What Reverse Auction Bidding is All About

WITH THE UNIVERSAL presence of computers and the nearly universal reach of the Internet, you are probably aware of the widespread use of online auctioning for the sale of goods. Therefore, it should be a surprise to no one that owners would think of a way to use them to get lower prices for purchase of goods and services. The concept is to describe what someone wants to buy and then let providers compete with one another to lower their prices until a pre-set time or other cut-off, and it is called electronic reverse auction bidding - ERAB.

A typical format for ERAB is as follows:

1. Potential bidders obtain all contract documents electronically.
2. A third-party service conducts the auction online with all bidders participating simultaneously with a set start and end time.
3. The identities of bidders are kept confidential during the auction.
4. Bidders submit prices, which are ranked and sent back to all bidders.
5. Bidders can re-submit lower prices until the closing time.
6. At the closing time, the lowest price is determined and all bidders are notified.

ERAB’s use started in the private sector, by large corporations with large purchasing staffs, such as General Electric, Target, Best Buy and Home Depot. Statistics show that results have been mixed.

A task force of the International Housewares Association reported that savings realized from first ERABs are often not replicated in subsequent auctions, particularly because of the expenses involved with the third-party vendors and computers. But some buyers are convinced that it is the most efficient way to purchase and that it yields lower prices. Whether either of these impressions is supported by facts, federal and state construction buyers have started to jump on the bandwagon as well.

The U.S. Army Corps of Engineers is conducting a pilot project to use ERAB for two construction projects; and the Army, Navy and Air Force have all been charged with trying it out and reporting back on their results. In addition to the military agencies, the Postal Service and GSA are testing the use of ERAB. Although some authors argue that it violates the Federal Acquisition Regulations to allow one bidder to see the price of another bidder (even though the bidders’ names are anonymous), for now OMB is taking a hands-off attitude.

Construction gray areas

Some states, including Indiana, Maryland, Minnesota and Pennsylvania, are already using electronic procurement for commodities. They have found, however, that it is not as easy to use it in construction because there are far more “gray areas,” such as differing local conditions, codes or labor markets that make it more complex to compare “apples to apples.”

One of the arguments against ERAB is that it is a veiled form of bid shopping. Buyers have attempted to avoid this by (they say) maintaining confidentiality and impartiality in their ERAB process. Proponents point out that bid shopping technically only occurs after a contract has been secured, not before, but clearly there is pressure to repeatedly lower prices where the bidders can see the work slipping away before their very eyes.

At some point, below-margin prices will drive a contractor out of work, and below-cost prices will result in defaults for buyers, and it seems safe to say that there is more potential for this happening in the ERAB environment. There is no opportunity in the ERAB process for seeking clarification or confirmation, which may indicate that it is not suited for anything but the most straightforward, cookie-cutter construction. There is no good way to evaluate non-price factors.

Both the Associated General Contractors and American Subcontractors Association have expressed concerns about the use of ERAB.

The AGC issued a statement last September in which it referred to reverse auctions as “unproven” and stated that, at best, reverse auctions raise significant issues such as encouraging imprudent bidding, prohibiting negotiation or clarification which might have led to lower prices.

ASA has taken the strongest position about the bid-shopping aspect of ERAB and has thrown its support behind a bill introduced in the last Congress to outlaw all forms of bid shopping on federal construction projects, including ERAB.

There is another wrinkle to reverse auctions — surety bonds, which are required on nearly all government construction contracts. Sureties often make a decision on whether to supply bid bonds on their review of the contractor’s bidding procedures and they know what is being submitted when they supply the bond. With ERAB, the bond must be submitted when the initial bid is made, with no opportunity for withdrawal even if the bidder, in the Vegas-like frenzy of an auction atmosphere, drops its bid below a reasonable level. This leaves the bonding company with more exposure for the bidder’s stupidity.

Many people on both sides of this issue are waiting to see whether the best hopes or worst fears about ERAB come to fruition. From my experience, once a new technological toy becomes available it is hard to stop it, although a rash of bad experiences certainly could put a damper on it use. As I see more reports about it, I will follow up with another column.

Susan McGreevy is a partner at Husch & Eppenberger, Kansas City, Mo., tel. 816/421-4800 or e-mail to [email protected].