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Electronic Reverse Auction and The Public Sector: Factors of Success Moshe E. Shalev & Stee Asbjorensen
Electronic Reverse Auction and The Public Sector: Factors of Success Moshe E. Shalev & Stee Asbjorensen
Electronic Reverse Auction and The Public Sector: Factors of Success Moshe E. Shalev & Stee Asbjorensen
INTRODUCTION
Introduced during the 1990s, electronic reverse auctions (e-RAs)
have grown popular in the business-to-business (B2B) and
government procurement communities. The use of e-RAs has
increased in both relative and absolute terms over time, and
practitioners expect this trend to continue (Jap, 2002; Beall et al.,
2003; Kaufmann & Carter, 2004; Schoenherr & Mabert, 2007).
Developed country governments, including Australia, Canada,
France, Korea, Portugal, the United Kingdom and the United States,
-------------------------------
* Moshe E. Shalev, LLM, MBA, and Stee Asbjornsen, BA, LLB, are the
Contracts Officer, and an Associate Procurement Officer, respectively,
United Nations Secretariat Procurement Division, New York.
OVERVIEW
Electronic Reverse Auctions
While auctions provide suppliers the opportunity to find the best
price among interested buyers, reverse auctions give buyers a chance
to find the lowest-price supplier. In e-RAs, the buyer is able to gather
all interested suppliers online, irrespective of their geographic
location, at a relatively low cost (Jap, 2002). During the e-RA,
suppliers submit multiple offers, usually as a response to competing
suppliers’ offers, bidding down the price of a good or service to the
lowest price they are willing to offer. By revealing the competing bids
in real time to each participating supplier, e-RAs promote
“information transparency”. This, coupled with the dynamic bidding
process, improves the chances of reaching the fair market value of
the purchase (Sashi & O'Leary, 2002; Mabert & Skeels, 2002;
Smeltzer & Carr, 2003; Beall at al., 2003; Schoenherr & Mabert,
2007).
The Advantages of e-RAs
e-RAs are promoted as providing purchasers with a number of
benefits. The foremost is that e-RAs often provide buyers with
significant price reductions. Savings from e-RAs generally average
5% to 30% when compared with traditional bidding methods, with
15% being more typical (Sashi & O'Leary, 2002; Jap, 2002; Beall et
al., 2003; Major, 2007), although exceptional savings as high as 90%
have been achieved (Beall et al., 2003). However, more recently,
Singer, Konstantinidis, Roubik, & Beffermann (2009) questioned
these purportedly high savings rates, suggesting that savings of
around 4% are more realistic.
ELECTRONIC REVERSE AUCTIONS AND THE PUBLIC SECTOR: FACTORS OF SUCCESS 431
LITERATURE REVIEW
The literature identified a wide range of potentially relevant
factors which may affect the success of e-RAs in the private sector.
The most commonly mentioned were (1) the number of bidders, (2)
auction volume, (3) competition among suppliers, (4) purchase
complexity, (5) purchase specification, (6) the importance of the
supplier-buyer relationship, and (7) switching costs (Wagner &
432 SHALEV & ASBJORNSEN
Schwab, 2004; NSW, 2006; Crane, 2008; Gattiker, 2008). The first
three factors addressed market conditions, and sought to measure
how much interest suppliers had in competing to provide a product or
service, including auction volume, the number of bidders and
competition among suppliers. The following two factors consider the
product or service in question: how complex the product or service is,
and how well the buyer specified it. The final two factors relate to
changing suppliers: the implications of potentially changing suppliers
through an e-RA on the quality of the product and the purchase price,
and the effect of the costs of switching to a new supplier.
Market Factors
As with any auction, favorable market conditions improve the
likelihood of auction success. The number of bidders participating in
e-RAs was identified as a crude indicator of supplier interest. Auction
volume is thought to be an important means to attract suppliers to
participate in e-RAs and to allow suppliers to accept lower margins
based on higher total profit potential. Competition among suppliers is
a measure of how strongly participating suppliers are competing with
each other to win the e-RA in the product-particular market.
Number of Bidders
The literature on e-RAs emphasizes the importance of the number
of bidders in ensuring that the lowest possible prices are achieved. In
a sealed-bid auction, each supplier has only a single opportunity to
bid. The difference when using e-RAs is that bidders dynamically drive
the bid price lower only when beaten by another bidder.
Consequently, there must be at least two suppliers, and preferably
more, to achieve savings.
Singer et al. (2009) found that e-RAs with only one supplier lead
to detrimental outcomes, that those with two suppliers had mixed
outcomes, and that most of e-RA savings can be attributed to
attracting more bidders. The literature also provides examples of
successful e-RAs with only two suppliers (Turley, 2002). However, in
such cases there is a risk that anonymity will be lost, and that
suppliers will be able to identify each other (Beall et al., 2003; Yukins
& Wallace, 2005). This may also create a greater risk of collusion,
whereby suppliers may agree not to compete and divide the auctions
among themselves (NSW, 2006).
ELECTRONIC REVERSE AUCTIONS AND THE PUBLIC SECTOR: FACTORS OF SUCCESS 433
Auction Volume
In order to compensate for lower prices and lower margins,
suppliers seek higher volumes to maintain or increase the total
revenue. Buyers, in turn, benefit from the lower transaction costs and
economies of scale that result from larger volumes (Smeltzer & Carr,
2003; Beall et al., 2003; Carter et al., 2004; Kaufmann & Carter,
2004). As well, buyers will seek to offset the additional e-RA costs,
normally resulting from third-party e-RA service-provider fees. This
cost depends on the scope of the service to be provided by the third
party provider, and may range between 0.25%-5% of procurement
volume, occasionally subject to minimum and maximum amounts
(Mabert & Skeels, 2002; Turley, 2002).
In part as a result, numerous studies have indicated that the
procurement volume must be sufficiently high to provide sufficient
profits to attract enough suppliers, and provide buyers with enough
savings to cover their additional costs (Jap, 2002; Sashi & O’Leary,
2002; De-Boer et al., 2002; Beall et al., 2003; Kaufmann & Carter,
2004). The Australian government of New South Wales [NSW]
recommended to public procurement buyers that “[g]enerally, the
higher the volume of the procurement, the greater the potential for
realizing savings” (NSW, 2006, p. 5).
434 SHALEV & ASBJORNSEN
Purchase Complexity
Simple e-RAs restrict suppliers to compete on the price alone.
Where other factors such as intangible concerns or non-price factors
are involved, direct negotiations with suppliers are thought to be
necessary to discuss all aspects of the purchase. It has therefore
been argued that e-RAs are best suited for simple purchases or
commodities, where the only differentiating factor is price (Jap, 2002;
Beall et al., 2003; Yukins & Wallace, 2005; NSW, 2006). Schoenherr
and Mabert (2008) also found that increased complexity in purchases
appeared to reduce success.
In addition, since simple e-RAs focus primarily on price
competition and fail to consider product quality or innovation,
suppliers may end up focusing on price to the exclusion of other
considerations, leading to decreased product quality and fewer
product innovations. This leads some observers to suggest that e-
RAs should be limited to standardized or commoditized purchases
(Smeltzer & Carr, 2003).
As there are often more suppliers for simple, commoditized
goods, some researchers have recommended that e-RAs be limited to
such goods, as the larger number of bidders would likely result in
increased competition and hence greater price savings (Beall et al.,
2003; Wagner & Schwab, 2004). Schoenherr and Mabert (2008)
found that the greater the complexity, the fewer bidders participated.
Furthermore, suppliers of complex goods are often also strategic
suppliers and have longstanding relationships with the buyer, which
the buyer is reluctant to risk. Smeltzer and Carr (2003) noted that, as
a result, buyers often fear destroying such suppliers’ trust, making
complex product or service procurement through e-RA too risky,
although they called for further research in this area.
While there are a number of arguments in favor of using only
simple products, some researchers noted that complexity may not
affect e-RA success. Wagner and Schwab (2004) found no
correlation between complexity and e-RA success, although they
noted that in all of the e-RAs surveyed the complexity was “rather
low”. Moreover, others observed that simple products may have
lower margins, particularly when they have been commoditized and a
large number of suppliers are in the market. In contrast, complex
products tend to have higher margins, and as a result offer greater
436 SHALEV & ASBJORNSEN
Purchase Specification
Purchase specification faces similar concerns to those relating to
purchase complexity. As e-RAs normally limit suppliers to compete
only on price, it becomes imperative that all suppliers bid on the
same specifications. As a result, researchers have recommended
that e-RAs be used only for very clearly defined products (De-Boer et
al., 2002; Smeltzer & Carr, 2003; Beall et al., 2003; Kaufmann &
Carter, 2004; NSW, 2006). One commentator expressed concern
that poorly specified products, combined with a lack of subsequent
rounds of negotiations, may create uncertainty in bidders and lead to
higher prices for buyers (Crane, 2008).
Wagner and Schwab (2004) found a strong positive logistic
correlation between “easy to specify demand” and “success”, but
noted that they did not find a correlation using linear regression.
Gattiker (2008) found that specification was the most important
factor in the opinion of buyers, echoing the comment “[i]f you can
spec it, you can bid it” (Beall et al., 2003, p. 51). As long as
purchases can be specified, e-RAs can be used for even complex
purchases (Kaufmann & Carter, 2004). However, Schoenherr and
Mabert (2008) found that difficulty in specifying demand has no
direct impact, either negative or positive, on e-RA success, although
they did find an indirect effect, as the difficulty to specify demand was
found to negatively correlate with the number of bidders.
ELECTRONIC REVERSE AUCTIONS AND THE PUBLIC SECTOR: FACTORS OF SUCCESS 437
Changing Suppliers
Some of the most common criticisms of e-RAs, particularly in
popular press articles, relate to concerns about buyers using e-RAs to
change longstanding suppliers, merely because of price. However,
we conclude that these issues do not apply in the public sector, first
because the nature of public sector procurement requires that most
purchases be made through a competitive bidding process,
regardless of form, and second because these arguments do not
apply to e-RAs any more than they would to more traditional auctions,
such as sealed bid auctions.
60) found “little or no evidence that e-RAs are driving suppliers into
non-sustainable relationships with the buyers. In fact, there is
evidence to suggest the opposite,” and Schoenherr and Mabert
(2007) observed that this was how e-RAs were perceived only in the
very beginning, and they suggested some strategies in order to
overcome this prejudice. Recent research has also noted that buyers
perceived the relationship to be suffering, but that suppliers largely
felt that their relationship with the buyers remained unaffected by e-
RAs (Loesch & Lambert, 2007).
One circumstance where e-RAs, and indeed any auction process,
is not appropriate, is with strategic suppliers. Strategic suppliers are
those that provide to the buyer a crucial product or service not easily
replaced in the market. In such circumstances a competitive auction
process is not appropriate, since replacing the supplier is not a viable
option for the buyer (Mabert & Skeels, 2002). Hartely, Lane and
Duplaga (2006) found that most buyers were able to distinguish
between strategic and non-strategic suppliers and applied e-RAs in
appropriate situations.
Switching Costs
Sometimes, the cost to a buyer of switching suppliers may be very
high. Wagner and Schwab (2004, p. 16) observed that “[i]n general,
the lower the switching costs, the more a buyer can benefit from
conducting a reverse auction because switching costs would be offset
by the potential savings. Therefore, several researchers have pointed
out that the lower the expense of switching suppliers, the more
suitable e-RAs would be”.
Wagner and Schwab (2004) also found a correlation between
switching costs and the number of bidders willing to bid, since
competing suppliers are unlikely to bid when they suspect that the
buyer is not going to change suppliers due to high switching costs.
Further, the incumbent supplier is likely to resist an e-RA in these
circumstances, as they may perceive it as just a gambit to reduce the
supplier’s margin (Smeltzer & Carr, 2003; Emiliani & Stec, 2005). In
certain circumstances, the costs of switching suppliers may exceed
the savings available from a procurement exercise, and alternative
solutions should be considered.
ELECTRONIC REVERSE AUCTIONS AND THE PUBLIC SECTOR: FACTORS OF SUCCESS 439
RESEARCH
Research Methodology
This paper reviewed the primarily private sector-focused literature
to identify factors that affect the success of e-RAs, and then identified
those most relevant to public sector procurement by considering the
structural difference between public and private sector procurement.
Data on these factors was gathered from 139 e-RAs conducted by
four organizations operating in the United States and the EMEA. The
139 e-RAs were used to purchase a wide range of products and
services, from simple commodities to electronics, to a variety of
services ranging from gardening to call-centers. Telephone interviews
were subsequently held with purchasing managers from these
organizations. The e-RA data was examined through statistical
regression analysis, with a view to evaluating which of these factors
440 SHALEV & ASBJORNSEN
correlated with e-RA success for public sector buyers, and to what
extent. We concluded by offering recommendations for public sectors
buyers considering whether to conduct an e-RA for specific products
or services.
Success
We considered e-RAs to be successful when the price achieved
was lower than the price the buyer expected to pay, based on past
auction experience and market surveys. The variable “success” was
defined by the ratio between the expected price and the price
achieved, and ranged from a high of 36.36% savings to a loss of
28.6%, with an overall average savings of 12.1%. Only four e-RAs
failed to achieve any savings. However, two organizations did not
provide data for e-RAs which had only one bidder, since such bids
were automatically cancelled.
Our study did not consider the additional administrative costs of
hosting e-RAs, and did not evaluate whether the purchase price
savings exceeded such costs. As well, it was not possible to place a
financial value on the administrative benefits which resulted from
implementing a more streamlined and efficient online process,
compared to paper-based procurement exercises. Due to the
difficulties of measuring the additional costs of conducting e-RAs
against any efficiency gains (Wagner & Schwab, 2004), the variable
success is limited to the difference between the expected and actual
costs of purchases.
Number of Bidders
The e-RAs reviewed attracted an average of 6.7 competitors, from
a low of 1 to a high of 26. While we evaluated the effect that the
number of bidders has on success, we did not seek to identify an
optimal number of bidders.
Auction Volume
The auction volume was defined as the final price achieved, and
ranged from $1,528 to $16.5 million, with an average of $771,492.
Research Findings
The bivariate correlations between the different variables of our
research are summarized in Table 1. The main findings of our
research are as follows.
TABLE 1
Correlation Matrix
Competition Number of Auction Complexity Specification
Bidders Volume
Success 0.4015* 0.0970 . -0.0034 -0.3224* 0.3411*
Competition - 0.5654** 0.0476 -0.5028** 0.5288**
Number of - - -0.0514 -0.4235** 0.3744*
Bidders
Auction - - - 0.0231 0.1447
Volume
Complexity - - - - -0.7209**
Notes: ** Significant at the 0.01 level.
* Significant at the 0.05 level.
442 SHALEV & ASBJORNSEN
Success
Surprisingly, we found that success did not correlate with either
auction volume or the number of bidders, despite widespread support
for their importance in the literature. However, we found that success
was correlated with competition (r=0.401, p<0.05) (the higher the
competition, the greater the success), specification (r=0.341,
p<0.05) (the better defined the purchase, the greater the success)
and complexity (r=-0.322, p<0.05) (the less complex the purchase,
the greater the success).
Competition
Competition was also found to correlate strongly with the number
of bidders (r=0.565, p<0.01), specification (r=0.529, p<0.01) and
complexity (r=-0.503, p<0.01), but not with auction volume.
Number of Bidders
We found that the number of bidders correlated with competition
(r=0.565, p<0.01), specification (r=0.374, p<0.05) and complexity
(r=-0.423, p<0.01). No correlation was found between the number of
bidders and either success or auction volume.
Specification
In addition to success, competition and number of bidders,
specification was also strongly correlated with complexity (r=0.721,
p<0.01), but not with auction volume.
Complexity
Complexity correlated negatively with all other variables except
auction volume.
Auction Volume
Auction volume did not correlate with any other variable.
Success
Success was found to be correlated with competition, complexity
and specification, and not correlated with the number of bidders or
auction volume.
Competition
Success correlated most closely with competition. The literature
widely supported the importance of competition as the primary driver
of e-RA success. Our findings appear to support that argument, as
competition correlated strongly with three out of the other four
variables measured, save auction volume. As e-RAs are designed to
leverage the competitiveness of suppliers to provide greater savings,
this conclusion is not surprising.
Specification
We note that Schoenherr and Mabert (2008) found no correlation
between success and specification, but did find it with complexity,
while Wagner and Schwab (2004) found the exact opposite. Our
findings, however, found a correlation between success and both
specification and complexity.
Some of the buyers interviewed suggested that specification
affects only the degree of competition among suppliers, and so any
effect on success would be indirect, if it exists at all. These buyers
believed that competition was the only causal factor affecting
success, while specification had either an indirect or spurious effect.
However, others noted that without clear specifications, some
suppliers would either hesitate to participate in e-RAs or would
provide themselves with additional margin in order to compensate for
this uncertainty, thereby directly affecting success.
Complexity
Success was found to be negatively correlated with complexity.
This finding may support the argument that complex purchases
require further clarifications and negotiations to discuss all aspects of
a purchase. We also observe that the same buyers that believed
444 SHALEV & ASBJORNSEN
Number of Bidders
Our findings did not show a correlation between success and
number of bidders. Unlike the recommendations in the literature
against conducting e-RAs with few bidders, we found no evidence that
public sector buyers should be concerned with the number of bidders.
Some buyers even observed that strong competition among two
suppliers may be all that is needed to hold a successful e-RA.
We also note however that the number of bidders is strongly
correlated with competition, and may be a factor which affects the
degree of competition among suppliers in the market.
Auction Volume
Auction volume was not found to correlate with any variable,
including success. The literature suggested that higher auction
volume would directly affect success, with higher volume leading to
higher savings through economies of scale and lower transaction
costs. However, our findings suggested that such savings, if any, were
not being passed on to buyers. Some buyers speculated that in some
cases, experienced suppliers were able to calculate their internal
ELECTRONIC REVERSE AUCTIONS AND THE PUBLIC SECTOR: FACTORS OF SUCCESS 445
Competition
Competition was found to be correlated with all factors except
auction volume.
Number of Bidders
As widely observed in the literature, our findings showed that
competition correlated most strongly with the number of bidders,
although causation is unclear. While it was assumed that more
suppliers would lead to higher competition and greater success, no
direct correlation was found between the number of bidders and
success.
Auction Volume
Auction volume did not correlate with competition, suggesting
that auction volume does not promote additional competition. Our
data included a wide range of products, and the degree of
competition in each market varied significantly. Further research on
this issue should be conducted to determine whether these findings
remain the same when purchasing the same product for both small
and high volumes. Keeping competitive factors constant, increasing
auction volume may further increase competition.
Number of Bidders
The number of bidders was found to be correlated with
competition, specification and complexity, but not with auction
volume or success.
446 SHALEV & ASBJORNSEN
Complexity
As anticipated by the literature, our findings appear to indicate
that simple purchases had more participating suppliers. However, it
is unclear whether simpler purchases cause more suppliers to attend,
whether there are simply more suppliers in the marketplace for
simple purchases, or whether both are true.
In order to address this issue, it may be useful to conduct further
research, such as measuring the proportion of the number of
suppliers participating against the total suppliers in the market for
each purchase. For example, it may be that very complex purchases
have four out of five suppliers in the market bidding, while for
commodities, ten out of fifty suppliers participate. While this appears
to show that simple purchases attract more bidders, in relative terms,
complex purchases may have very high participation rates among
very few total suppliers. Such research will assist buyers in
determining how changes in complexity affect the number of
participating bidders. We note, however, that since complexity is also
negatively correlated with competition, and competition is correlated
with number of bidders, it may be that the absolute number of
bidders, rather than the proportion of bidders participating, has the
greatest effect on e-RA success.
Specification
As expected, improving the specification appeared to increase the
number of participating suppliers. The literature suggests that this is
a result of reduced supplier uncertainty, which enabled them to better
assess their lowest price and gave them more confidence to
participate.
Auction Volume
Perhaps most surprising is that no correlation was found between
auction volume and the number of bidders. The literature
recommends increasing auction volume to attract additional
suppliers; however, the relationship is either very weak, or perhaps
indirect. Buyers noted that differing auction volumes may attract
different suppliers. For example, smaller auctions may attract
smaller businesses, whereas very large auctions may be dominated
by large, multinational companies. As a result, the number of bidders
ELECTRONIC REVERSE AUCTIONS AND THE PUBLIC SECTOR: FACTORS OF SUCCESS 447
CONCLUSIONS
This paper examined the factors which could affect the success of
e-RAs in the public sector. Our findings indicated that competition
among suppliers, the complexity of the purchase, and how well the
purchase was specified were the factors which were most strongly
correlated with e-RA success. We also note that neither the number of
bidders nor the auction volume should be a determining factor for
whether public sector buyers should use e-RAs. Our findings
indicated that success was possible regardless of the number of
bidders, provided that other factors such as competition, complexity
and specification were favorable. Similarly, the auction volume in
itself had no apparent effect on success, or on any other factor. Our
findings on the number of bidders and auction volume differ from the
general recommendations in the literature against conducting e-RAs
with few suppliers or with low auction volume.
448 SHALEV & ASBJORNSEN
NOTE
The views presented in this paper are those of the authors and do
not necessarily reflect the views of the United Nations or any other
organisation.
ELECTRONIC REVERSE AUCTIONS AND THE PUBLIC SECTOR: FACTORS OF SUCCESS 449
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