Are Reverse Auctions a Threat to Good Supplier Relationships?

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Can reverse auctions — and e-procurement in general — sour a good supplier relationship? One of our readers wrote in with this question, worrying that reverse auctions may put pressure on supplier margins to such an extent that it is detrimental to the buyer-supplier relationship.

In a reverse auction, suppliers compete for the buyer’s business by underbidding one another. This increased competition among the supply base ought to lead to lower prices for buyers, although it also runs the risk of undermining a supplier relationship that has taken time and effort to build. What’s the point of developing a strategic supplier relationship if you’re going to use an automated auctioning process anyway?

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It’s a classic question and raises an ever-relevant topic for debate and discussion. Spend Matters UK/Europe editor Peter Smith tackled it back in 2010 following an Iasta (now Determine) user panel. One panelist had argued that suppliers have come to expect formal auctions, and another panelist argued that supplier relationship management (SRM) was sometimes just a code word for avoiding competition.

In continuing this debate, we surveyed a number of buyers and suppliers with experience in reverse auctions. The consensus among them is that reverse auctions will not harm the buyer-supplier relationship, provided that they are used correctly and in the appropriate situations.

When Are Reverse Auctions Appropriate?

“About 75%–80% of the goods and services we buy are highly competitive,” says Gregg Brandyberry, president of RDPE Inc., who argues that there is no better way than using an auction format to set prices for this type of spend, provided that the suppliers competing are able to meet basic standards.

“Any supplier who can't figure out how and when to be competitive and maintain an overall acceptable profit margin is probably not a supplier you want to do business with over the long term,” he says. “Buyers need to remember suppliers sell the same goods and services to different companies at different prices. Those companies with good procurement pay less!”

For more strategic spend, which Brandyberry defines as spend that gives an organization a competitive advantage in its industry, a softer negotiation strategy may be better.

Brian Bancroft, chief procurement officer at Church & Dwight, agrees.

“A supplier who can help your company grow or differentiate itself in the market should not be engaged in the same way as one who is providing a good or service that is more of a commodity,” he says. “For many of these suppliers you would engage them in more of a transactional manner and the use of a reverse auction tool may be appropriate and effective.”

Bancroft warns that suppliers that are invited to participate in a reverse auction should first be qualified — that is, any of them should have an equal opportunity to win your business. After a number of suppliers have met your minimum requirements, you can then focus on cost as the differentiating factor.

What you want to avoid, Bancroft says, is using reverse auctions as a way to test the market. Not only is this arguably unethical, it is likely to backfire.

“The marketplace quickly realizes what you are doing and either refuses to participate or will not offer you a competitive proposal in the future,” he says. “Additionally, it trains your incumbents not to submit a competitive proposal since they know you will come back to them anyway.”

A head of procurement at a U.S.-based company summed up the decision on whether or not to use reverse auctions thus:

“If you consider four types of supplier segmentation — strategic, leverage, bottleneck [and] commodity — reverse auctions should only be used in the commodity segment and even then when appropriate. It is the best way to get the market clearing price. There is an opportunity to use reverse auctions in the other areas once. That is when [you are] setting up a category for the first time, have several suppliers and want to figure out who really wants to be your partner by truly giving you their best pricing. That is a one-and-done game, though.”

Do Auctions Favor Incumbents?

Let’s say you’ve done your preparation. You’ve screened the suppliers taking part in your reverse auction and are willing to award your business according to the auction’s outcome. No one is forcing the supplier to participate in the auction, of course, but does that mean that it won’t hurt the buyer-supplier relationship?

A 2002 study done by the NC State Supply Chain Resource Consortium found that there is a belief among suppliers that incumbent suppliers are at an advantage in reverse auctions due to potential insider information on buyer requirements. The cost of switching suppliers may be another factor favoring incumbents.

However, Brandyberry has noticed the opposite, having been involved in more than 100,000 auctions over the course of his career, which has included roles at GlaxoSmithKline, FedBid and Takeda.

“Incumbents dislike auctions because it takes away their ability to ‘work the business.’ Non-incumbents love the transparent and fair process and market visibility when given,” he says. “What I have seen through the years [is that] small suppliers can compete very nicely with large suppliers when a fair, transparent, level playing field is established.”

From 2010 to 2014, Brandyberry worked at FedBid, an online reverse auction marketplace that holds more than 30,000 auctions a year for the U.S. government, and he says that small and diverse businesses won more than 80% of the auctions.

“Small businesses want the access to opportunity regardless of the type of bidding format,” Brandyberry explains. “Overall there is less resistance from small suppliers as they understand they have a better chance of gaining new business than the more traditional negotiation models.”

A Two-Step Approach

Spend Matters Founder Jason Busch has written about the controversial nature of reverse auctions, noting that “one of the reasons that reverse auctions have gotten a bad label in some quarters is because many companies have come to rely on them almost exclusively as their only negotiation tool.”

However, reverse auctions do not necessarily favor the buyer. Let’s travel back in time again to Halloween 2013, when we published a memorable anecdote from a reader (and buyer) who had a fuels contract to re-bid.

The reader chose to schedule a reverse auction because it offered the fairest value for the least effort, but it did not quite turn out as hoped: “I would be hard pressed to describe the horror I experienced watching the bidding in real time. There was a handy little graphic to the right of the auction, with a line graph that was supposed to show the bids dropping, but instead just showed an initial two or three outrageous bids from each offerer, then a flat line.” And no, the bidding did not pick up once time was running out.

A two-step approach might have been appropriate in this situation. Busch supports such an strategy, whereby the lowest bidders in an online auction are invited to take part in a negotiation process in which cost is one of several factors considered.

“Now, a two-step process will never generate the level of savings that a reverse auction will when the lowest bidder will always be awarded the business,” Busch wrote. “But I’ve personally been part of teams that have used this approach to help yield significant savings in complex sourcing categories where a combination of competition and collaboration makes the most sense.”

It is also worth noting that online reverse auctions have been increasing in popularity, especially among sourcing, procurement and finance professionals between the ages of 30 and 44, as a 2017 white paper by Scout RFP found. Larger companies are more likely to use reverse auctions extensively. As reverse auctions become more mainstream, the perception that their use reflects apathy toward maintaining good buyer-supplier relationships may subside

The culture of sourcing is ever evolving, and so we welcome our readers — buyers and suppliers alike — to weigh in on this question in the comments. And don’t forget to send us your own questions using the box below!

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  1. David Monty:

    I am new to the procurement side as I have been a seller for 25+ years. The company I now work for, Procurex, offers reverse auctions, so I may be a bit biased, but follow my logic here. I am shocked at the reluctance of companies to disrupt their “strategic” relationships. When customers “protect” their strategic vendor, they are paying a premium for their relationship. You never hear a vendor say, you are a strategic customer, therefore I am giving you a lower price. Vendors never give anything away, they do anything in their power to sell at the highest price possible. I am not some sleazy sales guy. Every sales training I have ever been in is about selling at the highest margins possible. It is systematically taught by corporate America. Even commissions are set up that way, the higher the price, the larger the commission check. I say reverse auction everything. You will never hear a vendor say, I gave you too big of a discount, so now I am going to give you subpar support. If they do, they are not strategic. The risk you run is losing the strategic vendor because you learn they have been gouging you for years.

  2. Akshaya Rath:

    Thanks for an insightful article and detailing you have explained, Looking forward to similar articles in future.

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