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Bidding Wars

By Jerry Soverinsky 

It may be redundant to suggest that maximizing one’s bottom line is paramount to success. But during this time of sustained economic downturn, the recommendation takes on a relative urgency. With lending sources scarce, the abili­ty to grow one’s business through the traditional borrowing-capital investment route is, for now, a deferred proposition.  

Enter the reverse auction (also known as the e-auction, sourcing event, e-sourcing), a procurement solution that leverages the immediacy of the In­ternet and the most basic elements of free-market trading in an effort to un­cover new suppliers offering potentially significant cost savings on goods and services. 

A reverse auction is, as its name implies, an auction where buyer and seller roles are reversed. Whereas in the traditional auction, a seller offers a good or service to a group of buyers who compete in a bidding process, with the offer price rising as the auction progresses, in a reverse auction, sellers compete to win business by offering bids (purchase prices) that decrease in value as the auction unfolds. 

With the assistance of the Internet and reverse auction marketers whose preparation often assembles a deep pool of engaged sellers, the bottom-line cost savings for companies can be significant and quickly achieved, along any line item category, including equipment, supplies, labor and professional services.  

Kid Wonder, GE Blunder
A March 2000 Fortune article traces the history of the reverse auction to 1994, crediting its conception to then 30-year-old General Electric employee Glen Meakem. His idea was to overhaul the drawn-out "golf-course schmoozing" process of haggling with suppliers, or the tedious RFP and sealed bid processes. Rather, as Meakem proposed to his GE bosses, the market for goods and services could become as efficient as the stock market, generating billions in corporate savings. "This idea [can] transform the global economy!" he proclaimed.  

Except GE didn’t listen.  

Undaunted, Meakem launched Free-Markets Inc. in his basement later that year, and by 1999, his venture boasted a market cap of $7 billion, a reflection of a customer base that included ExxonMobil, United Technologies and Royal Dutch Shell, to name a few. 

FreeMarkets was eventually purchased in 2004 by California-based Ariba, a procurement services firm. Today, the company boasts 40 offices in 21 countries and generated $85.7 million in revenue during the first quarter of its 2010 fiscal year. 

"We celebrated the 15th anniversary of the reverse auction at our annual con­ference in May," said Kris Colby, Ariba’s director of spend management services, who explained that the rationale behind using a reverse auction as a procurement tool has remained relatively unchanged over its short history.  

"The reverse auction was started pri­marily as a way to do two things," Colby noted. "One, it streamlines the negotia­tion process, taking away a lot of the clutter of phone calls and paper. And two, when you get everyone in the same place doing real-time negotiations, it’s a more competitive process that moves faster. And once companies figured out that [reverse auctions] could drive sav­ings of 12 to 17 percent —a range that has held steady over time —it look off like a rocket."  

Schenectady, New York-based grocery chain Price Chopper has been participating in reverse auctions for three years, and it echoes nearly all of Colby’s comments."Before [reverse auctions], we were doing the standard RFPs and RFIs, manual processes that required analysts, conference calls and paper bids that were never immediate," said Jason Ken­nedy, Price Chopper’s manager of continuous improvement and supply chain. "The process used to take four to eight weeks, but with reverse auctions, it’s much, much quicker." And results have been impressive, delivering generous savings to the grocer.  

"Our cost savings range depending on the category," said Ken Gregory, Price Chopper’s reverse auction supply chain analyst, noting that the company has participated in roughly 100 reverse auc­tion events over the past year. "We’ve had some events that earned 50 percent in savings, though the average is proba­bly around 18 percent."  

These numbers would cause any CEO to pause, especially with many of retail’s biggest players already using the process to lower costs. "Of the top 50 or so retail­ers in the U.S., about two-thirds have real, ongoing auction programs in place," Colby said. "It’s got a very strong pene­tration with bigger companies."  

Size Doesn’t Matter
But you don’t have to be a Walmart, Albertson’s or Target to make the process a practical one for your company.  

"Ten years ago, maybe it was more appropriate for a company to pass a certain size threshold before proceeding [with a reverse auction]," Colby said. "But the prices on technology and support have come down so much that if you buy goods and services, [the reverse auction] should be an arrow in your quiver for how to do things."  

Other experts agree but cite challenges for the smaller retailer, whose spending behavior might not attract a deep supplier pool. In that case, a reverse auction company can help connect the smaller retailer with a larger retailer and offer aggregate activity. 

"[F]or that three-store c-store guy, if he spends $10,000 on bags and another customer spends $1 million a year, we do collaborative procurement," explained Len Kaplan, vice president of sales for Phoenix-based Intesource, a reverse auction specialist. "It’s a great benefit for the small retailer who otherwise wouldn’t have the leverage." For home fashions retailer Anna’s Linens (AL), the reverse auction tool has helped the company navigate a rapid expansion (30 percent per year, with 258 stores in 18 states) while ensuring cost control.  

"[W]e were growing so fast that our corporate support personnel did not have enough tools to buy properly," said Mike Harnetiaux, AL’s chief administra­tive officer. "Our buying, whether prod­uct, supplies or services, was handled by each department head for their area... which resulted in varying degrees of purchasing success."  

Investment Costs
Of course, the suggestion that reverse auctions are appropriate for purchas­ers, no matter their size, requires fur­ther qualification. Colby said that base costs start at "$15,000 to $20,000 per year for those looking for a small-scale, self-service tool," and can escalate into the millions for mega-retailers.  

"Our biggest program was for a huge department store chain; they spent about $4 million for a fully supported annual program," Colby said, adding that the returns, in nearly every case, justified the investments. "On average, ROI ranges from eight to one to 15 to one, a very real and rapid return, with most clients experiencing payback in three months," he added.  

Comprehensive Support
Ariba offers a range of flexible program options —"Over time, our clients tend to take on more of this internally as they get into the process," Colby said. Intesource, however, distinguishes itself with its comprehensive management solutions.  

"We offer a full-service, all-inclusive approach [to staging reverse auctions], primarily in the retail world," said Kaplan. "We do all of the work, from helping determine appropriate categories to de­veloping a strategy, to researching sup­pliers, and executing the actual event."

According to Kaplan, while there’s a cost savings inherent in online solutions, they’re fraught with risks for inexperienced users.  

"There are nightmare stories where suppliers weren’t trained properly, where the spec [the precise good or ser­vice required] wasn’t clearly defined and there wasn’t a good strategy," Kaplan said, adding that a successful reverse auction "consists of due diligence and doing one’s need a con­sistent process that works for all of the disparate parts."  

That process begins, Kaplan said, with the creation of a list of category spends and an overall assessment of the company. "Every department that spends money would be a candidate for this," Kaplan explained. "It’s construc­tion, services, supplies, IT, HR, distribu­tion, advertising, products, background checks for human resources —every department."  

Colby agrees, though he’s quick to point out that the process doesn’t work for name-brand goods, where there’s typical­ly just one buying source.  

Successful Events
While the rest of the process is relatively straightforward, ensuring success re­quires four key elements, Kaplan noted. "First, you need a decent spec," Kaplan said, "so that suppliers understand pre­cisely what they are bidding on."  

Second, there must be viable supply sources to generate competition. Intes­ource and Ariba maintain libraries of several hundred thousand suppliers, along with tools and process to assist in qualify­ing suppliers.  

Third, the retailers must be willing to consider a change in suppliers. If the in­cumbent supplier doesn’t feel his business is at risk, or the new suppliers don’t have a legitimate opportunity, the integrity of the process is diminished. This is a particular sticking point for many firms.  

"Many of our vendors are long-term suppliers with long-term relationships," Harnetiaux said. "Strong relationships have many positive affects, however, it sometimes masks opportunities for different approaches, including better pricing." 

Kennedy agrees, and also ad­vises retailers to get the buyers in their own company "to understand that [a reverse auction] makes their life much easier and that they’ll be exposed to more potential suppliers...They’re the expert, they’ve bought a category of goods for many years. You need to get them on board." 

Finally, market conditions must be favorable for the category. 

One, Two, Three, Sold!
The actual auction process is quick and "fun to watch," Kaplan said, noting that reverse auctions unfold in as few as 15 minutes (plus any extensions). During that time, retailers watch a computer screen and monitor the online bidding process, where anywhere from two to 30 suppliers might be bidding. For suppliers, the process is a blind one; they’re unaware of the competition and see only the cur­rent bid price (the incumbent supplier typically is invited to participate and usu­ally accepts the offer).  

After the auction ends, the buyer can choose any bid —not just the lowest. Pre-bid communications with interested sup­pliers stipulate how and when the final selection will be made (it’s almost never done immediately after the auction), with quality, service and price the most com­mon factors assessed.  

What to Expect (When You’re Expecting)
Of course, the fundamental reverse auc­tion question persists: Will a reverse auc­tion save you money? For both auction companies and retailers, the answer is an enthusiastic yes.  

"Based on our experience, sourcing tens of thousands of events across more than 500 categories, our clients realize savings exceeding 18 percent," Kaplan said, a figure that mirrors estimates from Ariba (17 percent) —and those are not self-serving embellishments, Harmetiaux at­tests. "[W]e have now run 17 events that in total have generated expected annual sav­ings of nearly $5 million."  

What’s in Store for Your Store
While the reverse auction may generate particular appeal during this harsh eco­nomic climate, it’s a legitimate procure­ment tool whose longevity will last far be­yond the current recession.  

"[T]here is no other new initiative at [Anna’s Linen’s] that has shown such ROI," Harnetiaux said. "It is our intention, where applicable, to expand the use of this tool to the basic buying process for each department and the company as a whole."  

Jerry Soverinsky is a Chicago-based freelance writer and a NACS Daily and NACS Magazine contributing writer.