Reverse Government Auctions
From GOVSALESWIKI
Installment [ 33 ] Reverse Government Auctions By Eric Aaserud
We're continuing our discussion on the general subject of e-procurement. This week we're focusing on reverse auctions.
Introduction
In a reverse auction, buyers set up an auction event to receive bids from suppliers. Buyers establish specifications for supplies or (far less often) services. When the auction opens, suppliers begin entering their price quotes. They bid down the price of fulfilling the requirement until a pre-determined time period ends.
A number of state and federal agencies have adopted reverse auctions as part of their procurement strategies. For example:
Pennsylvania's Department of General Services was the first agency in the country to use reverse auctions in procurement. Contracting with online auction firm FreeMarkets, the state purchased $30 million in rock salt for roads and saved $2.5 million. The state also purchased aluminum for license plates and coal for heating state buildings.
The Naval Supply Systems Command in Mechanicsburg, Pennsylvania held the first federal reverse auction, also with FreeMarkets. Firms competed to sell important components for ejection seats for various aircraft. The bidding period lasted fifty-one minutes. An award immediately followed. The Navy says that it saved $2.375 million.
Others that have tried reverse auctions include Army Tank and Armaments Command (TACOM), Army Communications-Electronics Command (CECOM), Army Space and Missile Defense Command, and the U.S. Postal Service. The General Services Administration has been planning a program for some time (Buyers.gov), but it seems to be perpetually on hold.
Typical Procedures
So what happens in reverse auctions?
Agencies often pre-screen their pool of suppliers before allowing them to participate. Because the low bidder is often declared the winner, buyers don't want to get stuck with irresponsible suppliers offering lower quality products. Bids that are too low make buyers nervous.
Auctions are usually run by private firms under contract with the agency. Vendors pre-register and, in some cases, undergo training before the bidding begins. FreeMarkets, for example, gives suppliers spreadsheet tools to help them quantify their costs and determine their bids in advance. It also has a practice auction running at all times to give suppliers a feel for what it's like to place a bid.
Suppliers bid remotely from their offices through an Internet connection and Web browser. Their identities are not revealed to fellow suppliers.
Typically the auction firm is paid by the agency, but sometimes the winning vendor pays a fee in the form of a percentage of the winning bid price.
Law and Best Practices
Until a few years ago, the Federal Acquisition Regulation (FAR) specifically prohibited auctions. Under a major FAR rewrite in 1997, the prohibiting language was omitted. (Some contend, however, that reverse auctions are still illegal on the theory that they're in violation of the Procurement Integrity Act.)
Within this legal vacuum, some federal buyers have announced "best practices" guidelines for conducting reverse auctions. For example, officials at Naval Supply Systems Command say this:
- They are not applicable in every situation.
- They require a clear and concise statement of requirements.
- Traditional documentation processes are still valid.
- Initial price proposals are required.
- Only sources deemed to be in the competitive range can participate in the event.
- Offerors must give permission before their prices may be disclosed.
- Offerors' identities must be protected.
How do you know whether your company is a candidate to participate in reverse auctions? Author Ina R. Merson notes that buyers have learned that reverse auctions work best when used for:
- Commercial commodity buys with well-defined specifications and universally accepted standards;
- Bulk purchases;
- Products with a well-qualified and established base of suppliers;
- Big dollar-volume actions for individual agencies;
- Aggregated small buys for multiple users.
Conversely, buyers have learned that reverse auctions don't work as well:
- If multiple competitive sources are not available;
- If services are required or essential to the commodity purchase. (Problem examples include warranty/technical support and return of damaged goods.)
A Few Thoughts
Not surprisingly, agencies that have implemented reverse auctions boast about all the money they've saved. The Naval Supply Systems Command claims that its savings have ranged from 2% to 25%, with a weighted average of 18%.
Doesn't this mean, then, that NSSC's participating suppliers have lost significant money relative to prior procedures? Something in the range of, oh say, 18%?
What this points to is this: Before you jump into one of these fast and frenzied reverse auctions, know your walkaway price. Establish the price in advance through thorough cost analysis and then stick to it under the heat of the event. Be warned: one executive described his first reverse auction as "wildly emotional" and "gut-wrenching." http://www.darwinmag.com/read/040101/low_sidebar1.html. Even more reason to have a solid plan in place before the event.
Use costing tools such as those provided by FreeMarkets, or use your own. Get your best numbers people involved. If there are very large dollars at stake and you can afford it, consider hiring a consulting firm such as NERA Economic Consulting. We don't know them and cannot directly endorse them, but they look impressive on paper. They say they'll walk you through every step of the reverse auction process. They have game theorists on staff with bidding strategy expertise.
Whatever you do, avoid getting bit by the "Winner's Curse." You don't want to have to look into the mirror after the auction is over, knowing you've gone too far trying to secure the buyer's business, mumbling to yourself, "Now how do I make money on this?"
Plan carefully and don't feel defeated if you have to walk away without entering the low bid. You don't want your "win" to really be a loss. And besides, there'll be other reverse auctions down the road, if you're still interested. It looks like they're here to stay.
Resources
FreeMarkets
http://www.freemarkets.com
eBreviate http://www.eBreviate.com
Procuri http://www.procuri.com
NERA Economic Consulting http://www.nera.com
"Reverse auctions win a bid for acceptance," Government Computer News http://www.gcn.com/20_22/procurement/16745-1.html