MAY 2006
Corporate Buyers Save Through Online Auctions
Illustration by Stuart Bradford
by Marguerite Rigoglioso
Buyers for some major corporations may be able to shave time and substantial costs from purchasing goods and services simply by employing procurement auctions wisely, says Tunay Tunca, assistant professor of operations, information, and technology. In certain cases, companies can realize improved savings by mixing auctions with negotiations in a systematic way.
Traditionally, most large corporate purchases require lengthy negotiations often involving multiple sources—a process that can take months and can be very costly. Today, by embracing online bidding auctions an increasing number of companies are saving up to hundreds of millions of dollars. Sun Microsystems, one of the industry leaders in utilizing online auctions for procurement, realizes savings reaching $300 million annually.
“The internet allows a buyer to bring suppliers together simultaneously in online auctions and accomplish a major purchase in less than two hours, but there are questions about the best way to run such auctions,” says Tunca, the 2005–06 Moghadam Family Faculty Fellow at the School.
While optimal procurement auction structures have long existed in theoretical economics literature, they generally involve such complex implementations that most companies justifiably simply ignore them and instead utilize a simple and often familiar “reverse” auction process, in which a select group of suppliers bids competitively for an order posted by the buyer. The buyer may choose the lowest-cost bid or split the purchase among several of the lowest-cost suppliers.
Tunay Tunca
Buyers can use a simple reverse auction to save the most money when they are in control, says Tunca and his co-author, doctoral student Qiong Wu. This occurs when eligible suppliers are plentiful, when suppliers themselves have to spend money to ramp up enough to fulfill the order, and when purchasers have a good sense of suppliers’ costs.
But when things are a little more uncertain and complicated—when there are few suppliers, when those suppliers can easily fill the orders without any extra investments, and when buyers are not so sure of what suppliers’ actual costs are—then a simple reverse auction makes the purchaser more vulnerable to losing out on pricing. In this case, says Tunca, buyers are better off instituting a two-stage process, in which they hold an initial auction to identify the lowest bidders, but then add an additional contracting stage to negotiate further with those bidders.
Industrial buyers, then, may want to consider employing a two-stage procurement process more frequently, advises Tunca. “However,” he adds, “companies also have to be careful about keeping good relations with their suppliers before they decide to implement such a system. Cooperation with suppliers in this decision is important to prevent unwanted disruptions in those relationships.”
“Multiple Sourcing and Procurement Process Selection with Bidding Events,” Tunay I. Tunca and Qiong Wu, Stanford working paper, 2005.
