Competitive Pricing

If you've ever bid on an item on eBay, you've seen the way your business will probably someday purchase everything from office supplies to critical production materials--in reverse. Online reverse auctions, or downward price auctions, stand the traditional rising price or English auction on its head. Buyers put out specifications for what they want to buy, and sellers submit bids electronically until someone wins the business.

Online reverse auctions came into being about the time the Internet became popular. So-called dynamic pricing commerce, most of which is online reverse auctions, will top $45 billion or 15 percent of all e-commerce in 2002, rising to $500 billion in 2006, says Rob Rosenthal, e-commerce analyst at research firm IDC.

Driving the boom is a desire for savings. Typical companies can expect savings of 10 to 20 percent on goods purchased through online reverse auctions, says Rosenthal. Purchasers also save time, compressing into hours price negotiations that normally take weeks. Buyers also reach new suppliers who, because of location or other reasons, never bid for their business before.

Today, large companies get the most benefit from buying through reverse auctions. The market-makers initially targeted Global 1000 and other big enterprises because those companies spend more. Big buyers are also more attractive to suppliers, so their requests for proposals attract more bids.

The economics of these auctions also favor big buyers. Sellers are charged transaction fees ranging from 1 percent to 3 percent. Buyers normally pay relatively nominal sums to use the services. Another option, using do-it-yourself software to conduct auctions, can incur licensing fees of $50,000 a month or more.

Auction providers have shown limited interest in changing fees or practices to accommodate smaller firms. "From an entrepreneur's perspective, online reverse auctions present some problems," says Bob Emiliani, a professor at the Center for Lean Business Management at Rensselaer Polytechnic Institute in Hartford, Connecticut. "Unless their business has some scale, they'll have difficulty generating the volume companies are interested in."

Future in Reverse

Online reverse auctions will, however, inevitably be widely used by smaller firms, say observers. Max Scoular, vice president at Freemarkets.com, a leading firm in the industry, says his company is beginning to tailor products and services for firms with less than $100 million in revenues. Smaller enterprises are responding, he says. "It's happening with midsize companies on a scale that it wasn't two or three years ago. And I expect it to continue down the chain."

Scoular says purchase size isn't the only factor determining suitability. "You have to have a good specification so that people know what they're bidding on," says Scoular. The second requirement is that there have to be enough suppliers to make a market of bidders. Third, the business needs to be sufficiently attractive for suppliers to compete for it.

Generally, if you've purchased the product or service via bid before, you can do it in an online reverse auction.

Reversal of Fortune

Online reverse auctions sometimes have trouble delivering the benefits they promise, warns Emiliani. For one thing, switching suppliers incurs implementation costs-such as the added time to teach them your requirements-that cut into the cost savings. Suppliers also may resent being played against one another, and try to make up lost revenues sacrificed to outbid the competition by raising prices elsewhere, he adds.

But online reverse auctions make sense for many purchases, almost everyone agrees. And it is only a matter of time before small companies use them. Online reverse auctions aren't going to go away, says Rosenthal. "And," he adds, "it will spread downward."

NEXT STEP: Learn more about reverse auctions at Freemarkets.com and at Rensselaer Polytechnic's Center for Lean Business Management.

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