Reverse Auctions Explained

Reverse Auctions allow the sellers to bid for the prices they wish to sell their products and services at. Read on to see how this can benefit the procurement process.

Procurement is a varied and broad field, and understanding every aspect is key to achieving the best products and services at the right prices.

For example, while a traditional bid process is popular in connecting buyers and sellers, the reverse auction is another strategy that can allow procurement teams to work within budgets and meet relevant suppliers.

In this article, DeepStream explores reverse auctions and how to use them to suit procurement needs, as well as looking at the various challenges they present and how to best mitigate them.

What is a Reverse Auction?

Ina typical auction process, buyers bid on goods and services offered by a supplier.

However, in a reverse auction process, those roles are switched. Instead of buyers outbidding each other to offer their maximum spend, suppliers compete to sell that product or services to the buyer for the lowest possible price. The buyer then selects the bid that suits them the best.

Reverse auctions are often a preferred option for buyers as they help lower purchasing costs through an increase in competition between suppliers, while also saving time and manpower in organising individual negotiations between each supplier.

How are Reverse Auctions used in Procurement?

Reverse auctions are used in the procurement process to help buyers get the most out of their suppliers by creating a competitive environment. There are multiple types of reverse auctions used for different purposes:

Ranked Reverse Auction

In this type of auction, participants bid at similar prices, but only the leading bidder knows the current best price for goods or services. Ranked reverse auctions help boost the confidence of some suppliers with a larger pool of resources but may turn away those who have less to offer.

Japanese Reverse Auction

In this type of auction, the buyer decides on an opening bid, which the suppliers must then agree to. From this point on, the price decreases as buyers accept or reject these prices as the auction continues. The prices continue to decrease until the last supplier in the auction remains. This is perfect for companies with a strict budget.

Dutch Reverse Auction

Before any bidding process begins, the buyer states clearly how much they’re able to pay, as well as the type of product or service needed, and the quantity. The bidding starts low but increases at fixed intervals until the first supplier accepts the bid. This is a good option for buyers to get immediate results.

Open Outcry Reverse Auction

Also known as ‘English reverse auction’, this is a transparent form of auction where all buyers and suppliers can see the leading bid. This isa good choice for a reverse auction in which price is paramount.

What is an Example of a Reverse Auction in Procurement?

A reverse auction is a long and sometimes complex process. Detailed below is an example of a step-by-step reverse auction to give a better understanding of what is involved:

Step 1: Conduct a Pre-Bidding

Pre-biddings are an opportunity for suppliers to know about a buyer’s needs and determine if they can fulfil those needs. This can help thin the supplier candidates and create a more streamlined process.

Example: A small bakery business needs to determine which suppliers can provide the best quality flour and icing. A pre-bidding can be conducted to determine which suppliers can provide both these services at the quantity needed.

Step 2: Confirm Logistics

It’s important to run through the logistics involved in the bidding process with all parties involved to avoid confusion and ensure everyone is given an equal opportunity to bid.

Example: Our small bakery business issues a memo to suppliers instructing them on how the bidding process will take place, and invite them into a voluntary call at a set time to discuss any questions.

Step 3: Set Auction Rules

Now it’s time to set the rules of the auction. First, decide on the type of auction that will be taking place, then those who will be receiving invites. Sometimes it may be useful to offer an auction extension for suppliers who need it, although this is optional.

Example: Our bakery firm decides on 10 supplier invitations and has set the auction as a Dutch reverse auction to help clearly state how much money they have and attempt to reduce the price from there.

Step 4: Run the Auction

Now it’s time to run the auction. Make sure a responsive line of communication is made available to answer any questions bidders may have.

Example: Our bakery business decides to run the auction with the 10 invitees over a single day. They’ve opened an instant messaging and phone line for responses to supplier questions.

Step 5: Make Award Decisions

Now it’s time to award the best bidder, this doesn’t necessarily have to be the lowest bidder (unless that is an auction rule) but it’s important to look for the best quality of service and what a supplier can provide, as well as the price.

Example: Our bakery firm decides the best bidder was the third lowest bidder, who offered the products in the right quantity, but also a level of quality assurance and supply protection the two more cost-effective bidders couldn’t offer.

DeepStream eAuction software makes the reverse bidding process effortless and compliant – tracking every stage and all supplier communications in a single intuitive platform.

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How do I Determine if a Reverse Auction Suits My Procurement Needs?

It’s important to understand when a reverse auction is preferable to a regular bid auction.

It is common to use a reverse auction when a buyer knows the cost of a product but cannot make it themselves. This typically includes companies that process goods from suppliers, like bakeries, restaurants, or car part manufacturers that need raw materials.

Reverse auctions are also useful for buyers wanting to compare rates and prices. It leaves the purchasing choice entirely in the supplier’s hands and is the best way to gain the best price advantage for a buyer.

What are the benefits of Reverse Auctions?

Reverse auctions are used across industries and businesses of all sizes, from commodity products to business services – allowing organisations to sample an array of relevant suppliers. Below is a list of additional benefits reverse auctions can provide:

Lower Purchase Costs

Reverse auctions use increased competition between suppliers to lower the overall purchasing costs of goods or services. This means that, instead of falling inline with the whims of the supplier, buyers can set the terms instead.

Avoids Drawn Out Negotiation

With reverse auctions, the process of finding and negotiating with multiple suppliers can be done at once, making eAuctions much faster and more efficient.Buyers can also tackle a larger variety of suppliers until they find the perfect fit.

Easier To Budget

Reverse auctions are also an easier method for a buyer to set a budget. Especially withJapanese reverse auctions that work downward in price, buyers can set a limit on exactly how much they’re willing to spend.

What are Some Difficulties Faced with Reverse Auctions?

Reverse auctions can still come with their challenges. Below are several difficulties buyers could face during the reverse auction process, and how best to overcome them.

Increased competition between suppliers is a great way for a new business to get the best price. But it can potentially undermine long-lasting buyer-to-supplier working relationships, which are often more important than a quick cost cut.

When this problem arises, offering long-term suppliers an olive branch by attempting to negotiate longer or fixed terms with successful suppliers can help to smooth any challenges.

Many suppliers also see reverse auctions as a way of exerting power and influence and may not take kindly to the process. For a successful reverse auction, it’s best to make the process as fair and beneficial as possible for all parties.

What is the Difference Between a Forward and Reverse Auction?

Forward auctions (also known as ordinary auctions) are the traditional form of auction structure, where buyers compete to access goods and services, whereas reverse auctions flip the relationship. Suppliers compete to sell to the buyer.

While forward auctions usually raise bids as the process continues, reverse auction slower them. With forward auctions, the suppliers have the power over the buyers and with reverse auctions it is the other way around.

The optimal method for a particular company depends on its budget, relationship with suppliers and which goods or services are required.

What are the Next Steps Following the Reverse Auction Process?

Once the reverse auction process is complete, there are still several steps a buyer must follow.

Firstly, RFx and bid contracts need to be exchanged, and money will change hands based on the quality of delivered services. The buyer and supplier are then free to continue to enjoy positive long-term relationships.

To find out how DeepStream assists the entire source-to-contract process and makes it effortless to identify suppliers, run eAuctions and align data in a single platform, chat with our team today.


Frequently Asked Questions (FAQs)

What are the types of reverse auctions in procurement?

There are four main types of reverse auctions, each with its own methodologies and benefits. They are ‘ranked reverse auction’, ‘Japanese reverse auction’, ‘Dutch reverse auction’ and ‘open outcry (English) reversed auction’.

When should a buyer use reverse auctions to select a supplier?

Reverse auctions can be used for both existing and new suppliers. With some auction platforms, suppliers are able to see where their bids rank, giving them valuable market insight which can help strengthen the transparent relationship between buyer and supplier.

What is the main downside of a reverse auction?

The main downside of reverse auctions is that they could potentially harm a supply chain by pushing away long-term suppliers with a strong working relationship. Therefore, it should be used with caution when approaching these types of suppliers.

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