Focus on auction business models

With the success of eBay (www.ebay.com), auctions have been highlighted as one of the new business models for the Internet. But how do auctions work, what infrastructure is required and what is the potential for B2B auctions? In this section we will address some of these issues.

Auctions involve determination of the basis for product or service exchange between a buyer and seller according to particular trading rules that help select the best match between the buyer and seller from a number of participants.

Klein (1997) identifies different roles for auction:

  1. Price discovery – an example of price discovery is in the traditional consumer auction involving bidding for antiques. Antiques do not have standardized prices, but the auction can help establish a realistic market price through a gathering of buyers.
  2. Efficient allocation mechanism – the sale of items that are difficult to distribute through traditional channels falls into this category. Examples include ‘damaged inventory’ that has a limited shelf life or is only available at a particular time such as aircraft flight or theatre tickets. Lastminute.com (lastminute.com) has specialized in disposal of this type of inventory in Europe, not always by means of auctions.
  3. Distribution mechanism – as a means of attracting particular audiences.
  4. Coordination mechanism – here the auction is used to coordinate the sale of a product to a number of interested parties; an example is the broadband spectrum licences for 3G tele­coms in the UK (spectrumauctions.gov.uk).

To understand auctions it is important to distinguish between offers and bids. An offer is a commitment for a trader to sell under certain conditions such as a minimum price. A bid is made by a trader to buy under certain conditions such as a commitment to purchase at a particular price.

There are many potential combinations of the sequence of bids and offers and these have been described by Reck (1997). Despite the combinations two main types of auction can be identified:

  1. Forward, upward or English auction (initiated by seller). These are the types of auctions available on consumer sites such as eBay. For these auctions, the seller sets the rules and the timing, and then invites potential bidders. Increasing bids are placed within a certain time limit and the highest bid will succeed provided the reserve (minimum) price is exceeded. The forward auction can also potentially be used to perform price discovery in a market.
  2. Reverse, downward or Dutch auction (initiated by buyer). These are more common on busi- ness-to-business marketplaces. For these auctions, the buyer sets the rules and the timing. Here, the buyer places a request for tender or quotation (RFQ) and many suppliers compete, decreasing the price, with the supplier whom the buyer selects getting the contract. This will not necessarily be the lowest price since other factors such as quality and capability to deliver will be taken into account. Companies may use reverse auctions to:
    • rationalize suppliers in a particular spending category;
    • source new components in an area they are unfamiliar with.

Some marketplaces also offer a basic exchange where buyers and sellers can offer and bid, but without the constraints of an auction. The scale of some auctions is shown by the auc­tion activity of large manufacturers such as DaimlerChrysler. Through 2001 there were over 512 online auction bidding events processed for DaimlerChrysler on vendor-supported portal Covisint (www.covisint.com) amounting to approximately €10 billion, that is, a third of their total procurement volume. In May 2001, DaimlerChrysler staged the largest online bidding event ever, with an order volume of €3.5 billion in just four days. As well as savings in material purchasing prices, DaimlerChrysler also reduced throughput times in purchas­ing by 80 per cent (Covisint, 2002).

Note that Covisint (www.covisint.com) is no longer a marketplace, rather it is a neutral supplier of technology owned by Compuware. The original vision of a neutral B2B market­place has not transpired. Instead, each manufacturer or company requiring B2B services uses e-business technology to source materials. So the e-business messaging technology has proved successful, but the B2B auction marketplace model has not. In 2006, Covisint technogies had 266,000 users in more than 30,000 companies in 96 countries. Although it doesn’t now exist as a single marketplace, many manufacturers still use this technology for procurement. For example, in January 2006, GM announced that it was going to continue using Covisint for links with its 18,000 worldwide suppliers.

Emiliani (2001) reviews the implications of B2B reverse auctions in detail and Case Study 2.1 shows how auctions can be used in a B2B context.

Case Study 2.1 The impact of B2B reverse auctions

This case explains the process of a reverse auction and the types of products suitable for purchase by this method. The benefits of reverse auctions are explored through many examples from different sectors including purchases by government departments.

A dozen people sit in a room staring at the projection of a computer screen on the wall.

For 20 minutes or so nothing much happens. ‘It’s a little like watching paint dry’, says Steve Dempsey, government partner with the consulting firm Accenture.

But suddenly someone miles away, linked via the internet, makes a bid. A pale blue dot registers at the top of the screen. Soon others follow, different colours repre­senting different companies. An e-auction, aimed at cutting the price the public sector pays for anything from paper to computer equipment to air freight, is under way.

Reverse auctions – where companies bid their way down to the lowest price at which they are prepared to supply – are a commonplace tool in parts of the private sector. Operating a little like eBay in reverse, they are a way for buyers to negotiate, online, with suppliers to source a range of goods – those whose quality and nature can be defined with absolute clarity.

Accenture has run more than 1,500 such auctions in the private sector in businesses as diverse as the oil and chemical industries, industrial equipment, marketing and foodstuffs. More than 125 different commodities have been bought and sold this way, including fork lift trucks, coffee, foil, fuel, filters, pallets, pipes and struc­tural steel. Auctions have also included services, such as temporary staff and contracts for earth removal.

The approach has now come to the public sector and has been greeted with enthusiasm by the Office for Government Commerce, which is charged with lopping £1bn off the government’s £13bn civil procurement bill over three years.

‘E-auctions are not suitable for everything’, Mr Dempsey says. The product has to be a commodity -one where the purchaser can specify precisely what standards the desired good or service has to meet. It could not, for example, be used to buy in the services of lawyers or consultants, or something where the purchaser has to design the service or innovate. But about a third of all commodities are suitable for auction, Mr Dempsey says. For the government, that may mean hundreds of millions of pounds’ worth of goods a year.

The auctions it has conducted in the private sector have produced average savings of 17 per cent on the historic price of previous contracts, Accenture claims.

In the public sector, only the Driver and Vehicle Licensing Agency, Royal Mail and the Police Information Technology Organization have used the reverse auction approach – buying computer supplies and security water­marked paper, for example. The four auctions, however, have each produced savings of between 22 per cent and 25 per cent on the previous contract.

The reason, Mr Dempsey argues, is twofold: the field of suppliers can be widened from those who traditionally do business with government; and the auction takes place in real time, increasing the competition on suppliers to find their lowest price.

The process works by the purchaser spelling out precisely what is needed, advertising the requirement and then drawing up an approved list of those who can meet it. Potentially, Mr Dempsey says, that opens up the market to small and medium-sized companies that might not normally see the government as a customer. The parameters of the auction are then set, the suppliers trained – and battle commences. Usually auctions are set to last 30 minutes but are extended for 10 minutes each time a bid comes in during the last five minutes. An average auction runs for about 90 minutes, although some have lasted for several hours.

‘You can really feel the tension and excitement’, Mr Dempsey says. A company may, for example, have excess stocks of what the government needs. Or it may have a hole in its production run, or a sales target that the contract fills. ‘It creates real time, dynamic competition between suppliers’, he says. ‘It’s a real marketplace.’ The DVLA, for example, saved more than £200,000 buying several tons of watermarked paper. It is now working on a similar e-auction for millions of the envelopes it uses every year. The Royal Mail, having saved £550,000 on its first two e-auctions, is in the process of buying more than £20m of air freight space to shift air mails.

Paul Cattroll of the DVLA says the reaction of suppliers is mixed. Some feel that it has forced them to reduce their profit margins. ‘But it is an opportunity for the government to get better value for money for the taxpayer’, he says.

Despite the need to prepare the auction carefully, Accenture argues that the process can prove quicker than traditional procurement, while cutting the adminis­trative cost for both purchaser and provider.

E-auctions have been slow to take off in the public sector because there was a question mark over whether they breached European Union procurement rules.

Another barrier is that government contracts tend to run for many years.

But over time e-auctions could become common­place. The DVLA and Royal Mail, having tried them on a pilot basis, both plan to use them again. And the Office of Government Commerce, happy they now fit within EU procurement rules, is encouraging other government departments to use them.

Source: Dave Chaffey (2010), E-Business and E-Commerce Management: Strategy, Implementation and Practice, Prentice Hall (4th Edition).

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