What is a Japanese Auction?

We have just implemented Japanese Auction capability in our software at the recent request of a customer of ours.  Despite our procurement consultancy past, this is an auction format of which we have very little prior experience.  In fact, how much knowledge and experience is there in the general purchasing community of this approach to negotiation?

For those who are not familiar, here is an excerpt from our website of the Japanese Auction process:
“The Host states an opening price and participants have to accept that price level or withdraw from the auction.  Acceptance indicates that the participant is prepared to supply at the stated price.  When all participants reply to a certain price, the software lowers the price level by a pre-determined amount and again asks participants to accept or decline at the new price level.”

The process continues in this manner until all participants have ‘opted out’ of the auction.

As you can see, the approach can be very effective at establishing the final price for each participant in turn, regardless of the market competition.  Consequently the approach can be adopted in situations where market liquidity is very low or markets which are dominated by a handful of major players, such as dairy or utilities.  The Japanese Auction can even be used for a single-source negotiation, which was the major reason our customer favoured the Japanese Auction, ever since they used it to negotiate a significant cost reduction with just a few keen participants involved.

Other situations where the Japanese Auction can be used effectively are when there are large cost differences between bidders, despite both quoting for the same specifications.  With your typical Ranked Auction, the participant in first place will unlikely be challenged, even though they may have built in some margin to play with.  However, utilise the Japanese Auction and even that participant will be asked to improve their offer.

So far we have outlined a reverse Japanese Auction, i.e. where the bidding comes down in value upon each round.  However, we have encountered situations where a Japanese Auction can be used in an upward price direction, such as the negotiation of rebates amongst your supply base.  Since it is fairly meaningless to give suppliers market feedback on their rebates, as each supplier could be contracted for different goods and services and different spend levels, the Japanese Auction presents itself as a superb way to negotiate with each supplier individually, yet concurrently in a single auction.  For example, in Round 1 the suppliers are asked whether they agree to a rebate of 0.5% of full year spend, with an answer of “Yes / No”.  For those who reply favourably, they are then asked in Round 2 whether they agree to a rebate of 1.0% and so on.  There is a huge efficiency saving compared to the traditional way rebates are negotiated, as well as the potential for far greater results.

There are of course challenges to Japanese Auctions.  Firstly, they are not widely known about, which means that participants will require a greater degree of hand-holding and reassurance.  Secondly, they offer little to the participants in the way of market feedback.  Nevertheless, post-auction you can certainly provide feedback at your own discretion and to whatever extent you wish.  Thirdly they operate in a rigid manner, with participants only able to accept or decline each price level rather than to come in at their own price level.  It may mean that some participants have to wait a little longer to submit their final offer but the goal of establishing the market price is still achieved.

If anyone would like to know more, please feel free to contact us and we would be happy to take you through a web demo to show you how it works.

About: Market Dojo provides accessible eSourcing software.   Find out more at www.marketdojo.com

What is ‘market price’ and how do I know I’ve found it?

I realised recently that this is a term we brandish about quite frequently at various meetings and conversations we have.   Occasionally we get nods of appreciation for the term, but more commonly we receive a look of faint recognition, as if it were a friend last seen in school days wearing braces and ill-fitting clothes.  So, perhaps it might be worth giving our take on the term, just to help freshen up the concept, plus a little advice on how you might seek it.

The Merriam-Webster dictionary provides the following:  “a price actually given in current market dealings”.

There are several key words in this definition.  Let’s take the word ‘actually’ for example, for the above sentence can make perfect sense without it, yet the insertion is deliberate.  It adds gravitas to the word ‘price’.  It is not a suggested price or an implied price or even a piece of estimation, but an actual price.

What we would interpret this to mean in the procurement world is that this price is genuinely valid and acceptable.  It has been submitted based on all the specified requirements of quality, technical, commercial, logistical, operational, administrative, health and safety and so forth.   In other words, it is real and it is based on a product or service that meets your needs.

Another key word is ‘current’.  A market price cannot be so if it is founded upon old or even future information.  It has to be based current facts and information.  If I purchased my property for £200,000 two years ago, I would be misinformed to say it is now worth the same.  And nor could I actually tell now you the market price for it in 6 months time.  If I want to know an accurate figure for my property today, I would consult the market today.  It’s the only way to be certain.

The same applies in procurement.  Where certain prices rely heavily on raw material costs, such as fuel or steel, don’t leave it to the supplier to hedge their bets on raw material price movements as part of their offer to you.  It won’t be a market price if this happens.  Instead, ask them to give you a price based on today’s raw material costs and to provide a raw material index mechanism for future price reviews.  This way no one needs to take a gamble and lose out.  Such a mechanism is fair, open and transparent.  Currency reviews should operate in the same way.

However, what this definition does leave open is that you could receive a number of so-called ‘market prices’.  Which one is the right one?

This is where we would go a step further.  We would classify a market price as, “the best actual price in current market dealings that is sustainable for the required term”.  It is in no one’s interest for the price to be so competitive that it causes a supplier to go out of business or conversely so uncompetitive that it causes the buying company to go bust.  So, put into plain English, we see the market price as being the best price for a product or service, based on current market conditions, that meets your needs and is sustainable for the duration you want.
So, if that is what the market price is, how do we go about finding it?

First you specify your requirements.   Second, you engage the market.  It’s as simple as that.  Think about something like Money Supermarket or Compare the Market.  By filling in your car insurance requirements, you are provided with up to 30 quotes.  The top two or three are usually around the market price level, i.e. the best price, based on current market conditions, that meets your needs and is sustainable for the period you require it.  Beware of spurious prices, the ones that look too good to be true, because usually they are! A bit of due diligence is required just to double-check that the quotes are based on what you require. You don’t want to later find out your excess, for example, is ten times more than the next best quote.

For procurement, it is a case of designing a robust RFQ or set of requirements, leaving as little scope for interpretation as possible.  Secondly, you distribute it to your own private market, whereby you should have a plentiful number of capable and interested suppliers. Finally, pick the top two or three bids and carry out that bit of due diligence to make sure everything has been understood and that the quotes are accurate.

The knack is in creating your market.  If you were to approach two suppliers down the road and get prices, would you say that you have approached the market?  No.  If however you approach 10,000 suppliers around the globe, would you say that you need a few more before you know the market?  Also no, you would say you have covered a sufficient number of bases.  Clearly something lies in between.

Thankfully this is where online sourcing technology can greatly help you by keeping everything together in an auditable and controlled manner, allowing you to involve huge numbers of suppliers.  My personal record was a sourcing exercise that involved 1,500 suppliers, of which 140 or so provided prices.  Having completed this, I was particularly confident I had found the market price.

However this is a one-off example.  The practical way to create and involve the market is to:
1) Outline your supplier criteria, such as geography, turnover, accreditations, capabilities etc.
2) Source suppliers using your contacts, your experience, trade shows, associations, sourcing agencies and databases such as Kompass, Hotfrog, Kellysearch, Applegate, Alibaba, TradeIndia and so on,
3) Qualify the suppliers against your criteria, using questionnaires and submitted responses if time permits.

Once done, send out the RFQ or grant the qualified suppliers access to it and simply manage any questions that come back.  Once all the prices are in, carry out the competitive negotiation, be it an e-auction or otherwise, and the market price will be revealed before your very eyes!

About:  Market Dojo provides business-to-business e-auction and e-sourcing software.  Find out more at www.marketdojo.com.

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