The most valuable businesses are those in which the owners are no longer valuable.
In material handling, reverse auctions are a new internet trend for buying goods and services. The process puts anonymous bidders against each other in an effort to bid a price down to the lowest price from an amount set by the buyer. This is different from a typical material handling auction in which bids move upward. The process includes specific times for rebids and continues until bidding stops and an award is made.
Reverse auctions are finding a place in industries where companies send out RFPs and RFQs to gather bids on business contracts and equipment. As these processes move online, auctions are becoming a powerful tool for procurement—for the buyer. Buyers can make their requests known to a much wider audience using matching engines, and the procurement process is reduced from months to a few days.
For distributors and manufacturers, however, reverse auctions seem to be another story. While buyers get a chance to open up their procurement requests and obtain a lower price, sellers participating in reverse auctions lose a significant profit margin.
The opinions on these pages from MHEDA members who have all participated in reverse online auctions – a distributor and three manufacturers – present the challenges of a new technology.
Long-Term Costs Outweigh Advantages
By Stephen Cloud
Recently, the U.S. Postal Service sent out an RFQ for conveyor belts. Contacted by a company that develops software for reverse online auctions, the Post Office agreed to bid the belts out on such an auction. The software company was confident that the Post Office could save millions of dollars. The software company, in turn, would receive a percentage of the savings. The very first bid the computer would accept would be the price the post office was currently paying. The reverse auction began at that price. The post office figured it had nothing to lose.
Several months ago, IBT participated in a reverse auction for bearing supplies. The purchasing agent was very clear that he would accept only one specific brand, a domestic bearing from a tier one supplier. We continued to bid until our margins got smaller and smaller, then we stopped bidding. We continued to watch the bidding as the prices fell below what we were paying our supplier for that particular brand. The numbers didn’t add up.
Later the purchasing agent told us the winning bidder did, in fact, agree to supply the required, specific bearing at that low price, so we went back to our manufacturer and asked if they were cutting a special deal with another distributor. “Of course not,” said the manufacturer, who had not even been in touch with the “winning” distributor.
Thirty days later, the distributor with the winning bid began shipping product into the end-user’s plant. With an opportunity to visit the plant, we went in search of the low-cost, high-quality, domestic bearing. What we found was a lower quality, off-shore built bearing, certainly not the specific one the purchasing agent demanded in the reverse auction. This purchasing agent’s response to our query went something like this: “I was told the distributor would ship Brand A, but if they shipped Brand B instead and the plant’s not complaining, I’m not getting involved.”
These two examples are common experiences for distributors who participate in reverse online auctions. IBT has participated in several of them since 2000, and only once were we the successful bidder.
I would like to point out three challenges of reverse online auctions for distributors.
The first is margin. End-user’s purchasing people are motivated by one thing, and the very nature of a reverse auction feeds into it—getting equipment for the absolute lowest possible price. Purchasing people love reverse auctions. Engineering people hate reverse auctions. Often those who run the plant end up with a piece of equipment or service that is below what is really required to run the plant.
A second challenge faced by distributors is the amount of time (labor costs) spent with end-users, helping them determine their specifications for the item to be auctioned. Historically, we have not charged for engineering services. Most distributors don’t because we assume we’re getting the order after we help set up the specs. End-user engineering departments have downsized over the last few years, and many are ill-equipped to specify equipment. Obviously, if this trend continues, we’ll have to start looking at charging for this service, but there will always be someone in the marketplace willing to provide it for free. Then the end-user will wind up with inferior design work, which everyone is bidding on, plus product purchased from the lowest bidder. The end-user wonders why they have problems with their purchase!
It’s not unusual for a few months to go by from the time of purchase to when the first repair problems start showing up. By then, the people who came in to run the reverse auction have already taken their commissions and are off spending them. The purchasing people who made the decision to go with the lowest bid on the reverse auction have already gotten their bonus checks for the initial savings. And the maintenance and engineering people are left with cleaning up the mess. Oftentimes the extra costs to fix the problem are never tied into the fact that they were caused by the reverse auction.
A third challenge involves our manufacturers. Often a distributor gets carried away in a reverse auction and ends up bidding a project below his cost. Unfortunately, some distributors reason that they can either cut some corners or they can try to get their supplier to reduce the cost, cutting the supplier’s margin. In the end, they end up substituting with a lower-priced “equivalent” product than what the customer expected.
As end-users continue to get pressed into cost cutting and cost saving behavior, the reverse auction becomes a more attractive option for them. People become intoxicated with all the talk of squeezing costs out of the system, and they want to jump in and play that game, but it ends up costing them more in the long run.
Short of waiting for reverse online auctions to go away, what should a distributor do? If you have a customer who wants to set up an auction, don’t talk to the purchasing department. They’ve already made their decision. Maintenance and engineering people at the plant already understand the problem. Try to talk with the plant manager or an executive committee that can take a broader view of the down side of a reverse auction.
Remind them that their company always has the option of buying the lowest priced item. The reverse auction will only guarantee that they will get the lowest possible price, along with the lowest quality product, as well as the lowest level of service available in the marketplace.
Let them know that long-term costs are much higher than any benefit of up-front savings, and then politely decline to participate in the auction. If material handling distributors would do that, we would all win!
|Meet the Author
Stephen Cloud is president of IBT, Inc. in Merriam, Kansas.