Reverse Auctions Raise Bid Shopping Concerns

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Reverse Auctions Raise Bid Shopping Concerns
Some contractors worry about services becoming commodities

enr.construction.com - 11/04/02

By William J. Angelo

If a manufacturer needed to purchase 50,000 lb of cement at a good price, it might try using a "reverse" auction on the Internet. That bidding technique is catching on among owners, particularly large industrial firms and nationwide retailers, as they try to cut costs for bulk commodities. But construction services also are becoming an auction item, and contractor groups are worried that reverse auctions are just another form of bid shopping.

COMMAND CENTER
Pittsburgh firm manages thousands of Internet reverse auctions. (photo courtesy of FreeMarkets Inc)

Reverse auctions are a new Internet trend for buying goods and services. The process pits anonymous bidders against one another in an effort to obtain the lowest price--the reverse of a typical auction in which prospective buyers bid upward. The process includes specific times for rebids and continues until bidding stops and an award is made.

FreeMarkets Inc., a Pittsburgh provider of Internet sourcing services, says reverse auctions are a safe and transparent method to help owners make effective real-time buying decisions. "We started doing reverse auctions in 1995 and have completed over 20,000 in all industry sectors," says Greg Anderson, the firm's director of global market operations. "We have helped source $45 billion in goods and services." Karen J. Kovatch, a FreeMarkets spokeswoman, says customers save 17% on average. "That translates into about $9 billion to date," she says.

FreeMarkets is one of dozens of consulting firms, software providers or industry-sponsored exchanges that now provide reverse auction services. It offers "self-serve" software or full-service support, in which FreeMarkets manages all reverse auction operations and promotion. The latter requires a client to sign a long-term contract.

According to Anderson, bidders and buyers sign agreements that vouch for the validity of their bids and/or contract awards. If a party reneges, it is suspended from further network participation.

FreeMarkets also helps full-service clients develop requests for qualifications (RFQs) and pre-qualified supplier lists. The firm also monitors log-ons to see if all bidders are participating. "We are a no-cost sales channel to buyers, and we are passionate about integrity, neutrality and trust," says Anderson. "We're not out to crack relationships, just give assurances that owners are getting true market pricing."

FreeMarkets has used the system for industrial, infrastructure and commercial construction projects. A recent reverse auction for a line-item, lump-sum powerplant project took four months to develop and drew four bidders. Preparation also included a site walk. "Anything traditionally done with sealed bids still happens before an online auction," says Krish Y. Pandya, engineering and construction market development manager for Free Markets. "Plus, we also encourage buyers not to short-list."

While sensitive to possible antitrust issues, the Associated General Contractors, American Subcontractors Association and Associated Specialty Contractors are watching the trend closely. While none have yet developed formal positions, they see ominous signs. "It's just another dress on the bid-shopping mannequin," says Dan Walter, ASC president.

Concerned about the trend, the Construction Industry Cooperative Council of Minnesota, a committee of 12 industry organizations, earlier this year asked Fabyanske, Westra & Hart, P.A., a Minneapolis law firm, to investigate. "More and more 'big box' firms such as Target, Best Buy and Home Depot, are using reverse-auction bidding," says partner Dean B. Thomson. "But contractors don't see construction as a commodity. They see it as a service dependent on variables such as labor and schedule."

"We don't like it," says Richard F. Kohls, vice president of finance at Fenton Rigging Co., a Cincinnati subcontractor. "We move machinery and bid many small jobs, in the $10,000 to $25,000 range, but we have never gotten a job." He says his firm started reverse auction bidding on jobs several years ago at a local General Electric Co. plant. "They provide good scope and we put our number in and they tell us whether we're low or not. We don't see other prices," says Kohls.

The sub says this plant typically awards prime contracts to large specialty contractors, one of whom asked him for a price adjustment. "We told them we gave them our price and if they want an adjustment they could take it out of their number," says Kohls. "We didn't get the job."

General contractors have similar concerns. "For the most part, the numbers awarded have been below our costs," says Mark A. Millich, president of J.M. Olson Corp., Detroit. He says bidders could see prices being offered but not the identity of the bidders. "When you're sitting in front of that screen, and you ask, 'Can I slash another $10,000 or so off my price?' it's a gambling mentality," Millich says.

After bidding 15 projects, Millich landed a $4-million plant expansion. "The work is going fine and, in this case, we picked our own subs," he says. "But I've bid on projects where subs have been auctioned off, usually for well defined scopes such as hardware or carpeting." Owners "give you plans and specs and ask for your best line-item, lump-sum bid," Millich contends. "That takes the intellectual process out of the equation."

Pandya says his the process is not just price driven. "We make real-time adjustments for hard and soft factors, such as a supplier's claim and safety record, and we balance that against his price," he says. "We also use ranked bids to eliminate collusion." Anderson adds: "Probably less than 1% of low-bid winners are selected because reputation, quality, location and other intangibles are also factored in."

Thomson says his research indicates that owners may not be getting expected savings "because, unlike sealed bids, bidders do not have to start off with their lowest bid." GE, Stamford, Conn., did not comment. Target Corp., Minneapolis, "has a policy of not sharing information with trade publications," says a spokeswoman.

Thomson also cautions that the anonymous nature of the reverse auction process raises the specter of phantom bidders, and its openness in tougher economic times also is worrisome. "Desperate contractors will underbid labor, safety and management costs just to keep their crews busy," he says.