Reverse Auctions in Industrial Marketing and Buying

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Reverse auctions in industrial marketing and buying
Larry R. Smeltzer
Professor, Supply Chain Management, Arizona State University, Tempe, Arizona

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Amelia Carr
Professor of Operations Management, The Ohio State University, Columbus, Ohio

uctions may be one of the world’s oldest commercial tools. Their use has been reported as early as 500 BC in Babylon, and several references are made in Roman history to auctioning everything from the spoils of war to royal furniture. Most historical references mention the English progressive auction that is derived from the Latin root auctus, “an increase.” But today the auction is different. E-commerce has matured and reverse electronic auctions have received as much as or more attention than any other electronic tool. Why? Many companies, including Quaker Oats, United Technologies, and SmithKlineBeecham, report millions of dollars of savings with reverse auctions compared to traditional industrial buying methods. And many consulting firms are hyping the advantages of reverse auctions for both buyers and sellers. As a result of all this attention, a survey conducted by Purchasing magazine (Porter 2000) found that 25 percent of the respondents expected to use reverse auctions in 2000, and that number is expected to rise during the next several years. Various estimates indicate that billions of dollars of industrial goods will be purchased in reverse auctions by 2004 as the tool becomes more commonly used. With this level of estimated use, no doubt more and more managers will be asking, “How and when should I be using reverse auctions to reduce my material and operating costs?”

Reverse auctions have been
a popular topic over the past
several years because they often
result in tremendous savings for
buyers and new markets for sellers.
But they also carry risks. Three primary
motivations, three potential disadvantages,
and four conditions and related guidelines for success are reported here. If a reverse auction is to succeed, the product or service specifications must be clear and comprehensive, the purchase must be large enough to provide an incentive for the supplier to participate in the auction, the appropriate supply market conditions must exist, and the appropriate organizational infrastructure must be in place.

What is a reverse auction?

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ny auction, note McAfee and McMillan (1987), is theoretically an attempt to create a pure market with perfect information among both buyers and sellers. The ideal is for everyone to understand the product being auctioned and to know the latest bid price. The forward auction, in which the seller offers a product to numerous buyers, is the most common type. The seller “controls” the market because it is offering a product in demand by a number of buyers. The price the buyers offer

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continues to increase until a theoretical rational price is met in the market. Supply and demand set the price. In a reverse auction, the desired item is offered by a number of sellers, so the buyer controls the market. The price the sellers offer continues to decrease until a theoretical rational market price is achieved. An electronic auction brings the buyers and sellers together via some type of electronic media, usually the Internet. In fact, reverse auctions gained popularity with the advent of economical and efficient electronic capabilities, and are often only feasible when used electronically, via the Net. Here, however, the process will be referred to simply as a reverse auction rather than an electronic reverse auction. A reverse auction may result in “dynamic pricing,” which means that the price for the item being auctioned changes instantaneously because of the electronic format. As sellers observe the price changing in real time, the assumption is that it will continue to fall until a rational market price is established. In economic terms, a balanced market for a particular item is established between buyer and...
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