When reverse auctions started off amidst the dot com boom, many viewed it with scepticism and did not think it would survive for long. However, contrary to popular expectation, this business has not only survived the dot com meltdown but has done so in good health. Rajneesh De, Srikanth RP & Stanley Glancy do some crystal gazing and try to find out where things go from here

At its launch, razorfinish.com seemed to be just another portal pretty similar to the umpteen launched during the time. However, one element that set it apart from its other counterparts was the reverse auction model it adopted (considered novel at the time), whereby hotels could post bids based on the customer’s requirements. Although today the site cannot boast of the popularity it enjoyed back then, what matters is that it is still in business something that can’t be said about its competitors.

Many believe that razorfinish was able to survive the dot com debacle only because of its reverse auction model. Though critics may say this is just one reverse auction success story in the B2C environment, it is in the realm of supply chain management, in a B2B sphere, where Net-based reverse auctions have tasted undisputed success. And with names like Maruti, Telco and Hindustan Lever swearing by reverse auctions, they have become a vital cog in the e-business wheel of the New Economy.

What are the dynamics of reverse auctions in a supply chain scenario and how do they differ from normal auctions? Typically, suppliers bid against each other for offering their wares to a manufacturer, and obviously the main criterion is that bid prices are constantly brought down. For example, an auto manufacturer would look for auto components from different suppliers, and with these suppliers bidding against each other in a reverse auction, the manufacturer might end up with considerable savings. Reverse auctions are now considered an important part of e-procurement. As more and more customers try out reverse auctions, the concept is increasingly finding acceptance as a mode of procurement.

Trade2gain’s Rakesh Malik says reverse auctions should be viewed as a complete solution and not just as cost savers

“Large buyers have today realised how critical e-sourcing is to the overall growth of a company,” says Amit Bhatia, vice president and general manager, Freemarkets, India’s leading reverse auctioneer. The potential for savings are huge as almost 70-80 percent of a company’s turnover is spent in procuring goods which leads to a massive opportunity for e-sourcing. There are already plenty of real life examples in India. SmithKline Beecham realised savings of 17-20 percent through reverse auctions for sourcing some direct materials. HLL realised savings of 35 percent through a reverse auction for an electrical wiring contract for a personal products plant. Maruti’s auction for conversion from diesel to CNG for 17 forklifts led to 40 percent savings. Even Ariba, which now conducts reverse auctions only with clients in the US has seen large savings. These include FedEx savings of 25 percent in just one sourcing event and General Dynamics saving an average of 16 percent from preliminary sourcing events on a variety of goods including copper piping, wiring and bare printed wiring boards.

The success stories do not end here. The cost-savings that Commerce One, which jumped onto the reverse auction bandwagon last year, delivered for its clients varied from 5 to 30 percent. The company’s first pilot auction event for the L&T group in Chennai for procurement of desktop computers for the entire country, resulted in a net saving of 17 percent over the offline negotiated prices with 9 suppliers participating. For the Mohan Meakins group, auctions were used for procurement of Crown. The auction was conducted from Chennai while 8 suppliers from across the country participated. For the auction value of approximately Rs 2.31 crore, savings of approx. 4 percent were achieved as compared to the last PO raised by company on its suppliers. In the subsequent auction, Commerce One delivered savings of more than Rs 1 crore

With savings of this magnitude, it’s no wonder that the market for reverse auctions has been growing over the last few years, and even though there is no unanimity on the figures, the fact that it is growing cannot be denied. Bhatia estimates the Indian market to be worth around Rs 2,000 crore, growing over 50 percent year to year. On the other hand, Rakesh Malik, chief operating officer, Trade2gain, the earliest reverse auction player in India, having started way back in 1999, feels that the market currently stands between Rs 800-1,200 crore, considering only the private sector as the main user. He adds that a compounded annual growth rate of 60-80 percent looks very much achievable.

Process dynamics

Amit Bhatia of Freemarkets says once infrastructure issues are ironed out, reverse auctions will take off in a big way

How does a typical reverse auction process work? The auctioning procedure is just a small part of the complete procurement solution that most vendors offer. The complete process can take as long as 4 months for certain items, where vendor development along with design inputs is required to be undertaken. For certain commodity based items, the process can take 2-4 weeks. The actual auction (bidding) is usually open from 2-6 hours depending on elements such as lots, participating community, value of the transaction, competition amongst bidders and buyers’ objective from the auction.

According to Mythily Ramesh, head, 01markets, the reverse auctioneer from the Wipro stable, the entire reverse auction process from the category amenability study to preparing the RFP, market making and the final online bid takes three to four weeks. She adds, “Our process is rigorous and ensures capture of all technical and commercial aspects of the client’s purchase. This helps us get all the suppliers and buyers on the same wavelength. We identify suppliers, source alternative suppliers for customers, contact them, familiarise them with the RFP and train them on bidding and rules of the auction. Our consultants, along with the buyer, decide on auction parameters such as operating price, reserve price, structuring of lots and rules of the auction event.”

What about the main players and their achievements till date? Trade2gain, the oldest in the business, has conducted more than 150 procurement auctions till date. In terms of volume, this translates to about Rs 350 crore worth of concluded business. However, Malik refuses to divulge the names of his clients. According to Ramesh, 01markets has conducted over 100 reverse auctions so far for a wide variety of materials from steel to sugar. Some segments where they have delivered substantial savings for buyers are steel, automotive, commodities (starch & sugar), freight, MRO items, infrastructure items and hi-tech equipment. 01market’s transactions for the first six months of operations (Septe-mber 2000-March 2001) for both reverse auctions and IT market place stood at Rs 55 crore. Some of its clients include Blue Star, Hindustan Motors, Ballarpur Industries and Wipro Technologies to name a few. Freemarket’s client list boasts of the likes of Telco, Maruti and Carrier. Though Bhatia refuses to give figures, he says that FreeMarkets is the leader both in terms of value and volume. He says, “A pointer to this can be seen by the fact that Telco alone e-sourced goods worth Rs 400 crore. Though we do not guarantee saving percentages,

customers like Telco have saved 15 percent while Carrier Aircon has saved 18 percent of their total purchasing costs. The end result for the company is a high return on investment.”

CommerceOne’s clients include DCM Sriram Consolidated, Hindustan Motors, Larsen & Toubro, Apollo Tyres, Hindalco Industries, Indorama, Hero Cycles, Godrej & Boyce, Mahindra & Mahindra, Ballarpur Industries, Mohan Meakins Group, Berger Paints, Carrier Aircon, Escorts Hospital and Research Centre, Fedders Lloyd Corporation, HCL Infosystems, Honda Power Products, Iris Computers, Tata McGraw Hill Publishing Company and NEI Bearings amongst others.

Other advantages

But apart from cost savings, are there other advantages to be gained out of reverse auctions? Malik feels that if the client only wants to use reverse auction as a price reduction tool and gives no credence to the market making services which are a significant part of the overall procurement solution, then only the client will be the loser in the long term. Savings are linked to input costs and can only be ensured in the first few transactions of a particular item. The ongoing benefits of reverse auctions are in negotiating prices and obtaining prices that are the most competitive at the time of conducting the auction. Along with monetary benefits, the client can expect benefits such as cycle time reduction in price negotiation, access to a larger base of vendors, technology based vendor evaluation, transparency in negotiations and benefits of an outsourced process.

Adds Vivek Agarwal, chief operating officer, Commerce One, “Reverse auction leads to greater transparency in the process and a more objective basis for deciding contract awards. It removes emotion from the process and leads to better understanding of supplier behaviour and economics. It also leads to better focus on strategic issues vis-à-vis transactional negotiation issues and lowered paper work/manual effort.”

The other advantage is obviously how reverse auctions have re-defined eProcurement. “eProcurement as a concept,” says Ramesh, “has dramatically changed corporate purchasing patterns, the world over. Companies are using the power of the Internet to improve the efficiency and effectiveness of its purchasing processes. As e-business matures, companies are increasingly migrating to purchasing or procuring goods through the Web. The migration to eProcurement provides tremendous return on investment with relatively little risk for companies who Web-enable the buying function.”

eProcurement solutions have an appeal because they span across multiple industry segments. The timeless question for purchase managers and production managers is how to extract lowest total cost without compromising on procurement time, delivery schedules and quality. eProcurement adequately addresses these concerns, while optimising costs. Studies have shown that a 5 percent saving in procurement costs translates into an effective increase in sales growth of 30 percent. Moreover, purchased products and services are the single largest expense in most organisations, accounting for 50-55 paise of every rupee spent. Any reduction in procurement costs translates into a rupee-for-rupee increase in profits. By contrast, external factors, such as overheads, cost of sales and profit margins dilute improvements in other functional areas such as sales.

What about the revenue model of these reverse auction players? 01markets works on a fixed and/or variable fee composition with its clients. There is a fixed fee and the variable component is either a transaction fee or a percentage of the savings generated for the client. Freemarkets charges a client a fixed price based on volume, which is close to 1.5-2.5 percent of volume. Trade2gain charges its clients as per the following schemes: one, fixed monthly fee linked plus percentage of savings; second, a fixed fee per transaction and finally, a percentage of savings.

The benefits from supplier discovery through auctions will not accrue unless there is sufficient liquidity or participation on an exchange. Auctions have set off alarm bells in supplier communities and many are unwilling to participate due to the fear of being commoditised. Says Bhatia, “In order to ensure participation and to get the best price, it is essential to deal with supplier concerns that auctions will not result in under-bidding without crediting them for other aspects of their offering.”

Challenges on the horizon

Says Ramesh, “One of the biggest challenges that we faced early on, that of convincing customers to try reverse auctions leveraging our market making expertise and technology. We were fortunate to have many customers realise the benefits of reverse auctioning early and do auctions with us as a proof of concept.” She adds that today, customers have not only been convinced of the benefits of reverse auctions, but have also become brand ambassadors for 01markets. Moreover, most vendors feel the acceptance of reverse auctions in the wake of the economic slowdown is far greater than it was couple of months ago.

Bhatia feels that the industry is still in an evolutionary phase. The CFO (chief financial officer) who is responsible for a majority of the decisions involving purchasing, rarely gets the CEO’s attention, who is responsible for taking top management decisions involving processes like reverse auctions. Therefore, there has to be a considerable change in mindset for adoption of processes like reverse auctions. The common problem, infrastructure, affects this industry too as clients need robust telecom networks for transactions to take place on a smoother scale.

Bhatia suggests that the government should take some forward-looking steps and adopt e-sourcing on a major scale. Everyone knows that the government is a very large sector with large monoliths in sectors such as Railways, Defence, Oil and Gas. In many of these PSUs, purchasing is not done in a transparent manner. By adopting e-sourcing, the government can save money in a huge way. The government of India should take a cue from the US and Singapore governments who have adopted e-sourcing in a major way.

01markets’ Mythily Ramesh believes once a customer is convinced of the benefits of the business, uptake will be quick

In India, though awareness is growing, it has yet to convert into adoption. Very few companies like Telco, Maruti, Hindustan Lever, Wipro and Carrier have showed the way with their early adoptions. Revenue wise, the difference in revenue in India and the US is high. For example, if a material sells for Rs 100 in the US, the actual price may be Rs 60 with the rest being labour and other taxes. But in India, with labour costs being very low, the difference between the cost of the material and the actual price is not very high. Hence the potential for cutting down costs in labour is less than with a market like the US. Due to this, if one earns say, 15 percent on the total volumes of a particular product, in India, it will be only 10-12 percent.

But what about security concerns in a free auction scenario where the bidding parties should be prohibited from knowing each other’s prices? Each bidder for a procurement transaction has to go through an exhaustive selection process before they are invited for participation in the actual bidding process. Specific IDs and passwords are provided to bidders after payment of an earnest money deposit which can be anywhere between Rs 5000-5,00,000. This process leaves very little scope for playing with the system. The software solution has built in security checks and balances to ensure that no unauthorised bidder can participate in the bidding process. Also, data encryption is used to ensure that data travels safely.

Another important issue is in case of bidders from overseas, how do vendors handle the differences in laws which may be contrary to each other. “In case of bidders from overseas we have to take care of the differences in the cost stack up, the duty structure, the freight costs and the currency differences. This we take care of during our market making process which includes the RFP preparation and compliance from the suppliers so that suppliers are clear what stack up they have to put,” says Ramesh. “The same is also incorporated in our software before an auction. Through this process, it ensures that all suppliers are brought on the same level so that comparison is easier and suppliers and buyers are very clear about the pricing before the auction starts.”

However, Malik feels that this does not usually present a big challenge, because for each procurement activity “we have to understand the entire legal structure around the transaction completely along with the client and then work out specific solutions for specific products.” There are tools available with vendors which help them use extensive customisation for handling events of a complex nature. For countries where there are different tax structures and issues such as anti-dumping duties, Freemarkets has incorporated intelligence into its solutions, so each of them can cater to a different market, while maintaining the core functionality of the product. Currently, FreeMarkets has over 40 different online markets to cater to different client requirements and countries.

Agarwal’s prescribed solution as used by CommerceOne: “All the electronic suppliers catalogues on our e-marketplace Gate2biz.net conform to the United Nations Standard Product and Services Code, the universally accepted standards.”

Looking forward

Where does the reverse auction industry go from here? In phase one, as in any industry, the adoption rates will gradually increase. In phase two, as the industry matures, there is likely to be a shakeout with the smaller and lesser focused players getting wiped out due to their focus on niche markets. Phase three will most likely be a phase of consolidation with larger players buying out smaller players. Though globally, the industry is in phase three with a lot of consolidation already happening, in India we are still in Phase one.

Bhatia says, “e-sourcing is not a business which can be operated locally. Local players with no knowledge of the overseas markets simply cannot last in this industry. In the future, either these players will pack off or will be bought over.” There are players in the industry who are immaturely selling auctions as a commodity and will realise over a period of time that low cost service is not the way to conduct this business. A holistic solutions approach is what is likely to develop over the next one to two years, where auctions will be available as a technology tool for corporates that can be integrated with the existing ERP of the client organisation. The industry is likely to move away from a hosted environment where the service provider does all the effort to a solutions environment where the clients will themselves conduct auctions amongst the existing base of suppliers and will approach service providers only for value added services such as market making, vendor development, international suppliers and setting up of complex RFQs/RFPs.