A subset of these online trading communities is the online auction, which provides an online, real-time exchange for commodities in a particular vertical or horizontal industryoffice supplies, auto parts, chemicalswith prospective buyers and sellers logging on and making some type of low-price offer against a request. The buyer then makes an online purchase from the vendor who provides an offer that best meets his or her needs. Some sites provide essentially a commodity market, with sellers posting their goods and prices and buyers logging on looking for bargains. Others are initiated by buyers making their needs known, with suppliers respondingbidding against other suppliers in real-timeto make a best offer. These sites can involve participants from all over the world, and most auctions are completed within an allotted amount of timesay an hourgiving suppliers time to move toward a natural floor-level price, and as in all markets, with a flurry of activity to get in before the bell. The result is actually most often a "reverse auction," where the price goes down, not up, as the bidding progresses.
Many of these e-market auction sites provide the software to generate the purchase order and exchange invoicing information, and provide at least some level of order tracking and delivery coordination. Others have gone even farther, providing tendering servicesusually in the form of a Request For Tender (RFT)rather than simple commodity auctions. In fact, the better online auction e-markets offer several important services beyond just providing the electronic, real-time negotiations between buyer and seller. These include easy-to-understand classification of RFTs, proactive electronic notification of upcoming auctions by category, calendars and scheduled times for important auctions, and even prequalification of likely suppliers on behalf of the buyer.
This type of real-time bidding is most appropriate for high-volume, generic, commodity-type goods, where small differences in price on large volumes add up quickly. As you might expect, online auctions are usually focused on indirect goods, although they too are beginning be seen as providing an instant online spot market for direct materialsparticularly if supplies of those materials are known and predictable. Some sites, like Free Trade Zone, are a combination of ASPs and e-marketplace, providing not only an online auction service, but also helping bring vendors that can supply difficult-to-find components to manufacturers. This is the type of service that will help e-markets move from indirect goods to MRO and direct materials in the future.
The cost of these auctions to participants varies widely. Most charge a straightforward fee based upon either transactions or on a percentage of the dollar value of the trade. SupplierMarket.com, for example, an auction that matches buyers and suppliers for build-to-order manufacturing contracts, charges a transaction fee averaging 2% of the total bid4. SciQuest, an online exchange for scientific supplies, takes a different approach. They began by offering premium placement for suppliers on a first come, first served basis. As they became more viable, they were then able to charge new suppliers an additional feesome 400 vendors have paid from $2,000 to $15,000 for advantageous positioning on the site. This is on top of a standard supplier fee of some 8% to 10% commission per order5.
There are two key advantages to the online auction: speed and cost reduction.
Speed. For anyone who has ever had to go through the cumbersome process of sending out or responding to RFPs, the value of the online approach is obvious. Instead of taking several months to receive and evaluate supplier responses, the entire process can be completed in little more than an hour. Today when companies send out RFPs, it can take weeks and sometimes months to evaluate all the bids and negotiate the final deal. Because the bidders do the negotiating, real-time, online auctions can reduce that time to 90 minutes.
Bruce Platzman was intrigued but wary when he first heard about SupplierMarket.com's Internet marketplace for buyers and sellers of manufactured direct materials. Platzman, CEO of Affordable Interior Systems (QIS), Inc., of Hudson, Massachusetts, a major manufacturer of office systems and workstations, liked the idea of going online to procure direct materials. "It sounded cutting-edge and exciting," he says, "but I also was skeptical. I always try to balance upside potential against risk."
No matter how he analyzed it, however, Platzman couldn't find any risk. The Burlington, Massachusetts-based marketplace provider charged no up-front fees for software installation or consulting services, and using the service required no technology beyond an Internet connection and a standard browser.
Platzman's procurement team pulled together a request for quotes (RFQ) for a year's supply of three-millimeter banding, the protective plastic molding that fits around the edges of office furniture. They did that using SupplierMarket.com's forms-based RFQ Builder facility, which guides purchasers step by step through the creation of an RFQ, complete with drawings. At that point, behind the scenes, SupplierMarket.com's SmartMatch technology automatically matched registered qualified suppliers with the RFQ, based on their technical and commercial capabilities. Those suppliers were then invited to participate in a live online auction.
A couple of weeks later, Platzman was working in his office and keeping one eye on his computer screen, watching companies place bids for his order. Suddenly the online action had his full attention. Six more suppliers had jumped into the bidding and the price had already dropped below his expectations. He called in other members of the company's management team and they all watched in amazement as the price continued to fall. By the time the bidding was over, a little more than two hours after it had started, Affordable Interiors was looking at a low bid of $102,000 for an item that typically cost around $170,000.
Euphoria quickly gave way to doubt. "When you look at a number like that, you have to ask yourself, 'Who the heck bid this thing? Is it some guy working out of his garage?' says Platzman. As it turned out, the bidder was no garage operation. It was the premier manufacturer of the required type of plastic edging, a company that regularly supplied Affordable Interior's largest competitors. "We landed with what we believe is not only the largest, but the highest-quality manufacturer of this product," says Platzman, who was so happy with that outcome that he has since posted 12 more RFQs.
Reverse auctionswhere suppliers bid prices down to win contractsare hot in B2B e-commerce. And Web sites where buying organizations can hold such auctions are springing up rapidly.
Since 1997, Quaker Oats has saved $8.5 million by purchasing via reverse online auctions, according to Carl Curry, vice president of integrated purchasing and logistics. And SmithKline Beecham, a pharmaceutical and consumer healthcare company, recently announced $3 million in savings through online auctions.
Both companies chose to conduct auctions at FreeMarkets Inc. (freemarkets.com). Other Web sites where buyers can hold reverse auctions include SupplierMarket.com, BidtheWorld.com, frpMarket.com, and eBreviate.com.
Curry says Quaker Oats first heard about online reverse auctions about three years ago when a senior member of his department encountered a FreeMarkets representative at the Center for Advanced Purchasing Studies in Arizona.
"At that point FreeMarkets was talking about the concept in terms of what they intended to deliver and how their system was going to work," says Curry. "[Our person] came back excited, saying 'Boy if this becomes functional we ought to be an early player.'"
From there, Curry and the rest of his department started looking for commodity contracts that were coming up for renewal, which the company could put out for bid on the FreeMarkets Web site. Glycerin was the first product they put out to bid. Since then the company has held regular auctions on the site, reaping large savings. Curry says the $8.5 million represents the amount of savings the company achieved versus prices it had in place before going to FreeMarkets.
The process for conducting a reverse auction on the FreeMarkets site begins with choosing which contracts will be put out for bid, Curry says. After that, a supplier evaluation process begins where the buying company looks at its list of suppliers to decide which ones will be offered a chance to bid for the contract. At that point, FreeMarkets also searches its own list for qualified suppliers.
"FreeMarkets typically brings back their list, which may differ somewhat from our own. They may have experience with suppliers with whom we haven't worked or they may be more global," says Curry. "We canvas the list of suppliers to determine if they can meet our initial needs from a quality and response perspective."
The next step, Curry says, is to write the RFQ and send it out via email to all qualified suppliers along with information as to when the bidding will take place.
After that, the buying company uses its Web browser to click into the Web site and watch the bidding. "The auctions generally take place in about 20 to 30 minutes," Curry says. "Then we determine who won the bid and award the contract from there."
Cost reduction. Obviously, for buyers, this type of online approach helps to cut the administrative costs of dealing with thousands of small companies. Auctions also tend to drive the price of goods down significantly, partly because the nature of real-time spot-buying itself quickly pushes prices downward, and partly because the certainty of immediate sale and contract acceptance means that the normal mark-up that the seller includes in their prices for covering risk can be eliminated. For sellers, the online auction greatly expands their potential customer base, allowing vendors an opportunity to quickly and dynamically price and move materials.
There are already many converts. United Technologies, for example, began an online, in-house auction that it has used since 1997 for commodity productselectronic components, motors, wire and plastic partswhich account for nearly 25% of the $14 billion that the company spends each year on these types of indirect and MRO goods6. Quaker Oats claims to have saved some $8.5 million using its own email-based auction system.
SmithKline Beecham, a pharmaceutical and consumer healthcare group, recently announced $3 million in savings through online auctions. The company has been using the FreeMarkets.com auction site since 1999 and has purchased more than $38.2 million worth of goods and services online. SmithKline Beecham reports it has cut overall price of goods by nearly 10%. The FreeMarkets auction site says it has facilitated more than $575 million worth of bids for indirect goods and services, saving an average of 13% for its Global 1000 clients. FreeMarkets deals with some 46 different types of indirect goods and services, from MRO items to tax preparation services and car rentals7.
Although the benefits are obvious, auctions have their drawbacks too. For one thing, at this time at least, they remain primarily focused on spot market buying of indirect goods. Although there is no doubt that the process drives prices down and greatly reduces administrative time and costs, the entire focus also works against some of the key principles of procurement. It is difficult to predict prices, for example, as each day may bring a completely different set of bid responses.
More important, and something that has been increasingly annoying to suppliers, the focus on real-time pricing undermines the added-value nature that differentiates one supplier from another. Many economists argue that the transparent nature of auctions, and the myopic focus on price, essentially eliminates any concept of competitive advantage. In fact, because the emphasis of an auction is on price alone, it makes it difficult for suppliers to maintain any close relationship with the buyer, and yet issues concerning collaborative part design, quality assurance levels, and delivery dependability, are often much more important in procurement of MRO or direct goods, particularly, than price alone.