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Use eAuctions Instead of “3 Bids and a Buy” for Greater Savings

Published January 8, 2021

Category: Business Process

Written by: Prabhav Pattapurati
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Prabhav Pattapurati

Prabhav Pattapurati, senior procurement consultant specializing in the chemicals, healthcare and FMCG industries for GEP, a leading provider of procurement and supply chain solutions to Fortune 500 companies.

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In late 2020, Robert Wilson and Paul Milgrom were awarded the Nobel Prize in Economics for breakthrough work on structuring auctions to deliver the best results for both the seller and buyer. Google, for instance, reinvented the advertising industry, which was based on face-to-face, closed-doors deal-making, with its programmatic, automated, real-time, largely auction-based digital platform. In doing so, Google grew exponentially by providing millions of small businesses with the ability to advertise cost-effectively.

So, why aren’t auctions used far more extensively by procurement?

Why does procurement rely heavily on “three bids and a buy” to secure everything from raw materials to marketing services?

eAuctions for Procurement

Procurement leaders believe auctions will not help them reach their savings targets due to the “winners curse,” a phenomenon where a supplier overestimates how much they need to lower their bid in reverse auctions to win. This creates psychological resistance in suppliers to lower prices as they fear that they will end up unnecessarily cutting into their own margins. Moreover, there’s a myth that auctions cannot be conducted for items below a certain price level, despite eBay disproving it 20 years ago.

Which brings us back to our Nobel Prize-winning scientists who proved that a bidder — a supplier — will choose not to lower their bid for an item in order to avoid the “winners-curse.” However, if all participants were offered a level playing field in terms of information, they would be able to make continuous modest alterations to their bids to reach the optimal price of any item. In other words, our Nobel scientists discovered that auctions eliminate bias and increase transparency into competitor pricing, leading to higher savings for procurement

Auctions provide the best way to drive savings for organizations in a way that is mutually beneficial for buyers as well as suppliers, and procurement is completely underusing them. It’s a massive missed opportunity.

To replace “three bids and a buy” with auctions, procurement needs to:

  1. Select the right format: When focused on savings, use a Reverse English format. As suppliers continually place bids, additional pricing information is distributed among all bidders, driving the price lower and lower. Whereas when you’re looking to establish multiple suppliers for a single category, use Reverse Japanese auctions since suppliers must indicate their willingness to continue participating after each round of lowered prices. This is as opposed to a Dutch auction where a winner is decided whenever a supplier accepts the price.
  2. Remove the “winners curse:” Today, procurement negotiations decide the final price and terms after receiving quotes from bidders. Instead, with auctions, providing feedback to all suppliers about their price-competitiveness enables them to bid more aggressively. Additionally, during the auction itself, by providing unlimited bids while sharing real-time bidding information amongst participants, suppliers can compete without fear of under-bidding. Most importantly, the transparent nature of the auction, in contrast to negotiations, will eliminate any feeling of politics, favoritism, personal connections and bias that suppliers generally suspect.     
  3. Group items when the value of each item is low: When procuring low-value resources, such as translation services or low-volume chemicals, group similar items together to create lots, enabling suppliers to provide an overall lower value to a lot. Additionally, it makes it easier for suppliers to participate because they won’t split their attention across too many items.

Despite auctions being far more efficient than negotiating prices, to secure direct and indirect services and goods, they are entirely underused by multinationals. By using auctions, your suppliers will see competitors’ price ranges while procurement will eliminate bias to achieve saving targets and build stronger vendor relationships.

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This article originally appeared in Outsource Magazine Issue #23 Spring 2011 Leading academics charted a path that challenges the conventional definition of winning. Smart companies are applying these concepts, showing that...
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