Procurement Innovation? Say konnichi wa to Japanese Auctions!

We’re delighted to feature a guest post from Nick Drewe of Market Dojo, e-sourcing software and solutions providers.

Upon the recent request of a customer of ours, we implemented Japanese Auction capability in our software.  Despite our procurement consultancy past, this is an auction format of which we have very little prior experience.  In fact, it lead us to ponder how much knowledge and experience of this auction format exists in the general purchasing community.

For those unfamiliar with the process, the Japanese auction gives participants a few minutes to simply state whether or not they can commit to a dictated price level (to supply the requested goods or services).  All those who said “yes” are allowed to progress and all those who said “no” are eliminated.  The price level then drops by a certain amount and the question is repeated to those who previously said “yes”.  The process continues in this vein until all participants have ‘opted out’ of the auction.

As you can see, the approach can be very effective at establishing the final price for each participant in turn, regardless of the market competition.  Consequently the approach can be adopted in situations where market liquidity is very low or markets which are dominated by a handful of major players, such as dairy or utilities, hence the popularity of this format within retailers.  The Japanese Auction can even be used for a single-source negotiation, which was the major reason our customer favoured the Japanese Auction, ever since they used it to negotiate a significant cost reduction with just a few keen participants involved.

Other situations where the Japanese Auction can be used effectively are when there are large cost differences between bidders, despite both quoting for the same specifications.  With your typical Ranked Auction, the participant in first place is unlikely to be challenged, even though they may have some residual margins to expend.  However, utilise the Japanese Auction and even that participant will be asked to improve their offer.

So far we have outlined a reverse Japanese Auction, i.e. where the bidding comes down in value upon each round.  However, we have encountered situations where a Japanese Auction can be used in an upward price direction, such as the negotiation of rebates amongst a supply base.  Since it is fairly meaningless to give suppliers market feedback on their rebates, as each supplier could be contracted for different goods and services and different spend levels, the Japanese Auction presents itself as a superb way to negotiate with each supplier individually, yet concurrently, in a single auction.  For example, in Round 1 the suppliers are asked whether they agree to a rebate of 0.5% of full year spend, with an answer of “Yes / No”.  For those who reply favourably, they are then asked in Round 2 whether they agree to a rebate of 1.0% and so on.  There is a huge efficiency saving compared to the traditional way rebates are negotiated, as well as the potential for far greater results.

You could consider taking this approach into new arenas.  For example, it would be possible to use forward Japanese Auctions as a way to sell assets, be it property, excess stock or even an entire business.  The auction will offer potential buyers nothing in the way of the level of competition they face, so it could be hugely effective at driving up the purchase price from just one or two interested parties.

There are of course challenges to Japanese Auctions.  Firstly, they are not broadly recognised, which means participants will require a greater degree of hand-holding and reassuring.  Secondly, they offer little to the participants in the way of market feedback, although post-auction you can certainly provide feedback at your own discretion and to whatever extent you wish.  Thirdly, they operate in a rigid manner with participants only able to accept or decline each price level rather than to come in at their own price level.  It could mean that some participants have to wait a little longer to submit their final offer, although the end goal of establishing the market price is still achieved.

One final thought was raised during a recent customer site visit.  They typically used Japanese Auctions to conduct their negotiations and were genuinely surprised on the day to see the fantastic result generated by a conventional Ranked Auction.  The success was due to the level of interaction by more than a dozen motivated bidders.  Their Japanese Auctions on the other hand typically involved fewer than half this number of bidders and, by the very nature of this auction format, did not offer any interaction.   It could be said then that Japanese Auctions lend themselves well to purchasing professionals who prefer a negotiation restricted to their handful of preferred bidders versus those who choose to proactively source from and involve the wider market, should it exist.

On a final note, when we incorporated Market Dojo eighteen months ago, we had a range of logo options given to us.  At last we have a reason to use our number two choice!

PS:  At the time we thought it looked a bit too much like a logo for a restaurant than that of an e-Sourcing software provider!

Comments

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  • John Hatton:

    Two other advantages of Japanese reverse auctions:

    1) you can use this format when there are fewer (sometimes as little as two) bidders. An English reverse event generally fails to cope with such a scenario, as if one of the two stops bidding, the auction dies. In Japanese, the other can keep bidding to his/her heart’s content.

    2) whereas the winning bid in an English reverse event is normally slightly lower than the second best bid (why would they bid even lower when they know they are the winner?), in a Japanese, the most competitive bidder can, and often does continue to bid lower. So the buyer can benefit.

    The Japanese format is often used by retailers, who can frequently find they are buying in a market with few suppliers.

    II works well – but as Nick has pointed out,there are drawbacks too, particularly if the supplier base is unfamiliar with the format.

  • Marketdojo:

    Thanks John for re-iterating the same points, always reassuring to see that our thoughts are in line with those of other sourcing professionals.

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