Sun Microsystem's strategy in using reverse auctions has come a long way over the last five years. And now, it's going even further.

Besides using them for everything from low-end memory circuits and low-capacity disk drives to high-end chips, power supplies and virtually every capacity disk drive the company buys, Sun is now using reverse auctions with its electronics manufacturing services (EMS) providers. It awards not just printed circuit board assemblies, but entire systems, including servers and mass storage units, to contract manufacturers through reverse auctions.

"This has taken some time to figure out how to do because it is a much more complex bidding environment," says Kurt Doelling, Sun's vice president of supplier management.

It's more complex because Sun, based in Santa Clara, Calif., has to have an understanding of what the development and prototype costs for the EMS providers would be in building a server or mass storage unit. "We do a full e-sourcing solution that goes beyond the price factors," he says.

Reverse auctions (Sun calls them "dynamic bidding events"—DBEs) with EMS providers are based on total cost-of-ownership, says Ken Leinweber, strategic sourcing manager, procurement and operations strategy for Sun's worldwide operations group. "Price is important, but it is only one of the pieces that we look at," he says. Also important, he adds, are availability, technical support, and quality. "Suppliers are score-carded on those items," he says.

Because Sun has done past business with suppliers invited to take part in reverse auctions, the company has already score-carded them on those criteria, and their performance in the past is part of the Procuri auction tool that Sun uses, Leinweber says.

He adds that in reverse auctions with EMS providers certain criteria may be weighted higher than others. "For instance, you could have product that comes out which has a steep ramp (high level of production). That sourcing group is going to care about availability and upside (unforecasted surges in demand), so they may weight that piece of the sourcing decision higher."

While business may be awarded based on TCO, price is still important and Sun has realized savings from DBEs with EMS providers.

Greg Thomas, supplier program manager for the enterprise systems organization, says "cost is taken off the table for Sun in DBEs with EMS providers." He has been involved in a DBE for a server for the telecommunications industry.

"It is not unlike eBay except in reverse. As the bid period winds down you will see the ranking of the suppliers change hands, flip flop back and forth. At the end of the day we have a lower cost."

The amount of business Sun Microsystems awards through dynamic bidding events will rise to $2.7 billion in 2007.

In total, Sun will award about $2.7 billion in business to suppliers of all kinds through reverse actions in 2007, up from $1 billion in 2003. Sun's total annual spend with suppliers is about $4 billion.

Doelling says there are several benefits to reverse auctions, but the main one is that they reduce materials cost by creating a competitive environment. He says when they are used initially it is common to get a 30% reduction in price. Then, over time, the cost reductions become incremental.

Doelling acknowledges that suppliers don't like reverse auctions. "There is no reason they should like them. It is a tool that is designed to transfer margins from them to me," he says. "However, I need to do that because I need to compete with companies that are much bigger than me." While Sun spends $4 billion a year with suppliers, Sun is competing with some companies that spend $40 billion.

"We aren't the biggest guys out there. We can't look big to a lot of suppliers in the memory space, but we can look big to three suppliers with reverse auctions," says Doelling.

Doelling says there is a right and wrong way to use reverse auctions. Reverse auctions can damage relationships with strategic suppliers if done incorrectly.

"You have to have very high integrity auctions," says Doelling. "That means we don't put anyone in a DBE that we are not going to award business to. Don't put someone in because you know they are cheap and will drive down pricing and then award business to someone else," he advises. "That's when your auctions lose integrity."

Most of Sun's reverse auctions are not winner take all. "We are auctioning off shares," says Doelling. "Suppliers make a big investment in us. They cannot have their share go from $200 million to zero and maintain the same level of resources for us." Each supplier has been qualified and is already doing business with Sun.

Typically, Sun asks three suppliers to bid. "Three is a great number. You can almost always get a good competitive environment going with three," he says. Each supplier knows it will get some of Sun's business.

A supplier can increase or lose share of business with Sun through DBEs. A supplier may have 50% share of business for a certain commodity. "If they do well with auctions, they can bring it up to 55—60%," says Doelling. "If they aren't aggressive their share may fall to 40% in a quarter. The other suppliers may get a 35% share and the third a 25% share. It is about share almost all the time."

During the DBE, which can last from several hours to several days, bidding suppliers can see their rankings, but they can't view the actual dollar amount of the bids.

"That can be valuable in share auctions because the supplier in second place, and hoping to get to first may keep lowering its price and never get to first place, but you've gotten the lower price," says Doelling.

Doelling says DBEs have resulted in Sun getting similar prices to what larger OEMs get. Large OEMs traditionally had gotten better prices than Sun because their volumes were much larger, he says, "but as soon as we did auctions, the gap shrunk to almost zero. In some cases we think we are getting the best prices."

He says although Sun is smaller than other large OEMs, it only buys from three suppliers for most commodities and that is an advantage.

"For instance with memory, if you are spending $5 billion a year, you have to be doing business with almost everyone. We have a much smaller memory spend and we get to choose the three best suppliers. We don't have to do business with everyone so we can leverage what we have through DBEs. We appear big to those three suppliers," says Doelling.

“Don’t put someone in a reverse auction because you know they are cheap and will drive down pricing and then award business to someone else.” —Kurt Doelling, vice president of supplier management at Sun Microsystems

Making sense

Although more than 50% of Sun's spend for production materials goes through DBEs, there is no goal to put a higher percentage of its spend through reverse auctions.

"We do it where it makes sense," says Doelling. "If you look at resistors or capacitors, those are very competitive, very efficient markets to begin with. It is hard to get huge percentage gains because those markets area already efficient," he says.

Doelling says it also is hard to do reverse auctions with suppliers that are involved in helping Sun design a new product because suppliers come up with different solutions. "If I want a blade server that has certain features and I want help designing it, suppliers will have slightly different specs," he says.

Additionally, he says the company has stopped doing reverse auctions when the results started to deteriorate. "Sometimes suppliers get comfortable with their share and they stop getting aggressive with pricing, so we go back to face-to-face negotiations," says Doelling.

While Sun is awarding EMS business through reverse auctions, it is also working with EMS providers to do business with the providers' own suppliers.

"We have run several successful DBEs partnering with EMS and running joint events," says Leinweber.

"We go through an analysis to cherry pick which parts would be an opportunity to run a DBE on," says Leinweber. "Then we will engage with a specific procurement group that is sourcing that part for the EMS provider and work with them to build the DBE."

He says Sun recently did such a joint DBE with fans that are used in multiple Sun products. The EMS provider runs the DBE and makes the award and Sun and the provider share the savings.

"It's a win-win," says Leinweber.