Procurement Auctions in E-Commerce

Southern Business Review, Fall 2003 by Barrett, Robert T, Pugh, Robert E

The development of the Internet has led to establishing a variety of electronic marketplaces or exchanges that facilitate business-to-business (B-to-B) transactions. These Internet-based marketplaces reduce transaction costs and increase market liquidity. The vast size of the U.S. economy gives the promise of strong future growth and development of these marketplaces. The size of the U.S. economy is such that about $10 trillion of goods and services are delivered annually to final users, which includes domestic, foreign, and capital-good customers. The inputs to the processes producing these goods and services for final demand change hands several times before the finished goods and services reach the final customers. In fact, it is estimated that an average of three B-to-B transactions occur before the delivery of goods and services to the final users. Thus, the total for B-to-B commerce supporting the production of final demand is about $30 trillion per year, and, for the world economy, the annual B-to-B commerce is estimated to be about $100 trillion (Hall, 2001). Strong growth is also expected in financial B-to-B transactions, including certificates of deposits and bonds. MuniAuction, which has conducted more than 5,500 B-to-B financial auctions for states and municipalities for about $3.3 trillion in its first five years of operation and is increasing in volume at about a trillion dollars per year, demonstrates this growth (Grant Street Group, 2003).

Electronic marketing is proving to be highly advantageous in conducting some types of B-to-B transactions, but it has little to contribute to other types of transactions. Many types of capital equipment are custom-made and will continue to be purchased through negotiations of design and price that are worked out over a period of weeks or months. Electronic marketing cannot contribute to completing these negotiations. For the same reasons, electronic marketing can contribute little or nothing to new product development. Components and parts that are critical to product quality and safety are usually best purchased through partnering arrangements between the buyer and seller. Again, electronic marketing has little to contribute.

In the procurement of commodity and standard parts or components, however, electronic marketing can help achieve efficiency and costeffectiveness. In fact, some electronic marketplaces handle large volumes of procurements in industrial chemicals and metals, injection molded plastic components, printed circuit boards, fasteners, and many other noncritical inputs. Dana Corporation, one of the world's largest suppliers of components and modules to automotive manufacturers, reported the use of electronic marketing to procure more than $850 million in goods and services in 2001. Among the items Dana sourced through electronic marketing were aluminum and various metals, metal pipes, tubes and fittings, plastic injection molded parts, castings, electrical wire and connectors, metal fasteners, printed circuit boards, and spring products (FreeMarkets, Inc., 2001a).

In electronic marketing in support of B-to-B transactions, auctions are increasingly being used. Most of these auctions are of the multi-unit variety. For example, a company that requests bids from suppliers for a large quantity of a commodity or standard product or service and requests that bids specify the quantity that can be provided at a specified price within the buyer's time frame, constitutes a multi-unit auction. While the ways to structure such auctions are numerous, little is known about the best way to structure them. Until recently, auction theory, which is a subfield of economics, has restricted attention to the auctioning of a single, indivisible unit. While the research on multi-unit auctions is less well developed, it has recently become an active research area due to the impetus provided by B-to-B electronic commerce and to such problems as government auctions of radio spectrum licenses (Klemperer, 1999).

Auctions in E-Commerce

Auctions have been used from time immemorial, dating back at least to the Babylonian and Roman empires. Traditional auctions bring buyers together for the purpose of determining the price a seller will receive for a product or service. Another type of auction, frequently called a reverse auction (multiunit procurement auctions, as discussed in this article, are invariably reverse auctions), brings sellers together for the purpose of determining the price a buyer will pay for a product or service. Auction participants are governed by a set of rules for making and processing bids and determining the transaction price or prices for the buyers and sellers. While the variants of auctions differ, only four traditional types of single-unit auctions exist:

(1) the ascending-bid auction,

(2) the descending-bid auction,

(3) the first-price sealed-bid auction, and

(4) the second-price sealed-bid auction.

In the ascending-bid auction, or English auction, the object for sale is bid upon in an open forum resulting in the bidder offering the highest price having the obligation to purchase the item for that price. The English auction is an open system requiring that all bidders be made aware of all bids offered. The descending-bid auction, or Dutch auction, works in an opposite manner from the ascendingbid auction. The auction begins with a high price and the price is lowered in steps, usually at set time intervals. The first bidder who agrees to accept the current price wins the object and pays that price. The first-price sealed-bid auction requires each bidder to independently submit a single bid without knowing the others' bids; the object is sold to the bidder who makes the highest bid. The second-price sealed-bid auction, or Vickery auction, requires each bidder to independently submit a single bid without seeing the others' bids; the object is sold to the bidder who makes the highest bid at the price bid by the second highest bidder (Klemperer, 1999). The rules for these four basic types of auctions have to be generalized to accommodate multi-unit auctions since in multi-unit auctions bidders bid on different numbers of units and may pay different prices per unit. The variety of ways in which these rules can be generalized is wide.