to achieve a normal return on capital."[24] Disadvantages of a Demsetz auction include the fact that the entire risk associated with falling demand is borne by one agent and that the winner of the bid, once locked into the contract, may accumulate non-transferable know-how that can then be used to gain leverage for contract renewal. Demsetz auctions are often used to award contracts for public-private partnerships for highway construction.
While a traditional Dutch Auction starts at a high bid which will then decrease, a Reverse Dutch Auction works the opposite way as it starts at a low price and then gradually increases over time.[25] It contains a list of items that buyers want to procure and the price rises after fixed intervals until a reserved price is reached. Before the reserved price is reached, if a supplier places a bid for the item, it is allocated to the supplier and the item closes for bidding.
In this auction, the buyer specifies a starting price, price change value, time interval between price changes, and the reserved price.
The auction opens with the first item with a specified start price and increases by the price change value (amount or percentage) after a fixed interval. The start price keeps on increasing until any supplier places a bid or the start price reaches the reserved price. After the bidding is closed for the item it moves to another item sequentially.
Auction is closed when the bidding for all items is completed.[26]
Japanese reverse auctions
Although the history of the Japanese reverse auction is unknown, they are widely used in the world of business-to-businessprocurement as a form of cost negotiation.
A Japanese auction is where the host of the auction states an opening price and participants have to accept that price level or withdraw from the auction. Acceptance indicates that the participant is prepared to supply at the stated price. When all participants reply to a certain price, the software lowers the price level by a predetermined amount and again asks participants to accept or decline at the new price level.
This kind of auction continues until there are no more participants bidding.[27]
Comparison of Japanese and Dutch reverse auctions
The major difference between Japanese and Dutch reverse auctions is in putting suppliers in two different position. While in Dutch reverse auctions suppliers opt-in at intended price point and thus end the auction immediately, in reverse Japanese auctions suppliers explicitly opt-out of a given market at their intended price point.
The benefits of the Japanese reverse auction are based on the fact that the buying organization has greater transparency to the actual market itself. In this regard, the format more closely mirrors that of a traditional reverse auction by providing greater visibility to each participant's lowest offer.
But in contrast to a Dutch auction format, Japanese auctions do not put what one Dutch auction users describes as "maximum psychological pressure" on the supply base and especially on the incumbent suppliers. This can put the buyer in a better position regarding with potentially earning more than he should based on the market.[28]
Strategy in Reverse auctions
The suppliers should firstly determine the lowest price for which they are willing to sell their products. To do this effectively they must be able to compute their true marginal cost and identify extra-auctions costs and benefits. However, that does not mean that the best strategy is to bid the lowest price. In the analysis of extra-auction costs and benefits, they should examine areas where winning or losing can generate unexpected benefits or avoided costs. Some examples include:
Winning or losing changes their volume discount, rebates and incentives with key suppliers,
Losing requires laying off personnel with its associated termination costs,
Winning opens a new account more inexpensively than hiring a sales representative.
Based on this analysis, the supplier should choose his goals for the auction. The obvious goal is to win the auction at a profitable price. However, that is not always the best goal. Because of the examples of reasons mentioned above the supplier might choose as a goal for example:
To come in second (or third) while keeping the price high,
To come in second while driving the price down to unprofitable levels for the winner,
To bid down to a certain price and stop, regardless of winning position and potential profitability.
After this preparation, the supplier should try to achieve his goal within the specific auction protocols and characteristics of the auction interface. The important characteristics that differ between auctions are the ability to see the current low bid and the knowing of their current relative position.[29]
An auction is usually a process of buying and selling goods or services by offering them up for bids, taking bids, and then selling the item to the highest bidder or buying the item from the lowest bidder. Some exceptions to this definition exist and are described in the section about different types. The branch of economic theory dealing with auction types and participants' behavior in auctions is called auction theory.
A request for proposal (RFP) is a document that solicits a proposal, often made through a bidding process, by an agency or company interested in procurement of a commodity, service, or valuable asset, to potential suppliers to submit business proposals.
A Dutch auction is one of several similar types of auctions for buying or selling goods. Most commonly, it means an auction in which the auctioneer begins with a high asking price in the case of selling, and lowers it until some participant accepts the price, or it reaches a predetermined reserve price. This type of price auction is most commonly used for goods that are required to be sold quickly such as flowers, fresh produce, or tobacco. A Dutch auction has also been called a clock auction or open-outcry descending-price auction. This type of auction shows the advantage of speed since a sale never requires more than one bid. It is strategically similar to a first-price sealed-bid auction.
An online auction is an auction held over the internet and accessed by internet connected devices. Similar to in-person auctions, online auctions come in a variety of types, with different bidding and selling rules.
Strategic sourcing is the process of developing channels of supply at the lowest total cost, not just the lowest purchase price. It expands upon traditional organisational purchasing activities to embrace all activities within the procurement cycle, from specification to receipt, payment for goods and services to sourcing production lines where the labor market would increase firms' ROI. Strategic sourcing processes aim for continuous improvement and re-evaluation of the purchasing activities of an organisation.
A bid price is the highest price that a buyer is willing to pay for some goods. It is usually referred to simply as the "bid". In bid and ask, the bid price stands in contrast to the ask price or "offer", and the difference between the two is called the bid–ask spread. An unsolicited bid or purchase offer is when a person or company receives a bid even though they are not looking to sell.
Auction sniping is the practice, in a timed online auction, of placing a bid likely to exceed the current highest bid as late as possible—usually seconds before the end of the auction—giving other bidders no time to outbid the sniper. This can be done either manually or by software on the bidder's computer, or by an online sniping service.
Auction theory is an branch of applied economics that deals with how bidders act in auctions and researches how the features of auctions incentivise predictable outcomes. Auction theory is a tool used to inform the design of real-world auctions. Sellers use auction theory to raise higher revenues while allowing buyers to procure at a lower cost. The confluence of the price between the buyer and seller is an economic equilibrium. Auction theorists design rules for auctions to address issues that can lead to market failure. The design of these rulesets encourages optimal bidding strategies in a variety of informational settings. The 2020 Nobel Prize for Economics was awarded to Paul R. Milgrom and Robert B. Wilson "for improvements to auction theory and inventions of new auction formats."
Industrial marketing or business-to-business marketing is the marketing of goods and services by one business to another. Industrial goods are those an industry uses to produce an end product from one or more raw material. The term, industrial marketing has largely been replaced by the term B2B marketing.
Bidding is an offer to set a price tag by an individual or business for a product or service or a demand that something be done. Bidding is used to determine the cost or value of something.
A request for quotation (RfQ) is a business process in which a company or public entity requests a quote from a supplier for the purchase of specific products or services. RfQ generally means the same thing as Call for bids (CfB) and Invitation for bid (IfB).
A private electronic market (PEM) uses the Internet to connect a limited number or pre-qualified buyers or sellers in one market. PEMs are a hybrid between perfectly open markets and closed contract negotiations. The core idea of PEMs is to create competition among buyers/sellers while allowing buyers/sellers to adjust all those aspects of the deal that are typically only dealt with in a negotiation. This creates a problem of "comparing apples and oranges": bids may be quite different in many dimensions and therefore cannot easily be compared. Apart from the dimension of price these could include pre-negotiated discounts, specific qualities, combinations of goods and services with conditional pricing, freight differentials, contract fulfillment timing, payment terms, or deliberate constraints such as market share limits.
Forward auction are auctions, which can be used by sellers to sell their items to many potential buyers. Sellers and buyers can be individuals, organizations etc.
Customer to customer markets provide a way to allow customers to interact with each other. Traditional markets require business to customer relationships, in which a customer goes to the business in order to purchase a product or service. In customer to customer markets, the business facilitates an environment where customers can sell goods or services to each other. Other types of markets include business to business (B2B) and business to customer (B2C).
FedBid, Inc. is now known as Unison Marketplace Inc. Unison Marketplace is a privately held company based in Vienna, Virginia, that operates a full-service online marketplace designed to optimize how federal, state and local governments, and educational institutions purchase simple goods and services such as IT products, office supplies and lab equipment, through a reverse auction-based platform.
Pricefalls Marketplace was an online marketplace. In 2019, it was acquired by Loblaw Companies.
An invitation to tender is a formal, structured procedure for generating competing offers from different potential suppliers or contractors looking to obtain an award of business activity in works, supply, or service contracts, often from companies who have been previously assessed for suitability by means of a supplier questionnaire (SQ) or pre-qualification questionnaire (PQQ).
An ‘‘‘electronic bidding system ‘‘‘ is an electronic bidding event according to defined negotiation rules (eAgreement). A buyer and two or more suppliers take part in this online event.
There are many types of e-commerce models, based on market segmentation, that can be used to conducted business online. The 6 types of business models that can be used in e-commerce include: Business-to-Consumer (B2C), Consumer-to-Business (C2B), Business-to-Business (B2B), Consumer-to-Consumer (C2C), Business-to-Administration (B2A), and Consumer-to-Administration
OpenProcurement is an open source procurement software toolkit that automates procurement processes. It provides tools to design and build a transparent and competitive procurement process backed by strong data collection, electronic documents, and detailed reporting.
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