Reverse Auction Business Model – How Does It Work?

In the reverse auction business model, the sellers compete amongst each other to win the business (products or services) from the buyers. The process is called reverse auction as the bidding prices gradually decrease in contrast to the forward auction model.

Reverse auctions happen with procurement and tender bidding processes. The suppliers of the services or products bid for the lowest possible prices to win the project. Long-term supplier contracts, construction projects, and government tenders are common examples of the reverse auction model.

What is the Reverse Auction Business Model?

A reserve auction is a strategy used in outsourcing procurement and supplier contracts to the successful bidders at the lowest possible prices. Such scenarios occur when there are large buyers and multiple suppliers in the same market.

Large businesses often outsource raw materials and key components to their reliable suppliers. These contracts are awarded a reverse auction process. However, it may also compromise the quality on offer as multiple sellers bid for the lowest possible prices. The reverse auction model works well where multiple and qualified suppliers bid to the sellers.

The procurement auctions through tenders and supplier contracts are the most common forms of reverse auction business model. The buyers looking for sophisticated products may be at a disadvantage of receiving a low number of qualifying bids through a reverse auction though.

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How Does the Reverse Auction Business Model Work?

The business advertises the need for the products/supplies first. The qualified buyers then submit their quoted prices to the seller. Sellers may directly approach selective buyers through a call or request for Quotation (RFQ).

A reverse auction happens for the continuous supply of goods or services. The bidders advertise the prerequisites and qualifying terms. These terms are initiated to maintain the quality of procured products/services. As the bidders would focus on winning the auction at the lowest possible prices.

The buyers must put the qualifying terms and product specifications clearly. The long-term procurement process and the conditions should also be clarified. Otherwise, non-qualifying bidders may win the auction without prior knowledge which ends up as disqualification of the process.

The reverse auction process also takes several forms.

English or Open Reverse Auctions

As the name suggests, in an open reverse auction all bidders are aware of the competition. Unlike forward auctions, the bidding prices fall gradually with each bid to win the contract. The bidders here are the sellers of the product/service, not the buyers.

Dutch Auctions

A forward Dutch auction starts with the highest possible bid by the buyers. A reverse Dutch auction starts with the lowest possible prices acceptable for the seller. The bid prices offered by the sellers then gradually go up in a Dutch reverse auction.

Japanese Auctions

It is a form of auction where the sellers approach selective buyers directly. It is often used to procure the supply of raw material or components used in product manufacturing. The sellers start the process by asking for a request for quotations from the buyers. The lowest possible quotation meeting the product specification and quality standards win the auction.

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The rise of the reverse auction business model came through the competitive nature of the internet markets. The shrinking boundaries between the sellers and buyers have made it possible for such scenarios. The buyers can transparently award the contracts to the most suitable bidders on time with a reverse auction process.

Advantages of Reverse Auction Business Model

If done transparently, the reverse auction process can get the highest quality products at the most competitive prices. The reverse auction model can save time and resources for both the sellers and buyers.

The reverse auction business model has many advantages:

  • The sellers keep control over the full auction process, unlike the forward auction where buyers control the prices.
  • The sellers get the highest possible quality at the lowest prices.
  • It increases the competition as multiple bidders join the reverse auction to win the contracts.
  • Large businesses can use the reverse auction model to outsource key supplies to the qualified bidders.
  • Buyers can compare the bidders and select the most qualified bidder, not necessarily the lowest price bidder.

Disadvantages of Reverse Auction Business Model

The biggest disadvantage of the reverse auction model is to find the qualifying bidders without a compromise on the quality. Some other limitations of the reverse auction model include:

  • It cannot be applied where the number of bidders is lower.
  • The lowest price bidders may not qualify for the product specification requirements.
  • It cannot be applied to all the industries unanimously.

Examples

The Japanese firms adopted the reverse auction, business models. Toyota is the prime example of a reverse auction business model where it awards the outsourcing of some components to the qualifying suppliers.

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