Shall We Go Dutch? Auctions, That Is …

In my final series post on Iasta tomorrow, I mention that the vendor will soon be unveiling Dutch auction capabilities. But what is a Dutch auction and are they appropriate in today's climate? According to Wikipedia, "a Dutch auction is a type of auction where the auctioneer begins with a high asking price which is lowered until some participant is willing to accept the auctioneer's price, or a predetermined reserve price (the seller's minimum acceptable price) is reached. The winning participant pays the last announced price. This is also known as a 'clock auction' or an open-outcry descending-price auction." A reverse Dutch auction, the type that we would use in a sourcing context, starts with a low price vs. a high one, and rises from the opening amount. Sounds clear enough, but when it comes to how they work in practice, the verdict is definitely mixed.

A couple of years back, Alan Buxton (ex-Trading Partners CTO), penned a piece on his blog e-Sourcing Place titled "The Trouble With Dutch Auctions". Alan suggests in his column that he's "not a big fan of reverse Dutch auctions on the Internet, from either the buyer's or the seller's point of view." But why? His argument against them is that they're not really auctions at all because in his experience, "all implementations of online reverse Dutch auction that I have seen allow the bidder to place their best bid before the auction starts and then have the system work out when to stop the clock. The system gradually ticks upwards and eventually reveals the winning supplier's bid to the buyer ... There is no competition, no unleashing of those 'animal spirits', no nervous energy. In short, nothing of what makes auctions the best tool for allocating goods and services in a market."

Furthermore, the Dutch auctions restrict the buying organization to only seeing a single bid, affording them fewer options if any downstream implementation or quality issues arise. But is there an upside to Dutch auctions? Some practitioners who have experimented with the format suggest there is. In fact, one of Iasta's customers who has been able to kludge the existing software to work in a Dutch format believes that the format can be a great tool to put "significant psychological pressure on suppliers" because the approach does not afford them the same level of information and market feedback they currently receive in reverse auctions today. In other words, if you want to force an incumbent be as aggressive as possible, the Dutch format might make sense.

Moreover, Dutch auctions can be hosted with a limited number of suppliers (especially in markets where there are only 2-3 suppliers bidding, the format can prove advantageous because the first bid ends the auction and suppliers are always on the seat of their pants to submit the first logical bid that makes sense before their competition does). As one current user told me, they're "a great remedy for suppliers sitting on their bids" and it's a way to know that "you're getting a supplier's best shot" especially in "supply constrained markets". It's also a way to insure that you get "bidding activity" in markets which might otherwise result in a no-bid (or single high bid) situation.

But how does it work in practice when it comes to comparable results with reverse auctions and sealed bids? One company that's actively using them found that the savings from Dutch auctions in recent quarters was "1%-2% higher" than other reverse auctions held during the same period. And compared with sealed bids in an online format, Dutch auctions provided the same organization with an additional 600 to 700 basis points of savings.

In my view, Dutch auction may very well be appropriate in a situation where the buying organization has done a good job with target costing (including determining what an acceptable supplier margin should be). But when I presented this view at the Iasta event, one sourcing manager responded by saying he did not know what his suppliers' costs (and cost breakdowns) looked like. Perhaps this organization -- not to mention many others -- would be well served to better understand their supplier's total cost models and cost breakdowns before pulling the trigger on a Dutch format which, in my view, represents a way to aggressively -- and potentially belligerently -- implement a competitive target costing program.

Enough from me. What do you think about Dutch auctions? Anyone out there with experience using them? I've never been directly involved myself, and given the fact I think they're potentially quite damaging to supplier relationships -- because they do not afford the transparency of regular competitive bidding events -- I doubt I ever will be.

Jason Busch

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