Reverse Auctions Set Low-Bid Traps

August 19, 2004
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Every so often, innovations come along that are proclaimed to be the best thing since sliced bread. They promise to make old processes easier, old methods less costly, and old ways of doing business obsolete. All of these qualities have been attributed to the newest dog in the bidding kennel: the Internet reverse auction.

By now, most people know what an Internet reverse auction is: an Internet-based method of bidding for the supply of goods and services. Simply stated, after a certain number of rounds of bidding, during which competitors can see each other's bids, the lowest bid wins.

The process started out as a method of procuring commodities - objects that don't vary much. Companies that host these reverse auctions for commodities claim that the process saves time and money.

In the last year, Internet reverse auctions have been extended to the procurement of construction services. Companies that host reverse auction sites for construction services are now making the same claim: that the process can be accomplished in a shorter time and will result in lower prices for owners.

As every contractor knows, though, construction services bear little resemblance to commodities. Bidding for construction jobs is a dynamic, volatile, and complex process. Every construction project is unique.

Problematic

With the increasing use of these auctions by owners and some attention in the trade press, a number of organizations have studied the situation and have put forth some guidelines that careful contractors would do well to consider.

One study came from the Construction Users Roundtable (CURT), an organization representing owners whose goal is to "keep construction and maintenance costs competitive." In its Guidelines on the Use of Reverse Auction Technology, CURT details a number of possible advantages and drawbacks.

For owners, advantages include the possibility of more competitive bids. Bidders may profit from knowing how their bids compare to their competitors'.

Possible drawbacks for owners include the fact that well-qualified bidders may not participate be-cause they don't trust the process, the lowest possible price may not in fact be offered, and bidders may perceive cost as the only matter of importance to the owner.

The Mechanical Contractors Association of America (MCAA), Rockville, Md., studied Internet reverse auctions from the point of view of contractors. During the latter part of 2003, an MCAA task force studied the reverse auction process and released a statement in March 2004. The first sentence of the statement is short, to the point, and cautious:

"MCAA considers the use of Internet reverse auctions for procurement of construction services to be problematic for owners and contractors alike."

MCAA and other specialty construction trade associations have worked hard over the years to combat an across-the-board policy of low-bid, price-only selection criteria. The Internet reverse auction process seems to represent a step backward.

From the point of view of contractors, the low-bid, price-only standard can easily lead to a number of undesirable outcomes, including fragmented scopes of work, disputes, unnecessary changes and delays, and overhead waste relating to defensive contract administration, claims, disputes, and lawsuits.

Ultimately, these outcomes can lead to diminished project quality and increased life cycle costs.

Necessary Qualities

It comes as no surprise, then, that many of the innovations in construction procurement, contracting, and project administration over the past 20 years have been in direct response to the inefficiencies that stem from low-bid, price-only selection criteria.

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.

The MCAA statement points out that many applications of e-commerce and Internet use have been valuable to the construction industry and represent real progress.

However, it regards Internet reverse auctions as a use of a new technology to allow the industry to regress, throwing away the project efficiency gains that have resulted from innovative, value-added contracting procedures.

The statement acknowledges, however, that Internet auctions are not going to just up and disappear because MCAA and many other construction trade associations disapprove. In fact, reverse auctions may actually be appropriate when certain elements are present. The MCAA statement describes some of the qualities necessary for optimum use of Internet reverse auctions:

  • A well-defined scope of work is essential, because reverse auctions are least likely to lead to problem jobs in those cases where the owner has firm, detailed design drawings and specifications.

  • Best-value prequalification criteria should be strictly applied and should include demonstrated superior past performance related to project performance overall, including cost and schedule delivery; project safety experience; workforce training and development investments; and project management and site supervision expertise relating to equipment purchasing and other aspects of contract administration.

  • Reverse auction procedures should also provide maximum transparency in the interest of fairness for all competitors. The identity of all participants should be disclosed, as well as the dollar amount and ranking of all bids. The owner also should disclose the existence and amount of any reserved price above which the project would not be let.

    Auction procedures should provide careful safeguards against both imprudent and administrative mistakes in bidding, as overall project success is strongly compromised by mistakes in selection decisions.

    The experience of some contractors suggests that the sometimes-frenzied reverse auction process often results in hasty and unwise bidding. Clerical mistakes also should be excused in the auction process in the same manner they would be treated in the sealed bidding context.

  • The procedures should provide adequate safeguards against fraud and abuse, including express warranties against fictitious ("phantom") bidders and other conditions that would constitute fraud in the inducement of the contract award.

    Do Homework

    In general, most of the construction trade association responses to Internet reverse auctions advise contractors to follow the same good business practices they use when negotiating a job or submitting a sealed bid.

    A history of dealing with the owner is beneficial; at the least, knowing the owner's reputation is important. If the owner has a good reputation for valuing a contractor's excellence in project management, it probably follows that the owner will not change its character just because it is using an Internet reverse auction to take bids.

    Doing your homework on the owner and the project specifications is no less important with Internet reverse auctions than under traditional bidding processes.

    Gentille is with MCAA. He can be reached at 301-869-5800 or by e-mail at jgentille@mcaa.org.

    Sidebar: U.S. Army Corps of Engineers Nixes Reverse Auctions

    The U.S. Army Corps of Engineers (USACE) issued a strongly worded and detailed negative finding against reverse auction e-sourcing for construction projects.

    USACE did find, however, that e-sourcing was appropriate for commodity/spare parts/raw material procurement in some instances. Moreover, the USACE report also agreed in full concert with MCAA's position in favor of best-value procurement for construction services as opposed to uniformly applied low-bid selection procedures.

    The USACE findings and report were based on a Congressionally mandated pilot project carried out in 2002 and 2003 testing Internet reverse auctions on some nine procurements, five of which were construction projects - two of those resulted in bid protests, and one of the protests was upheld.

    "There is no valid method to project ‘savings' by the use of reverse auctions for construction services" (emphasis in the original), the USACE report stressed, adding, "Construction services cannot be equated with or treated as commodities such as spare parts, manufactured goods, or basic raw materials."

    USACE went on to explain:

  • " ... In reverse auctioning ... the contractor is provided with multiple rapid chances to submit multiple rapid bids. And, he does know the relative ranking of his bid versus the bid of other contractors between each round of bids. Hence, the contractor can engage in bid gaming from his very first bid to his very last bid, because he is not forced to play his very best hand up front due to his multiple chances to bid."

  • USACE also emphasized that the reverse auction process is more complex, labor intensive, and expensive as compared with the traditional sealed bidding ("set it and forget it") process, which also forces competitors to submit their best price the first time or risk losing the job altogether. USACE concluded, "Reverse auctioning is neither an efficient nor effective method to procure construction services."

    Furthermore, USACE went on to agree with MCAA's position in support of a 2003 Office of Federal Procurement Policy memorandum, re-emphasizing that construction services should not be defined as commercial items/commodities for purposes of Federal procurement procedures. (There had been an attempt by some civilian agencies to buy construction services under commodity purchasing rules.)

    In full concert with MCAA's position in favor of more discerning best value purchasing procedures instead of uniformly applied low-bid selection decisions, USACE concluded:

    "DoD contracting has long since progressed from non-productive, dogmatic thinking that one size fits all. As such it no longer exercises the erroneous and misguided reasoning that the best stewardship focus in procurement is always the lowest price. In a ‘best value' procurement, price may not be the sole or the major factor for determining an award. ... In a ‘best value' procurement, price/cost simply becomes one of many independent variables for review and evaluation to determine the best award."

    See www.mcaa.org for a complete copy of the report.

    - John McNerney, of MCAA

    Publication date: 08/23/2004

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