The Role of Reverse Auctions in Strategic Sourcing

1 13414_Cover 4/11/03 10:11 AM Page 3. The Role of Reverse Auctions in Strategic Sourcing .. by Stewart Beall CAPS Research Craig Carter, Robert H. Smith School of Business University of Maryland Phillip L. Carter, CAPS Research Carey School of Business Arizona State University Thomas Germer Graduate School of Management WHU, Otto Beisheim University Thomas Hendrick, Carey School of Business Arizona State University Sandy Jap, Goizueta Business School Emory University Lutz Kaufmann, Graduate School of Management WHU, Otto Beisheim University Debbie Maciejewski CAPS Research Carey School of Business Arizona State University Robert Monczka, CAPS Research Carey School of Business Arizona State University Ken Petersen, Carey School of Business Arizona State University CAPS RESEARCH. 2003. 13414_Text 4/11/03 8:28 AM Page 1.

2 The Role of Reverse Auctions in Strategic Sourcing .. by Stewart Beall CAPS Research Craig Carter, Robert H. Smith School of Business University of Maryland Phillip L. Carter, CAPS Research Carey School of Business Arizona State University Thomas Germer Graduate School of Management WHU, Otto Beisheim University Thomas Hendrick, Carey School of Business Arizona State University Sandy Jap, Goizueta Business School Emory University Lutz Kaufmann, Graduate School of Management WHU, Otto Beisheim University Debbie Maciejewski CAPS Research Carey School of Business Arizona State University Robert Monczka, CAPS Research Carey School of Business Arizona State University Ken Petersen, Carey School of Business Arizona State University Copyright 2003 by CAPS Research. All rights reserved. Contents may not be reproduced in whole or in part without the express permission of CAPS.

3 13414_Text 4/11/03 8:28 AM Page 2. 2 The Role of Reverse Auctions in Strategic Sourcing 13414_Text 4/11/03 8:28 AM Page 3. Table of Contents Executive Summary .. 7. Defining E-RAs.. 7. Overview of the Study's Methodology .. 7. Why E-RAs?.. 7. E-RAs Are Controversial .. 7. Beneficial Aspects of E-RAs .. 8. Dysfunctional Aspects of E-RAs .. 9. Benefits to Suppliers .. 9. Actual vs. Potential Applications of e-RAs .. 9. E-RA Spend Dollars, Percentages, and Trends .. 9. Sustainability of the Use and Economic Value Add of E-RAs .. 10. Non-User Observations and Issues .. 11. Ethical Issues Related to E-RA Use .. 12. Conclusions .. 13. Executive Overview .. 14. Introduction .. 22. Defining E-RAs.. 22. Reverse vs. Forward Auctions .. 22. Objectives of the Study .. 23. Overview of the Study's Methodology .. 23. Why E-RAs?

4 24. Top Management's Expectations and Support of E-RA Use .. 25. Benefits/Dysfunctional Aspects of E-RAs .. 26. Direct Cost Reductions .. 26. Biddable Attributes .. 26. E-RAs Can Create Markets .. 26. Cycle-Time Savings for Buyers and Suppliers .. 27. Increased Buyers' Reach .. 27. Total Cost Analysis .. 27. Price Visibility .. 27. Transparency of the Purchasing and Supplying Processes .. 28. Overall Process Efficiency/Productivity .. 28. Other/Indirect Savings .. 28. Benefit/Cost Justification .. 28. Dysfunctional Aspects of E-RAs.. 28. CAPS Research 3. 13414_Text 4/11/03 8:28 AM Page 4. Benefits to Suppliers .. 29. Actual vs. Potential Application of E-RAs.. 29. The Strategic Context of E-RAs.. 30. The E-Oriented Strategic Sourcing Process .. 30. Spend Analysis and Opportunity Assessment .. 30. Develop E- Sourcing Strategy.

5 32. Identify Potential Suppliers .. 32. Issue and Evaluate Returned RFxs.. 32. Develop Reverse auction Strategy .. 32. Hold the Reverse auction .. 33. Award Business If Conditions Are Met.. 33. Follow-Up and Re- Sourcing .. 34. The Interaction of E-RAs and the Other Components of the Strategic Sourcing Process .. 34. Spend Dollars, Percentages, and Trends .. 35. E-RA Event Experience .. 35. Experience across the Global Economy .. 35. Experience across Industries .. 37. Experience across Commodity Types.. 37. Sustainability of the Use of E-RAs.. 39. Sustainability of E-RAs As a Tool.. 39. Sustainability of E-RA Results .. 40. Sustainability of Supplier Performance .. 40. E-RA Implementation Strategies .. 42. Implementation of E-RAs in Buyer Organizations .. 42. Implementation of E-RAs in Supplier Organizations.

6 42. E-RA Training for Buyers and Suppliers.. 43. Planning and Managing the E-RA Event .. 44. The E-RA Sourcing Decision .. 44. Preparation for the E-RA Event .. 44. Observations from Interviews Regarding Preparation .. 45. Role of Cross-Functional Teams in E-RAs .. 45. Buyer-Supplier Communication .. 45. Buyer-Supplier Communication during an E-RA Event .. 46. Role of RFxs in E-RAs.. 46. Test Runs, Contingency Planning, and Supplier Training .. 47. Non-Participation Rules .. 48. Lotting Strategies by Buying Firms .. 48. Closing Strategies .. 48. Bid Commitment Duration .. 49. E-Tool Suite Development.. 49. Successful vs. Unsuccessful E-RA Events.. 50. Defining Success.. 50. Level of Competition .. 50. Size of the E-RA Event .. 50. Supplier Visibility .. 50. Lotting Strategies .. 51. Item Specificity and Complexity.

7 51. Switching Costs .. 51. Supplier Success and Change Costs.. 51. 4 The Role of Reverse Auctions in Strategic Sourcing 13414_Text 4/11/03 8:28 AM Page 5. The auction Experience of Buyers and Suppliers .. 52. Buyer-Supplier Relationships.. 52. Emerging Issues .. 53. Will Repeat Buys Deliver Value? .. 53. Will Smaller or Larger Supplier Bases Develop? .. 53. Do E-RAs Result in a Shift in Power from Suppliers to Buyers? .. 54. What Effects Will E-RAs Have upon Negotiation Skills?.. 54. What is Happening to the Development of E-RA Functionalities from Providers?.. 54. Are Dynamic E-TCO Tools Available? .. 54. Will the Importance of E-RFxs Increase? .. 55. Do Global Obstacles Limit the Use of E-RAs? .. 55. Non-User Observations and Issues .. 56. Reasons for Non-Use .. 56. Conclusions Regarding Non-Users .. 56. Ethical Issues Related to E-RA Use.

8 57. Observed Ethical Issues .. 57. Potential vs. Actual Unethical Practices .. 58. Avoiding Actual or Perceived Unethical Practices .. 58. Ethical Issues Unique to E-RAs .. 58. Conclusions.. 60. Case Studies .. 61. GlaxoSmithKline .. 61. Bechtel .. 66. Volkswagen Group .. 68. METRO Group.. 73. CAPS Research.. 86. CAPS Research 5. 13414_Text 4/11/03 8:28 AM Page 6. Figures, Tables, and Appendices Figures Tables Figure 1: Components of Typical E-Oriented Table 1: CAPS Research Large Company Strategic Sourcing Process .. 30 Survey .. 35. Figure 2: Sourcing Strategy Matrix .. 31 Table 2: Ethical Issues Surrounding Reverse Auctions .. 57. Figure 3: Companies' Use of E-RAs .. 36. Table 3: Items GSK Sources via E-RAs .. 65. Figure 4: Applicability of E-RAs: Switching Costs vs. Length of Current Contract .. 37 Table 4: VW Application Transfer Volume.

9 70. Figure 5: GSK Management's Changing Expectations of E-Ras .. 62 Appendices Figure 6: GSK's Definition of E-Ras .. 63 A: Methodology .. 80. Figure 7: GSK's E- Sourcing Tools .. 64 B: auction Typology .. 82. Figure 8: GSK Sourcing Tool Matrix.. 64 C: Methodology References .. 85. Figure 9: Bechtel Reverse Auctions .. 67. Figure 10: Bechtel E-RA Process.. 67. Figure 11: VW/Supplier Areas of Collaboration 70. Figure 12: VW Online auction Positions .. 71. Figure 13: VW Sample Invitation.. 72. Figure 14: E-RA Process at METRO .. 75. Figure 15: METRO Registration Form +. Undertaking .. 77. Figure 16: Code of Conduct GlobalNetXchange .. 78. Figure 17: auction Typology .. 82. 6 The Role of Reverse Auctions in Strategic Sourcing 13414_Text 4/11/03 8:28 AM Page 7. Executive Summary In the mid-1990s, a new electronic Sourcing tool Third-party providers of e-RA services ( , emerged that has had, and is continuing to have, a eBreviate, FreeMarkets).

10 Profound impact on the way in which firms source A targeted number of firms who had specifically goods and services from current and potential external chosen not to use e-RA tools for Sourcing . suppliers. This tool, while known by other names ( , online negotiation ) is the electronic Reverse auction (e-RA). The purpose of this study is to present the initial Why E-RAs? results of a comprehensive study of e-RAs undertaken by CAPS Research during 2002. Why the intense interest in e-RAs? The dramatic growth of the use of e-RAs over the past few years has been facilitated both directly and indirectly by a number of Defining E-RAs converging internal and external developments and forces, including: In its basic form, an e-RA is an online, real-time dynamic auction between a buying organization and a group of Widespread ability for buyers and suppliers to pre-qualified suppliers who compete against each other economically communicate in real time, worldwide, to win the business to supply goods or services that have via the Internet.