You know what a reverse auction is. Leaving the light, moving into the darkness, and finally oblivion. From a contractor’s perspective anyway.
I don’t like reverse auctions. They’ve been called zero-sum, power-based bargaining. Meaning customers have all the power, and through coercion, extract savings from contractors’ profits. Not my idea of a partnership.
Did You Know?
- U.S. Army Corps of Engineers won’t use reverse auctions for construction services
- Associated General Contractors of America (AGC) has a White Paper stating reverse auctions are worse than existing selection procedures
- A 10-year research project finds reverse auctions don’t deliver promised savings, and harm supplier relationships
- Research shows majority of incumbent suppliers (as high as 70%) seek to charge retaliatory higher pricing to customers who’ve put them through a reverse auction
Reverse Auction Defined
Wikipedia defines reverse auction as a b2b procurement tool where “…sellers compete to obtain business.”
Reverse auction is found 407,000 times on Google. And a lot of those are about sellers’ (contractors) bad experiences. Here’s what I’ve learned from you and Google .
At one time reverse auctions were thought to cover 10-50% of corporate purchases. However, over the years that’s shrunk down to 1-5% of total spend, because reverse auctions didn’t live up to the hype.
My guess is reverse auctions are held for about 1-2% of facility service contracts (security, janitorial, grounds, etc).
Reverse auctions seem to be used on large volume, facility service contracts rather than small ones. Probably because of the reverse auctions’ expense.
Also, reverse auctions are held primarily by customers who produce products. Maybe it’s their “economies of scale” mindset. They know it works for tangible things – they think it should work equally well for services. Bid out a large dollar contract and they’ll get huge savings, right?
No one’s told them the larger the contract – the smaller the contractor margin.
Sad Story Both Ways
One facility contractor told me he was in a reverse auction against only one other bidder. He suspected it was the customer using the reverse auction to drive down his incumbent price.
Don’t laugh. It happens. Here’s a few other areas where customers get sideways with reverse auctions:
- Not intending to switch contractors, just checking market pricing
- Intentionally including unqualified contractors to drive pricing down
- Providing incomplete or inaccurate specifications
Don’t get me wrong. There are unethical contractors out there too. And they’ll do dumb or ignorant things in reverse auctions, such as:
- Bidding without intending to honor their pricing
- Knowing they can’t meet contract terms & conditions, but bidding anyway
- Buying business at low pricing, then charging high prices for “extras” and/or renegotiating scope after the auction
Over the years, unethical, and illegal, behavior has happened so often that voluntary guidelines and codes of conduct have been developed. For customers (buyers) and contractors (sellers). In industries such as the U.S. auto industry, Canadian general contractors, and British aerospace companies.
However, voluntary codes are ineffective and reverse auction abuse remains common.
Success Stories Sell
You’ll come across stories from reverse auction providers touting millions they’ve saved customers, see Ariba. That’s what sells their next job.
Customers also praise reverse auctions, see U.S. State Department.
It’s understandable. Customers have already spent money on the reverse auction’s pilot program. Their professional credibility is on the line and it must be protected. Kind of like “I chose this; therefore I’ll find the short-term evidence to prove I’m right. I’ll ignore long-term results because they don’t support my position”.
Why Net Savings are Misleading
Net savings are held up at the end of an auction as proof of success.
The formal measurement is Purchase Price Variation (PPV). For facility service contracts it’s the difference between the customer’s last purchased price and the lowest, winning bid price.
Why Gross Savings aren’t Shown
What’s not shown in net savings are costs associated with delivery, quality or implementation.
Why? Because those costs aren’t available at the end of the auction. Only when customers take delivery.
And for facility service contracts, implementation happens over months and years.
Even when it occurs, it’s difficult to quantify facility services’ impact on most customers’ businesses.
Does anyone measure customers’ productivity when employees work in a dirty office? Or how much free overtime customers lose when employees don’t feel safe working after hours?
It’s easier with manufacturing and production lines. The line stops. It costs the customer. That’s the performance penalty the facility service contractor may have to pay. Same in a cleanroom environment. Contaminated product, contractors pay.
Those are the implementation costs that affect gross savings. But they don’t show up in net savings at the end of the auction.
Why Reverse Auctions Don’t Work for Facility Service Contracts
- Focus is on price – not reducing cost, problem solving, or service delivery
- Damages supplier (contractor) relationships
- May encourage imprudent bidding (not you of course)
- Focuses people on short-term, instead of long-term results
- Promotes customers’ zero-sum, power-based bargaining
- Difficult to define service intangibles in specifications
- Supplier relationship crucial to delivery of service value
What Can You Do About Reverse Auctions?
1) Work to Avoid Reverse Auctions
>>> Educate Customers
- Help them understand why reverse auctions don’t work for facility services
- Send them a link to this blog posting & see links at end of this post
- Try this pre-auction decision analysis tool, it’s a downloadable Excel file from Lee S. Crane. a buyer with the U.S. Postal Service
>>> Build Stronger Relationships
- First, understand how your service impacts customers’ businesses
- Then strengthen what you do to better serve customers’ business needs
>>> Continually Increase Value
- Bake more value into your basic offering
- Not as an add-on service – but as an integrated solution so customers can’t deconstruct it
- You’ll be increasing your service above perceived commodity status
2) Boycott Reverse Auctions
Why not? The Cabletelevision Advertising Bureau is boycotting online auctions.
They say selling advertising is not a commodity. They’re putting together custom packages and providing added-value.
So instead of selling price alone in an online auction, their members are boycotting the eBay developed auction.
3) Participate in Reverse Auctions
Your choice. There’s a lot of research and info on games theory. Couple of interesting things were:
- Winner’s Curse – which says the winning bidder will tend to overpay for actual value – for reverse auctions it means contractors have to figure out how to deliver service at their winning bid pricing. Yikes!
- Entrapment Game – really interesting exercise showing illogical, but typical auction behavior
Information Links
- Dr. M.L. “Bob” Emiliani, website with numerous articles,
“REVERSE AUCTIONS, A Ten Year Research Project Investigating the
Effectiveness of B2B Reverse Auctions“ - AGC of America: Reverse Auctions Resource Center white paper
- US Army Corp of Engineers on Reverse Auctions
- Mohanbir Sawhney, “Reverse Auctions Cutting Costs“, June 01,
2003, CIO.com - Karen Prema, “SRM + E-AUCTIONS: Tools in the toolbox“,
Purchasing, April 6, 2006 - David Hubler, “Reverse auctions become a diplomatic tool:
State Department stretches its budget with online buys“, Federal
Computer Week, Aug. 14, 2006 - Ariba success stories on their web site
How Are You Handling Reverse Auctions?
~~~~~~
Chris Arlen
President & Senior Consultant / Service Performance
http://www.serviceperformance.com/
Technorati tags: reverse auctions, pricing, facility services
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{ 2 comments… read them below or add one }
You list three things that buyers do to vendors that sound awfully unethical to me:
* Not intending to switch contractors, just checking market pricing
* Intentionally including unqualified contractors to drive pricing down
* Providing incomplete or inaccurate specifications
What you are referring to sounds like self-serve reverse auction technology to me, which is why outsourcing of procurement through reverse auctions has been so successful, where companies are contracted for specific one-time or term-bid source and supply purchases. These companies do the research required, source the eligible vendors, ensure that every vendor meets all qualifications – all prior to the first bid being placed during a reverse auction. You can’t give a child a toy as powerful as reverse auction software and leave him with it without supervision and guidance. With most self serve software, although service is provided, it has to be requested. With a managed reverse auction solution, the guidance comes with each and every purchasing event.
Construction projects do work in conjunction with reverse auctions. Build terms, contract pricing and materials, labor force and follow up can all be specified, and just as in any paper bid system, surely those items can be skewed, ambiguous or downright misleading, but it doesn’t mean that every reverse auction provider out there is dishonest, or that every buyer has evil intentions at heart. Certainly contractors may not like the process, but as a former contractor, I hated bidding against anyone for anything. I wanted my full markup. So to register their complaints without acknowledging the nature of the construction beast seems a little skewed in my opinion.
I have had companies ask me to run “test bids” to see if they can drive pricing down. I always, without exception, refuse. There’s no gain in it for my company, and in the end, if I engaged in that behavior, then I haven’t provided the guidance I was hired to provide. I only get paid once a company chooses to buy what I have assisted them in procuring. I know their existing pricing prior to a reverse auction, and many times set a “Baseline Price” for consideration, so that vendors know up front if they want to get involved. If I don’t believe I can save my customers money and time, I don’t take on a specific project.
Yes, Ariba and SAP have huge market share. But they have that market share because many times they run around and tell potential clients that they can save them money on anything and everything they can buy. I despise self serve software for that reason, as it gives all of us, even those of us who practice managed reverse auction services, who have integrity and value the effectiveness of our business model, a bad name.
I have found in my dealings with suppliers, that the most push-back comes typically from the incumbent supplier who is afraid to “get in the ring” as I say, with a new supplier. In this day and age of volatile pricing, why would a company or municipal not want to find where the market really lies for a given product? It would seem almost irresponsible to refuse to do so.
Not to put too fine a point on my point, but it would be great if writers of blogs would stop lumping those of us who provide managed reverse auction services in with self serve reverse auction software. There are those companies out there who actually care about what we do, and care about preserving the buyer/supplier relationship.
Vaughn Blaylock
Southern Procurement Services
Vaughn,
Your comments are well presented and well taken. In the spirit of discourse here’s a few thoughts that come to mind:
Separating software from consultants
Thank you for making that delineation. I agree, self-serve software without the procurement, or specific service/item intelligence, can be dangerous for the buyer.
However, customers looking to save money (many attracted to reverse auctions in the first place) may be reluctant to hire a professional firm to manage their reverse auction. They’re seeking to save money, and their procurement people will justify their jobs in the process. Obviously your firm is capable of providing the value proposition that persuades customers to use your firm’s intelligence/experience for greater outcomes.
But I’d guess your customers are more of the enlightened buyers, leaving a large majority of lower cost buyers out there.
Buying Facility Services vs. a Project-based Service -or- Products
I’m not knowledgeable about construction contracting, but I’d consider a construction service as a project (beginning, middle, end), and the processes used to accomplish desired outcomes may be very similar from contractor to contractor (i.e. pouring foundations, framing, etc. – these examples show my ignorance don’t they?).
With that said, facility service contracts (i.e. security, janitorial, etc.) are on-going operating expenses where each contractor can differ widely in “how” they deliver service and comply with contract terms.
Maybe this is just my familiarity with these niche services, but there’s a world of difference between “how” things get done. And for facility services, “how” service is delivered (courteously, visibly, etc.) is as important as the finished result (clean office, safe parking lot, etc.).
Services differ from products in buyers’ ability to spec out both the resulting outcomes as well as “how” those services are delivered.
Reverse auctions work great for products and select services that can be more finitely specified for comparison. I don’t believe facility services in particular falls into that category.
Going Forward
In the facility services’ industry, reverse auctions are shaking out as buying experiences (realized over the term of contracts) bring home painful lessons learned.
Reverse auctions for facility services are now often used as only one step in the evaluation process and not the final determinant. In these instances they’re used to simply the financial comparison of data, and are then combined with the qualitative assessment of contractor delivery for a final decision.
Thanks for your insights.
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