Online reverse auctions create two procurement camps
By Staff -- Purchasing, 3/21/2002 2:00:00 AM
Conspicuously absent from IBM's list of e-sourcing applications is an online reverse auction tool, which has become a hot topic lately. While some of the biggest companies in the world (General Electric) swear by them, IBM has shunned the technology, saying the auction capability is built into IBM's sourcing applications, but it has been basically dormant.
"We don't use reverse auctions now, but there may be some situations where a reverse auction may be appropriate," says Henry Pruitt, IBM's director of e-procurement and technology deployment. "It would not be for a long-term sourcing deal. It would more likely be for a commodity on a transactional basis. There may be a handful of situations where reverse auctions may be appropriate, but right now it is not one of our primary sourcing arrangements."
John Gabriel, manager of communications, benchmarking and environmental affairs for IBM Global Procurement says that reverse auctions need to be viewed as one e-sourcing tool among many, noting, "Many other companies have been sucked into the thought that e-procurement is all about reverse auctions because they were marketed and hyped in the past couple years. I think the ones that followed that path are now realizing they haven't seen a long-term payback from this."
Two outspoken opponents of reverse auctions are former Pratt & Whitney commodity managers turned professors Bob Emiliani and David Stec. Emiliani says Pratt & Whitney was on the reverse auction bandwagon early when a former GE procurement professional was hired at Pratt & Whitney and introduced the concept. Emiliani viewed the new technology as nothing more than traditional power-based bargaining moved to the online world, and buyers weren't going to learn any more about cost than they knew before.
"My first exposure to reverse auctions was in 1998 in the small machined parts commodity which accounted for about $60 million in Pratt & Whitney's annual spend with over 40 suppliers and 6,000 part numbers, 3,500 which were active," says Emiliani, now a professor at Rensselaer Polytechnic Institute. "I felt this commodity was driven by a large amount of part numbers, not dollars, and there would be significant implementation risk to achieve maximum benefit from online reverse auctions. To achieve the savings you would have to re-source thousands of parts. And that is a concern for the individual buyers that are responsible for getting parts in the door."
Stec says he learned about the downside of reverse auctions with specialized parts from personal experience at Pratt & Whitney, when the company awarded a contract to an aerospace parts supplier based on its bid in a reverse auction. After a year of trying to get parts from the supplier, Pratt & Whitney had to terminate the contract because the supplier could not produce the product it had quoted, which created animosity between the two companies. Then Pratt & Whitney had to go back to its original supplier and pay a hefty premium to get the parts.
"Another time, we had a new supplier we brought in to apply competitive pressure against the incumbent supplier in an auction," Stec says. "That supplier quickly figured out that was all we were using them for when we weren't awarding them any work, despite being the lowest bidder on several lots. The new supplier finally said if we weren't serious about using them, then they would terminate the agreement. In essence, they, the supplier, fired us."
One company that feels it has struck a happy medium in the use of online reverse auctions is Phoenix-based America West Airlines. Michael Inman, director of general purchasing, says buyers have been given the freedom to choose when a reverse auction is applicable and when a more traditional sourcing strategy should be employed.
"We use a matrix tool that tells us when to hold an auction based on how many suppliers there are, and how strategic and tactical the buy is," says Inman. "The buyers have taken to it well. It wasn't forced on them and we have supported the buyers' decisions, both when they do auctions and when they say we shouldn't do it."
America West has focused its use of auctions on the indirect or general procurement side of the business. Inman says the direct materials side is not a good fit for reverse auctions because the small number of suppliers would limit the competition in an auction format. To date, the only direct materials America West has bought through auctions are fasteners and filters.
The advanced capabilities in reverse auction software have made it a more appealing option to America West than it may have been a couple years ago. In a pilot auction early on, America West awarded a contract to a supplier that was not the lowest bidder, after evaluating some quality issues offline. Not surprisingly, the lowest bidder in that auction was miffed that the contract did not come their way. To solve that problem, America West signed on with an auction tool from MaterialNet, which includes a value-adjusted pricing component. "This allows us to put a dollar value on the intangibles," Inman says. "For example the software will add a 0.25% discount for a supplier that will work with us up front on a design or load in payment terms."
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