Tip of the Week #77                    Tip Index

Go to the Prior Tip "Making Decisions with Precision"
Go to the Next Tip "America, the beautiful carbon sink" by Peter Huber
Return to MaxValue Home Page

Reverse Auctions

Reverse auctions are live auctions where the price is incremented (higher or lower, depending on whether the competition is buying or selling) until a bidder "strikes." For example, in Japan, coffee contracts are sold in this manner.   An electronic clock decrements starting from a high price until one of the participating buyers presses a button.

Most of the world's assets are sold auction. Sellers have long been interested in determining the form of auction that will maximize their value. Most auctions are "English" voice auctions. Reverse auctions are another form of live auction (as compared to a sealed bid) that some believe provides a higher value to the seller.

Apparently the U.S. Office of Management and Budget (OMB) believes that reverse auctions can reduce the cost of buying goods and services. They plan to issue new rules next spring to regulate how some agencies will use reverse auctions in real time. The Internet will enable this .

Kenneth Oscar of OMB, says . "The technology wasn't really there before to make this feasible." Oscar said the practice helps foster competition by encouraging more businesses to step into the ring. "If you are a company making fax machines or something, and you want to bid on a government contract, well, how much do you bid?," Oscar explained. "So, you pick a point and it's a sealed bid and you write that down. Maybe you win and maybe you don't." With reverse auctions, bidders don't know who they are competing against, but they can see bids as they are made. "You bid, say $50, and all of a sudden somebody else bids $45 and you say 'Maybe I can still make a little money at $42,' " Oscar said. "It encourages people to go down a little on price."

The U.S. Navy experimented with the method and claims saving about $1 million on purchasing aircraft ejection seats. Oscar said the practice has netted savings from 5 percent to 40 percent more than what agencies had previously paid.

(Most of this is adapted or excerpted from an e-mail that I received from Jose Martinez of the Small Business Administration, Nov. 20, 2000).


Simulating competitive bidding is a very interesting application of decision analysis. In some of my Applied Decision Analysis classes, when there is sufficient time and interest, 2-person teams set up Monte Carlo simulation models in a bidding exercise. Example uncertainties include exploration asset value, number of bidders, and quality of the information. When I first started building such models, I found that my intuition was poorly calibrated for the behavior of the competitive situation. It is fun to build and experience how such models work.


Here is an on-line auction site that uses reverse auctions:

http://www.onedayfree.com


I haven't seen this book, though it sounds interesting: The Complete Guide to Buying and Selling at Auction, 1997, C. Hugh Hildesley, W.W. Norton & Co., US$25.00 list.  This is an auctions primer by a Sotheby's executive and seasoned auctioneer.


—John Schuyler, November 2000.  Revised Dec. 13, 2000.

Copyright 2000 by John R. Schuyler. All rights reserved. Permission to copy with reproduction of this notice.