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The business of bidding: Reinventing auctions for better results

Innovative auction design boosts procurement, sales teams


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by Jamie Beckett

In early 2000 when the world was intoxicated with online auctions, Kemal Guler wasn't among those rummaging through his garage for treasures to sell on eBay. Guler, an economist at HP Labs, was instead thinking about how the Web would change auctions forever.

Auctions have been around for about five millennia, selling to the highest bidder everything from horses to silver to securities to works of art. But electronic auctions open up a range of new possibilities – including the opportunity to easily experiment with different auction formats. Suddenly, almost anyone could run an auction, or participate in one, and all sorts of goods – from Victor gramophones to an entire plastics factory in Mexico – were attracting bidders from all corners of the world.

"An auction house like Christie's or Sotheby's had a fixed set of rules and applied it in auction after auction after auction," Guler says. "With the Internet, we were in entirely new territory that would create new forms of auctions that had never before existed."

Online procurement on the rise

Guler set about exploring that new territory as part of a larger effort at HP Labs in business-process innovation, a means of finding smarter ways to manage commonplace business tasks such as product portfolio optimization, supply chain planning and, in this case, business procurement, which increasingly involves auctions.

Over the past four years HP has used online bidding to purchase some $21 billion worth of materials – items like power cords, memory or packing materials – at an estimated savings of $1 billion so far.

Overall, U.S. businesses are expected to use online auctions for more than $660 billion worth of procurement operations in 2006, according to a recent IDC report.

"An auction allows you to quickly identify the lowest cost you can achieve in certain conditions," says Karim Mohara, HP's manager of e-sourcing. "When you negotiate one-on-one, there is always room for uncertainty. It's like buying a car: you always wonder if you got the best price."

Auction format affects outcome

For HP, the goal was not just to reduce costs or speed up the procurement process. It was to use auctions intelligently and to do so without putting a strain on its supplier relationships.

"Today people configure auctions randomly or intuitively," says Mohara. They make ad hoc decisions about such auction attributes as whether bids will be open or sealed, the order in which items are auctioned, lot sizes and the amount of information buyers receive.

But ‘ad hoc’ auctions aren't necessarily the most successful. Changes in auction format and bidding rules can substantially affect auction outcomes.

Handling complex purchases

Electronic auctions, says Guler, make it easier to change these rules, to set up more complex auctions and to collect data on the results.

"In a traditional auction, you were restricted in that everyone had to be present," he says. "More importantly, the way bidders expressed what they were willing to pay had to be simple because all that information had to be processed very quickly by one fast-talking guy."

In an electronic auction it is possible, for instance, to allow bidders to offer different discounts for different quantities.

"If you take bids for 10 different quantities from 10 bidders, determining how much you purchase and from whom is not something you can figure on the back of an envelope," says Guler. "Traditional 'price-only' bidding languages, in their beautiful simplicity, are simply inadequate for the kind of communication needed for complex business cases."

Winning bids

HP has put the same tool to use when it's been on the opposite side of the auction block – bidding to win business from a prospective customer. In one instance, a large telecommunications firm held a reverse auction (in which sellers lower their prices until the buyer accepts one) to purchase workstations, desktops and notebooks.

The result: HP not only beat rivals, but the company won the $15 million contract at a higher-than-anticipated profit margin.

Now, researchers are exploring applying this knowledge to HP's overall pricing and sales policies.

HP is also putting its expertise to work for selected partners. Researchers' auction analytics work has shown a major car manufacturer how it can reap more revenue from wholesale car auctions to dealers by adjusting the order in which cars are put up for bid.

By adjusting this one factor, the car company can boost the sale price per car by one percent, the probability of a sale by three percent, and auction revenue overall by four percent – and pocket $160 million a year more in profit.

Better business processes

So far, HP has 20 patents pending on various aspects of auction analytics.

Researchers have created an early version of software that can help procurement professionals design better auctions. They're now working with the eSourcing team to collect and analyze more data so the tool can be customized according to specific auction details.

"Our dream is to make auction decision support a more automated process," says Guler.

Long term, Guler says, researchers want to apply their skills in game theory, economics, econometrics, statistics and decision analysis to a whole host of business processes.

"There are volumes of scholarly literature on these topics and, at the same time, there are emerging business needs," Guler says. "We want to fill the gap, to bring science to business decisions."

Jamie Beckett is managing editor of the HP Labs Web site. Before joining HP, she was a reporter and editor at the San Francisco Chronicle. She is also a published fiction writer.

Related links

» Analytical tools for auction design
» HP Procurement services
» ERP and supply chain services

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Mix economics with some game theory, decision analysis and some smart PhDs, and you get an auction design tool that has helped HP save $1 billion – and counting – in procurement costs.

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