E-Procurement — Successfully Using and Managing Reverse Auctions

Contract Services E-Procurement — Successfully Using and Managing Reverse Auctions Edward P.Moser rocurement-based processes have By 2001, however, according to the re- begun to govern outsourcing prac- search and consulting firm IDC (Fram- tices in many pharmaceutical com- ingham, MA), many e-marketplaces had panies. This means that transactions folded, while others continued operating Pwith contract service providers will be after layoffs and restructuring. The initial, increasingly incorporated into the e- widespread belief that on-line auctions Today, reverse procurement infrastructure that sponsor would revolutionize and even replace the companies are developing. traditional procurement process now has auctions are Most sponsors still are feeling their way given way to the more realistic view that regarding how they will use their e- they are a sometimes-useful adjunct to es- perceived more procurement capabilities, and an impor- tablished modes of buying and selling. The tant area of experimentation is reverse number of public chemical-industry on- realistically than auctions. Reverse auctions are the oppo- line exchanges has fallen from 74 to 42, site, or reverse, of traditional auctions in according to a December 2001 Gartner G2 in years past but which the seller accepts bids from would- Group report (2). still offer many be buyers. In the reverse auctions that are Reverse auctions are less common in now commonly hosted on Web sites, a the pharmaceutical industry, in which benefits for buyer accepts bids from several would-be highly specialized goods are exchanged sellers and settles on the best offer. Goods less easily on-line. However, auctions have both buyer and are bought and sold, and information is been attempted for the purchase of chemi- exchanged among buyers and sellers in a cal raw materials and early-stage inter- seller. private (i.e., hosted by a single company) mediates as well as R&D materials, both or a public (i.e., with many firms) e- through private auctions and Inceutica. marketplace. com (a reverse-auction site for R&D ser- On-line reverse auctions have been used vices that closed last year when it ran out frequently in the chemical industry, in of venture-capital funding). which huge amounts of commodities are Reverse auctions can benefit both buy- bought and sold daily. Reverse auctions ers and suppliers of goods and services, ac- also are being used increasingly for prod- cording to business analysts, executives, ucts and services related to day-to-day maintenance, repair, and operations re- THIS MONTH: quirements. A Forrester Research survey of 361 businesses found that on-line auc- 100 E-Procurement — tion use across all industries rose from 17 Successfully Using to 23% of buyers in the final quarter of and Managing Edward P. Moser is a 2001 (1). Reverse Auctions freelance writer for Reverse auctions have experienced a PharmSource Information Edward P. Moser Services, Inc., tel. 703.914. boom-and-bust cycle paralleling the 1203, fax 703.914.1205, dot.com phenomenon. By the late 1990s, 106 Outsourcing Outlook [email protected], numerous fledgling on-line exchanges Jim Miller www.pharmsource.com. were targeting the $1.7-trillion chemical industry and its 50,000 buyers and sellers. 100 Pharmaceutical Technology APRIL 2002 www.pharmtech.com Contract Services and users of such Internet-based procure- include reductions in process costs and price savings fail to reflect other, less- ment tools. However, much preparation is accelerated product development, ac- obvious costs. Such expenses include the required to successfully exploit these on- cording to a recent IDC study (3). time and effort of resourcing (i.e., setting line marketplaces. Moreover, the value of Michelle Hincks, ChemConnect’s vice- up and fostering relationships with new on-line auctions depends on industry con- president of marketing, said that to ob- suppliers). Poor product quality as a re- ditions and the enterprise’s needs. Propo- tain the greatest benefits from the auction sult of buying from an untested supplier nents claim that the auctions can provide process the key is to determine which is another potential downside. Buyers many economic advantages, while critics products should be auctioned. Reverse must have realistic expectations about believe that these benefits are overstated. auctions are better suited to certain kinds moving from one supplier to another, ac- This article will examine how buyers of products such as high-volume bulk cording to Robert Emiliani, president of can obtain the most benefit from reverse commodities (e.g., methanol). Among the RPI’s Center for Lean Business Manage- auctions. A companion article in next products commonly bought and sold are ment. Although measuring the price com- month’s issue of Pharmaceutical Technol- benzene, toluene, ethanol, and naphtha. ponent of an auction is easy, “there’s no ogy will describe how suppliers should re- The average purchase at one major chemi- metric for the supply relationship,”noted spond in a reverse-auction situation and cal auction house is $1.3 million. David Stec, the center’s vice-president. how they can determine the pros and cons Reverse auctions “are not as useful with “You always lose some of the savings of public versus private auctions. small quantities,” noted Rozwell. Reverse from auctions, upwards of 50%. Buyers auctions also are less advantageous for don’t understand the total cost of acqui- The buyer’s perspective more-specialized goods.“High-price, high- sition,” Emiliani said. Costs can rise fur- Reverse auctions attract buyers with the quality items are dealt with outside the ther if a new supplier fails to deliver the allure of lower prices, a broader supplier reverse-auction process,”said Martin.“The product. In such cases an embarrassed base, and a more efficient procurement more highly specialized the product, and buyer may have to return to the previous process. On-line buyers often do save on the more complex its specifications, the supplier, who will likely raise prices for the purchases of goods because the nature of less likely it could be handled in an auc- privilege. “If it looks too good to be true, auctions tends to force a supplier to pro- tion [because they are more risk-prone, it probably is,”states a report by Emiliani gressively reduce its asking price. Carol and their specifications are more difficult and Stec (4). Rozwell, vice-president at Gartner G2 to define].” In addition, establishing, administer- Group (Stamford, CT), said that the sav- An exception to this rule is Chemfinet ing, and finding personnel for a com- ings on an average purchase at a reverse Services, Inc. (Overland Park, KS), an auc- pany’s auction program can lead to sig- auction “can be between 5 and 25%.”AMR tion house for custom-manufactured nificant expenses. Large firms could spend Research (Boston, MA) service director molecules and specialty chemicals. The up to $40 million to establish a private Roddy Martin noted, “Some companies company works with more than 1000 sup- trading house (5). Registering with a pub- have saved tens of millions of dollars on pliers of complex chemicals, from inter- lic auction house also entails new ex- reverse auctions.” Auctions also generate mediates to drug candidates. penses such as annual subscription fees valuable pricing data for planning future Rozwell advised that, to gain a com- ranging from a few hundred dollars to a purchases. petitive position, buyers should seek ex- few hundred thousand dollars. Reverse auctions also can save time. changes that feature five or more suppli- Moreover, reverse auctions can put “They can reduce the cycle time of the ers. Also, the buyer has an advantage when undue pressure on the industry’s supplier transaction significantly, by 50–70%,” suppliers have similar supply capabilities. base. Buyers representing large corpora- Rozwell said. Auctions commonly de- Some e-marketplaces enable buyers to pre- tions “are using their leverage to force sup- crease the entire bidding process from screen suppliers for certain characteris- pliers into a bidding frenzy,” noted Stec. months to days. The Gartner report about tics. For example, a company concerned Before engaging in reverse auctions,“firms chemical-industry auctions found that about protecting its intellectual property should consider whether they are damag- “on-line negotiation reduces the elapsed rights may want to screen suppliers by ing their existing supplier relationships,” time by at least 50% by eliminating the their country of origin, and a firm wor- Rozwell said. Such relationships can re- need for phone calls, faxes, and face-to- ried about reliable sources of supply may quire years and considerable resources to face meetings” (2). want to screen suppliers by corporate size establish. Emiliani and Stec urge buyers Furthermore, buyers can widen their or years in business. Reverse auctions do to engage in collaborative cost reduction supplier base by posting product specifi- not offer as many benefits for products on with suppliers. cations on Internet-based exchanges. The which one or two dominant suppliers Some corporate buyers who are dubi- Gartner report also stated that the ability exert market control or if the supplier base ous about the value of e-marketplaces be- to identify new suppliers electronically is is not fragmented. However, in markets in lieve that if they conduct enough exten- valuable especially in a fragmented inter- which suppliers are few, buyers have been sive research to make smart purchases national industry such as chemicals and known to reduce the suppliers’ advantage from suppliers, on-line auctions will be plastics. With these marketplaces, buyers by restricting the information suppliers unnecessary. Certainly, buyers must de- can quickly find backup and alternative see about one another on-line. cide on a multitude of details before en- sources of supply. Additional benefits may Skeptics of reverse auctions say that tering an auction.

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