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The Impact of Reverse Auctions on the Life Science Supplier Market

April 7, 2015

Even though reverse auctions may save money for buyers of life science products and services in the short term, some believe that reverse auctions may have an overall net negative impact because they may have an unintended impact on relationships, have a negative effect on quality, and enable unrealistic hyper-competition, which may drive some suppliers out of business and ultimately increase prices and reduce choices for buyers.

What are reverse auctions?

Unlike standard auctions, where buyers compete to acquire an item of interest, ultimately driving up the selling price, reverse auctions pit sellers against each other, ultimately driving the selling price DOWN.

RevAuction_Figure_1

Figure 1. Price profiles – standard versus reverse auctions

Reverse Auction Planning

Prior to the start of a reverse auction, the buyer provides you and your competitors with a list of products or services they wish to buy at auction. This is similar to a standard request for proposal (RFP). If you are the incumbent supplier, you may simply supply your current pricing.

RevAuction_Figure_2

Figure 2. Economies of scale

Within your company you should plan out your strategy for each item, taking your cost, the opportunity at hand, and your relationship with the client into consideration. For example, if you are the incumbent supplier, you may be worried about keeping the business and concerned that a competitor will try to "buy the business." On the other hand, a supplier that doesn't do any business with this customer may be willing to offer a low price to get in the door. In fact, it may be easier for a new supplier to offer a lower price than it is for an existing supplier. A new supplier may experience economies of scale; therefore, they might be willing to offer a large discount, yet still be able to improve their bottom line, whereas the existing supplier already has the volume from this buyer.

 

For the incumbent, the loss of volume, should they lose the business, might create challenges for their overall cost structure, perhaps making them unprofitable, as shown in Figure 3.

RevAuction_Figure_3

Figure 3. Cost structure challenges

When the auction starts

Table 1 provides an example of the information you possess just prior to the auction starting. In this case, you know that you are the incumbent supplier and your opening price, which is the buyer's current price, and you have approval for your lowest price on each item.

RevAuction_Table_1

Table 1. Reverse auction opening costs

Going in Blind

When the auction opens, you only know your price and your current rank. The online screen may look something like the image below (Figure 4). In this case, you're ranked second, so one supplier came in at a lower or equal price.

RevAuction_Figure_4

Figure 4. Opening price

After the time remaining reaches 45 seconds, you see that you are now in seventh place, but you do not know what anyone else is bidding.

RevAuction_Figure_5

Figure 5. Price after 45 seconds

So, you bid $19.99 and you jump to first place (Figure 6). One rule of reverse auctions is that any bid that occurs within the last minutes adds 2 minutes to clock. Auction rules vary, but usually time is added when bids are made close to the ending time. As a result, the auction may involve a lot of back and forth bidding, which may take a lot of time.

RevAuction_Figure_6

Figure 6. Price after 2 minutes, 45 seconds

Unfortunately, after another 2 minutes at $19.99, you are now ranked ninth. And after 15 minutes you bid $13.89 and you are back in first place. But 15 minutes later, the price is $13.00, your lowest price, and you are in tenth place.

RevAuction_Figure_7

Figure 7. Price after 3 minutes, 18 seconds

Should your company walk away from a $30M account? Even though it's not going to be worth $30M anymore, because competitors are clearly trying to buy the business, it still may be hard to walk away. Should you keep bidding? There are 16 more items to go. And even if you don't win each item, maybe you can gain some intelligence, or maybe you can win the overall opportunity.Now what?

Are reverse auctions good for buyers?

In the short term, from a cost savings perspective, buyers clearly benefit. However, in the long term, this may not be the case, and reverse auctions may have a negative effect on relationships.

According to a November 2000 Harvard Business Review article, Going, Going, Gone, by Sandy Yap,1 reverse auctions "tend to undermine relationships with suppliers. Sellers can feel exploited by the process, and when the event is over, they are then less trusting of the buyer." As one supplier put it, "[The buyer] talks about the relationship being a partnership, and this [the auction] really takes that away.... What they do is take your existing business that you have worked very hard to achieve and maintain...and they send it out across the board for a competitive bid. I just do not think that is fair." Such reactions can damage business relationships, ultimately eroding the economic performance of both buyer and supplier."

The chart below depicts how reverse auctions potentially play out for buyers.

  • (T1) Short term = Big Savings: The example customer saved at least $460,000 on the first item ($24.50 - $13.00) * 40,000. And they can stick with their incumbent supplier if the want to.
  • (T2) Mid Term = Increased Innovation and Risk: Although this hyper-competition doesn't really result in market pricing, it might drive some suppliers to innovate; however it might also create supplier quality risk as a result of operating at far lower margins.
  • (T3) Long Term = Fewer Suppliers, Decreased Innovation, and Increased Price: Ultimately, reverse auctions will drive some suppliers out of business, like the incumbent described above, who may have lost a major customer and will be operating at a loss. And in the long run, having fewer suppliers could decrease innovation, decrease competition, and increase price.
RevAuction_Figure_8

Figure 8. Reverse auction price over time

Do reverse auctions help determine market price?

According to an April 2014 University Business article by Kyle Lacy, Bid for Savings: Reverse Auctions, "Running a reverse auction allows procurement staff to find out what the market price on a good or service actually is..." However, others believe that the reverse auction price, which results from an unrealistic hyper-competition, is below market pricing and likely unsustainable.

An April 6, 2014 New York Times article by Danielle Ivory, Reverse Auctions Draw Scrutiny3, raises the concern that "reverse auctions may result in unrealistically low bidding designed to "outmaneuver business rivals". Daniel I. Gordon, former head of the United States Office of Federal Procurement Policy, is quoted as stating that "These reverse auctions only make sense when all you care about is price..."

Are reverse auctions good for suppliers?

In the example above, the reverse auction was clearly not good for the incumbent supplier, but for the new supplier the reverse auction was presumably good because they increased their volume and profit. What choice does an incumbent really have? If the incumbent in the example walks away, especially from a large client, the financial impact may be catastrophic. On the other hand, if they don't walk away, they may have financial challenges anyway.

What do you think?

Is there anything that could have been done to avoid this situation in the first place? Does this issue pertain to all life science supplier product and service categories? Have we as suppliers done a good enough job demonstrating that what we offer is NOT a commodity? Is there anything we can do as an industry?

Visit the link below to provide your thoughts on this subject via a 2-minute survey. The Association will publish the results in a future article.

Participate in the survey.

References

  1. Jap, S. 2000. Going, Going, Gone. Harvard Business Review. https://hbr.org/2000/11/going-going-gone. Accessed February 28, 2015.
  2. Lacey, K. 2015. Bid for Savings: Reverse Auctions. University Business Magazinehttp://www.universitybusiness.com/article/bid-savings-reverse-auctions. Accessed February 28, 2015.
  3. Ivory, D. Reverse Auctions' Draw Scrutiny. The New York Times. April 6,  2014.
    http://www.nytimes.com/2014/04/07/business/reverse-auctions-draw-scrutiny.html?_r=0. Accessed February 28, 2015.

Chuck Drucker

Chuck DruckerChuck Drucker is a results-driven leader with over 20 years of experience in selling and marketing scientific products and services. In addition to his role as President of the Association of Commercial Professionals – Life Sciences (SAMPS), Mr. Drucker is Director of Client Facing Operations and Alliance Management for Quest Diagnostics Clinical Trials.

SAMPS, Sales And Marketing Professionals in Scientific research, is the first and only organization dedicated to sales and marketing professionals within the life sciences.

The association’s goal is to serve its members who work in commercial roles for life science products and services companies and associated businesses, globally.
 
SAMPS was previously named ACP-LS. We feel that SAMPS more clearly describes the membership, and will form a better foundation from which to expand this membership globally. 
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