RiP Fixed Pricing: The Internet Is on Its Way to "Marketizing" Everything - price transparency online

Business Economics, April, 2000 by Sam Kinney

Each auction follows three general steps, followed by an implementation phase. If markets are inefficient when prices do not reflect all available information, then the objective of the preparation is to make markets efficient. There are three general steps involved:

* Perfect the market information.

* Select the market participants.

* Conduct the Internet auction.

Most industrial markets begin in a state that is classically inefficient. Market information is very poor, driven by market structure characteristics. First, because many products are custom-made, there are no price lists to help buyers comparison shop. Second, because many supply markets are fragmented, it is difficult for buyers to have a complete view of the available suppliers and production techniques they employ. Third, because many markets still work with direct salespersons whose agency relationship is with the seller and not the buyer, product and pricing information tends to get obscured.

If that characterizes the state of market efficiency before the auction, the first step in the auction preparation is to make information more uniform and transparent. FreeMarkets does this by working with the buyer to form a detailed request for quotation (RFQ) whose information is as complete as possible. The objective is to transform as much information as possible into public-value information, rather than leaving participants to make their own assumptions and resort to private-value best guesses. For buyers and suppliers, this document typically has more engineering and commercial detail than was historically shared during price negotiations. And the information has to be made equally available to all participants. Note that the agency relationship is reversed--the Internet auctioneer works on behalf of the buyer, not individual sellers.

Selecting the market participants is another important step in a seller-bidding reverse auction. Buyers care from whom they buy. As a result, they must control which potential suppliers are shown the RFQ and invited to bid. Often, participant selection occurs after an exhaustive search and profiling exercise, so through the selection process buyers are given detailed comparative information about potential suppliers.

The preparation phases serve to perfect the information that suppliers have about the product and the buyer and to perfect the information the buyer has about sellers. Even without the Internet auction, we would have gone a long way toward making a more efficient market. And it would be impossible to hold an Internet auction without the preliminary work of creating a level competitive playing field.

However, the auction itself is the dramatic demonstration of markets becoming more efficient. A typical FreeMarkets auction occurs over a few hours, after the participants have had a few weeks to prepare quotations and bidding strategy.

Most FreeMarkets auctions are classic English-style reverse auctions. Bid prices begin high. Each participant can see the value of each bid and the current low bid seconds after the bid is submitted. Bidders can amend their bids downward in response to the competitive market price level. Supplier identities are disguised to prevent collusion. Figure 1 shows bidding after twenty minutes. Figure 2 shows bidding as the scheduled closing time approaches. Note that activity picks up near the end. The [BidWare.sup.TM] software automatically extends bidding into overtime if activity continues right up until closing, analogous to the live auctioneer's "going, going, gone" sequence. Figure 3 shows the same graph after 53 minutes of overtime. Activity continued rapidly right up until no bidder responded to the last bid.