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In this guest post, Procurement Leaders invites CRA's Margarita Sapozhnikov to look at best practices in auctions and where the traps lie.
Auctions increasingly are becoming a standard procurement tool. From an economist standpoint this is great news, but all too often the wrong type of auction is used and in general, auction approaches still are not utilized to their full potential. Procurement auction mechanisms that are becoming more common often are too simplistic and limited in many ways.
For example, suppose you want to use an auction to procure 100 units of a product. Two common, seemingly simple, approaches are as follows: (1) a one-shot sealed-bid (sometimes referred to as a request for proposal or RFP), and (2) multiple-round bidding with each supplier bidding to provide all 100 units.
In the first case, each supplier submits an offer consisting of a price-quantity combination. So, supplier A may offer to provide 50 units at $20 per unit, supplier B offers to provide 30 units at $21 per unit, etc. You end up with an array of offers and will need to mix and match prices and quantities until you fill your order. This approach becomes cumbersome quickly and likely will not provide the least-cost supply for the purchaser because it lacks competitive bidding dynamics.
The alternative of multiple-round bidding and enforcing a "winner-take-all” outcome in which you commit to purchase from only one supplier can work well when a relatively small number of units need to be procured. However, in many cases the purchaser is much better off by allowing two or more suppliers to provide the desired number of units. Having the flexibility to contract with more than one supplier allows for a more competitive bidding outcome and lower prices (but doesn't preclude purchasing from only one supplier if that supplier can provide all 100 units at the lowest cost). Also, the purchaser may prefer to contract with more than one supplier on a large order in order to mitigate the risk of supplier default. This requires a somewhat more sophisticated or carefully designed auction approach.
With small quantity orders, the two approaches described above can work sufficiently well. For large procurement orders, or when you want to allow for two or more winning suppliers, or when you want to procure multiple products, there are better auction designs than those above. Some of the key best-practice rules are as follows:
Ultimately, your procurement process should result in least-cost supplies, predictability, risk mitigation, and efficiency. Properly designed auctions achieve those goals, but care is needed to ensure you have the right auction for your needs.
Margarita Sapozhnikov is an Associate Principal in CRA International's Auctions & Competitive Bidding consulting practice.