Debate rages over use of e-auctions for components
Jim Carbone -- Purchasing, 12/11/2003 2:00:00 AM
During the electronics industry downturn, many buyers at electronics OEMs and contract manufacturers used reverse auctions to reduce prices of many production parts and materials. A 20-50% savings was common for many commodities, including printed circuit boards, resistors, capacitors and semiconductors. While the number of reverse auctions in the electronics industry is hard to pin down, many electronics companies conduct several reverse auctions per month. Other companies are leery of them because they are afraid they could jeopardize strategic relationships with suppliers.
While many buyers use reverse auctions to determine market prices and to reduce materials costs, companies that run reverse auctions or provide software say the events can be used more effectively. Buyers can use reverse auctions to get suppliers to come up with creative bundles or supply scenarios to further reduce costs, says Kevin Potts, director of product marketing for Emptoris, which provides software solutions and services for reverse auctions.
Often in a reverse auction suppliers are asked to offer a price for a specific quantity of a part number. However, if the buyer gives a volume range instead of a specific number, suppliers may be more creative in their bid responses, according to Potts. "Say a buyer needs one million capacitors. What if he allows suppliers to bid on a range of between 500,000 and two million? You give them a market dimension to compete on rather than just who has the best price," he says.
Buyers can also put two or more items out to bid at the same time and see what creative options suppliers can come up with. "A supplier may say, 'If you buy part A and part B from me, I'll give you an additional discount. If you buy one million units from me take another 2% off the price.' In fact one supplier may come in with a discount for a bundled buy, another with a volume discount based on quantity. A third supplier may give a volume discount based on total value of the award," says Potts.
Buyers are starting to take more sophisticated approaches to reverse auctions and not just awarding business to the low bidder. Potts says the low bidder gets the business only about 40% of the time. Sometimes the OEM hasn't qualified a bidding supplier and the cost of qualifying the supplier may exceed the cost savings of the low bid.
In some cases the supplier may not be able to support an OEM's plant in a different geography where the parts are needed. Or a supplier may have the lowest price, but can't meet the delivery date requirement. Buyers are also more sophisticated about when to use reverse auctions. They should be used for products where there is a high level of competition, says John Madrid, senior vice president of customer development for Procuri, a software provider for reverse auctions. But that doesn't mean there has to be a large number of suppliers bidding. "You can have an effective reverse auction with two or three suppliers," says Madrid. However, before doing a reverse auction buyers should factor in the effect the auction may have on a supply base if there is a limited number of suppliers for a part. "You don't want the reverse auction to ruin the competition of that supply base," he says. "You have to think of your supply assurance in the long run."
While the use of reverse auctions in electronics increased over the last two years, there likely will be fewer conducted over the next several years. Reason: It will likely turn into a sellers' market over the next six months for many components. "The ideal auction scenario is that suppliers need you more than you need them," says Madrid. "If that turns around to where buyers need suppliers more than suppliers need buyers, typically a reverse auction is not going to be a good alternative."
Potts of Emptoris agrees. "Once the market changes and demand exceeds supply, I think you will see a movement away from reverse auctions," he says. "We still think there will be online competitive bidding, but it won't be where suppliers are competing against each other face to face. It may be more sealed bid formats or one-on-one negotiations," says Potts.
However, Sun Microsystems has no immediate plans to cut back its number of reverse auctions, says Scott Wong, program manager, dynamic bidding for Sun. Sun started reverse auctions in 2000 using FreeMarkets and does about 10-12 per quarter for commodities such as cable assemblies, printed circuit boards, hard drives, DRAMs, plastic moldings and software packaging.
Wong notes that Sun started doing reverse auctions during the middle of an upturn. He says reverse auctions can still be used when supply tightens but the terms will change. Prices will be higher, but auctions can be used to minimize price increases.
Sun may also use reverse auctions to convince suppliers to provide parts for longer periods of time than they would during a buyers' market. In a tight market, Sun would want to lock in supply of parts for six months or a year rather than one quarter.
Wong says, unlike many of companies, Sun does not do reverse auctions for spot buys. Rather it uses them to award annual contracts. "We see reverse auctions as a strategic sourcing tool," says Wong. "We do them with our approved suppliers with whom we have long-term relationships." Business isn't awarded to low bidders in nine of 10 reverse auctions, adds Wong. Price is an important part of the equation, but Sun takes into account suppliers' previous overall performance before awarding business.
Wong sees the reverse auction evolving into an online sourcing tool. "A reverse auction is just one way to negotiate online. There are other types of bid formats that are available," he says. Those formats include bundling products in bids or bidding based on quantity of product.
Besides getting a lower cost, Sun has also been able to reduce its procurement cycle time by 40% since moving to reverse auctions.
Wong says that reverse auctions cannot be used to buy all parts. "It will never be 100% because you have to have two or more suppliers for a part. Some parts are customized and we have to work with a co-partner and co-develop them," he says.
Initially Sun realized about 20% cost savings for the items it bought through reverse auctions. Now savings are more incremental because Sun regularly does auctions and the electronics market is tightening. Buyers usually have target prices before doing reverse auctions, and, in most instances, the price that Sun gets through online bidding is lower than the target price.
While Sun will continue to use reverse auctions, one company that has no plans to use them is IBM. Reverse auctions are not worth it, according to John Paterson, chief procurement officer for Big Blue. Paterson says IBM did a couple of reverse auctions but the results were less than overwhelming. He says prices from the auctions ranged from 1% lower to 1% higher than prices IBM was already paying. "When you lay down the minus 1% against the downside of reverse auctions, it doesn't seem compelling," says Paterson.
The downside is reverse auctions can damage relationships with suppliers. "Suppliers universally hate them," says Paterson. "No one likes to have their goods or services commoditized in that way. There is no future if the only differentiator is price. No supplier would ever say they don't differentiate in other ways besides price," he says.
He says IBM is heavily dependent on external suppliers, "not just for parts, but for innovation and intellectual capital. We look to them to make huge investments in research and development to keep fueling innovation in our industry," says Paterson. "If price is the only determinant of what we buy and we collectively squeeze every cent of margin that suppliers can earn out of the equation, I think we do ourselves a great injustice going forward. If there is no investment, there will be no innovation. If there is no innovation, what we sell becomes less attractive to potential customers."
He says from a cost point of view reverse auctions aren't necessary—at least not for IBM. "We have seen that if we have knowledgeable skilled buyers, we can negotiate as good a price through more conventional means as we could through a reverse auction and avoid running the risk of damaging a relationship," says Paterson.
Paterson believes that reverse auctions will fade away once it turns into a sellers' market. "What's the incentive for suppliers who have much more leverage in their relationships to keep on discounting prices just to win your business, when they can sell somewhere else for a higher margin?" asks Paterson.
However, while IBM has no plans for reverse auctions, "We watch the space," says Paterson. "If there is an opportunity somewhere that perhaps drives better results than we have seen, we would consider it. But we haven't seen any opportunities that would compel us to jump in that direction," he says.
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