Reverse Auctions — Is it Hammer Time?

In a comment to a post a few weeks back, Gartner's Debbie Wilson questioned whether or not the current economic and commodity markets environment might lead to a rising use of reverse auctions (according to CAPs, reverse auction use declined in 2007). Debbie raises a good point and it's one we should all think about next time we have an option to choose a negotiation format. However, if we lived in a sourcing world where all practitioners and consultants were skilled in how to optimally set up a negotiation event, then we'd probably not be having this discussion at all. For in the commodity upswing that took place throughout 2006 and 2007, it was still possible to run highly successful auctions. The key was running them in markets where it was possible to strip out the value-added portion of a contract from the underlying commodity and transportation elements -- not to mention insuring available capacity in the market. Or, in cases where suppliers really did have the upper hand, running events that focused on multi-round or real-time negotiations where suppliers had greater flexibility in submitting custom bundles or offers.

But in today's market, these advanced approaches are not necessary -- though they may very well lead to better results. What's needed on the most basic level to get the maximum benefit from reverse auctions today is a knowledge of bidding formats and how best to deploy them. For example, knowing when to apply a transformational factor to a bidding event (e.g., handicapping for quality, factoring in inventory carrying costs with global suppliers or taking into account out-year discounts using NPV bidding). In another case, having suppliers bid on only the value-added portion of a category and tying the underlying components to an index price (e.g., linerboard in the case of corrugated) might yield the best results. Most sourcing tools on the market today let you take advantages of formats and capabilities such as this, yet I'd still argue that most companies run reverse auctions where unit cost -- not total cost -- is the primary determining factor in providing market feedback.

Category managers and sourcing leaders need to brush up on negotiation formats and capabilities to get beyond running price-only auctions. What's the best approach for coming up to speed? Become familiar with the features that your software allows by taking a training course that your provider offers. Or work with your provider in a full-service engagement to learn from them. Other options include sharing templates and negotiation approaches with others in a controlled and highly structured social networking environment (look for a new Spend Matters affiliate offering that will enable just this in the coming months). Most important of all, outside of training, begin to test the market and the willingness of suppliers to compete. After all, if you begin to see the downward curve -- that FreeMarkets used as its logo -- drive to lower market prices as you begin to test the reverse auction waters anew, then chances are you'll see greater competition across a range of spend areas.

- Jason Busch

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