How the "Profit Leverage Effect" Works When Using Reverse Auctions

The Profit Leverage Effect in purchasing tells us that if your organization must find ways to reduce or contain costs, the best place to start is in the Purchasing function. This is because a high percent of many organizations’ total costs are in purchased goods and services. When cost containment becomes a strategic necessity, whether due to reduced sales or revenues, high labor costs, or other factors, companies too often focus on cutting costs in areas such as labor and overhead rather than on purchasing. It is too often assumed that it is easier to implement job cuts than it is to reduce purchasing costs.

For example, as an industry average, 60% of all sales dollars are spent on purchased materials, and therefore, small changes in the cost of purchased materials result in large changes to profit. So if your business spends 10% of the revenues on labor and salaries and 25% on overhead, then your profit is an industry average of 5%. A five percent reduction in purchased costs will result in a three percent impact on net income ~ (.05 X 60% = 3%). This will boost your profits up to 8% from 5%, resulting in a 60% increase in profits. In conclusion, a 5% reduction in purchase costs will result in a 60% increase to profits.

Reducing your procurement costs will also help your company in a highly price competitive market. Your company most likely will be losing margin as lower prices are required to compete in your market. If you can reduce your purchasing costs, then you will be able to lower prices without losing your profit margin.

Fortunately, e-sourcing technologies like reverse auctions have become affordable, easy to implement, and are being used by mid-market and small organizations to control purchasing costs.

While reverse auctions cannot be used to procure everything, they can make a positive impact in the profitability of your company without implementing painful decisions.

You can visit eDynaQuote for examples of reverse auctions that companies have been successful with.

How Buying and Selling Has Gotten a Lot Easier With Reverse Auctions

Over the years, a lot has changed in the way people transact businesses. A few years ago, whenever a seller listed something for sale, the whole process of actually negotiating with the buyer was too tedious. First they had to post an ad, wait for the customers to respond to the offer, sit with them and then complete the transaction. Usually in such cases, the amount sellers get from the buyers is much less than what they had wanted due to several rounds of negotiations.

Auctions are always convenient

A far more practical option back then was to arrange an auction whereby buyers competed with each other to buy the goods or services which the seller is offering. In this case, prices usually went up, and the highest bidder could acquire the things on sale. In traditional auctions like this, buyers ended up paying over the odds while sellers enjoyed enormous profits.

But as technology has advanced, it has brought a lot of changes and one of them has been the introduction of reverse auctions. These auctions, unlike the traditional ones, are entirely different. For instance, here it is the buyer who initiates the auction. Usually, the process comprises of:-

  • Posting the job in a reverse auction website
  • Description of the desired service or product from the buyer
  • Receiving and evaluating bids
  • Choosing the lowest bid
  • Handing the job

Unlike traditional auctions, prices are driven down by competing sellers. Here vendors are competing to obtain business from the buyers. But it’s not always the price which is the primary factor when buyers are deciding which bid to accept from a seller and which to reject. It depends on a lot of other factors. The buyer might accept a higher bid from a seller if they feel that their proposal is much better.

There are several advantages of reverse auctions like:-

  • Firstly, as sellers compete with each other to drive the price down, buyers end up saving at least 30-40% on an average.
  • Secondly, it saves a lot of time. All that buyers need to do is post the things they want in a reverse auction website. Sellers will then bid with price quotations.
  • Thirdly, buyers can compare the bids from all the sellers at a glance. This enables them to choose the best proposal.
  • Fourthly, for companies, reverse auctions can be of great help in generating more business if their bid is accepted.

Analysis of Reverse Auctions and the Hardware and Software Components Thereof

Unlike some technologies that have sprung up for business use in the recent years, reverse online auctions is not at its core a technology, but rather an amalgamation of a plethora of technological subsets, both hardware and software. Reverse online auctions is a concept, a business process, that utilizes technology to facilitate the exchange of money and supplier contracts at the lowest possible price while still taking into account many other factors that may affect a business deal and prohibit it from reaching its potential success level. Reverse online auctions can be broken down into two components: hardware and the hardware vendors and software and the software providers.

First, the issue of hardware is paramount. If the current IS implementation of a company cannot handle the increased load of database calls and other integrated systems, then the client-side software provided will be of little use. The minimum software requirements for a server run by the company for the auction software are Apache Web Server, PHP 4 to 5, and a SQL database. Though Apache is the most resource intensive application on this list, it is one of the least resource intensive applications available as web server software. Existing servers can be used for the hardware as long as they are able to support the Linux operating system. However, if the software is being purchased on demand from a vendor, then the only hardware needed is a computer that can run the Windows operating system.

On the software side, multiple vendors sell the components needed to establish a connection to an online marketplace and offer contracts to suppliers. One of the largest suppliers of software as a service (SaaS) is Procuri. Procuri offers bundle packages for both suppliers and buyers, each available on demand. This software combines to form the backbone which allows for the completion of a reverse auction online. There are relatively few steps from signing up with Procuri to completing a successful auction. First, a financial management software package is implemented which allows a budget to be made for the auctions. Next, suppliers are found by listing the auction in Procuri’s marketplace and then evaluated using the sourcing software package. Next, the auction takes place, each subsequent supplier bidding lower than the previous supplier in order to win the contract. This allows for incredible cost savings for the company that listed the contract, though it is disputed how much these savings apply when all factors are considered. At this point, contract management software is used to ensure that the contract remains permanent in a digital environment and easily accessible for approval and renewal. Lastly, the supplier management software suite allows companies to audit their suppliers based on the claims that were set forth when the contract was created. This allows for corrective action to be taken quickly and effectively while alerting both the supplier and the buyer that an issue has arisen.

It is easy to think of this entire process as simply online reverse auctions, though there is much more underneath the surface than can be initially grasped. Like every new technology, studies constantly conflict about the benefits of using it; some, like Fortune Brands, claim savings of over 18 percent, while others debate if these savings, when they do exist, serve as a detriment to company/supplier relations and negatively impact the future of the business. As this technology is studied more heavily, businesses will eventually be able to see both sides of this argument clearly and make an informed decision about whether this technology is cost-efficient and prudent to use in their industry.