Auction procurement: a new trend? Foreign firms are bringing savings to Japan via auctions

Japan, Inc., July, 2004 by John Dodd

THE ability to procure raw materials and parts cheaply has always been a competitive weapon for major companies in Japan. Traditionally, large brand-name manufacturers have dictated terms and pricing to their keiretsu subcontractors, who in turn did the same with their job shops, and so on down the food chain.

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BUT THE DRAWBACK of such a multi-layered system is that over time its human managers become slow and lazy--as happened through the 80s and 90s.

Carlos Ghosn proved as much when one of the most decisive methods he used to fix Nissan was to slash the number of locked-in vendors and open up procurement to newcomers. Suddenly Nissan was able to cut its procurement costs by more than 11 percent, boosting its profits [yen]331.1 billion ($3.01 billion). Today, Nissan is one of Japan's most efficient car manufacturers.

Still, a recent survey by the Electronic Commerce Promotion Council of Japan (ECOM) found that only 35 percent of technology-aware SMEs are actually using electronic procurement, and of those, just 10 percent of their transactions were done online. According to Ernst & Young, 40 percent of the average company's purchasing expenditure is on nonproduction items such as travel, office supplies and services. A 20 percent saving on such costs might amount to an average of 5 percent on costs overall and for a typical 100-person foreign firm in Japan is likely to amount to [yen]26 million ($236,000) a year.

How procurement auctions work

The concept is simple: the buyer sets up an online or offline "marketplace" (a Web site or procurement office notice board), defines and posts the service or product to be procured, solicits and qualifies a range of existing and new vendors, then invites typically no more than five of those vendors to enter the auction to bid.

Auctions are usually conducted in a Dutch auction format, whereby the buyer sets the opening price and descending bids are made in rounds. Each round, the vendors respond with their best price, and everyone gets to see the lowest bid at the end of the round. Then, the next round is opened and the process repeated, often with just two vendors grinding away, until one of them gives up.

The winner then receives an order confirmation from the buyer, and the terms and conditions are not adjusted beyond those stated before the auction. To make such a system acceptable to Japanese vendors, the system has to be reliable, transparent and fair.

The rules are important, because not only do they keep things fair, they also spell out to vendors that things are changing and collusion between buyers and vendors is a thing of the past.

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* Vendors participate by invitation only, therefore they must be pre-approved as being able to fulfill the requirements of the buyer.

* After issuance of the procurement request, vendors may not directly contact the buyer or their staff.

* Questions must be limited to no more than 10 items and must be clearly expressed.

* Responses to any particular question will be by email and will be open to all bidders, to maintain transparency.

* Everyone bids to the published buyer specification--no extras, variations, or deviations will be considered.

* Bidding will continue until there is no further price movement. The last bid is the winning bid.

* The winner of the auction may not further negotiate the terms and conditions (since this would obviously compromise the entire process).

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The Chanel experience

In 2002, while Chanel was still in the planning stages for its new [yen]24 billion ($218 million) Japan head office in Ginza, enterprising private consultant Blaise Anthony approached Chanel with the idea of starting up a procurement control function within the company for the purchase of interior architectural and construction services as well as office furniture. Anthony's proposition to Chanel's CEO Richard Collasse was simple: "Let me save you money by proactively managing your vendors and costs for this project."

Given the large sums of money involved, the proposition was both attractive and yet a potential risk. With deadlines on the building looming, what if vendors became offended by the initiative and refused to do business? Delays in the office opening would cost far more than the savings such a program might offer. Furthermore: What if the quest for better prices resulted in lower quality? This would be the antithesis of everything Chanel stood for.

To Collasse's credit, he decided to give Anthony a chance. In June 2003 Anthony was tasked with sourcing vendors for Chanel's multi-office relocation project.

One of his first innovations was an auction process for furniture and IT/cabling services. He made sure that the vendors were well informed of the company's intentions, and he produced the same level of RFP documentation that might be used in a traditional tender. He called the vendors in for two mass meetings: First to give them the RFP and to answer any preliminary questions, then a week later, to announce the vendors who had been selected and to actually conduct the auction.