Auctions in Theory
Some Basic Terminology
Auctions as a concept are, of course, not new. However the ability to conduct auctions electronically (thereby ensuring transparency, auditability and equality of opportunity to all participants) means that obstacles to their use in the public sector are largely overcome. For the supplier, electronic auctions (to distinguish them from "in-person" auctions) offer the benefit of allowing bidders to participate simultaneously, remotely and anonymously.
The term " reverse auction" simply refers to an auction in which sellers (rather than buyers) bid to provide goods or services. In a reverse auction, the price drops as sellers compete with each other to meet the buyer's requirement.
" Electronic auctions" (which, in procurement, generally mean "electronic reverse auctions") refer to auctions which are conducted using internet-based software.
Why Use Auctions?
The most frequently cited benefit of auctions is the lower prices which might be expected to result from the heightened sense of competition. Claims of price savings of around 25% are typical. Other quoted benefits are time savings (firstly, in shortening the time and effort which might otherwise be involved in prolonged rounds of post-tender negotiation and, secondly, in facilitating the re-use of auction formats) and the ability to open up a procurement to a wider market. Two further benefits of particular importance to the public sector buyer are the transparency of the process to all participants and an automatically-generated audit trail of activity.
Whether to use an auction?
As with any business tool, care should be taken to ensure that an auction is the right tool for the job. The key considerations are:
- Is there adequate competition in the supply market? If there is little competitive pressure among the participating suppliers, then the very visibility of the auction process can even lead to a "winning bid" which is higher than might have been obtained using a traditional "sealed bid" competition.
- Is the subject-matter suited to an auction? Auctions are being used successfully for a growing range of goods and services. But they tend to work best - and are easiest to design - for "commodities" (meaning not just bulk purchases but any good or service so long as it can be specified completely and accurately). Goods and services which require a qualitative evaluation can still be auctioned successfully so long as the two processes are handled in one of a number of recommended methods.
- Is there enough time to mount an auction? Auctions do not necessarily take any more time than that needed for "traditional" procurements - and may be a time-saver. However, planning for an auction may require the re-sequencing of some procurement activities (such as ensuring that technical evaluations are completed and all terms & conditions agreed prior to the auction event) and sufficient preparation time - particularly if the buying organisation has little experience of applying auctions to that particular requirement - needs to be built into the procurement timetable.
- Might buyer-supplier relations be damaged by the use of an auction? This is possible, although it is more often used as a threat by suppliers to discourage the use of auctions. In requirements of genuinely strategic importance, however, buying organisations should consider the long-term consequences and whether use of auctions to drive costs to a minimum might have an adverse effect on the quality of goods/services to be purchased.
Other considerations
Auctions may be simple in concept, but the importance of auction design to a successful event should not be underestimated. Auctions need to be both well-managed events in their own right and a coherent part of a wider procurement strategy. Setting the auction parameters, for example, may call for detailed pricing research and a degree of tactical planning. It may be necessary to compromise on the number of variables which can realistically be auctioned.
In most cases, an auction will build on a tender exercise and some form of evaluation will have taken place as a "prequalification" to the auction. The simplest cases occur where the technical or quality aspects of all pre-qualified bidders have been fully understood, have been fully evaluated, and can be taken as being equally acceptable, so leaving price as the sole differentiator. In most cases, however, there will be a need to combine the results of the auction with a separate technical or quality assessment.
The intense nature of auctions makes it even more important than normal that the buyer ensures that suppliers do not make unacceptable cuts in quality or other less-visible areas (such as any attendant service elements) in response to what they might otherwise perceive as a focus on price from the buyer.
Auction bids can be considered to be legally binding on suppliers only if all other aspects of the supplier's overall offer have been provisionally agreed upon. (Even then, suppliers will sometimes state before the auction that all their bids should be regarded as non-binding.) So it is generally preferable for the buyer to be in a position to conclude the contract with the winning bidder as soon as possible following the auction. (But note that, where the EU directives apply, a delay of around 10 working days between identifying the winning bidder and notifying unsuccessful bidders will usually be needed to meet the requirements of the Alcatel ECJ case).
Sources of further information:
Policy aspects of auctions are covered by the OGC's website at: http://www.ogc.gov.uk/index.asp?docid=1001034
Policy on the use of electronic auctions
Are public sector organisations permitted to use auctions?
Yes. Nothing in the existing directives prohibits the use of e-auctions and the position is clarified in the new European Directive on public sector procurement (Directive 2004/18/EC, due to be implemented in Scotland by January 2006). It is recommended that the rules in the new directive relating to e-auctions are applied to current activity. And, while it is less clear whether buyers can insist that suppliers participate in an electronic auction , it is always possible to arrange for a proxy to participate on a particular supplier's behalf.
What rules surround the use of auctions?
Advance warning. An intention to use an electronic auction during a procurement should be communicated to suppliers as early as possible in the procurement process - preferably at the outset. (Procurements advertised in OJEU must state an intention to use an auction in the contract notice.)
Supplier anonymity. The identity of each supplier should be withheld from other bidders during the auction. (This is a standard feature of most auction software, with only the buyer's view showing all bidders' identities.)
Proxy bidding. Where a supplier is unable (or unwilling) to take part directly in an electronic auction event, they can nonetheless still take part by means of proxy bidding (i.e. using an agent to input bids working on the supplier's instructions).
Must auctions always be based on price only (i.e. won by the lowest bidder)?
No. As with all procurements, what constitutes best value for money may be determined either by reference to lowest price or to the "most economically advantageous tender" (MEAT). The most obvious use of auctions tends to occur where a focus on lowest price can be pursued (for example, in commodity purchases or where the evaluation process can yield a number of "pre-qualified" suppliers with otherwise undifferentiated offerings). But auctions can also be used where MEAT criteria are used, by combining the auction results with a separate technical or quality assessment.
In any case, the buyer should always take the precaution of communicating to suppliers that the lowest bidder during the auction might not be the winner of the contract and that the winning bidder can only be determined after taking account of all the evaluation criteria. There may be a very few cases where the buyer feels confident that they can afford the risk of a "race to the bottom" but, as with other methods of procurement, an abnormally low bid may need to be investigated and rejected. It is important, therefore, that other bidders understand that it is in their interests to submit their own best possible offer even if it does not overtake a seemingly unbeatable bid. (For this reason also, the buyer will normally not wish to use the "Enforce Best Bid" feature available in some auction software.)
In some cases it may still be possible to achieve a "straight" auction contest (i.e. where the winning bid can be determined solely by reference to the unmodified bids made during the auction) by converting all remaining variables to "price equivalent" elements which are included in the auction. (An example might involve "bronze/silver/gold service levels" with their corresponding values to the buyer.)
How can auction results be combined with a quality assessment?
There are two permitted methods of proceeding, as follows:
- Run the auction as a "handicap race". This approach requires all aspects other than those which will be subject to the auction to be evaluated prior to the auction event and the results converted into a mathematical system of weighting factors. These weightings are then used within the auction itself to modify the value of each bid as it is submitted. This "transformational bidding" allows bidders to see how they are placed "in real time" with the (probable) winning bid being clearly identifiable at the auction's close.
- Employ the equivalent of a "two envelope" system (not permissible for contracts subject to the EU procurement directives). In this approach, the auction and the quality evaluation (sometimes called a "beauty parade" in this context) are kept entirely separate and the results of both are combined only after both processes have been completed and according to a transparent and previously agreed formula. A major drawback to this arrangement is that the bidders (and the buyer) cannot tell when a bid is a "winning bid" and this may act as a disincentive to competitive bidding It can also be difficult to prevent "leakage" (or simple double-counting) between "auction elements" and those "non-auction elements" that are subject to the "pure" quality evaluation.
It should be clear from the above that the evaluation of all "non-auction" aspects should either be completed prior to the auction event or be capable of proceeding to a conclusion independently of the auction. Further, the method by which the results of the auction will be combined with the evaluation of all "non-auction" elements should also be determined before the auction.
Electronic Auctions and eProcurement Scotland
Links:
eSourcing Scotland link
For more information, contact:
Neil Stewart, eSourcing Specialist
Tel: 0131 244 3509
email: neil.stewart@scotland.gsi.gov.uk