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A reverse auction is a type of auction in which the roles of buyer and seller are reversed. In an ordinary auction (also known as a forward auction), buyers compete to obtain a good or service by offering increasingly higher prices. In a reverse auction, the sellers compete to obtain business from the buyer and prices will typically decrease as the sellers undercut each other.
A reverse auction is similar to a unique bid auction as the basic principle remains the same, however a unique bid auction follows the traditional auction format more closely as each bid is kept confidential and one clear winner is defined after the auction finishes.
In business, the term most commonly refers to a specific type of auction process (also called procurement auction, e-auction, sourcing event, e-sourcing or eRA, eRFP, e-RFO, e-procurement, B2B Auction) used in government or private sector procurement.
In consumer auctions, the term is often used to refer to sales processes that share some characteristics with auctions, but are not necessarily auctions.
The most common application of reverse auctions is for E-procurement, a strategy used by purchasing and supply management organizations to reduce spending as part of strategic sourcing and other supply management activities.
In a typical auction the seller offers an item which they wish to sell. Potential buyers are then free to bid on the item until the time period expires. The buyer with the highest offer wins the right to purchase the item for the price determined at the end of the auction.
A reverse auction is different in that a single buyer offers a contract out for bidding (by either using specialized software or through an online marketplace). Multiple sellers are then able to offer bids on the contract. As the auction progresses, the price decreases as sellers compete to offer lower bids than their competitors whilst still meeting all of the specifications of the original contract. As the buyer is able to see all of the sellers' offers, and to choose any of them, a reverse auction is not a true auction.
Bidding performed in real-time via the Internet results in a dynamic, competitive process. This helps achieve rapid downward price pressure that is not normally attainable using traditional static paper-based bidding processes.
The buyer may award the contract to the seller who bid the lowest price. Or, a buyer may award contracts to suppliers who bid higher prices depending on the buyer's specific needs with regard to quality, lead-time, capacity, or other value-adding capabilities.
The use of Optimization software has become popular since 2002[clarification needed] to help buyers determine which supplier is likely to provide the best value in providing goods or services. The software includes relevant buyer and seller business data, including constraints.
Reverse auctions are used to fill both large and small value contracts for both public sector and private commercial organizations. In addition to items traditionally thought of as commodities, reverse auctions are also used to source buyer-designed goods and services; and they have even been used to source reverse auction providers. The first time this occurred was in August 2001, when America West Airlines (now US Airways) used FreeMarkets software and awarded the contract to MaterialNet.
In 2003, researchers claimed an average of 5% of total corporate spending was sourced using reverse auctions.
Reverse auctions gained popularity in the late 1990s as a result of the emergence of Internet-based online auction tools. Pioneer of online reverse auctions, FreeMarkets, was founded in 1995 by former McKinsey consultant and General Electric executive Glen Meakem after he failed to find internal backing for the idea of a reverse auction division at General Electric. Meakem hired McKinsey colleague Sam Kinney, who developed much of the intellectual property behind FreeMarkets. Headquartered in Pittsburgh, PA, FreeMarkets built teams of "market makers" and "commodity managers" to manage the process of running the online tender process and set up market operations to manage auctions on a global basis.
The company's growth was aided greatly by the hype of the dot-com boom era. FreeMarkets customers included BP plc, United Technologies, Visteon, H.J. Heinz, Phelps Dodge, Exxon Mobil, and Royal Dutch Shell, to name a few. Dozens of competing start-up reverse auction service providers and established companies such as General Motors (an early FreeMarkets customer) and SAP, rushed to join the reverse auction marketspace.
Although FreeMarkets survived the winding down of the dot-com boom, by the early 2000s, it was apparent that its business model was really like an old-economy consulting firm with some sophisticated proprietary software. Online reverse auctions started to become mainstream and the prices that FreeMarkets had commanded for its services dropped significantly. This led to a consolidation of the reverse auction service marketplace. In January 2004, Ariba announced its purchase of FreeMarkets for $493 million.
Fortune magazine published an article in March 2000, describing the early days of reverse auctions.
In the past few years mobile reverse auction have evolved. Unlike business-to-business (B2B) reverse auctions, mobile reverse auctions are business-to-consumer (B2C) and allow consumers to bid on products for pennies. The lowest unique bid wins.
Very recently business-to-consumer (B2C) auctions with a twist have started to evolve; they are more similar to the original business-to-business (B2B) auctions than mobile reverse auctions in that they offer consumers the option of placing a specification before retailers or resellers and allowing them to publicly bid for their business.
In congressional testimony on the 2008 proposed legislative package to use federal funds to buy toxic assets from troubled financial firms, Federal Reserve chairman Ben Bernanke proposed that a reverse auction could be used to price the assets.
In 2004, the White House Office of Federal Procurement Policy (OFPP) issued a memorandum encouraging increased use of commercially available online procurement tools, including reverse auctions. In 2005, both the Government Accountability Office and Court of Federal Claims upheld the legality of Federal agency use of online reverse auctions. In 2008, OFPP issued a government wide memorandum encouraging agencies to improve and increase competitive procurement and included specific examples of competition best practices, including reverse auctions. In 2010, The White House Office of Management and Budget cited “continued implementation of innovative procurement methods, such as the use of web-based electronic reverse auctions” as one of the contracting reforms helping agencies meet acquisition savings goals.
- Request for Quotation
- Request For Tender
- Request For Information
- Request For Proposal
- Optimization (mathematics)
- Operations research
- Definition of Reverse Auction, BusinessDictionary.com
- Beall, S., Carter, C., Carter, P., Germer, T., Hendrick, T., Jap, S., Kaufmann, L., Maciejewski, D., Monczka, R., and Peterson, K., (2003), “The Role of Reverse Auctions in Strategic Sourcing, CAPS Research Report,” CAPS Research, Tempe, AZ
- Ariba to buy FreeMarkets for $493 million | Tech News on ZDNet
- Tully, Shawn (2000-03-20). "Going, Going, Gone! The B2B Tool That Really Is Changing The World. Web Auctions Are Revolutionizing The $5 Trillion Market For Industrial Parts. In The Process They're Wiring The Rust Belt For Good". CNN.
- Memorandum for Federal Acquisition Council Agency Senior Procurement Executives, White House Office of Federal Procurement Policy, May 12, 2004
- MTB Group, Inc. v. United States, 65 Fed. Cl. 516, 523-24, February 23, 2005
- Memorandum for Chief Acquisition Officers, White House Office of Federal Procurement Policy, July 18, 2008
- Memorandum for Senior Executive Service from Jeffrey Zients, Federal Chief Performance Officer, September 14, 2010
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- Womack, J., Jones, D., and Roos, D., The Machine that Changed the World, Rawson Associates, New York, NY, 1990, Chapter 6
- Jap, Sandy D. (2007), The Impact of Online Reverse Auction Design on Buyer-Supplier Relationships, Journal of Marketing, 71(1), 146-50