Wednesday, September 11, 2002

The dark side of reverse auctions. Reverse auctions, where the buyer posts a requirement and sellers compete for the business, are becoming more popular for two reasons: Internet technology allows reverse auctions to be conducted without regard to geographic location of the participants, and software or services are now widely available to facilitate reverse auctions. Leading software solutions include Moai, Emptoris, eBreviate, Ariba, Commerce One, and Procuri. Examples of online marketplaces that support reverse auctions include Covisint, Elemica, Forest Express, Quadrem, World Wide Retail Exchange (WWRE), E2Open, and Transora.

Nevertheless, there is a dark side to reverse auctions. The main objection is that reverse auctions focus on a single dimension of the trading relationship: price. Unless the buyer takes specific actions to account for differences in supplier quality, lead times, flexibility, or service, suppliers are forced to sacrifice everything for the sake of lowest price. This seems like a step backward in an enlightened supplier relationship, and it reinforces the worst tendencies in some industries that have traditionally fostered adversarial relationships between trading partners. The second objection is that in many reverse auctions, suppliers can see each other’s bids but not their identities. This makes it possible for an unscrupulous buyer to game the system by inviting unqualified suppliers into the auction, thus driving prices unreasonably lower.

Although in some supply chains, reverse auctions can be a wake-up call to a complacent supplier base, the negative effects on supplier relationships should not be ignored. Therefore, buyers should limit the use of reverse auctions to purchase of commodity products, where there is less emphasis on the relationship and more on minimizing cost of the transaction. In cases where buyers really want to use reverse auctions in the context of strategic supplier relationships, it is essential that they take explicit steps to address dimensions other than price. HBS Working Knowledge has a good article on the subject.

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