Online Reverse Auctions Can Be Deceiving

February 17, 2005
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Saving money has always been a prime directive for successful businesses, and for many people, online reverse auctions may look like an effective e-business tool for doing just that. But research and testimonials show that in this case, appearances can be deceiving.

An online reverse auction is an Internet-based bidding event with a fixed deadline, hosted by a single buyer, in which multiple suppliers compete for business. Goods and services alike can be obtained through this process.

During the rounds of bidding, competitors can see each other's bids, though they do not know the identities of specific bidders. In most cases, the lowest bid is selected. Online reverse auctions are now being used to find the lowest bidder on construction services. While this procurement method may appear to be a high-tech innovation, ultimately, it only propagates the negative results brought about by low-bid, price-only selection.

Construction organizations around the country, including the Mechanical Contractors Association of America (MCAA), consider the use of online reverse auctions for procurement of construction services to be problematic for owners and contractors alike. The mechanical contracting industry covers the installation and service of HVACR systems, as well as fire sprinklers, plumbing, and process piping.

Marsha Babcock, executive vice president of the MCA of Omaha Inc., said that when online reverse auctions focus on price that only advances the wrong priority.

"The real priority," she said, "is quality - quality installation done by workers with the training and experience to do the job right. Online reverse auctions do not take into consideration the reputation of the contractor or even the quality of the work. They do not investigate the contractor's track record for success in similar projects."

Bob Emiliani and David Stec of the Center for Lean Business Management are researchers on reverse auctions who have written numerous papers on the subject. Emiliani and Stec are former supply/commodity managers who used online reverse auctions.

"Fundamentally, reverse Internet auctions are a technology-assisted form of power-based bargaining," said Emiliani.

"It's a zero-sum purchasing tool where the buyer gains as a result of the supplier's loss, and that is by design. That doesn't do anything to improve business relationships. Suppliers are forced to drop their prices quickly in a reverse auction, and it all comes out of the supplier's margin. That's going to create hard feelings.

"Sometimes suppliers look to get even by retaliatory pricing - charging more at a later date. It's the same for all reverse Internet auctions, whether you're talking about purchasing goods or construction services. It's more similar than different. The whole process is oversold and it under-delivers. Buyers often go back to the original suppliers and more collaborative ways of managing costs."

Principles And Integrity Matter

Charles Ettner, corporate consultant to Miglin Properties, works with major construction projects on a regular basis, and is the first to admit he is a fussy customer. "I like to have a strong business relationship with contractors," he said. "They have to be reliable and responsible. Principles and integrity are important to me."

Ettner prefers to keep the lines of communication open throughout the entire construction process, so he can interact with architects, engineers, contractors, and other project participants. "I have to know the people I am doing business with if I expect to get a good night's sleep without having to worry about my work," he said. "That's why I would never use an online reverse auction - the process leaves too much up to chance."

Low Bid, Best Value Don't Mix

LTC A.J. Castaldo, program manager and deputy principal assistant responsible for contracting, U.S. Army Corps of Engineers (USACE), is the author of a July 2004 report to Congress on online reverse auctions, entitled "Final Report Regarding the U.S. Army Corps of Engineers Pilot Program on Reverse Auctioning."

He has studied this procurement process extensively and in his report, states, "reverse auctions are a game strategy." He goes on to conclude that these auctions are a generally inappropriate means for procuring construction services, and only in exceptional cases can it be used as a strategic tool. This method does have value in the procurement of commodities.

"The low-bid concept doesn't work with best-value standards," Castaldo said. "You can't have it both ways."

He added that online reverse auctions encourage bid gaming, a practice in which contractors do not offer their best bids initially so they can first see the bids of other contractors. Bid gaming continues through the process as contractors try to figure how low they have to go - a figure which may never arrive at the actual lowest price. "Bid gaming and related collusion are very possible in online reverse auctions," he said.

He noted that no actual research exists to prove the superiority of this method in procuring construction services.

"Construction encompasses one-of-a-kind projects built under one-of-a-kind conditions," he said.

"Online reverse auctions have no valid benchmark. They can only address theoretical savings, which have no bearing in the real world."

Online reverse auctions are also time-consuming, he said. "The online process isn't as simple as the traditional sealed bid method," Castaldo added. "And, our study did not reveal any proven savings in the auctions. If a procurement process is labor-intensive and the savings can't be proven, why should anyone use it?"

A Better Solution

In addition to the MCAA, organizations such as the Associated General Contractors, Associated Builders and Contractors, Construction Users Roundtable, and American Subcontractors Association have expressed concerns about the negative effects of online reverse auctions.

John Gentille, executive vice president of the MCAA, commented on the effectiveness of the construction industry's time-proven procurement methods.

"Value-based selection criteria, careful past performance evaluations, prequalification screening of competitors, project partnering, integrated project contracting and delivery systems, design-build services delivery, and other positive contract administration procedures were all developed to avoid the pitfalls of the low-bid, price-only standard," he stated.

These methods exemplify the straightforward, collaborative business practices required to facilitate complex construction projects. To ask contractors to compete for such projects through a time-consuming, impersonal online process only creates hard feelings while perpetuating the pitfalls of low-bid, price-only selection.

Leo Reed is executive vice president legal counsel, New England Mechanical Contractors Association and a member of the MCAA's Task Force on Direct Purchase and Internet Auctions. For more information on MCA contractors and their workforce, visit www.mcaproof.com.

Publication date: 02/21/2005

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