Recommendations of the Texas Comptroller

Use “Reverse Auctions” to Reduce Procurement Costs

Summary

In an on-line “reverse auction,” the suppliers, rather than the buyers, bid for contracts to provide goods; prices start high and go lower as the bidding continues. Numerous governments are using this technique to save money and increase competition in the bidding process. State government should use this technique to obtain goods and services.

Background

Business-to-business (B2B) commerce is the fastest-growing segment of e-commerce, and on-line marketplaces are developing in almost every industry. New on-line purchasing partnerships among automakers, airlines, and aerospace companies are expected to save the participating companies hundreds of millions of dollars. General Motors, Ford, and DaimlerChrysler, for instance, plan to process $250 billion in annual purchases through a joint Web site.[1] Delta, United, American, Continental, Air France, and British Airways are also planning to create an Internet procurement company to pool their $32 billion-a-year purchasing power.[2]

Web-based procurement systems can produce significant savings for organizations in two ways. The first is by lowering transaction costs. The second way is by reducing the actual sale price of goods by creating more competition between buyers or sellers through electronic auctions.

One type of on-line procurement, the reverse auction, can reduce the actual sale price of goods, rather than transaction costs only. In a reverse auction, the suppliers, rather than the buyers, bid on-line for contracts; prices start high and go lower as the bidding continues. Unlike traditional sealed bidding processes, Internet-based reverse auctions allow vendors to see each other’s bids in real time, and decide whether they wish to make lower offers. Numerous companies specialize in setting up reverse auctions. Businesses and government agencies using on-line reverse auctions have claimed savings ranging from 2 percent to 30 percent.[3]

Using reverse auctions, the State of Pennsylvania cut its expenditures for aluminum for license plates and coal for heating by 10 percent and saved 31 percent on office furniture (Exhibit 1).[4] (Some of these savings may be attributable to aggregated buying power, since these reverse auctions marked the first time the state had bought some of these commodities on a statewide, rather than a regional, basis.)

The federal government has recognized the potential of reverse auctions, and the federal General Services Administration (GSA), the US Postal Service (USPS) and the US Navy are all using or planning to use reverse auctions.

Exhibit 1

Results of Pennsylvania Reverse Auctions

* Indicates that costs are higher using reverse auction.

** Total reflects savings only.

Source: Pennsylvania Department of General Services.

The Navy’s Supply Systems Command conducted an online auction on May 5, 2000 to buy parts for airplane ejection seats. The historic cost for the parts was $3.3 million. In less than an hour of bidding between three pre-qualified vendors, the lowest bid came in at just below $2.4 million, a 28.9 percent savings.[5] A second auction for shipboard aluminum berthing saved the Navy $2.8 million.[6]

GSA has developed its own site to host reverse auctions for computer hardware and software, and will begin a six-month pilot program in Summer 2000 to test whether federal agencies can pool orders to drive prices down further.[7] In addition, a company providing reverse auction services has been added to GSA’s procurement schedule, allowing federal agencies to hire the company to conduct on-line reverse auctions of their own.[8]

The Defense Logistics Agency has applied for a waiver to use reverse auctions for some of the $3.5 billion in fuel it buys each year for planes, ships, tanks and military bases.[9]

USPS used an online reverse auction to solicit bids on preprinted and prestamped envelopes, fuel, and leases on truck trailers. The service hopes to save 10 percent on envelopes, $5 million to $7 million on fuel, and $3 million to $4 million on trailers.[10]

The key to a successful reverse auction is the standardization of the bid components of the bid, which allows the auction to be based on price alone. Specifications such as delivery schedules, payment options, or inventory arrangements, unless carefully defined, can make it hard to compare bids in an auction format.

Reverse auctions usually produce the best results for large, bulk purchases. Reverse auctions may not be the best course when price is not the overriding consideration, as with the procurement of certain information technology or professional services.

Reverse auctions give new suppliers a better chance to compete against established companies. Vendors can be prequalified before the auction to ensure that they have the means to fulfill the contract and meet any state requirements, including participation by historically underutilized businesses.

The General Services Commission (GSC) is the purchasing authority for the state. Current state law does not specifically authorize or forbid GSC to conduct reverse auctions in its procurement process. Current state law does not specifically authorize or forbid reverse auctions. Because the law is unclear, the General Services Commission (GSC) asked the Office of the Attorney General for an opinion on its authority to conduct reverse auctions. The opinion, delivered December 15, 2000, states that GSC does not have the authority to conduct reverse auctions because such auctions would not constitute competitive bidding as required by chapters 2155, 2156, and 2157 of the government code, and reverse auctions would violate the confidentiality of the bids submitted by vendors, which is required by Texas Government Code §2156.005(b).[11]

Recommendation

State law should be amended to explicitly allow state agencies to use reverse auctions.

State law should be changed to explicitly state that the General Services Commission (GSC), as the purchasing authority for the state, may use electronic auctions to purchase goods and services, and may delegate that authority to other state agencies. GSC should develop rules for the use of reverse auctions, and should contract with a vendor or vendors who can provide the software, training, and technical assistance needed to institute a reverse auction process for state government. GSC also should add reverse auctions to its online procurement pilot project, TxG2B, as appropriate.

Fiscal Impact

The savings resulting from this recommendation would depend upon future events and cannot be estimated. Numerous goods or services could be procured through reverse auctions, and savings from 2 percent to 10 percent are typical for bulk commodities. The table below provides a sample of the kinds of goods that the state could purchase through reverse auctions and a range of savings the state might expect. The auction vendor typically absorbs the cost of setting up auctions in exchange for payments averaging 20 percent of the savings realized through each auction.

[1] Keith Bradsher, “3 Automakers Plan Private Online Purchasing System,” New York Times (February 26, 2000) (http://www.nytimes.com/library/tech/00/02biztech/articles/26auto.html). (Internet document.)

[2] “Business Digest,” Austin-American Statesman, April 28, 2000.

[3] William Matthews, “Postal Serve First To Try Online Reverse Auctions,” Federal Computer Week, April 17, 2000 (http://www.fcw.com/fcw/articles/2000/0417/cover-04-17-00.asp), (Internet document) and William Matthews, “Bold New Bid,” Federal Computer Week, April 17 2000 (http://www.fcw.com/fcw/articles/2000/0417/cover-04-17-00.asp). (Internet document.)

[4] Shawn Tully, “The B2B Tool That Really Is Changing The World, Part III,” Fortune, March 20, 2000 (http://www.fortune.com/fortune/2000/03/20/the.html). (Internet document.)

[5] Anne Laurent, “E-Invasion: Dot.coms Swarm into the Government Market,” GovExec.com, June 2000 (http://www.governmentexecutive.com/features/0600/0600s1.htm). (Internet document.)

[6] Joshua Dean, “Procurement Execs Consider Reverse Auctions,” GovExec.com, August 4, 2000 (http://www.govexec.com/dailyfed/0800/080400j1.htm). (Internet document.)

[7] Judi Hasson, “GSA makes bid for auctions,” Federal Computer Week, May 31, 2000 (http://www.fcw.com/fcw/articles/2000/0529/web-gsa-05-31-00.asp). (Internet document.)

[8] William Matthews, “Reverse Auctions on GSA schedule,” Federal Computer Week, May 1, 2000 (http://www.fcw.com/fcw/articles/2000/0501/web-free-05-01-00.asp). (Internet document.)

[9] Anne Laurent, “E-Invasion: Dot.coms Swarm into the Government Market,” GovExec.com, June 2000 (http://www.governmentexecutive.com/features/0600/0600s1.htm). (Internet document.)

[10] William Matthews, “Postal Services First to Try Online Reverse Auctions,” Federal Computer Week, April 17, 2000 (http://www.fcw.com/fcw/articles/2000/0417/coverside-04-17-00.asp). (Internet document.)

[11] Office of the Attorney General, Opinion JC-0316, December 15, 2000.

e-Texas is an initiative of Carole Keeton Rylander, Texas Comptroller of Public Accounts
Post Office Box 13528, Capitol Station
Austin, Texas

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