Online Auctions: What Is Your Bid?
Introduction
In their endless quest for perfection, economists have long loved auctions. There is no better way to achieve a perfect balance between supply and demand, maximizing financial rewards in the process. In a pioneering pilot program, Accenture, in conjunction with Sun Microsystems, has proven just how effective online auctioning can be for both selling and buying products. Here we explain:
- Traditional versus online auctions
- The importance of e-auctions as a sales and procurement mechanism
- What they have achieved for Accenture/Sun Microsystems
The Internet revolution has brought advantages that off-line (i.e., traditional auctions) can not attain. During a traditional auction the price in the sales room or auction ring rises or falls until the buyer and seller strike a deal at a level that satisfies them both.
Until recently auctions were seen as a fair but expensive way of doing business particularly as they often involved the physical presence of buyer and seller at the auction. This co-location is often necessary because the sale involves an on-site appreciation of the lots - it also means bidders are co-located in time, which has traditionally played an important part in proceedings.
After inspecting the goods, the buyer enters the sales ring with "near market" information - knowledge of the lot that is about to be sold, some idea of the reserve price the seller is prepared to accept, and a view of the top price others are willing to pay. Other buyers gather and the intractable laws of supply and demand determine the eventual price. The use of telephone bids may have slightly relaxed the need for co-location of buyer and sellers, but it still produces a restriction on the number of buyers at the auction and limits its success.
There is no doubt that the far-reaching effects of the e-revolution are remaking the world of the e-auction, into one of the New Economy's most popular tools of trade.
Bidders participating from different locations, and the ability to alter the length of time the online auction takes, make a world of difference. A fine art sale might take place over an afternoon at Christie's, but the time horizon for price discovery on the Web may be many days. The global access enabled by the Internet allows news of auction lots to reach new customers and expands the number of bidders. The fact is a whole new generation of online auctions are being developed especially for the Internet. They are being customized to suit the needs of different industries and markets - and to fulfill the strategic goals of buyers and sellers.
English and Dutch Auctions
A distinction needs to be drawn here between two specific types of auction - the English and the Dutch. In the English model, the auctioneer begins with a reserve price and increases it in regular increments or allows potential buyers to bid up the price. This climb in price stops when the bidders are no longer willing to increase the price and the winner takes all. No real value can be placed on these lots, and their worth is determined by the top bidder.
In the Dutch version, the auctioneer offers lots from a high level at which the goods are unlikely to be sold. The price then gradually decreases with the first bidder to accept becoming the purchaser. Perishable commodities traditionally have been traded in this way. It has also been used successfully for the Web sale of concert tickets, airline seats, and container space on ships.
In terms of market information, the English auction reveals how interested other bidders are in a product and the price they are willing to pay while the Dutch model only discloses the price at which the overall winner takes the product.
However, on the Internet, the Dutch method has been seen to generate higher prices for sellers. In order not to lose a desired lot, a bidder will stop the clock at a higher price than he or she would have paid in an English auction. A number of e-businesses have recognized this advantage and adopted the Dutch method. Refined versions of these models are cropping up all over the net. The establishment of house rules for transactions reduces the costs to the different parties as they do not have to be continually re-invented to determine the price of each trade.
Other auction forms, particular to the Internet, are also being developed including a "Yankee Auction." This form has been tailored to suit the selling of large numbers of lots of moderately priced items in small lot sizes. The highest bidder wins the available merchandise at their bid price. Bids are ranked in order of price, then quantity sought, then time of the initial bid. So if bid prices are the same, the bidder for the larger quantity takes priority, and if price and quantity are still the same, then the earliest bidder wins.
The Bottom Line
The reason that consumers and large businesses are becoming excited about online auctions is their ability to give them cost savings. Where an e-auction is used to buy something, (and this is the most common use for e-auctions), it is called a "reverse" auction. Where an e-auction is used to sell something, (and this is still more unusual in e-auctioning today), it is called a "forward" auction.
Business-to-business (B2B) online auctions are becoming popular among large multinational companies to buy anything from production-related materials (that go into making manufactured product) to non production related (NPR) expenditure:
Up to 30% of a company's gross revenue is spent on non-production related goods and services like providing a water cooler service, buying stationery, or company cars. Years of carefully planned sourcing may have made supply chains and production related procurement more efficient, but a study at Cisco showed their average purchase still took nearly 13 days to complete with over a third of the time spent waiting for requisition approval.
Savings on NPR expenditure go straight to the bottom line and a 10% reduction in purchase costs can result in a 50% increase in a business's profit margin. In fact, the figures for overall e-procurement are staggering. A survey from early adopters Aberdeen Group reveals they realized a 300% return on investment in the first year. The average transaction cost per purchase order falls from $80 to $33 with a best-in-class cost of $6 after e-procurement is introduced. The most successful form of e-procurement so far is the auction.
Success Stories
Accenture demonstrated just how profitable auctions can be when they hosted a reverse online auction for stationery supplies using their own auctioning facility. In one hour eight suppliers watched the contract price fall from $1.29 million to $0.92 million. The winner of the contract made ten bids during the auction with an average price drop of $46,000 per bid.
A similar two-hour reverse auction of a two-year manufacturing contract attracted 267 bids and 21 suppliers from all over the world including the U.S., Canada, Taiwan, China, and Singapore. The historic contract price of $9.8 million was reduced to $6.7 million by the winner representing a 31.1% reduction.
For its pilot online reverse auction program, Accenture developed a refinement of the Dutch auction method. The Accenture auction model features five minutes of extra time when the clock stops as suppliers consider how to respond to their competitors and the auction ends when prices no longer fall.
In these experiments, Accenture used pre-qualified suppliers to ensure competition and considered auctions to be valuable only if there were at least ten bidders and the amount being transacted was greater then $250,000. The results were astounding with businesses making average savings of 17% and best-in-class examples of 37%.
A Key Alliance
In a ground-breaking initiative in Europe, Accenture has joined with Sun Microsystems to provide forward auctions, which were used to sell Sun products to existing Sun customers. These forward style auctions were modeled to work with Sun's current European Sales Channel model and identify new opportunities to maximize total revenue. In Europe, Sun has used this tool to explore how to lower inventory costs, react to changing market conditions, and gather real-time market information. As Chairman and CEO of Sun Microsystems Scott McNealy says, "Auctioning is an economically efficient and dynamic way of running a business. You know exactly what your products are worth because the market dictates the final price. You throw away the price list and move to a spot product market," enthuses McNealy. "I'm a total believer in the auction of anything that isn't bolted down."
Utilizing the services of Accenture's Procurement Centre of Excellence, based in Kensington, London, Sun Microsystems executed three different trials of forward auctions targeted toward second-tier inventory holding channel partners across Europe. Although not committed to solely focusing on this specific group, Sun viewed this approach as an ideal opportunity to determine if and how auctions would fit within their existing sales model. In the first instance, this was to test the mechanics of the auction process. In the second scenario an auction was used to relieve an inventory shortage caused by excess demand. The third event was to use auctions as a business tool to better manage quarterly revenues. By holding auction events at the end of each quarter, Sun could react to any disparities in the market between current and projected demand, resulting in higher revenues and lower inventory costs.
The Accenture team created for Sun Microsystems a 10-stage planning and execution process. They identified, coached, and motivated 10 bidders to drive a lively auction dynamic. The auction revealed that price was not the only driver for bidders but that the delivery period and additional services were important factors as well. Additionally, because Sun wanted to work within their traditional Sales Channel Model, careful attention was placed on the overall sales relationship and pricing structure for each event.
Tony Lo, the Sun program director spearheading the auction trials in the U.S., stated, "Online auctions have rapidly emerged as an important venue in the Internet economy for reaching new markets including the entrepreneurs who are building tomorrow's success stories."
The Accenture team discovered forward auctions were far more complicated than reverse auctions. It proved essential to clearly understand if the end goal was sustained margins or increases in overall revenue.
Overall the trials proved it was possible to derive a higher yield while obtaining better customer information. Additionally, through such pilots, Sun identified opportunities where auctions could be conducted in a partner-friendly manner. By working with their Channel Partners, Sun was able to create a business model that avoided channel conflict and overall customer dissatisfaction. However, one key lesson learned from this trial period was that despite the immense amount of communication and attractive pricing that Sun offered, special attention needed to be made to generate sufficient demand in the market for products sold within these specific events. Unlike procurement auctions where the buyer forces their supplier to participate by making the sale only available through this platform, Sun's forward style auctions were not the sole procurement vehicle for their partners.
The feedback from buyers and suppliers at these auctions was mixed. They could see benefits from increased competition but also risks to long-standing partnerships. Most buyers appreciated the visibility on prices quoted by competitors but there were fears also. "Auctions upset the partnership approach and can become confrontational," said one supplier at a reverse auction.
In Conclusion
As online auctions proliferate they will become one of a range of dynamic pricing strategies used by businesses as e-commerce makes pricing more transparent, competition more intense, and margins smaller.
But auctions also offer new opportunities They can be used to evaluate the demand for goods and set price levels in other channels to market. It is also true auctions may upset the apple cart of competing interests and cozy and consensus on trading rules among buyers, sellers and intermediaries.
There may be apprehension about incorporating the auction process into traditional ways of trading due to the novelty and internal changes required within an organization. But the lesson for all is that with careful implementation and detailed planning, electronic auctions, as Sun Microsystems Scott McNealy forecasts, could bring benefits to all.
