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Do Reverse Auctions Destroy Value?

March 19, 2008

As an advocate of technology, I am always fascinated to learn about its consequences in practice. That is why I am especially looking forward to interviewing Andrew Moorhouse, a Research Consultant with Huthwaite International.  Andrew has recently issued a report on the uses (and, it would appear, abuses) of e-sourcing tools – and in particular reverse auctions.

I have a very strong regard for the work done by Huthwaite, who I first encountered in the 1990’s. This research was driven by a supply-side perspective, but unearthed significant concerns among senior procurement managers about the negative effects of reverse auctions.  For example, one manager is quoted as saying “self-serve auction tools have degraded and destroyed the reverse auction market place”.

The purpose of this commentary is not to anticipate the interview with Andrew (for details about this, click here). What interests me more is the underlying philosophy of the reverse auction – and the questions this raises.

IACCM has regularly highlighted that the emergence of our global services economy and the push by buyers towards ‘commoditization’ has prompted many suppliers to abandon the historic ‘caveat emptor’ approach to contracts. In other words, to escape the commodity trap, they set out specifically to understand customer requirements and, rather than deny responsibility, are in fact assuming some levels of accountability for outcomes.  In the process, they obviously lay themselves open to greater risk if things then go wrong.

Reverse auctions turn this concept on its head. Buyers argue that the reverse auction creates a level playing field and enables them to avoid the confusing behavior of ‘added value’ solution providers – the auction environment enables them to compare apples with apples. But implicit in this approach is that the customer has a very clear understanding of their requirements and is giving the supplier no real opportunity to influence the process or the outcome.  Logically, therefore, the terms and conditions associated with a reverse auction ought to be considerably less onerous. The customer should – in the interests of gaining the lowest price or cost of ownership – be prepared to take on higher levels of risk and responsibility for selection and use.

Yet as most suppliers know, the reverse is generally the case. Buyers want to have their cake and eat it. They demand not only conformance to specifications, but then also impose onerous terms on the supplier – indemnities, liabilities, often also areas like IP rights and liquidated damages. While it may be a moot point whether courts would uphold such terms (and I would be interested to hear of any case law in this regard), there is no doubt that theoretical risks are high.

And this, perhaps, is what led that same procurement executive quoted in the introduction to this posting to make the observation that “the way companies approach reverse auctions has damaged integrity and resulted in abuses of power.”

What are your thoughts and experiences? I hope you will post them here and also join the interview with Andrew Moorhouse on April 1st.

  1. Catherine Uffen permalink

    Where can I find a copy of the whole whitepaper?

  2. Huthwaite’s whitepaper can be downloaded here:

    DISCLAIMER: The reverse auction research findings are based upon in-depth interviews with global and national sales leaders and the paper thus presents an inherently biased viewpoint of the process.

    However, there is real value for procurement professionals, as the paper identifies how supplier response strategies have evolved and the mistakes still made by procurement when hosting reverse auctions.

    If you would value a deeper insight into the findings, please let me know, as I am happy to help.

    Best regards,

    Andrew Moorhouse
    Huthwaite International

  3. Tim and Andrew,

    The issue is fundamentally whether any tool destroys value. Arguably hammers and drills destroy value if used erratically. The issue is the behavior and not the tool. Reverse auction tools should be used selectively, and it is incumbent upon the buyer to recognize that he or she is responsible for preserving the company’s reputation for ethical business practices. That reputation will be affected, in part, by how well the buyer manages, among other things, unethical seller manipulation of the reverse auction process.

    Like anything else in business, the issue boils down to leadership, processes, training and governance.

  4. chrisarlen permalink

    Reverse auctions for services are fatal. Even if the service is considered a commodity, i.e. janitorial service. The nature of services, and their delivery makes lowest price decisions (without other qualifiers) foolish.

    Online auctions have a place for a very specific range of products. True commodities.

    Purchasing departments with lots of commodity buying tend to lump all purchases into the reverse auction process, if they’ve had one success. That’s unfortunate.

    When variances in specifications, quality or other factors impact items’ value, then the more traditional purchasing processes are better.

    Reversing into Darkness was written from the facility service contractors’ perspective:

    Research exists pointing to the detrimental effect reverse auctions have on more complex buying relationships.

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