Bold new bid

• By William Matthews
• Apr 17, 2000

Caterpillar Inc., the bulldozer builder, decided to experiment with an online auction for buying hydraulic parts and watched with glee as the price of stainless steel connectors dropped from 30 cents to 22 cents apiece.

United Technologies Corp. tried it and saw the cost of the circuit boards it installs in appliances plummet 43 percent. The company saved $32 million. From helicopter makers to wine merchants, businesses are uncorking big savings through online auctions. Now, the federal government wants a taste.

With an eye on plummeting prices in the burgeoning world of business-to- business online auctions, the General Services Administration has decided to try its hand at bargaining on the Internet.

It already has a name — buyers.gov.

As early as next month, GSA plans to begin experiments with three types of online purchasing:

* Private buyer auctions. These are electronic versions of the traditional "request for quotes" that agencies have issued for years. Agencies post electronic solicitations for items they want to buy, and suppliers respond with price quotes. The difference, however, is bidders have a chance to lower their prices in hope of landing a contract. The agencies pick the best deal, which may be a combination of price and services.

* Volume purchasing auctions. In this case, several agencies would combine their purchases to increase volume and, hopefully, reduce prices. This would be similar to commercial online auctions where consumers now buy vacuum cleaners, digital cameras, electronic toothbrushes and oil paintings.

* A World Wide Web site where agencies can buy information technology products. GSA envisions this alternative as more of an electronic store than an auction. Ever since Congress and the Clinton administration freed agencies from the tight restrictions of government procurement years ago, agencies have experimented with commercial methods of buying IT products and services. But GSA's bid to open up an auction site marks a foray into commercial buying techniques that no other reforms have.

"This is a concept that would have been unimaginable two years ago," said Christopher Wren, a program director at GSA's Federal Technology Service and one of the architects of the agency's planned online auctions. Before, the robust search engines, sophisticated software and Internet platforms needed for competitive government purchasing online didn't exist, he said.

In an era of government reform with politicians pressing agencies to practice performance-based business management, it's no wonder the government finds online auctions intriguing.

From General Motors to United Technologies to The Quaker Oats Co., some of the nations biggest corporations are bragging about the bargain-basement prices they have paid for supplies through online auctions.

Whether it is molded plastic auto parts or circuit boards or ingredients for granola, companies — and the online auctioneers that help them — claim to cut costs by 10 percent, 30 percent or more.

If the federal government, which buys an estimated $260 billion worth of goods and services annually, could attain such results, the savings would be enormous.

What Makes Business Sense

The key to online auctions in the business-to-business arena — and, GSA officials hope, in the business-to-government realm — is that they turn traditional auctions on their head.

Instead of displaying a valuable antique before an audience of anxious bidders who push the price ever higher, these auctions feature multiple sellers vying for the business of a single buyer. To get the business, the companies push the price ever lower.

An automaker, for example, might go online with four rubber hose manufacturers that pinch and trim their prices to undersell one another and win a contract to supply radiator hoses to the automaker's assembly plants.

Thus, auctions turn the traditional "request for quotes" process from a static and secretive exercise of submitting sealed bids to a dynamic and open price battle.

Under the standard sealed-bid process, suppliers have to know their market well enough to accurately guess what the competition's price is going to be and calculate how to be the low bidder and still make money. Typically, there is one round of bidding and all but the winning bid remains secret. Those who guessed too high learn little more than that they lost.

An online auction begins with a target price set by the buyer. Bidders submit their offers and then have one or more chances to adjust them downward in an effort to get the contract.

Because they drive the price down, rather than up, business-to-business auctions are often referred to as "reverse auctions" or aggregate buying sites.

It's a "new form of negotiation strategy," GSA explained in a published notice stating that it "intends to establish an electronic Web-enabled auction."

"Bidding prices down is one aspect" of what GSA wants to do, Wren said. But there are others. Aggregate buying or volume purchasing is a big part of GSA's plan. "If you increase the number of buyers, you should be able to cut the price," Wren said.

Volume buying is a concept frequently touted on Internet sites for consumer purchases. The price of a product goes down as more people line up to buy it. At mobshop.com, for example, a digital camera from Eastman Kodak Co. priced at $899 recently was selling for $689. But if more than 25 buyers signed up, the price would drop to $679. And if more than 200 would buy, the price would drop to $659, and so on.

GSA hopes to exercise similar strength in numbers.

"Using the auctioning and volume purchasing concept, the orders should be large," the agency said in its published notice. Orders "can come from single customers or can be aggregated orders from many federal buyers."

Like reverse auctions, aggregate buying is on fire in the business world.

General Motors, DaimlerChrysler and Ford Motor Co., for example, have created a "supply-chain network" to merge their parts requirements and present them as giant purchase orders to sellers at auction. Aerospace giants Lockheed Martin Corp., Boeing Co., Raytheon Co. and BAE Systems last month announced a similar Internet buying consortium.

What makes sense for business also makes sense for government, said Raj Raghu, technology manager for ACS Government Solutions Group. When the government is the buyer, it will be able to get a better price if it pools purchases from 20 agencies rather than letting each make the same buys independently, he said.

ACS is one of several IT and consulting companies anxious to join GSA when it jumps into online auctioning — another is American Management Systems Inc. Both firms have formed partnerships with online auction companies in hopes of landing government auction business.

A Risky Venture?

The government is starting small, but it hopes to get going soon. Before the end of May, GSA officials said they want buyers.gov to be online. The Web site initially is expected to offer 25 popular IT items — computers, printers, monitors and the like. But the selection is expected to expand to other commodities.

However, IT equipment may be a risky way to get into online auctioning. "I'm not sure all IT systems and services are well suited" to auctions, said Max Peterson, vice president for technology solutions at GTSI, the giant reseller of goods and services to the federal government.

Auctions emphasize price, Peterson said, but the "cheapest widget" is not necessarily what the federal government needs, especially when buying IT. Worldwide and multiyear warranty support, the ability to return damaged goods and 24-hour technical support are critical to many IT operations. But such multifaceted details do not lend themselves well to auctions, which tend to focus on the price, he said.

"Auctions have a place" in government acquisition, "and they're going to find their niche," he said. "Exactly how deeply you can drive that into the IT arena remains a question."

Michael Dow has similar reservations. Dow, who is vice president of AMS' defense group, said he soon expects to see the military buying things such as fuel and airplane parts through online auctions. "But as you move into more complex goods and services, it gets tougher to make sure you're comparing apples to apples" when bids come in.

AMS has formed an alliance with FreeMarkets Inc., one of the pioneers in business-to-business online auctions, in anticipation of the government's entry into online auctioning. FreeMarkets attempts to overcome some of the potential complications of online auctioning by conducting extensive "prequalification," ensuring that bidders understand the requirements of the buyers and are able to meet them.

ACS' partners, SupplierMarket.com and Volumebuy Inc., promise to provide the government with "pre-qualified vendors." And, Wren contends, "In theory you can pretty much use [online auctions] for virtually any commodity."

The Pennsylvania Online Case

FreeMarkets, a Pittsburgh-based company, conducted the first government online auction in March 1999. The company orchestrated bidding by suppliers anxious to sell the state of Pennsylvania coiled aluminum for making license plates.

During the auction, the price dropped from $2.8 million to $2.5 million, netting the state a savings of 9 percent. Several months later, the Pennsylvania Department of General Services again tapped FreeMarkets, this time to buy coal for heating and rock salt for melting ice from state roads with similar savings. And an auction to buy office furniture cut the price by about a third.

Bulk commodities such as Pennsylvania's coal and salt may be ideal products for buying and selling through auctions, said Steve Kelman, chief of the Office of Federal Procurement Policy in the Office of Management and Budget from 1993 to 1997. Such items are bought in quantity and do not require post-purchase support from the supplier.

For items such as IT equipment, however, auctions may be a bit trickier, Kelman said. "In a lot of situations, the government will probably want to get service" on the equipment after the sale. In those cases, a longer-term relationship with the vender may be more important than a price driven down by competitive bidding, he said.

Acquisition officials at the Defense Department concur. As the government's biggest buyer of goods and services, the military has been investigating online auctions. In March, David Oliver, the military's principal deputy undersecretary for acquisition and technology, wrote that "online auctioning may be especially suited for competitive, high-volume, commodity-type purchases."

ACS officials said they do not expect the need for after-sale service to impede online auctions. "It's not just price, it's a best-value thing," said ACS technology manager Raghu. Companies that have a history of providing good support may still win contracts despite lower bids from less reliable competitors, he said.

Auctions are really intended to focus on price, said Gregg Mossburg, senior principal in AMS' Government Solutions Group. Other details, such as service and warranties, can be worked out offline. The auction sets the price, but formalizing a contract comes later, he said. "Auctioning won't take the place of source selection." The best supplier — when price, services and other factors are considered — will get the contract, he said.

Legal or Illegal?

Another impediment to online auctions may be the question of their legality, Kelman said. "Some government lawyers say they're illegal" because procurement integrity laws restrict the government from providing companies' bid information to other bidders.

Bidders accustomed to the secrecy of sealed bids may be taken aback to see their price offers displayed on video screens for all other bidders to see.

"Knowing what your price is can sometimes give your competitor pretty good insight into your cost structure," which can be uncomfortably revealing for some businesses, said AMS' Dow.

"There are some areas we're going to have to work around," Dow conceded. During FreeMarkets auctions, bidders can see other bidders' prices, but they now know who the other bidders are. Is that good enough for businesses in the habit of operating secretly? "Different people have different opinions on whether that's adequate," Dow said.

DOD confronted the same questions earlier this year when it began exploring procurement possibilities through online auctions.

In a letter to Sen. Rick Santorum (R-Pa.), who was promoting Pennsylvania's FreeMarkets to the Pentagon, senior DOD officials wrote, "The office of the general counsel has advised that if properly structured, auctioning is permissible within the framework of existing law and regulation."

And they added, "The department believes that online auctioning has the potential to save the department significant resources in time, funding and labor."

Until recently, auctions were banned by the Federal Acquisition Regulation, but revisions in 1997 specifically removed language that disallowed them, and the general interpretation now is that auctions are permissible, Dow said.

FreeMarkets officials said they believe current laws require federal agencies to meet three conditions to conduct online auctions:

* Bidders must be allowed to remain anonymous to their competitors.

* Only price, not cost, information is disclosed during bidding.

* Bidders can choose to use offline channels such as the telephone to place bids.

But several other concerns remain.

Pennsylvania officials worry that auctions might exclude small businesses from winning state business. The same concern exists in the commercial sector, where some say that large companies will dominate auctions, raising possibilities of government restrictions to prevent collusion.

And there is the ubiquitous computer concern — security. Auction operators must be able to guarantee that hackers can't tamper with bids.

Still, with all the questions remaining, GSA's Wren remains convinced auctions are in the government's immediate future. "This is leading edge," he said. "We don't know how it will play out. There are still a lot of questions to be resolved, but it could benefit the government immensely."