PA Consulting Group
17 August 2009
At first they were beset by problems and badly run, but now a new breed of e-auctions can deliver both quality and value and are a useful tool for procuring services.
Are e-auctions an effective way of securing savings for cash strapped organisations or, as a BBC Panorama programme on homecare claimed, the equivalent of, "selling elderly care to the lowest bidder"?
The first wave of these e-auctions, online competitions in which firms compete to win supply contracts, have had something of a bad press and undoubtedly there have been some problems with their use.
However, our experience shows that, when managed well, e-auctions deliver robust contracts, highly competitive pricing, and considerable savings (between 10%-50% when measuring prices before and after the auction).
So why, then are e-auctions distrusted? And how can buyers make them deliver the right results, every time?
The first wave of e-auctions went wrong
At first e-auctions were eagerly adopted by many organisations because they often delivered double-digit percentage reductions in suppliers' prices. Confidence grew as auctions were employed successfully to source contracts for critically important items ranging from computers to components for aircraft ejector seats.
That initial welcome did not last, as procurement managers began to worry that e-auctions brought too narrow a focus on slashing prices and profit margins, leading suppliers to cut corners. These concerns were then compounded by the increasingly poor execution of many e-auctions.
Some e-auctions were used inappropriately – where there were very few bidders (and even in one case in the car industry, a single bidder). Then responsibility for running the auctions fell to inexperienced staff.
Early e-auctions were supported by internal or external specialists, who had vital experience but as auctions became more mainstream this support was taken away. It was common for suppliers to misunderstand specifications, for example, and phone buyers for vital clarifications whilst auctions were actually running.
Another problem arose because e-auction bidding software would often support only pure price auctions. Yet procurement professionals knew that quality was also vitally important, and so were reluctant to source the lowest bids. This meant that often, the selection of the successful supplier ended up being a separate event to the running of the e-auction.
Having seen some of failures of this first wave of e-auctions many buying organisations decided to steer clear.
The case for a second wave of e-auctions
However, in the current economic climate, with increasing pressure on costs and a more competitive supplier market e-auctions are becoming an attractive proposition again. e-auction technology has also matured so that it can easily combine price and quality and that lowest price does not determine the result of the auction.
Buyers can make e-auctions a success if they follow three key principles of getting the strategy right, executing well, and building capability.
Getting the strategy right
e-auctions must be used selectively. They should only be used where there is an adequate number of bidders for the business, with three bidders the minimum, and preferably five or more. The costs of changing supplier must be small in relation to the overall value of the contract in order to maintain a level playing field, and the package of business on offer must be sufficiently valuable to make suppliers sit up and take notice.
Having decided to use an eAuction, the buying organisation must follow it through and ensure the eAuction itself determines the winner. The practice of merely using the auction to obtain some pricing information for later consideration outside the auction significantly reduces the value and transparency of the e-auction process.
Good practice has spread in the public sector since 2006, when the British government enacted an EU law setting out the obligations of public sector buyers running e-auctions. This has, arguably placed the public sector at the forefront of the e-auction strategy and helped it deliver significant cost savings. For example, the Office of Government Commerce has delivered average savings of 31% on IT hardware purchases for hundreds of public sector organisations over the past four years. This amounts to £44m in savings on the prices paid before the auction.
The presence of legal requirements also spurs public sector buyers to prepare rigorously for every e-auction, bringing back the thoroughness that characterised the successful early e-auctions in the first wave.
e-auctions happen in real time and there is little opportunity to rectify errors once the auction is running. This places a premium on thorough preparation, both on the part of the buyers, and the bidding suppliers.
This means the specification must be complete, and clear. Suppliers must submit full tenders, including indicative prices, before the eauction is run. The indicative prices act as a check to ensure that the suppliers fully understand the pricing structure they are bidding against.
It is essential to ensure that suppliers' bids are comparable. So steps need to be taken to answer any questions that the bidders have regarding the Invitation to Tender, and any areas of doubt within the suppliers' tender responses need to be clarified. It is surprising how little preparation suppliers sometimes do – and that they sometimes scramble for approval to offer lower prices during the e-auction itself, rather than working out a "walk away" price beforehand.
e-auctions can be challenging to get right and this places a premium on building the capability of the buying organisation in managing e-auctions well. For most organisations this means that an individual or team should be nominated to develop experience in the eAuction process.
The support of stakeholders is also vital, as the perception that e-auctions are a risky approach and can quickly spell an end to an auction programme.
One way of securing that support is making an occasion of every e-auction that is run. There is no better way of attracting interest and support is to show the delivery of savings "live" on screen, and we have watched rooms of 60 people or more cheering as more bids come in during an important e-auction.
E-auctions are still evolving
It is clear that e-auctions have undergone a natural evolution where lessons have been learned from the first wave, and it is equally clear that the transparency of the process compels both buyers and suppliers to raise their game and develop their capabilities. Some organisations, such as GlaxoSmithKline and Hewlett Packard, who have run thousands of e-auctions in the last few years, learned to exploit e-auctions very quickly and to use them on a large scale.
We expect that, increasingly, many other organisations will recognise the role that e-auctions can play. This growth will add vigour to the continuing evolution of e-auctions and, provided that they are managed properly, will deliver significant value for money.