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Suppliers, Researchers Question Reverse Auctions
At the risk of being repetitive, reverse auctions stink

By Rick LeBlanc
Date Posted: 5/3/2002

At the risk of being repetitive, reverse auctions stink. Our publisher, Ed Brindley, articulately stated the case against them in his column in the February issue of Pallet Enterprise.

A lot of pallet companies have decided not to participate in reverse auctions, a process in which pallet suppliers bid for contracts via the Internet.

"We have told our members to stay away from them," Gordon Hughes, executive director of the Canadian Wood Pallet Association, said recently, "but one company, a new kid on the block, just bid and got a contract through an auction. He was very excited, but now not so. He was the successful bidder, and then they called him and told him if he wanted it he would have to reduce his price again...He did it and is now losing money due to the softwood lumber and hardwood lumber increase."

It goes without saying that pallet suppliers are not the only industry to see longstanding supply chain relationships bludgeoned by the reverse auction fad. "A reverse auction takes 25 years of partnership and trust and shoots it in the heart," said a plastic pallet manufacturer.

Not surprisingly, the Original Equipment Suppliers Association, an automotive supply group, is calling for the creation of a code of conduct for reverse auctions. A key concern of this group of 270 companies is that their huge customers are using reverse auctions to test the waters with no intention of actually awarding business to the low bidder. Hundreds of auctions have been conducted, they say, but only a handful have resulted in actual contracts. Instead, buyers are using auction information to "beat down" existing suppliers on price after bidding is closed.

Neil De Koker, managing director of the Original Equipment Suppliers Association, wants to promote standards for reverse auctions. "We've talked to at least one of the OEMs about it and are trying to talk to a couple more," De Koker told Automotive News recently. "We need to develop some standards that say that there are right ways and wrong ways to use market tests." De Koker believes a code of conduct should include a commitment on the part of buyers not to initiate a reverse auction unless they intend to re-source business or source new business. Executives from Ford Motor Co. agreed to take a serious look at the issue.

In Europe, suppliers have also attempted to make reverse auctions more equitable. Last year, the European Aluminum Foil Association (EAFA) published recommendations for fair trading practices for reverse auctions on the Internet. The goal was to prevent misuse and contribute to greater transparency and fairness. Three other packaging-related trade groups subsequently endorsed EAFA’s recommendations. Before anyone starts asking National Wooden Pallet and Container Association to take a look at such a policy for the pallet industry, it is worth noting that a year after its introduction, not a single customer has agreed to abide by the EAFA recommendations. (They may be accessed on the Internet at www.alufoil.org.)

The Center for Lean Business Management has some excellent information available at its Web site (www.clbm.org) if you are interested in better understanding and articulating the case against reverse auctions. Bob Emiliani and David Stec, two researchers with considerable actual experience in procurement, are president and vice-president, respectively, of the center. There are better ways to reduce costs than beating up on suppliers, they contend. "Our position is that it is power based bargaining," Bob said.

They challenge the actual savings provided by reverse auctions. ‘Gross savings’ that appear to be realized at the close of auction and ‘net savings’ that seem to be realized at the close of transaction are different, they note. The reasons for the difference include direct losses, which may be attributed to such variables as decisions by the buyer to refuse the lowest bid, all the items that were bid, or data errors. Typically, unquantified indirect losses further erode savings, according to the researchers.

They looked at GE's aggregate reverse auction results for 2000. The company reported a close of auction savings of 16% over previous prices but a net savings of only 8% after direct losses. After including indirect costs, real savings are only just a few percent, they say.

"Reverse auctions are very peculiar" Bob observed. "When these events end at 4 p.m., people look at (close of auction) savings of 25 to 30 percent, and everyone jumps up and down, but they haven’t saved anything yet." When businesses launch other efforts to cut costs, they do not start celebrating when they begin an initiative, he noted, but after they have actually achieved the savings. With reverse auctions, for some reason companies start popping the corks before a dollar has actually been saved.

While the results when the auction closes may look tantalizing, it is important to peel back the layers of the onion in order to measure the direct and indirect costs. In focusing on the closing price, companies that conduct reverse auctions misrepresent what they have accomplished -- and saved -- for their clients.

The two researchers believe that there are more effective ways to achieve supply chain savings through collaborative supply chain efforts. Read about them at their Web site. In the mean time, some key terms to use with reverse auction-crazed purchasing agents: gross savings, net savings, direct losses, and indirect losses. Refer them to the research at www.clbm.org.

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