Benefits of Transformation Bidding while conducting Reverse Auctions
Key Takeaways
| Focus Area | Takeaway |
|---|---|
| Why Transform Prices | Raw bids aren’t comparable when shipping, payment terms or switching costs differ |
| Transformation Factors | Factors like switching cost are added to a supplier’s bid to normalise it |
| Worked Example | A $1,000-$2,000 switching cost can flip which supplier is cheapest after transformation |
| Documentation | Record and sign off transformation factors and formulas for audit purposes |
| Added Benefit | Transformed pricing shows stakeholders that auctions reward capability, not just cost |
Why do we need to transform prices received from suppliers during a reverse auction?
Prices need to be transformed because raw bids from different suppliers often aren’t comparable on cost alone: shipping terms, payment terms, quality, switching costs, or incumbency can all differ between bidders.
Here are some scenarios where bids received from suppliers aren’t comparable.
- Shipping costs are incurred by the buyer and are different for each supplier i.e. supplier provides goods ex-works and the buyer is responsible for transportation of goods.
- Payment terms are different
- Quality and service levels are different
- Switching costs are incurred with a new supplier
- Preference given to incumbent suppliers
- plus others
So if we need reverse auctions to be conclusive in themselves, then they cannot be applied in such scenarios. This can be a challenge for companies trying to establish reverse auctions as a norm for supplier negotiations.
The way to address this is via Transformed Price bidding. How does that work? The bids placed by suppliers are transformed by applying ‘Price Transformation Factors’, thus normalizing the bids received from suppliers i.e. ‘Transformed Price’.
Illustration:
Let’s take an example of a lot of Gears being purchased from 3 suppliers.
| Item | Qty | UOM | Unit Price | Extended Price |
|---|---|---|---|---|
| Gears | 30 | each | $ 800 | $ 24,000 |
A Switching Cost needs to be applied to a couple of new vendors, B and C. It’s not applicable to the incumbent Supplier A.
| Invited Suppliers | Switching Cost |
|---|---|
| Supplier A (incumbent) | $ 0 |
| Supplier B (new) | $ 1,000 |
| Supplier C (new) | $ 2,000 |
Transformation Formula would be:
Transformed Price = Submitted Price + Switching Cost
| Invited Suppliers | Submitted Price | Transformed Price |
|---|---|---|
| Supplier A (incumbent) | $ 24,000 | $ 24,000 |
| Supplier B (new) | $ 23,500 | $ 24,500 |
| Supplier C (new) | $ 23,000 | $ 25,000 |
Here we can see that transformation factors are applied on the prices submitted by suppliers. It does not make sense to shift to the new suppliers though their unit pricing is lower than that of the incumbent supplier.
A suggestion to teams conducting such events is to document the transformation factors and the values for each supplier along with the transformation formula being applied on supplier bids. Additionally, have these documents signed off by the relevant authority. This can be an area of internal audit in future and the right documentation helps.
It does not end here though. The reverse transformation is then applied to compute one supplier’s bid’s view by other suppliers. In some way, this is similar to how multi-currency bidding works, just a tad more complex.
An added benefit of using Transformed Price bidding is in convincing other stakeholders that reverse auctions are not just about cost reductions (cost is often perceived to be directly proportional to quality) and that better and more capable suppliers can be given a (fair) advantage.
A suggestion
A suggestion to teams conducting such events is to document the transformation factors and the values for each supplier along with the transformation formula being applied on supplier bids. Additionally, have these documents signed off by the relevant authority. This can be an area of internal audit in future and the right documentation helps.
Krinati‘s eSourcing solution allows customers to conduct transformation bidding for RFPs and well as Reverse & Forward Auctions.