An auction is basically motivated when you suspect lack of transparency. One of the most famous examples of getting more transparency by using an auction is the German author Goethe, who used a second price auction to establish his market value. In 1797 he wrote to his publisher Vieweg:
“I propose to offer Mr. Vieweg an epic poem, Hermann and Dorothea, which will have approximately 2000 hexameters. (...) Concerning the royalty we will proceed as follows: I will hand Mr. Böttiger a sealed note which contains my demand, and wait for what Mr. Vieweg will suggest to offer for my work. If his offer is lower than my demand, then I take my note back, unopened, and the negotiation is broken. If, however, his offer is higher, then I will not ask for more than what is written in the note to be opened by Mr. Böttiger.”
The complete setting of this auction has been analyzed by the game theory experts Benny Moldovanu and Manfred Tietzel in “Goethe’s Second-Price Auction”. Pressure pays off, even in the eighteenth century!


Set up a process
Even if you decide to use auctions only infrequently, it makes sense to set up a clear process. First define criteria when an auction should be used and when it is not applicable. Ask your purchasers why they do not want to use an auction for a specific commodity - you’ll be surprised at some of the answers. In theory (and also in practice) you can start an auction with only one supplier and maintain a fair process. Using a so called Dutch auction involving only one supplier sometimes achieves amazing results.
If you choose to use auctions as the standard tool for negotiating certain commodity groups, make sure that you also establish regular reporting on the results. This will allow you to identify which auction types and strategies are the most successful for certain products and services. The big advantage of this approach is that the auction process will force you to create clear specifications for all products and services. These can then be reused in future negotiations and tenders, saving valuable time in the purchasing process.
Setting a code of conduct is another crucial task for sustainable auction success:
• Only allow qualified suppliers to participate in the auction.
• Only invite suppliers which you potentially would consider for the contract – don’t invite unqualified suppliers just to create price pressure.
• Set a reserve price and commit to the bidders to award the contract if this price is met or underbid. Clearly communicate your award scenario.
• When you apply quality factors or change costs to the bids of certain suppliers– communicate this to them. In other words – play fair and square!
If you stick to a systematic code of conduct your suppliers will recognize the auction as a fair negotiation process, also bringing a new level of process transparency to them.

Choosing the right strategy
There are a lot of possible configurations for an auction and you can make a science of designing your strategy. Should the suppliers see the actual prices or only their ranking? Should they see who’s in the lead? Should they only be able to underbid the given price or should they be also able to “close up”? A clever configuration can be very rewarding, but the most important issue when setting up an auction is what format you should use. There are only six main formats, and only two of them are really relevant.

• Reverse English auction. The most common auction format. The bidders outbid each other until the best price is set.
• Reverse Dutch auction. Starting with a very low price, the price is automatically increased in predefined steps. The auction stops as soon as a price level is accepted by one of the bidders.
• Japanese auction. This is more or less like a big poker round. Starting with a very high price, the price is automatically decreased in predefined steps. The bidders have to accept each new price reduction in order to remain in the game. The auction ends when participants stop bidding or if only one bidder is left.
• Sealed Bid Second Price (Vickrey auction). Every bidder places one sealed bid. The bidder with the lowest price gets the deal, but gets paid as much as the second cheapest bidder has offered.
• Sealed Bid First Price auction. Every bidder places one sealed bid. The bidder with the lowest price gets the job.
• Yankee auction. Yankee auctions are two-dimensional. They are used when the desired amount of goods cannot be supplied by one sole bidder. The Yankee auction creates a ranking based on the price and the amount that bidders can deliver.

The main auction formats used are the Reverse English auction and the Reverse Dutch auction. Whenever possible, try the Reverse Dutch approach. Why? First of all, it is a very time-efficient negotiation format. As soon as a bidder accepts a price step the negotiation is completed. Bidders have to be well prepared for this negotiation format as they have to clearly know their lowest price limit. The risk of getting carried away by a lengthy bidding process is eliminated.
This format is not only time-efficient. Experience has also proven that you can achieve higher savings, as the bidders reach the final price from the other direction. This means that the bidder with the most competitive price will usually accept the price step as soon as his price limit is met.