It’s not just about price

By Alan Buxton -- Industrial Distribution, 8/2/2006

Reverse auctions often get bad press. Critics have blamed them for focusing too much on short-term savings at the expense of long-term supplier development. And the recent issues at GM and Delphi have shown vividly that squeezing the supply base too much can have disastrous consequences for all concerned.

Yet e-auctions remain a key tool for buyers and are becoming more and more popular. They allow buyers to negotiate with far more suppliers, much quicker, and with more transparency than traditional tenders.

If we return to the GM/Delphi story—and the pressures GM placed on Delphi to supply parts at or below cost—it is clear that the pressure on buyers to reduce costs is a much broader issue than reverse auctions alone.

There is good news on the horizon though. Sophisticated buyers are coming to realize that measuring themselves primarily on cost-savings is a short term strategy. If their job is just to save money, and they save $10 million this year, then the CEO will expect them to save $15 million next year. Buyers are increasingly keen to demonstrate that they add value through the supply chain rather than just cut costs.

Fortunately for both buyers and suppliers, new technologies are evolving to address these concerns. A new type of auction–called a multi-attribute auction–promises to deliver bigger profits to suppliers and better value to buyers.

A multi-attribute auction takes account of the fact that a supplier’s bid for a contract is made up of several attributes, of which price is only one. Other attributes might include service levels, lead times, environmental considerations, payment terms, or anything else that is of significance to the contract award decision.

Taking all these attributes into account allows suppliers to be more imaginative with their bids and deliver greater value while retaining margin. For example, a supplier might find himself competing by extending a warranty period rather than lowering price.

Multi-attribute auctions have a major advantage when elements of the specification can be varied at the discretion of the supplier within agreed tolerances.

This is because the buyer may not know the most efficient specification profile for the suppliers. For example, the buyer may offer two alternative specification profiles only to find out subsequently that a third option would have been available at a far more attractive price had it been offered. Suppliers know their cost base better than buyers do.

Therefore, if suppliers are able to amend non-price elements of their offer (within reasonable limits) they can often come up with imaginative solutions that better meet the buyer’s requirements than simply responding to a fixed specification.

It is not necessary for all non-price attributes to be negotiable during the auction process, but it is important to remember that all non-price attributes receive an appropriate weighing. For example, ISO certification status might not be negotiable but lead time might be negotiable, even though in a multi-attribute auction ISO certification could still make up part of the overall value of the supplier’s bid.

In the words of Paul Milgrom, one of the leading lights in auction design: “Sellers dislike bidding in price-only auctions in which their special advantages and characteristics receive no weight. By encouraging a more complete comparison of the attributes of suppliers and products, scoring may increase bidders’ expected profits and encourage participation by more bidders, serving the interests of all parties.”

More work for buyer
So far, so great. Now for the catch: Preparing a multi-attribute auction is more work for the buyer than designing a price-only auction. A multi-attribute auction relies on the buyer being able to assign weights to the different attributes–and not all buyers have the skills needed to extract this kind of detail from their internal clients.

Indeed, for pure commodity items, there is no benefit to the buyer of calculating the weights for different attributes. It is better for the buyer to pre-qualify suppliers to this minimum requirement and then run a price-only reverse auction with the remaining suppliers.

The challenge implicit in all this is for suppliers to educate buyers that their offerings should not be treated as pure commodities, and that
(a) the non-price elements of the contract are significant sources of differentiation and value add;
(b) a collaborative approach to specifying the goods or services being procured could be beneficial for the buyer and for the supplier.

The multi-attribute auction industry is still in its infancy because of the practical difficulties faced in designing these kinds of auctions. Until recently it was easier for auction designers to dodge the issue.

However, things are changing. In Europe, public sector procurement rules now explicitly state that if an auction is to be used for public procurements, then all the relevant non-price attributes must be factored into the auction mechanism, so that the supplier with the winning overall value wins the contract.

This legal background has driven the development of tools and methodologies that make it as easy as possible for buyers and suppliers to take part in multi-attribute auctions. For example, in January 2006 the UK’s Ministry of Defense ran an auction for £12 million ($21 million) of Consultancy Services. The auction explicitly included non-price attributes into the auction mechanism and the contract was awarded 35 percent on price and 65 percent on non-price.

All this does not mean that price-only reverse auctions will die out. Suppliers need to understand that reverse auctions will continue to be used for the majority of commodity item categories.

But for the right categories, where non-price attributes play a key part in the award decision, and in the differentiation amongst suppliers, suppliers should encourage buyers to use multi-attribute auctions.

Alan Buxton is product director at TradingPartners, which specializes in manufacturing management, e-sourcing, distribution and site location consulting. They have offices in London, Chicago and New York, among other locations. Contact Alan at alan.buxton@tradingpartners.com