Reversing Into Darkness

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.

Reverse AuctionsAlso, 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.

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

? Emiliani, M. with C. Giampietro, ?Coercion and Reverse Auctions,? Supply Chain Management: An International Journal, Vol. 12, No. 2, pp. 75-84, 2007

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