Although it's proven viable for the private sector, the reverse auction remains a small piece of the government-purchasing pie.
You'd think a procurement method that lets potential vendors keep lowering their offer would be a no-brainer for any organization locked into the lowest-price paradigm. Same with a method that doesn't penalize buyers for not awarding a bid. Or one that doesn't cost the buyer a penny to conduct.
But it's not. Of 326 public entity responses to a recent survey by the National Institute of Governmental Purchasing Inc. (NIGP), only 12 indicated they use reverse auctions. That's down slightly from 2003, when the institute reported that 17 out of 276 respondents used the method.
Periscope Holdings Inc. manages the commodity and services code, the standard that state and local governments use to identify their specifications, for the institute. At the behest of public customers, the firm developed software only to find that reverse auctions had fallen out of favor.
Part of the reason is that governments have been burned. “Every time the economy has gone down, we've seen several players jump into the government market from the private sector,” says CEO Brian Utley. “But they don't understand that it works differently. Government procurement is run by law.”
Despite its lack of popularity in recent years, the reverse auction method is still attracting all sorts of attention, most notably during the American Public Works Association's annual Congress in Columbus, Ohio, last year. Curious department heads and financial managers packed a room for a session about reverse auctions. As a result, we decided to examine the method more closely for our annual “money issue.”
Is your operation a good fit for reverse auctions?
MYTH 1: REVERSE AUCTIONS WORK BETTER FOR EQUIPMENT AND COMMODITIES THAN SERVICE AND CONSTRUCTION CONTRACTS.
In 2006, Pennsylvania Gov. Ed Rendell signed the Local Government Unit Electronic Bidding Act into law, allowing municipalities, school districts, councils of government, authorities, and others to incorporate electronic bidding and reverse auctions into their competitive bidding processes.
Before then, most local governments were restricted by the competitive bidding language in their municipal codes. The law amended the state's procurement code to allow local governments to use electronic bidding and reverse auctions for their own purchases.
The Delaware County Regional Water Quality Control Authority in Chester, Pa., immediately tried it out. That November, a reverse auction facilitated by eDynaQuote, which has since been acquired by Procurex, cut the cost on orders for liquid caustic soda and liquid chlorine by $87,500.
“We could never have saved this much with the old paper process,” says the county's Procurement Coordinator Sue Hart. The agency has used the method every year since then. The winning bids shift among the same handful of suppliers, but each year the final price has been lower than the previous year. “It's easy. We just sit back and watch the results come in.”
As a general rule, the buyer has achieved true market value if the two lowest bids differ by no more than 2%.
In 2009 the City of Norton, Ohio, used a facilitator called BidBridge to find a contractor to replace 12,000 feet of water main. After an hour, 10 companies had submitted 283 bids, dropping the final price to $423,786 — a 40% savings over the engineer's estimate.
It wasn't the city's first experience with reverse auctions. Two smaller water main projects yielded good results; the first came in 17% below the engineer's estimate, and the second was almost double that. So Administrator Rick Ryland decided that it would likely produce significant savings for the larger project.
And in February, the 10,500-resident city of Dallas, Ga., shaved almost half — 44% — off its original budget of $500,000 on a two-year waste collection contract for 2,700 residential waste pickups and a handful of commercial pickups, also using BidBridge.
MYTH 2: A REVERSE AUCTION WON'T EXPAND MY POOL OF POTENTIAL VENDORS.
Facilitators such as eDynaQuote and Bid-Bridge organize the event by alerting their customer's current supplier list, combing through their own database, and seeking new suppliers based on the parameters set by the public works department, such as a preference for locally based suppliers.
The companies review bid documents for specifications that could potentially restrict competition, adding — for example — language that opens the field to minority- or veteran-owned businesses.
Although the client has to put some work in as well, you're only as limited as you choose to be.
After the city's previous waste hauler went bankrupt last year, Dallas, Ga., City Manager Kendall Smith negotiated a month-to-month contract with Raleigh, N.C.-based Waste Industries USA Inc. before deciding to send out requests for proposals (RFP) and qualifications in hopes of finding a long-term replacement.
None of the respondents met all the city's requirements. So Smith, who'd spent 18 years as the city's public works director, did some research.
He lowered the previous requirement of proof of a previous contract of at least five years for governments of more than 3,000 customers to attract larger local contractors that had plenty of successful commercial and residential work but little government experience. After learning that some of the largest nearby cities didn't require such large policies, he reduced the requirement for a $10 million umbrella insurance policy to $3 million. He also added a restriction that vendors would not be allowed to raise the fuel cost.
That expanded the field to 13.
It's simpler to maintain a customer account than win a new one, so incumbents often get more aggressive with their pricing to keep existing business. And that's what happened.
In the last half hour of the auction, Waste Industries dropped its original quote of $389,786 by about $50,000 as competitors outbid each other. The company won the award with a final bid of $280,850. Of that, it paid BidBridge a small percentage.
And that's who keeps reverse auction facilitators in business: the winning bidder. The fee is 2% to 5% of the final bid.
“Reverse auctions do drive pricing down, but compared to the traditional bid process, you have the opportunity to come back with another number,” says Jim Auten, vice president of marketing & sales for Waste Industries. It was the first experience with a reverse auction for the company, which also operates in South Carolina, Maryland, Tennessee, and Virginia. “It was certainly more exciting than the traditional bid process. I felt like I was in Vegas.”
That said, contractors generally oppose reverse auctions, arguing that material quality and contractor experience aren't taken into consideration during the bidding process. In Ohio, House Democrats slipped a provision into the state budget last year banning reverse auctions for the purchase of supplies or services in road, building, and sewer projects. The Associated General Contractors of America did not return calls from PUBLIC WORKS for comment.
MYTH #3: A REVERSE AUCTION'S NOT WORTH MY TIME BECAUSE IT WON'T BEAT THE STATE CONTRACT PRICE.
For the most part, though not always, this is true.
Like public works departments, facilitators also have certain requirements. The value of the transaction must be at least $75,000. Potential bidders must be confident they can beat the state contract price.
“We have to be really sure that it's a good fit for reverse auction,” says Bid-Bridge Vice President of Operations Cindy Sisloff, who says the eight-year-old firm has had more repeat business over the last several years from public clients and logged a 91% award ratio so far this year.
MYTH #4: MY GOVERNING BODY WON'T ALLOW IT.
A reverse auction is nearly identical to a traditional bid process except that potential suppliers are allowed to submit more than one bid. Potential vendors don't know who their competitors are, nor can they see individual competitors' bids. During the auction, they're alerted only when their bid is no longer the lowest, at which point they can choose to submit another — or not.
The auction is monitored by the buyer and facilitator in a controlled environment, usually in a government office. Because it's conducted online, potential vendors participate from anywhere they'd like: the office, the library, and even, in some cases, the local coffeehouse. The final bid tabulation is released immediately to all participants.
Though sometimes not required, Bid-Bridge's Sisloff suggests public clients issue an RFP without asking for the price. In this way, the RFP acts as a prequalification and price becomes the final component.
The method has stood up in court during two legal challenges in 2005.
The Government Accountability Office and the U.S. Court of Federal Claims ruled that the Department of Housing and Urban Development didn't violate federal procurement law by disclosing bids during an auction for inspection services. Because the Web site didn't display the names of vendors to other vendors, the court considered the process legal. So far, there have been no such challenges at the state level.
Although some limit it to cities of certain sizes and others to certain powers or require enabling legislation, nearly all states provide for some type of home rule. Only three — Alabama, Nevada, and New Hampshire — do not; and 12 — Delaware, Massachusetts, Nebraska, Nevada, New Hampshire, New Mexico, Oklahoma, Rhode Island, Texas, Vermont, West Virginia, and Wyoming — don't provide for county home rule.
But even with the power to write its own procurement code, a governing body may need some convincing that reverse auctions are both fair and legal.
Johnson County, Kan., had a bid in hand when Purchasing Manager John Mahin decided to give it a try. “Normally you wouldn't have a bid in hand, so you'd assume that your low bid from the auction was really the low bid,” he says. It turned out to be a good way to gauge the true market value of the original quote.
The legal department wouldn't let Mahin move ahead until the county's purchasing procedure was amended. The procedure had defined competitive methods one of two ways: For products or services budgeted at $50,000 or higher, formal public bids must be conducted; for those valued at less than $50,000, informal competition such as written quotes was allowed.
To allow for the third methodology, the language was revised by the Purchasing Division with assistance from the legal department. The county manager then approved the revision.
“There was a lot of activity from the three higher bidders who got to within a small percentage of the opening bid, but not at the point where the higher bidders surpassed the low bid,” Mahin says. “The low bidder never had to move.”
Mahin decided not to award anyone from the auction and stuck with the original offer. This is allowed in the reverse auction process with no penalty to the buyer. Thus, local governments that have a best-value clause in their procurement guidelines can use the process to get the lowest price and the best value.
In addition, the auction data is highly valuable. “You can receive excellent reporting and tabulation, and in a successful auction event you can document the fact that you received good competition and best pricing,” Mahin says. Facilitators provide such documentation at no additional cost.
What about collusion? There are unconfirmed stories of bidders working with each other on the day of the auction, with one agreeing to relinquish the job to the other in return for doing the same the next time around.
BidBridge's Sisloff isn't naïve enough to claim that bid tampering never occurs in the industry, but she stands by her company's process. “I'm sure some of these vendors know what their competitors' prices are,” she says. “They all bid against each other all the time.”
But that doesn't faze Dallas, Ga.'s Smith. “I don't see any reason not to do it again,” he says.
And in Kansas, Mahin isn't disappointed that the reverse auction hasn't worked for him yet, mainly because he understands the benefit to his agency's bottom line.
“We had planned to use it for capital equipment purchases and had focused on our public works department as good potential users,” he says. “It's a good idea. We're just looking for the right fit.”
For a closer look at how a reverse auction works, click here.