Do online auctions adversely affect quality or not?

Electronic reverse auctions1  are becoming increasingly popular. However, the emphasis on price means they could stand in the way of a lasting relationship between the buyer and the supplier, with all the associated consequences. A team which included Professor Steve Muylle and post-doctoral researcher Willem Standaert has examined whether this is the case and if so, how it is possible to guarantee honest communication between buyers and suppliers.

From a few weeks to a few minutes

In a traditional procurement procedure, the buyer will receive several tenders which he will analyse before inviting one or more suppliers to put forward a better price. Depending on the number of iterations, a process like this can easily take several weeks. By using digital technology and organising the procurement procedure as an online auction, the turnaround time can be reduced to as little as ten minutes.

In the case of a classic auction, whether online or otherwise, interested bidders bid against each other and the lot is awarded to the highest bidder. In the case of an electronic reverse auction, interested suppliers who can supply what the buyer is seeking offer their products and/or services online for an increasingly low price, within a predefined time span. The lowest bid wins.

Winner’s curse

‘For buyers, the benefits are clear: the procurement process is faster and cheaper and they can retain a complete log of all the offers,’ says Willem. ‘Suppliers also benefit as a result. Electronic auctions provide insight into market prices and also make it easier to participate in procurement processes all over the world, thus increasing their market coverage.’

‘But just like in classic auctions, the winner’s curse applies here too,’ warns Steve. ‘The cheapest supplier may have got the job, but the question is at what cost? If a supplier feels that he is being squeezed too hard, he might well try to make the deal profitable anyway by cutting corners when it comes to quality or service, or by charging for all kinds of extras.’ And poor service or a supplier who does not provide what he promised means a painful wake-up call for the buyer and his organisation.

Satisfaction is not a question of price

An initial study in the form of a survey among buyers (see box) examined which results of a reverse auction led to satisfaction on the part of the purchasing organisation and what constituted the critical success factors. For these results, the team worked on the basis of a conceptual model developed by Amelinckx et al.2  which distinguishes between three types of results: (1) financial, i.e. price benefits, (2) operational, i.e. cost savings, shorter turnaround times and the quality of the offer and (3) strategic, i.e. the quality of the relationship, learning effects and the simplification of the supplier base.

As expected, the level of satisfaction grew as the results improved. However, the impact was not the same for all the results. Certain operational and strategic results, i.e. shorter turnaround times, the quality of the offer and learning effects – knowledge gained during an auction which could prove useful in future auctions – had the biggest impact, while no significant effect was observed as a result of price benefits and cost reductions, for example. This seems odd, as buyers usually try to achieve the lowest possible price. According to Willem, this striking result can be explained as follows: ‘In an initial electronic reverse auction, the price benefit does have a significant impact on the satisfaction levels. This is logical, as you would expect the price benefit to be considerable the first time round. In successive auctions, it will not be possible to repeat the initial price benefit and other factors will therefore weigh more heavily.’

Critical success factors

The survey also showed that the experience of the project team involved in the electronic auction has a favourable influence on the financial results. This means that the support of the top management is crucial for the strategic results. For the operational results, it is mainly the organisational effort – the way in which the organisation involves various different roles in these kinds of auctions – that makes the difference. ‘If it is not only the purchasing department but also quality and production that have a say in the matter, this lessens the overly strong emphasis on price and also helps to achieve other results which lead to satisfaction,’ explains Steve. ‘This means that you can have greater control over the results by paying extra attention to specific factors.’

Fair procedures make all the difference

The results of the survey also showed that the use of procedural fairness by the purchasing organisation has a favourable influence on aspects such as the quality of the offer and the relationship, and therefore on the buyer’s ultimate level of satisfaction. A fair process involves transparent communication about the specifications of the tender and the auction and objective decision-making criteria, which do not discriminate. Steve and Willem examined the effect of such a process in more detail in a follow-up study.

‘This confirmed that the buying organisation can ensure it gets the price benefit it is seeking, but in a way which does not affect the quality of the relationship and the quality of the offer,’ says Steve. ‘The quality can be assured through the use of a fair process. This would seem to be common sense, but in practice you often see buyers behaving differently.’

Sceptics will no doubt object that these aspects depend on the specifications of the tender. ‘If you cannot clearly specify what is to be provided, this would make it easier for the supplier to cut corners at a later stage, for example by reducing the quality of a service. All the same, our research showed that this effect did not occur.’

Size matters

However, the size of the deal does play a role. Willem: ‘If there is a lot at stake, suppliers are more likely to go the extra mile and this will only benefit the quality of the offer and the relationship with the buyer.’

‘For organisations considering the use of electronic reverse auctions, I would say that if you use a fair process, the quality of the relationship will improve systematically in the case of repeat auctions,’ he says. ‘The impact of a fair process increases the more you use it.’

Steve: ‘It’s interesting that the results were also confirmed on the selling side. For the buyer, an electronic reverse auction remains a method of buying as much as possible at the lowest possible price. However, suppliers stated they would at least feel that the deal were fair if a buyer made it clear in advance that he would treat them fairly. If the buyer were to contact them at a later date, for example in connection with a problem or for service, they will then behave differently themselves.’

Focal points

‘According to the classic view, there is a trade-off between price and quality. Our study shows there is a way of avoiding this decision,’ as Willem summarises the results. ‘An auction will not necessarily harm your relationship with suppliers.’
 
Finally, Steve also has advice for both suppliers and purchasing organisations. Electronic reverse auctions have gained a poor reputation because of the disproportionate focus on price, to the extent that some buyers use them as a big stick to force suppliers to make price concessions. ‘Suppliers must do their homework and know their cost structure inside out, covering all possible combinations which could occur in auctions,’ he says. ‘For example, they must not make the mistake of sacrificing their R&D budget to get the deal at any price, because if you can’t innovate your business will fail.’

Purchasing is also under pressure to achieve more with fewer people and digital tools can prove useful here. ‘However, if your organisation decides to participate in electronic auctions, you must ensure that buyers are well aware what they are getting themselves into and understand the strategic implications. Training, insights into strategic sourcing and a good understanding of how digital tools fit in can help to prevent many problems. And if you do use electronic auctions, you must aim to achieve a fair process and involve the entire organisation,’ he says.

Large and varied sample survey
Of the 851 procurement professionals who were invited to take part in the online survey, 180 gave usable answers. It is very difficult to obtain details about electronic reverse auctions. As a result, a sample survey of this size is exceptional. The auctions included in the reports took place in various sectors, from the automobile industry to the pharmaceutical sector and telecoms, and related to both goods and services. The head offices of the respondents’ organisations were spread all over the world: 77% in Europe, 15% in the US and 8% in other regions. 

1 These are known as either electronic reverse auctions or online reverse auctions. The authors have chosen to use the term electronic reverse auctions.
2 Amelinckx, I., Muylle, S., Lievens, A., 2008 ‘Extending electronic sourcing theory: An exploratory study of electronic reverse auction outcomes’, Electronic Commerce Research and Applications 7, 119–133.

Sources: (1) W. Standaert, S. Muylle and I. Amelinckx ‘An empirical study of electronic reverse auction project outcomes’, Electronic Commerce Research and Applications 14 (2015) 81–94 and (2) S. Muylle and W. Standaert ‘The Use of Procedural Fairness in Electronic Reverse Auctions to Enhance Relationship Quality’, Psychology & Marketing, Vol. 33(4) 283–296 (April 2016). The studies are available from the authors.

About the authors: Isabelle Amelinckx was a doctoral researcher at the University of Antwerp and is currently a business analyst at 3M. Steve Muylle is a professor of marketing and digital strategy and Willem Standaert is a post-doctoral researcher, both at Vlerick Business School.

Accreditations
& Rankings

Equis Association of MBAs AACSB Financial Times