SO77 Using the Reverse Auction Procurement Method to Save Millions

Summary
The state saves money when vendors compete against themselves to provide goods or services. A reverse auction procurement methodology is an electronic based process whereby vendors bid and then re-bid until the lowest price is reached. When the Department of General Services fully implements the reverse auction process, state departments will have a procurement tool that increases competition and reduces costs.

Background
What is a reverse auction?
How does a buyer know for certain they are getting a good deal when purchasing products and services? There’s only one way—to have suppliers compete for your business. Competition is the key to unlocking favorable deals, letting you discover and capitalize on the best terms the market is willing to offer. Competition is exactly what reverse auctions provide.

The reverse auction process is a competitive strategy being deployed by many procurement organizations as an advanced procurement tool allowing purchasing staff to shift from administering the procurement process to managing tools that automate many steps in the manually intensive sourcing process.[1] It is a process of “selling in reverse,” meaning the buyer and seller reverse positions; it is the buyer who drives the event.[2] A reverse auction operates similar to an on-line auction website: a state department advertises a need to purchase a certain good or service and interested qualified vendors have the opportunity to bid and re-bid on the contract to provide the good or service. At the end of the specific time limit, the lowest bidder would get the contract.

Numerous studies and research data have shown that savings of 5 percent to 15 percent, and in some cases even higher, can be achieved over prices previously paid.[3] Yet another report indicated that a properly executed reverse auction has the potential to yield an additional 8 percent to 20 percent savings for an organization below its current price.[4] William Brandel, research director for e-business at Aberdeen Group in Boston, notes that on-line reverse auctions can reduce the time it takes to purchase goods and services from months to a few days. In addition, buyers and procurement agents are able to make their requests for service known to a much wider audience.[5]

Reverse auctions should be a component of any well developed procurement sourcing strategy. They allow companies to minimize the cost of goods and services purchased while maximizing the value received.[6] In addition, reverse auctions provide an unbiased method that avoids the intent and appearance of unethical or compromising practices in relationships, actions and communications.[7]

The benefits offered by reverse auctions
The most tangible benefits come from reducing the cost and enhancing the value of purchased goods and services. Secondary benefits come from automating parts of the sourcing process, and increasing the efficiency of the purchasing organization.

Exhibit 1
Buyer Benefits Vendor Benefits
  • Lower purchase prices (find out the market price);
  • Consolidation of the supplier base;
  • Increase competition among existing supplier base; and
  • Very disciplined and much faster process.[8]
  • View others’ bids real time;
  • If firm is unsuccessful they know immediately; Less resources have to be committed to win a contract;
  • Break into existing business (reverse auctions challenge incumbent suppliers); and
  • Fast efficient and fair process (i.e., less paperwork, short negotiation time, short cycle time between bidding and contracting).[9]

Savings examples
The U.S. General Services Administration (GSA) noted that the Defense Finance Service (DFAS), Air Force, and the Coast Guard experienced savings of 12 percent to 48 percent under various reverse auctions conducted during the GSA Buyers.gov pilot program.[10]

The Reason Public Policy Institute and the Performance Institute stated that the U.S. Postal Service has achieved cost savings totaling more than $100 million on purchases of supplies and services using the reverse auctioning method. Reverse Auctions are most efficient for high dollar, large quantity, clearly defined purchases.

Reverse auction case studies for personal computers and carpeting show a reduction of costs for personal computers of 34 percent and for carpeting, 22 percent.[11]

Status of reverse auctions in California
Assembly Bill 722 authorized the Department of General Services to implement reverse auctions in state government beginning January 1, 2004. The department anticipates releasing a Request for Proposal in August 2004, with a goal of having reverse auctions available to state departments by July 2005.[12]

Recommendation
The Department of General Services, or its successor, should complete the Request for Proposal process as soon as possible. The sooner the select vendor can implement the reverse auction process and train state procurement staff to conduct reverse auctions, the sooner the state will start saving money.

Fiscal Impact
Although no funding currently exists to procure a reverse auction system, there is potential to implement the technology through achieved savings. Several vendors offer reverse auctions as an out-sourced service through which the state can obtain the electronic environment necessary to conduct the auctions. Cost of implementation will be a part of the value of the auction, meaning that the state will have no direct start-up costs. Savings estimates are therefore shown net of estimated implementation costs.

General Fund
(dollars in thousands)
Fiscal Year Savings Costs Net Savings (Costs) Change in PYs
2004–05 $17,100 $0 $17,100 0
2005–06 $22,800 $0 $22,800 0
2006–07 $28,500 $0 $28,500 0
2007–08 $34,200 $0 $34,200 0
2008–09 $39,900 $0 $39,900 0
Note: The dollars and PYs for each year in the above chart reflect the total change for that year from FY 2003–04 expenditures, revenues and PYs.

Other Funds
(dollars in thousands)
Fiscal Year Savings Costs Net Savings (Costs) Change in PYs
2004–05 $17,100 $0 $17,100 0
2005–06 $22,800 $0 $22,800 0
2006–07 $28,500 $0 $28,500 0
2007–08 $34,200 $0 $34,200 0
2008–09 $39,900 $0 $39,900 0
Note: The dollars and PYs for each year in the above chart reflect the total change for that year from FY 2003–04 expenditures, revenues and PYs.

Endnotes
[1] Robert B. Hanfield, Samuel Straight, North Carolina, and William A. Stirling, “Reverse Auction: How do Buyers and Suppliers Really Feel About Them.”
[2] Stoddard, J.K., Associate Raine Consulting, Inc., “Strategies for Reverse Auction Survival.”
[3] BottomLine, “What is a Reverse Auction?”
[4] Wes Guillemaud, Ted Farris and Dan Hooper, “Lowering Total Costs Through Reverse-Auctions,” Sorcity.com, Inc., May 2002.
[5] Article by Stephanie Sanborn, “Reverse Auctions Make a Bid for the Business World,” “Infoworld, “March 16, 2001.
[6] A Purchase Pro Inc., a White Paper, “Strategic Sourcing Through Reverse Auctions.”
[7] Wes Guillemaud, Ted Farris and Dan Hooper, “Lowering Total Costs Through Reverse-Auctions,” Sorcity.com, Inc., May 2002.
[8] Reiner, Kai, University of Melborne, Week 4 Presentation, “Strategic Sourcing and Ordering,” August 19, 2003.
[9] Department of the Treasury, Reverse Auctioning Presentation, http://www.treas.gov (last visited June 8, 2004).
[10] U.S. General Services Administration, Reverse Auctions, http://www.gsa.gov (last visited June 8, 2004).
[11] Hedgehog Reverse Auction Software and E-Procurement Services, Case Studies, http://hedgehog.com/case_study/case7.htm, and http://hedgehog.com/case_study/case3.htm (last visited June 8, 2004).
[12] Interview with Michelle Ogata, Mary Kuwamotto, Earl Santee, Scott Norton, Bob Riola, George Hortin and Janice King, Procurement Division, Department of General Services (April 20, 2004).