Thursday, September 26, 2013

Reverse Auctions

A reverse auction (sometimes referred to as a dutch auction) is a bidding process that operates differently that a regular auction where the highest bidder wins. In a reverse auction, the bidders may continue to re-bid at lower prices in an attempt to win the business. In the end the one with the lowest price wins. I’ve always felt that it is best to negotiate the final price after you have reached agreement on the contract terms as changes to the contract terms may add to or reduce your cost and may add to or reduce your risks. As such a concern that I’ve always had with reverse auctions is how to make them effective from a total cost perspective.

I suppose that if you purchased a commodity product with a simple set of terms such as a purchase order you might be able to get all parties to the auction to agree to that a standard agreement in advance. If you don’t get agreement in advance on what the terms of the contract will be, when it comes time to negotiate the contract you need to be prepared for “our price did not include that” in the contract. I personally like to negotiate the final price I will pay after I’ve agreed upon all terms in the contract. Throughout the negotiation I will document all the terms
That have added to or reduced my cost and risk based upon changes to my documents that have been agreed. I like to put a price on each change and argue that such change needs to be reflected in the final price I’m willing to pay. In doing that some negotiators will be willing to accept the original language to avoid having to provide a price reduction. One of the concerns that I have with using reverse auctions with more complex purchases is there is a disconnect between pricing and costs or risks. Your supplier with the lowest auction price may be higher from a total cost perspective when you take into account the terms they will agree upon.

I also suppose that you could require a red-line of the proposed changes to the agreement in advance of the reverse auction and could assign costs to each issue and somehow take that into account in determining the total cost of each bidder’s offer. The problem is that not all changes they propose will you be willing to accept. That complicates the negotiation and also puts you in the situation where they will say “our price was based upon our redline” and to provide you with that we need to adjust our price.

I think reverse auctions work well when you deal with standard commodities where there aren’t variables in what the supplier can provide so all are bidding on the same thing, and they work well when you have purchase orders or simple agreements that will be readily accepted.