How do Reverse Auctions work?

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Who uses Reverse Auctions?

• Reverse auctions do assure the lowest price for buyers
• Reverse auctions discourage imprudent bidding practices (closed auctions conducted by invitation only)
• Open bidding allows the fairest live and consistent auctioning system
• Two round bidding ensures that the winning bidder is qualified and prescreened
• Reverse auctions comply with federal and certain state procurement laws

What is a Reverse auction?

Reverse auction is a strategy used by many purchasing and supply management organizations for spend management, as part of strategic sourcing and overall supply management activities.

In a typical auction, the seller puts an item up for sale. Multiple buyers bid for the item, and one or more of the highest bidders buy the goods at a price determined at the conclusion of the bidding.

In a reverse auction, a buyer contracts with a market maker to help make the necessary preparations to conduct the reverse auction. This includes: finding new suppliers, training new and incumbent suppliers, organizing the auction, managing the auction event, and providing auction data to buyers to facilitate decision making.

The market maker, on behalf of the buyer, issues a request for quotation (RFQ) to purchase a particular item or group of items (called a "lot"). At the designated day and time, several suppliers, typically 5-20, log on to the auction site and will input several quotes over a 30-90 minute period. These quotes reflect the prices at which they are willing to supply the requested good or service.

Quoting performed in real-time via the Internet results in dynamic bidding. This helps achieve rapid downward price pressure that is not normally attainable using traditional static 3-quote paper-based bidding processes.

The prices that buyers obtain in the reverse auction reflect the narrow market which it created at the moment in time when the auction is held. Thus, it is possible that better value - i.e. lower prices, as well as better quality, delivery performance, technical capabilities, etc. - could be obtained from suppliers not engaged in the bidding or by other means such as collaborative cost management and joint process improvement.

The buyer may award contracts to the supplier who bid the lowest price. Or, a buyer could award contracts to suppliers who bid higher prices depending upon the buyer's specific needs with regards to quality, lead-time, capacity, or other value-adding capabilities. However, buyers frequently award contracts to incumbent (i.e. current) suppliers, even if prices are higher than the lowest bids, because the switching costs to move work to a new supplier are higher than the potential savings that can be realized. This outcome, while very attractive to buyers, is often strongly criticized by both new and incumbent suppliers.