Understanding Reverse Auctions in Procurement Part Three: Running Successful Events
These Five Factors Will Determine the Success of Your Reverse Auction
I remember a reverse auction K2 Sourcing ran that truly stood out. We were auctioning a packaged item for resale. The products were custom engineered, included a complex bill of materials, and required specific certifications.
Once it was underway, the results were nothing short of astounding. The Five suppliers competed fiercely, bidding against each other 79 times in one hour and generating over 30% savings. Watching the competition confirmed we had selected an excellent category for reverse auction.
Despite this auction consisting of highly engineered items rather than commodities, the reverse auction allowed us to move faster and capture greater value from suppliers than traditional negotiation techniques could.
We were confident it would work. Why? Because it met all five of these critical factors that will determine the success of a reverse auction.
The Five Keys to Successful Reverse Auctions
1. A Competitive Marketplace
For a reverse auction to work, you need competition. Ideally, this means having at least three suppliers actively participating. While auctions with two suppliers are possible, they often lack the dynamic tension that drives prices down. For maximum effectiveness, having four or more suppliers competing is best. The more you increase competition the more likely you will be successful.
2. Clear Price Comparisons
One of the most critical aspects of a reverse auction is the ability to compare bids on a like-for-like basis. For services or software, where suppliers like to use different cost models, it might involve normalizing bids to reflect annualized costs. For goods it may involve total cost modeling. Without an apples-to-apples comparison, you risk an unclear outcome that does not truly reflect the best value. Additionally, suppliers may feel uncomfortable participating.
3. Well-defined Requirements
Precise requirements are essential to a successful auction. Whether you are sourcing software, services, or physical products, you must ensure all suppliers are bidding based on the same specifications, performance criteria, and/or statement of work. Consistent requirements allow suppliers to bid with confidence and make it possible for you to evaluate suppliers fairly and transparently.
4. Leverage with Suppliers
To attract competitive bids, the spend you control must be of interest to your supplier base. For example, a $50,000 local electrical services bid might be highly appealing to small contractors. However, if you are running a reverse auction for resin with a limited spend, the large chemical companies will ignore you. One exception is software agreements, even with large providers, the buyer has greater leverage than they might believe. Aligning your spending level with the right supplier base ensures engagement and meaningful competition.
5. Market Trends and Conditions
Lastly, consider the broader market conditions. Reverse auctions work best in stable or declining markets where suppliers are willing to compete aggressively. Where many suppliers can provide the good or service, like transportation and software, reverse auctions are remarkably effective at neutralizing cost increases even in upward trending markets. Running an auction during a true market shortage will limit participation and results. Understanding the dynamics of your supplier market is crucial to timing your auction effectively.
Conclusion
At the start of this article, we discussed auctioning highly engineered items. Some people would shy away from such a category. Remember the reverse auction is just a method of automating negotiation. Also, keep in mind the more value built into the product or service or supply chain, the more opportunity there is to capture savings.
Reverse auctions are a powerful tool for automating negotiations and driving savings. If your category meets the five criteria outlined above, there is a strong chance a reverse auction will yield faster and better results than traditional negotiations.
For additional articles about reverse auctions, economics, geopolitics and critical trends impacting your procurement success keep visiting our blog and follow K2 Sourcing on Linkedin.