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Contract Management | October 2012
Reverse Auctions: Turning Winners into Losers
Leaders
in the field
of U.S. government
procurement are thrilled that reverse
auctions are saving time, increasing participation
of small businesses, and generating cost savings. Yet, no
government procurement leader should be pleased at the prospect
of the expanded use of reverse auctions.
The short-term benefits championed by
proponents of reverse auctions come
at the long-term expense of adversarial
supplier relationships and depressed
supplier margins. Ultimately, the “win-lose”
proposition that reverse auctions present to
industry is unsustainable.
“Procurement leadership” means creating
sustainable procurement strategies that
provide value for both buyers and suppliers.
To develop procurement strategies that are
sustainable, government procurement leaders must pursue “win-win” strategies that
benefit buyers and suppliers, foster collaborative relationships, and promote a healthy
industrial base supported by reasonable
profits. This is where reverse auctions fail—
reverse auctions are not a sustainable way
of providing value to buyers and suppliers.
The Rise of Reverse Auctions
In the present era of shrinking federal budgets,
it becomes more difficult each day for government buyers to meet mission objectives amid
dwindling budgets. In response, the reverse
auction has been billed as a best practice in
lowering procurement costs to the government.
Reverse auctions, also called “downward
price auctions,” rely on direct price competi-
tion to reduce procurement costs.1 In 2004,
Robert A. Burton, associate administrator
for the Office of Federal Procurement Policy
(OFPP), stated: “If used correctly, the reverse auction approach can ensure that the
government receives competitive prices.”2
In 2010, Dr. Ashton Carter, then under
secretary of defense (acquisition, technology, and logistics), reiterated what many
government buyers already knew, that
“[r]eal competition is the single most powerful tool available to the Department to drive
productivity.”3
On the face of it, one can understand why
reverse auctions have become so popular.
Reverse auctions are attractive to procurement officials because they rely on the
power of direct, head-to-head supplier
competition to offer three key benefits to
buyers:
ƒƒ
They drive prices down,
ƒƒ
They increase small business participation, and
ƒƒ They shorten the buying process.6
The use of electronic reverse auctions is
widespread and growing. In 2011, Dan
Reverse auctions are also the safe choice
Gordon, administrator for OFPP, stated that
for procurement officials seeking to obtain
the Department of Homeland Security runs
a fair and reasonable price because Federal
more than 2,000 reverse auctions every year, Acquisition Regulation 15.305(a)(1) states:
typically saving 15–18 percent over histori“Normally, competition establishes price
cal costs.4 As of late 2011, the Department
reasonableness.” So what could be so bad
of the Interior requires contracting officers
about reverse auctions?
to consider reverse auctions when buying
commercial products and simple services
within certain dollar thresholds.5
Contract Management | October 2012
41
Reverse Auctions: Turning Winners into Losers
Adversarial Relationships
In 2009, Professor Guhan Subramanian
stated that “[r]everse auctions can create
the opposite of the collaborative suppliercustomer partnerships held up as a best
practice by many today.”7 Professor Subramanian’s view is hardly unique. In 2000,
Professor Sandy Jap wrote about the damaging effects of reverse auctions on business
relationships:
As one supplier put it: “[The buyer] talks
about the relationship being a partnership,
Criticism of reverse auctions is not limited
to the academic realm, either. A 2004
survey of aerospace parts suppliers’ reactions to reverse auctions found that “[t]he
incumbent suppliers surveyed view online
reverse auctions as a divisive purchasing
tool that damages relationships with longtime customers.”9 It is not just that reverse
auctions make it more difficult to get along.
Reverse auctions have the potential to
create a chasm between buyer and supplier,
making coordination and collaboration all
but impossible.10
than allowing procuring organizations to
partner with their suppliers.”11 The exploitative relationship and inherent unfairness
of reverse auctions drives home the point
of this article: How are reverse auctions
supposed to be a sustainable approach
to procurement if suppliers are always
the ones getting the squeeze? Should the
government pursue procurement strategies
that have been characterized as exploitative
and unfair?
Professor David C. Wyld, director of the
Strategic e-Commerce/e-Government Initiative at Southeastern Louisiana University,
recently wrote that “the reverse auction
scenario may cause an exploitative relationship between buyers and suppliers, rather
One Fortune 10 technology executive described reverse auctions as a tool designed
to transfer margins from the supplier to the
buyer.12 In this light, reverse auctions are a
pure value-claiming tool. Reverse auctions
are designed to take from the supplier and
and this [the auction] really takes that
away.... What they do is take your existing
business that you have worked very hard to
achieve and maintain...and they send it out
across the board for a competitive bid. I just
do not think that is fair.”8
Depressed Supplier Margins
Figure 1.
Number of Sellers Bidding Compared to the Number of Sellers Notified
(Department of State, Fiscal Years 2007–2010)
4500
7
4000
6
3500
5
3000
4
2500
3
2000
1500
FY2007
FY2008
FY2009
Average number of sellers notified
Average number of sellers bidding
42
Contract Management | October 2012
FY2010
2
Reverse Auctions: Turning Winners into Losers
give to the buyer. With each successive bid
in a reverse auction, bidders lose and buyers win. In short, the supplier’s loss is the
buyer’s gain.
In fact, the competitive pressure can be so
great that it sometimes leads to suppliers
bidding below cost. In 2001, the Section of
Public Contract Law of the American Bar
Association alleged that “many contractors
routinely reduce their margins or bid at a loss
for sound business reasons.”13 John Conroy,
president of Xcelcom, a specialty contracting
and technology integration firm, noted that
in all of the reverse auctions that Xcelcom’s
member company has participated in, the
final price has been below the company’s or
any reasonable competitor’s cost.14
It certainly appears that reverse auctions
achieve Pyrrhic victories—turning winners
into losers. While suppliers are free to bid
as they wish, how long will they continue
to participate in reverse auctions where a
win necessitates a loss? As Ernest Gabbard,
director of Corporate Strategic Sourcing
for Allegheny Technologies, Inc., put it:
“Supplier prices can only be compressed so
far before suppliers may no longer find your
business desirable.”15 Are suppliers beginning to get the message? The data suggests
that they are.
An Unsustainable Strategy
A case study of reverse auctions at the
Department of State during fiscal years
2007 through 2010 suggests that suppliers
may be choosing to avoid reverse auctions
in growing numbers.16 The data shows that
the average number of bidders participating
in any one reverse auction dropped by 30
percent from 2007 through 2010, while the
average number of suppliers notified grew
by 227 percent (see FIGURE 1 on page 42).
Furthermore, the supplier participation rate
in reverse auctions where bidders were notified dropped by 70 percent over the same
period (see FIGURE 2 on page 44). These
trends suggest that suppliers, once tempted
by the glossy marketing of reverse auction
providers like FedBid, are taking notice of
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Contract Management | October 2012
43
Reverse Auctions: Turning Winners into Losers
the threat that reverse auctions represent
to their business.
Leadership
As noted previously, procurement leadership
is about sustainability, which separates procurement leadership from a series of haphazard procurement strategies. Balancing
competing priorities is inextricably linked
to the question of sustainability. Reverse
auctions tip the scale out of balance. They
create poor working relationships, win-lose
results, and erode the ability of suppliers to
earn a reasonable profit. In this light, the
rise of the reverse auction as a best practice
is shortsighted and unsustainable. In sum,
reverse auctions are a failure of procurement leadership.
strategies that provide mutual benefit to
buyer and supplier.
Suppliers understand that reverse auctions
are bad for business and are beginning
to take steps to avoid them. A procurement strategy that is built around reverse
auctions is unsustainable and is therefore
bound to fail. The success of any sustainable procurement strategy cannot rest on
the buyer’s outcomes alone, but instead
must rest on the outcomes of both parties.
If government procurement leaders are
going to rebalance the scale, they must
work with suppliers, not against them. This
means abandoning reverse auctions as a
procurement strategy and pursuing win-win
Government procurement leaders could
learn a lesson from a greatly successful
business leader—Wayne Huizenga. He
personally built the Blockbuster, AutoNation,
and Waste Management Inc. empires over
the course of hundreds of acquisitions, both
large and small. In the context of discussing
repeated business dealings, he stated:
You have to treat the other person fairly
and honestly, just as you would want to be
treated. It has to be a win-win situation for
both sides. The other players in the deal
can’t feel they’ve lost. This is especially
Figure 2.
Seller Participation Rate in Reverse Auctions
(Department of State, Fiscal Years 2007–2010)
0.40
0.35
0.30
0.25
0.20
0.15
0.10
0.05
0.00
FY2007
FY2008
FY2009
Seller Participation Rate
44
Contract Management | October 2012
FY2010
Reverse Auctions: Turning Winners into Losers
critical if the two parties are going to con-
3.
tinue to work together.17
At the heart of Huizenga’s wisdom lies the
“Golden Rule”: to treat others as you would
like others to treat you. The idea of fairness
inherent in the Golden Rule is also an ethical
trait that we value in leaders, yet reverse
auctions violate the Golden Rule by exploiting suppliers to create win-lose outcomes
that only benefit the buyer.
It is not too late for government procurement leaders to demonstrate real leadership and abandon reverse auctions as a
procurement strategy. True procurement
leadership should not be measured by
the savings captured at the expense of
industry, but by the ability to sustainably
create value for government and industry
alike. There is still time to change course
and to create win-win solutions that will
provide meaningful, long-term value to all
parties involved. Government procurement
leaders just need to know where to look. I’d
say that the Golden Rule is a good place to
start. CM
4.
U.S. Department of the Interior Acquisition
Policy Release, “First Consideration to Use
FedBid Reverse Auction Service” (September 2,
2011).
6.
See David C. Wyld, “Reverse Auctioning: Saving
Money and Increasing Transparency” (July
2012), available at www.
businessofgovernment.org/report/
reverse-auctioning-saving-money-andincreasing-transparency.
7.
Guhan Subramanian, “Negotiation? Auction? A
Deal Maker’s Guide,” Harvard Business Review
(December 2009).
8.
Sandy Jap, “Going, Going, Gone,” Harvard Business Review (November 2000).
9.
See Emiliani and Stec, note 1, at 150.
10.
See Joel Caparella, “5 Reasons Why a Reverse
Auction is the Worst Method for Selecting an
RPO Provider” (June 6, 2011), available at
http://blog.yoh.com/2011/06/5-reasons-whya-reverse-auction-is-the-worst-method-forselecting-an-rpo-provider.html.
11.
Wyld, see note 6, at 22.
12.
Andy Moorhouse, white paper, “Playing the
Game: Effective
Strategies for
Combating
Reverse Auctions”
(2008), published
by Huthwaite
International.
13.
Letter to FAR Secretariat, “Re:
Reverse Auction
Notice,” from
Section of Public
Contract Law
(January 5, 2001).
14.
See Amy F. Fischbach, “Bidders
Beware: The Ins
and Outs of
Reverse Auctions”
(February 1,
2005), available
at http://
ecmweb.com/
mag/
electric_bidders_
beware_ins/.
15.
Ernest G. Gabbard, “Electronic
Reverse Auctions—The Good
and the Bad”
(2003), available
at www.ism.ws/
files/Pubs/
Proceedings/
GabbardKG.pdf.
ist with the U.S. Air Force Space and Missile
Systems Center in Los Angeles, California. He
is a Distinguished Graduate of NCMA’s 2012
Contract Management Leadership Development Program.
Send comments about this article to
[email protected].
Endnotes
1.
2.
See M.L. Emiliani and D.J. Stec, “Aerospace
Parts Suppliers’ Reaction to Online Reverse
Auctions,” Supply Chain Management: An International Journal (2006): 139.
Robert A. Burton, “Utilization of Commercially
Available Online Procurement Services” (May
12, 2004), available at http://georgewbushwhitehouse.archives.gov/omb/procurement/
publications/online_procurement_051204.pdf.
“White House Forum on Accountability in Federal Contracting” (July 7, 2011), available at
www.screencast.com/t/ouUuptDKPP.
5.
About the Author
JACOB RUYTENBEEK is a contract special-
Ashton B. Carter, memorandum, “Better
Buying Power: Guidance for Obtaining Greater
Efficiency and Productivity in Defense Spending” (September 14, 2010).
16.
See Wyld, note 6, at 6.
17.
As quoted in D.J. Kadlec, Masters of the
Universe: Winning Strategies of America’s
Greatest Deal Makers (New York: Harper
Business, 1999): ix.
Contract Management | October 2012
45