This must be “Frequently Asked Questions” week. Starting at ISMWorld a couple weeks ago, I fielded lots of questions about e-auctions both in casual conversation and in speaking sessions. Then my website administrator suggested adding an FAQ page to my website, so I spent some time adding that. (She was right, I like the addition!) One question about e-auctions keeps popping up: Which category should we e-auction first? Procurement professionals who ask me this question are often expecting a quick response of “direct materials with simple specs” or even expecting me to name a category. Instead, I usually ask some questions that define good categories at their business, because truly every business is different. Today let’s talk about the questions that lead to the right first categories to e-auction, and let’s also talk about some of the “conventional wisdom” categories that are actually quite difficult (MRO anyone?).
Which Category Should I Start With?
There are five questions where the answers lead to good e-auction categories. The answers are simply not the same between different companies because one business’ strategic sourcing category is another business’ tail spend (i.e. sheet steel is strategic to a welding manufacturer, but tail spend in a casting shop). The first three are my favorites, and the last two are secondary but can’t be missed.
1 . Are suppliers hungry for the business? This question feels very intuitive, but I’ve met a lot of procurement professionals who don’t know which pieces of their business or categories are most appealing to suppliers. You know you have hungry suppliers when:
- Suppliers are calling you after a bid, asking how they did and how they can do better.
- Suppliers are cold-calling, asking to be put on your bid list. Or filling out your intake form on your procure-to-pay software.
- You are being a good “customer of choice” and suppliers want to work with you.
- Your category represents what would be a large part of the supplier’s business (not yours). If you are a large manufacturer of lawnmowers, chances are good your engine category would represent a lot of business for any small engine manufacturer. If you are a small steel machining manufacturer, steel shapes might be critical to your business but the steel mills don’t even notice your volume. Meanwhile, you are 20% of the local tooling distributor’s business.
- The category’s industry is extremely fractured, there are many suppliers who are qualified to do the work, or the supplier’s industry is in a downturn.
Examples: Temp labor/Managed Service Providers, office space leases right after COVID, many consulting service categories, janitorial/landscaping services in large cities (not in rural areas).
2. Do the resources to fill the sourcing need vary? This means you’re asking, “Who has X this week/month/year?” I’ve seen e-auctions that meet this criteria for fish served in the company cafeteria, supplies of fresh pork for a grocery store chain, and labor crews for utility tree-trimming. The key here is when suppliers have the resource needed, possibly in excess, and they’re willing to sell to offload expiring goods or keep idle labor occupied. I’ve also seen this go well when a supplier has excess inventory to get rid of for cash flow reasons or because another customer cancelled an order. This kind of purchase is often called a “spot buy” because it’s either under a general contract or no contract at all.
It’s worth noting the “spot buy” criteria is one of the criteria for which I recommend a straight-to-auction instead of an e-auction after an RFP. These are very “strike while the iron is hot” situations, and that excess inventory can be easily snapped up by your competitor while you’re still running an RFP. Especially if it’s something you’re buying regularly (i.e. Every two weeks, here’s the construction projects we need done over the next two weeks), running a quick e-auction at the same time every week can save both the procurement and sales teams a lot of time and effort.
Examples: Work, labor, or construction crews, perishables that can come from multiple contracted suppliers depending on supply, an end-of-year equipment purchase without a strong preference for one supplier or even a very specific spec.
3. How high are supplier margins? This one gets tricky because you have to keep your eye on the total cost of ownership and value instead of just using an e-auction to squeeze margins. That being said, some industries have thicker margins than others and so their pricing is more flexible. When the difference between a supplier’s costs and what they charge their customers is more than about 30%, I consider them a high margin supplier. The other reason I like these for e-auctions is that it’s incredibly common for these suppliers to be new to e-auctions. That means they have no preconceived notion of what an e-auction is and they are more open to listening to the benefits of using an e-auction (transparency, clarity, and speed) instead of a drawn-out, opaque negotiation process. That also means it’s incredibly important that the buyer run the e-auction well, professionally, and with the utmost integrity. I don’t recommend running these without an RFP because even the best scopes of work tend to have gaps, there are multiple options for schedule, and there are a number of other things that have to be trued up before you can run a fair e-auction.
Examples: IT software implementation services, non-custom software, financial investment firms, (sometimes) commercial real estate leases, office furniture.
4. Is this in my tail spend? We all have categories we don’t really touch. They’re simply “not worth it”. Yet every supplier costs something to maintain: gathering tax documents like W-9 forms, maintaining correct contacts in the system, even cutting POs costs money. Not to mention, you’re probably holding inventory for your tail spend suppliers because your volume isn’t high enough for them to hold it. In this case, I like to gather up as many tail-spend SKUs as I can and create an auction between multiple distributors. Perhaps these distributors are already in your system, maybe they’re even part of the current tail spend but more business would pull them into more strategic spend. The trick is this: don’t e-auction all of those SKUs. It’s a mess, and we’re not looking for a race to the bottom here on substitute parts. We’re looking for a supplier partner who will help us clean up all these pieces and bring true value. So take the total spend estimated in the SKUs and put it in your e-auction quantity. Then have suppliers bid on the markup to manage all this spend as a decimal (i.e. $1,000,000 in spend with a 15% markup, the quantity is 1,000,000 and suppliers enter 0.15. The resulting bid, $150,000 is the supplier’s commission to manage this inventory). Suppliers can see an estimated amount they’ll be paid to manage all of the SKUs, they get a good view on what kind of SKUs they are taking on (because you send the list out), and you’re really using the e-auction for value instead of just cost. Your supplier management costs go down and you probably can work out a good deal with the awarded distributor for holding inventory for you as part of their markup (include this in the scope of work so it’s perfectly clear before e-auction). In many cases, the distributor can find you an alternate for a lower cost because they have a good relationship with multiple manufacturers. You might even save on shipping fees by consolidating truckloads or shipping multiple SKUs on one pallet. So while initially it looks like you’re spending money to reduce tail spend, the total cost of ownership drops and cash flow (in the form of inventory) improves.
Examples: All that stuff you never touch and you don’t even give to the interns to manage.
5. Is the scope of work for an incredibly clear lump sum project? These often surprise people and are sometimes not even bid by procurement. Running an e-auction for a lump sum capital project is especially effective when you’re currently operating under “three bids and a buy” but have seven suppliers qualified to do the work. An e-auction can be an easy way to let all qualified suppliers see the business and decide if they have bandwidth to complete it, and three vs. seven suppliers are not dramatically harder to manage or evaluate. These types of project also tend to have a beginning, an end, a clear scope with solid specifications, and multiple processes in place to manage them. While certain suppliers may be preferred (in which case, use a bid transformation to distinguish between them), capital projects often come down to just price after suppliers are qualified.
Examples: Factory expansions, utility line construction work, office remodels (not the design side, the execution side), new equipment installation.
What Category Should I NOT Start With?
There are a couple categories it seems like everyone wants to start an e-auction program with, and they simply don’t work for the beginning stages. Here are some examples, and why they don’t make good first auctions. Note: These can be excellent auctions! I ran MRO for a client last week and it’s one of the most successful auctions I’ve ever seen. But it took a LOT of work to get there and was in no way easy.
- Fasteners – I feel like a lot of e-auction programs try to start with fasteners (nuts, bolts, screws, etc.), thinking the specification is straightforward and therefore a straight-to-auction will be easy. Yet fasteners have a lot of service items going on. Yes, there’s a clear spec for a ⅜”x2” coarse thread zinc-coated grade 8 bolt. But how do you want it shipped? Do you want all the fasteners for a machine kitted up for each build station in a manufacturing line? How is shipping charged or structured? Do you want vendor-managed inventory? Do you want vending machines and are you willing to pay for them? (The leading supplier who includes vending as an option charges $40 per month per machine. They won’t tell you so and it will appear on none of your contracts. But that invoice will show up and they will expect it to be paid or they will take the vending machine away.) Fasteners and related items (adapters, fittings, etc.) seem like easy auctions and they simply aren’t.
- MRO and PPE – MRO (which is defined differently at every company I’ve ever worked for/with) is the group of small-dollar materials that keep your operations team running: stretch wrap, trash hoppers, ladders, janitorial supplies, etc. PPE is the personal protective equipment that keeps your workforce safe and operating smoothly: gloves, boots, safety glasses, hearing protection, etc. These seem like great auction categories, and they can be. It’s true that specs are clear, they are low spend, and suppliers are competitive for business. Just like with fasteners, there are a bunch of service items that are hard to account for in a straight-to-auction. How will shipping be handled? What about the fact that department A likes the blue gloves and department B likes the green gloves, even though they’re essentially the same glove from different manufacturers? How do you get the hundreds or thousands of SKUs down to a manageable level? What about when a supplier doesn’t realize that particular glove needs to be cut-resistant and so they quote a really great price but it turns out to be for the wrong thing? Not to mention, two of the major players in this space completely refuse to participate in anything resembling an e-auction for any reason or any customer. MRO and PPE are extremely tricky to e-auction well and so many people I talk to judge e-auctions based on an experience trying to auction these categories.
- Major strategic direct materials – many e-auction experts will disagree with me on this one. They will want to get their hands on the big, strategic spend first. I get it. But your strategic direct materials that are how your business makes money shouldn’t be in your first five auctions. They shouldn’t even be in your first twenty auctions. If something goes wrong with your major direct material spend, it brings the whole company down. Until you really feel comfortable using the e-auction tool, start with the less critical categories. You can and should work your way into these, but after you’ve mastered how to talk to suppliers and internal stakeholders, and have clear parameters on when you will and won’t be using e-auctions as your negotiation tool.
I hope these notes on where to start are helpful if you’re considering running e-auctions. If you’d like to talk about the right first categories for you, let’s chat. If you’d like to get these articles weekly straight to your inbox and never miss one, sign up for my newsletter.
My book, Transform Procurement: The Value of E-auctions is available in ebook, paperback and even hardcover format: https://www.amazon.com/dp/B0F79T6F25
My chapter in the powerful anthology Femme Led: Hard-Learned Lessons from Women in Leadership is now available in ebook and paperback format: https://a.co/d/0bOzma8F
