SAP White Paper

SAP Solutions for E-Sourcing

REVERSE AUCTION BEST

PRACTICES: PRACTICAL
APPROACHES TO ENSURE
SUCCESSFUL ELECTRONIC
REVERSE AUCTION EVENTS
© Copyright 2006 SAP AG. All rights reserved. Citrix, ICA, Program Neighborhood, MetaFrame, WinFrame,
VideoFrame, and MultiWin are trademarks or registered
No part of this publication may be reproduced or transmitted in trademarks of Citrix Systems, Inc.
any form or for any purpose without the express permission of
SAP AG. The information contained herein may be changed HTML, XML, XHTML and W3C are trademarks or registered
without prior notice. trademarks of W3C®, World Wide Web Consortium,
Massachusetts Institute of Technology.
Some software products marketed by SAP AG and its distrib-
utors contain proprietary software components of other Java is a registered trademark of Sun Microsystems, Inc.
software vendors.
JavaScript is a registered trademark of Sun Microsystems, Inc.,
Microsoft, Windows, Outlook, and PowerPoint are registered used under license for technology invented and implemented
trademarks of Microsoft Corporation. by Netscape.

IBM, DB2, DB2 Universal Database, OS/2, Parallel Sysplex, MaxDB is a trademark of MySQL AB, Sweden.
MVS/ESA, AIX, S/390, AS/400, OS/390, OS/400, iSeries, pSeries,
xSeries, zSeries, System i, System i5, System p, System p5, SAP, R/3, mySAP, mySAP.com, xApps, xApp, SAP NetWeaver,
System x, System z, System z9, z/OS, AFP, Intelligent Miner, and other SAP products and services mentioned herein as well
WebSphere, Netfinity, Tivoli, Informix, i5/OS, POWER, POWER5, as their respective logos are trademarks or registered trademarks
POWER5+, OpenPower and PowerPC are trademarks or of SAP AG in Germany and in several other countries all over
registered trademarks of IBM Corporation. the world. All other product and service names mentioned are
the trademarks of their respective companies. Data contained in
Adobe, the Adobe logo, Acrobat, PostScript, and Reader are this document serves informational purposes only. National
either trademarks or registered trademarks of Adobe Systems product specifications may vary.
Incorporated in the United States and/or other countries.
These materials are subject to change without notice. These
Oracle is a registered trademark of Oracle Corporation. materials are provided by SAP AG and its affiliated companies
(“SAP Group”) for informational purposes only, without
UNIX, X/Open, OSF/1, and Motif are registered trademarks representation or warranty of any kind, and SAP Group shall
of the Open Group. not be liable for errors or omissions with respect to the materials.
The only warranties for SAP Group products and services are
those that are set forth in the express warranty statements
accompanying such products and services, if any. Nothing herein
should be construed as constituting an additional warranty.

2
CONTENTS
Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

The Strategic Sourcing Process and Reverse Auctions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Supplier Selection Tools and Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

When to Use Reverse Auctions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Selling Auctions to Internal Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Ensuring Supplier Buy-In . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Choosing the Right Auction Settings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Running an Auction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
About SAP Solutions for E-Sourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

3
 THE STRATEGIC SOURCING
PROCESS AND REVERSE
EXECUTIVE SUMMARY AUCTIONS
Procurement organizations have been running electronic Strategic sourcing is a systematic process to formally select a
reverse auctions for many years. However, the use of auctions supplier or suppliers to provide products or services. Organiza-
has a long way to go to reach full potential. In fact, many tions should build a sourcing strategy with defined expecta-
organizations have yet to explore the benefits of auctions. Most tions and benefits. For example, one expectation could be as
others have yet to apply auctions to the full range of goods and follows: “Our organization will reduce the number of suppliers
services for which auctions can deliver value. with whom we do business from 1,000 to 500.”

Reverse auctions are hosted by a single buyer and feature two To achieve such goals, organizations can use a variety of
or more suppliers competing for business. Such auctions are processes, such as the request for proposal (RFP) process and
commonly used by organizations as a tactical way to achieve the reverse auction process. In the RFP process, a buyer creates,
sourcing objectives. issues, collects, and analyzes one or more of the following doc-
uments: request for information (RFI), request for quote
We have all heard the objections: “Auctions don’t fit the catego- (RFQ), and RFP. Reverse auctions take the supplier selection
ry we’re sourcing.” “Our suppliers would never participate.” process a step further, enabling a buyer to collect and compare
“Our company does not do business this way.” Every objection price and bid information of two or more suppliers in a real-
stems from valid concerns. However, if your organization’s goal time, open bidding environment.
is to conduct fair and open competition among your supply
base, reverse auctions can be a very effective tool in bringing These strategic sourcing processes are supported by electronic
transparency to the sourcing process. tools, including RFx and reverse auction tools. RFx stands for
RFI, RFQ, or RFP. Note that the process is referred to as RFP but
This white paper provides information that will assist your that the electronic tool is called RFx.
organization in driving the use of auctions and – most impor-
tant – delivering bottom-line results for your procurement Electronic tools that support automated negotiation can be
organization. important elements of a sound strategic process; however, these
tools are not strategies in themselves but rather tactical ways to
achieve sourcing objectives.

Supplier Selection Tools and Benefits

Many organizations use electronic RFx and reverse auction
tools because of the significant benefits they provide. RFx tools
often integrate with reverse auction tools to streamline the
supplier selection process.

An RFx tool is a Web-based application for defining supplier

selection criteria, soliciting information and proposals from
suppliers against those criteria, and analyzing suppliers’ propos-
als in order to make the best award on a total cost of ownership
basis. RFx tools can produce substantial benefits over tradition-
al software such as e-mail, Microsoft Word, Microsoft Excel, and
so forth.

4
An RFx tool offers the following benefits: When used appropriately, reverse auctions support the goal of
• Consistent and streamlined use of RFPs, especially in highly strategic sourcing to significantly reduce the cost of purchases
fragmented organizations without sacrificing quality and service. Buying organizations
• Well-documented objectivity in the supplier selection can also realize the following benefits of auctions:
process, especially for organizations governed by legal • Greater insight into current market pricing
compliance • Superior savings as a result of the competitive dynamics
• Speedier RFP cycle times by automation and simplification of • Less time spent negotiating best-and-final pricing
the RFP response collection and analysis process
• Cost savings associated with a paperless process There are virtually no limitations to what can be sourced via
reverse auctions, including the following examples:
Unlike the process that uses an RFx tool, in which suppliers • Raw materials (such as iron ore, crude oil, and natural gas)
have no insight into bids from other suppliers, a reverse auction • Processed goods (such as steel, chemicals, and polymers)
is a process in which suppliers participate in an openly competi- • Business services (such as travel, accounting, printing, and
tive bidding event in real time, using a Web-based application. legal)
Suppliers receive a login and use a Web browser to access the • Components and subassemblies (such as molded or
application. Once they are logged in, the software gives them machined parts, electronic components, or finished
the following tools to assist in their bidding: products)
• An area to place bids • One-time capital buys (such as cell towers or laboratory
• Summary information indicating the status of the auction, equipment such as freezers or centrifuges)
details about the marketplace, and the supplier’s competitive
position in the marketplace
• Question-and-answer functionality, such as instant
messaging
• Online help
Auctions generally occur in a compressed time frame,
anywhere from 20 minutes to a couple of hours. Typically, the
auction provider will also offer a telephone hotline for bidders
to call if they have questions during the live auction.

The role of an auction is an alternative to one-on-one negotia-

tions with each supplier. Auctions are meant to obtain best-
and-final bids from qualified bidders; they never eliminate the
need to manage a sound sourcing process.

5
WHEN TO USE REVERSE
AUCTIONS
Guidelines for when and how to use RFP only, RFP plus reverse For companies that are just starting to conduct reverse
auction, and reverse auction only, on the basis of spend charac- auctions, the best practice would be to use an RFP process plus
teristics, can help you determine the right tool for your an auction. The buyer would use the RFP to prequalify suppliers
electronic-sourcing (e-sourcing) strategy. (See Figure 1.) and obtain quotes before running the auction event. By obtain-
For example, auctions are not recommended for a spend category ing quotes as part of an RFP process, the buyer gets a good sense
with highly customized specifications where only a small of the market pricing and can determine the auction parame-
number of suppliers have the appropriate manufacturing capa- ters with greater confidence. This process ensures the least risk
bilities. However, for a commodity or off-the-shelf item that and greatest success of an auction event.
has a manufacturer’s part number, you could directly run an
auction by inviting dealer-distributors to the event.

E-Sourcing Strategy
Use of RFP Process Use of RFP Process Use of Reverse
Only and Reverse Auction Auction Only
Spend Complex Custom Generic
Characteristic
Specifications Developed jointly by Created by buyer Defined by
supplier and buyer (may be patented) industry standard
(may be patented)

Market driver Value only Value and price Mostly

price/volume
Industry Not very competitive Competitive Very competitive
competitiveness (monopoly/oligopoly) (commoditized)

Supplier availability Single or few Many Very many

(large pool)
Riskiness of Very high Medium Low
switching suppliers
Supplier Strategic Limited Transactional
relationship
Switching cost Very high Medium/low Negligible
Level of detail High Medium Low
for supplier
qualification
Supply lead time Long Medium Short/immediate
Spend examples Patented carbon block Plastic enclosures; Noncustom
filter; patented drug circuit boards; packaging; bulk
delivery system machined parts chemicals; lab
supplies
Figure 1: How to Determine the Right E-Sourcing Strategy

6
SELLING AUCTIONS TO
INTERNAL STAKEHOLDERS ENSURING SUPPLIER BUY-IN
At a macro level, the trend for reverse auctions is steadily In order to ensure a successful reverse auction event, the buyer
increasing. Analyst firm AMR Research predicts a compound also needs to sell the concept to and get buy-in from suppliers.
annual growth rate of 12% through 2010 for revenue from Some selling points to suppliers are as follows:
sourcing applications (spend analytics, RFx, reverse auctions, • Auctions can reduce the sales cycle time, as award decisions
and contract management).1 However, running auctions is still can be made very quickly upon the completion of the bidding
a relatively new and unfamiliar process for many companies. event.
Thus, it is important to sell the concept internally to the buying • Auctions offer transparency and set an even playing field,
organization. since all suppliers follow the same rules of engagement.
• Participating in one auction event for an organization may
The key to ensuring a successful auction program begins with create opportunities to sell to other divisions or business
developing an organizational reverse auction goal in terms of units.
monetary value, number of events, and target spend categories. • Awards are made on the basis of more factors than just price,
Once your auction goal and strategy are in place, your next step including quality and service level.
is to align them to specific business units and individuals using • Auctions promote fair competition driven by market
specific metrics. For example, your organization has buyers who dynamics.
need to execute two auction events in the first 90 days of start-
ing an auction program, followed by three events on an annual
basis. The objective is to determine the criteria to identify those
spend categories that will deliver double-digit savings in an auc-
tion event and establish proof of success. You can offer buyers
the following key selling points of auctions:
• Auctions save a tremendous amount of time compared with
one-on-one negotiations.
• The dynamic nature of auctions drives pricing to levels that
cannot be achieved in one-on-one negotiations.
• Auctions provide objectivity and transparency in the supplier
selection process.
• The time savings generated through auctions can be used on
more strategic initiatives.
• Auctions do not replace relationships; they can solidify rela-
tionships by providing an even playing field.

Once you have conducted several auction events, you should

recognize the successes and challenges by offering recognition
awards in a publicized event and documenting best practices
and common pitfalls. Such actions build confidence and
encourage adoption within an organization.

1. Mickey North Rizza, AMR Research, “The Procurement and Sourcing

Applications Report, 2005–2010,” July 27, 2006.
7
CHOOSING THE RIGHT
AUCTION SETTINGS
A successful auction event is one in which you can maximize the markets are driven by volume/market share, “leading bid
price compression by creating a healthy competitive environ- only” tends to drive maximum price compression. Conversely,
ment. To do so, you must understand the impact of the various with a value-based commodity or service such as legal services,
auction parameters: the rates per hour may vary significantly, so it is best to go with
• Visibility or disclosure rules a “rank-only” event.
Visibility refers to how much information you want to • Line item versus lot bidding
disclose to bidders. See Figure 2 for the most common types You can set up auctions so that bidders compete on prices per
of visibility rules – also known as disclosure rules – and their line item or on a group of line items, called a lot. (See Figure
applicability. 3.) Lots force suppliers to bid on all the line items in a lot.
Hence, you should package line items around a supplier capa-
Visibility Rule What It Is When to Use It and Why
bility. For example, in an auction event for labels, you can cre-
Leading bid only Bidders can see only their • Is most effective in auctions
bid and the leading bid.
ate two lots: one with line items for plastic labels and the
driven by price/market share
• Is for a category that is com- other with those for aluminum labels. However, if you are
moditized and competitive unsure of the supplier capabilities in the market, it is best to
• Has price as key factor in award
decision not create lots but simply list all line items. Typically, organi-
• Can be used with as few as two zations set up lots by delivery location, raw material, manu-
bidders
facturing process, and award strategy.
Rank only Bidders can see only their • Is most suitable when the bid
bid and rank; they cannot values have a large spread
see the leading bid. • Features value-based
categories
• Has a supply market sensitive
to price disclosure
• Has price as weighted factor in
award decision
• Needs at least six to eight sup-
pliers for a successful event

Leading bid and rank Bidders can see the • Is used in events with a large
leading bid and their number of bidders (more than
rank. 30) and lots
• Is used as a mechanism to
establish a “preferred supplier
base” for subsequent auctions
comprising actual line-item
awards

Figure 2: Visibility Rules and Guidelines

Do you want bidders to see just the leading bid, or do you want
them to see the leading bid and their rank? Alternatively, do
you want to hide bids and allow bidders to see only their rank?
Each of these visibility rules has an impact on the level of
bidding activity and competitiveness. With commodity items
such as standard (noncustom) packaging or copy paper, where

8
 Line-Item Type What It Is What It Does and When to Use It • Bid decrement
You can specify two types of bid-decrement parameters: per-
Line item A line item is an individual item • Enables the buyer to cherry-
on which the suppliers can bid.
centage or monetary value (such as dollar or yen). Determin-
pick on a line-item basis to
Bidders enter the price per line come up with the lowest award ing the right bid decrement is extremely important to the
item. mix; however, note that suppli- success of an event. A too-large bid decrement will prevent
ers can also then cherry-pick
which items on which to bid some companies from bidding and thus reduce competition.
• Provides more visibility into Also, when there is a wide range in the price of the line items,
pricing
• Used when the buyer is unsure you should use percentage instead of a monetary amount.
of volume demand • Beating leading bid or beating own bid
Beating leading bid generally works better in forward
Lot A lot is a grouping of line items, • Enables the buyer to get bids on
based on delivery location
auctions, which are used by suppliers to solicit buyers, than
low-margin or low-volume
(Boston or Houston, for exam- items on which suppliers might reverse auctions. For reverse auctions, you should have sup-
ple), raw material (plastic labels not bid if the items were listed pliers beat their own bid. This allows suppliers to give the best
or aluminum labels, for exam- individually
ple), manufacturing process • Enables the buyer to consoli- possible price on the basis of their costs and processes. In a
(through-hole technology or date the supply base strategic sourcing process, price is only one factor of supplier
surface-mount technology, for • Used only if the volumes indi-
example), or award strategy (lot A cated for bidding are actual selection. Often, you may find that the lowest bidder is not
or lot B or winner takes all, for volumes, not estimates, that meeting quality and service grades and thus may select the
example). Bidders enter the price will translate into award vol-
per line item for each item in the umes
second-lowest bidder. In such situations, you want to ensure
lot; the application calculates the that the second-lowest bidder has given you its best possible
extended value (price multiplied
by quantity) and uses the extend- price.
ed value for visibility and bid- • Duration and use of extensions
decrement rules.
The duration of an auction depends on the number of line
items and the number of suppliers participating. For auctions
Figure 3: Line Items and Lot Bidding Guidelines with 15 to 20 line items (and four to eight suppliers), the min-
imum auction period recommended is 20 minutes. However,
If you have a large number of line items that make up the total bidders commonly wait until the last few minutes to place
spend, you can use a market-basket approach. With this their bids. In order to ensure an even playing field, you
approach, you select a cross section of line items – on the basis should enable time extensions, which would kick in only if
of delivery location, raw material, manufacturing process, and bids are placed in the last few minutes of an event, thus
so on – to create the market basket. You can then choose to use extending the period of the event for an additional few min-
a line-item or lot approach. Note that the goal of market- utes. The number of extensions largely depends on the num-
basket-type events should be to identify and establish contracts ber of line items and number of bidders.
with a group of preferred suppliers for the organization. Each
division or subsidiary of the procuring organization then con- For events with more than 20 line items, you should use a stag-
ducts independent auction events with this select group of sup- gered open or close; this enables bidders to focus only on those
pliers to make the final award. line items that are currently open so as to not overwhelm the
bidders with the bidding activity.

9
RUNNING AN AUCTION
The approximate timeline for a reverse auction – from 3. Determine the auction strategy and rules, and then
determining the category to capturing savings – is between four build the event.
and six weeks. However, the timeline can vary dramatically, Once suppliers are on board – and, if necessary, the buyer has
depending on the type of category and whether the category received initial bids through an RFP process – the buyer needs
has been previously sourced. For example, conducting an auc- to analyze the bids to determine the best strategy and parame-
tion event for a highly commoditized product or service could ters for the event. This is explained in detail in the “Choosing
take an experienced buyer as little as one week, whereas a full- the Right Auction Settings” section of this white paper. The
blown selection in a new category would start with an RFI, then buyer then sets up the auction event.
an RFP, and then an auction, with the entire process lasting 4. Train suppliers.
from two to six months or more. Once the auction is built, the buyer should conduct a Web-
based training event to demonstrate to suppliers how to navi-
Take the following steps to run a successful auction: gate the auction tool and place their bids, as well as answer
1. Determine category spend amounts and specifications. any questions related to the auction event.
The first and most important step in any sourcing process is 5. Conduct the live auction.
to obtain accurate and comprehensive category spend data For the live auction event, suppliers log on to the Web site
and specifications. Data to be collected includes historic and place their bids. Ensure that all suppliers have access to
annual spend, estimated future spend, line-item detail (last the buyer’s hotline for any issues that may arise during the
item price or average item price for last year), annual usage auction event. It is important to keep communication lines
quantities, pricing trends, market assessment (such as level of open with suppliers during an auction for any questions that
fragmentation), current specifications/drawings, and may come up during bidding.
commercial terms (such as payment terms, shipping require- 6. Award business.
ments, and so on). Run bid analysis reports to analyze bids, determine the award,
2. Identify suppliers and get initial quotes. and execute the contract or issue the purchase order. The
Identify suppliers to invite to the auction event, including any buyer should communicate the award decision to suppliers
incumbents. New suppliers should be required to go through within 30 days of the live event.
an RFI process to ensure they meet the basic qualifications for 7. Capture savings.
event participation. The buyer should document savings and publish the results
to other buyers within the organization and plan for the next
If your organization is new to auctions, or the category is event.
new, acquire initial quotes through an RFP process to ensure
adequate interest from suppliers as well as provide the buyer
with data to support the auction strategy and parameters.

10
CONCLUSION
Reverse auctions are an emerging tool that sourcing organiza-
tions can use to bring about huge success if executed along with
a well-defined sourcing process. Careful thought and planning
must precede an auction event in order to achieve double-digit
price compression. Organizations that have succeeded in using
the tool have the following commonalities:
• A strong mandate to use auctions
• A well-defined process to use auctions
• A centralized point of contact to drive the adoption through
best practices and to minimize pitfalls

About SAP® Solutions for E-Sourcing

SAP® solutions for e-sourcing are hosted, Web-based offerings
that help you maximize savings through fast, flexible, and sus-
tainable sourcing. With multiple solutions, deployment
options, and support services, only SAP addresses the supplier
relationship management needs of your entire procurement
organization – now and in the future.

The solutions help you attain bottom-line savings and acceler-

ate time to benefit by cutting costs and encouraging user adop-
tion. With the SAP solutions for e-sourcing, your procurement
operations can grow over time; when you’re ready, you can easi-
ly and quickly move to other SAP solutions for e-sourcing and
retain your existing investment.

If you would like to know more about SAP solutions for

e-sourcing – and learn what they can do for your procurement
organization – visit
www.sap.com/srm/e-sourcing/index.epx.

11
 www.sap.com /contactsap

50 081 221 (06/09)