Shaving Costs With Reverse Auctions

By: - April 23, 2010 12:00 am

One afternoon two weeks ago, Bob Furman, a purchaser for the state of Delaware, was staring at a computer screen in a conference room in Dover. Bids on a big state contract for electricity were rolling in over the internet, and as he munched on popcorn, the price Delaware would pay to power its state buildings kept going exactly the direction Furman hoped: down.

Furman was running what’s called a “reverse auction.” It’s a bit like using eBay, but with a twist. Rather than selling something to buyers who bid the price up until one of them wins, Furman was doing the opposite. He was buying something from sellers who bid the price down lower and lower until one of them gets the state’s business.

On this day, the bidding would go on for six hours. Five electricity sellers battled each other for the three-year state contract. Much like an eBay auction, the most furious bidding and countering came at the end, just before the close of the event. In the end, Washington Gas Energy Services won the contract, at a price projected to save Delaware more than $13 million on its utility bills over the next three years. The agreement also included a guarantee that more than 30 percent of the power would come from renewable sources in the first year of the deal.

Reverse auctions are nothing new. It’s been a decade since Pennsylvania became the first state to use this technology to save millions of dollars on salt to spread on roads during winter storms. Despite the potential to create big savings on government purchases, however, only a handful of states have taken advantage of reverse auctions as Delaware and Pennsylvania do. At a time when most states are struggling to close huge budget deficits, some think the strategy could help governments pay less for the things they buy — especially commodities such as office supplies or landscaping mulch that don’t vary much in quality from one vendor to the next.

Not for everyone

Yet if reverse auctions haven’t caught on, there are reasons for that. The real-time bidding process is not for everyone, cautions Furman, Delaware’s chief purchaser for state government facilities.

For one thing, reverse auctions move much faster than the normal government procurement process does. “All the action takes place in the last 30 seconds,” Furman says, suggesting that not all government purchasing agents are up for this type of “electrifying” experience.

Also, it only works in a competitive marketplace where states can conduct large-volume purchases by aggregating the needs of many state agencies — as well as counties and cities, when possible. That’s a big challenge, says Jeff Strane, of the Commission for a New Georgia , which aims to make Georgia state government more efficient. Coordinating the purchase of pencils with 150 different state agencies isn’t easy, but if states don’t do it, they’re leaving money on the table, he says.

One commodity states have had success pooling together on is electricity, at least in states that have deregulated their electricity markets as Delaware has. Connecticut, Maryland, Massachusetts, New Jersey, Ohio, Pennsylvania and Texas all have used the reverse-auction process to save millions of dollars on their power bills. Even deals like the one Furman struck for Delaware can make some government purchasers antsy, however. Power prices can be quite volatile, and for some purchasers, the potential risk in contracting for it three years into the future is not worth the potential savings.

“There are ups and downs to reverse auctions,” says Brian Selander, chief of staff to Delaware Governor Jack Markell and a former private-sector procurement expert. “The good news is that they work well on large-scale commodity purchases such as electricity and road salt,” he says. The bad news is that in smaller markets, states have to work hard at recruiting, training and retaining vendors to participate in the auctions if states want to see significant savings.

Seller’s remorse

Indeed, keeping vendors interested in playing the reverse-auction game has been part of the challenge for states. For vendors, losing a heated and fast-paced bidding war can be a pretty frustrating experience. And winning can be just as bad if a vendor gets caught up in the moment, bids too low for a state contract, and winds up losing money on the deal.

Still, a few states continue to make reverse auctions work. And some procurement experts predict a resurgence in the high-tech technique as state budget woes force more vendors to aggressively cut prices if they want to keep selling to governments.

Indiana, one of the biggest users of reverse auctions, continues to save millions on road salt and a range of other products, including work boots for state troopers, televisions for inns located in state parks and heavy equipment. 

But the National Association of State Procurement Officials cautions that the bidding process only works in certain markets. In Minnesota, for example, reverse auctions proved successful in purchasing snowmobiles, walleye fingerlings, and traffic safety equipment. But for printing services, motorcycles, muskellunge fingerlings and fishing nets, it didn’t work as well.  

Stateline staff writer David Harrison contributed to this article.

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Christine Vestal

Christine Vestal covers mental health and drug addiction for Stateline. Previously, she covered health care for McGraw-Hill and the Financial Times.