A reverse auction is a process in which sellers bid to sell their goods and services. The bidder at a reverse auction is the seller, as opposed to a traditional auction where the buyer is the bidder. For example, a company might put up a request to hire an accounting company for a special project. The bidder that offers to fill the request at the lowest price or best terms usually wins the reverse auction, although other factors might come into play. When conducted on the Internet, the process is called "e-bidding" or "e-procurement." Reverse auctions can be effective, but only when there is a sufficient amount of competition.
Buyers Conserve Resources
In the regular request for proposal process, sellers frequently make bids using their own formats and styles. By comparison, in Internet reverse auctions, sellers bid by filling out standardized forms and charts specified by the auction site in conjunction with the buyer. Buyers save time and money through reverse auctions because all of the bids arrive in the same format, which simplifies comparison. The buyer can easily eliminate certain bids that don't conform to deadline or price requirements. In addition, the buyer has the flexibility to rule out a low bidder that doesn't meet the quality standards set by the buyer. E-procurement software allows buyers and sellers to communicate and refine the details of the bid.
Risk of Bad Specs
A disadvantage to the buyer is the need to write detailed specifications up front for the products or services it wishes to buy. The deadline pressure of a reverse auction front-loads the need to create complete specifications. This differs from other methods, which typically involve a reiterative process in which the specifications are negotiated, corrected and refined over a period of time. Misunderstandings stemming from incorrect or incomplete reverse auction specifications can result in a buyer selecting the wrong bidder. Depending on how the contracts are written, this can be a huge, expensive hassle to straighten out. In some cases, the buyer might have to enter into a new reverse auction after fixing the specification.
Access for Sellers
Reverse auctions, especially ones on the Internet, have the advantage of allowing participants from around the globe to compete for business. This increases a seller's access to foreign markets. It also allows smaller businesses to compete on an equal footing with the big players. By concentrating on qualified buyers, sellers at reverse auctions can eliminate wasteful marketing and selling expenditures on clients that are unlikely to purchase. In fact, companies that operate primarily through reverse auctions might function with a minimal sales staff.
Rush to the Bottom
Just as in regular auctions, a reverse auction puts pressure on the bidder to outdo the competition. This might mean throwing in added services or cutting prices so low that it eliminates profits. If a seller repeatedly gives away the store at reverse auctions, it won't remain in business very long.
Competition is Key
Reverse auctions only work when there is real competition. If only one or two vendors bid, the buyer might accept terms that result in higher, rather than lower, prices. Competition also enables sellers to find different ways to compete beyond price alone, thereby providing more options to buyers. Too much competition, however, can cause bidders to make unrealistic bids that understate the final bill. Buyers benefit from understanding all of the fine print attached to each bid, so that they avoid surprises after the contract is awarded.
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.