Reverse Auction

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What is a Reverse Auction? Definition

A Reverse Auction is the auction business model in which the role of the buyer and the seller are inverted, mainly with the objective to drive purchasing prices downward. It is a strategy used by many purchasing and supply management departments.

The Reversed Auction Process

In a reverse auction, a (mostly powerful) buyer issues a Request for Quotation (RFQ) for particular items or services. Multiple suppliers quote the price at which they are willing to supply the requested items or service, typically using specialized software or through an online marketplace. The sellers offer bids on the items, competing to offer the lowest price that meets all of the specifications of the bid. As the auction progresses, the price decreases as sellers compete to offer lower bids than their competitors.

So, unlike a regular auction, prices in a reverse auction decrease as the bidding process is going on.

Power Positions

Reverse auctions primarily aim to achieve cost savings for BUYERS by securing goods or services at the lowest possible price. This focus on driving down costs aligns with the procurement and sourcing needs of organisations seeking to obtain supplies or services from multiple suppliers. In contrast, regular (forward) auctions are designed to maximise revenue for SELLERS by obtaining the highest price possible for the goods or services being sold. This revenue-driven approach is commonly observed in retail and e-commerce settings, where sellers seek to optimise profits through competitive bidding.

Nowadays, the quoting is often performed via the internet, resulting in a real-time bidding process. This results in a downward pressure on prices to levels that are normally not achieved using a traditional, static 3-quote paper-based purchasing process.

The contract is often - but not always - awarded to the supplier that provided the lowest price: quality, lead-time, capacity, and other value-adding capabilities can also play a role.

Disadvantages of Reverse Auctions. Risks

In reverse auctions, sellers face the risk of price erosion and reduced profitability as they compete to offer the lowest bid. However, winning bids can lead to the establishment of long-term business relationships and recurring revenue streams. Conversely, buyers participating in forward auctions risk overbidding and paying higher prices than necessary to acquire desired items. Despite this risk, successful purchases in forward auctions can result in obtaining valuable goods or assets that meet specific needs or preferences.

Critics of the model say the model is often a zero sum game, especially for suppliers.

Also called: Buyer-Driven Auction.

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