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
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
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,
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
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
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
"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
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
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
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."