What Is an Auction, Anyway?

Auctions are unmistakably among the hottest eSourcing technologies on the Internet today. But what exactly is an auction, anyway?

According to The Pocket Oxford Dictionary, fourth edition (1942), an auction is a "public sale in which articles are sold to the highest bidder." While auctions can be traced as far back as 500 B.C., in today's new Internet economy, that auction definition is a bit too narrow.

Some of the first auctions were for labor or the spoils of war. Luckily, what's being auctioned has changed dramatically. Today, business-to-business (B2B) auctions are surging in popularity for such items as personal computers, cellular phone service, telemarketing services, printed circuit boards, corrugated paper, drill bits, steel and chemicals, to name a few.

But auctions of old and auctions today vary across the same eight dimensions.

1) How does price move over time? Auction price movement falls into one of three patterns: up, down or haphazard. Price goes up until the bidding stops, price goes down until the bidding stops, or each bidder communicates privately and individually with the auctioneer, in which case price is not required to go up or down (haphazard).

2) Are there many buyers and one seller or many sellers and one buyer?
Most traditional auctions involve many buyers vying for the good or service being offered by one seller. But today's downward auctions instead include many sellers bidding for the business of one buyer.

3) Is price the only factor?
In many auctions, price is the name of the game, but in others, the best price may not win. Throughout history, auction formats often gave auctioneers the power to ignore bids from undesirable bidders, even if they offered the best price. Today, price-only auctions are typical, but total cost auctions are the wave of the future. Total cost functionality enables buyers or sellers to more formally indicate which non-price factors are important. They enable a buyer, for example, to incorporate purchase criteria, such as warranty, quality, delivery time, customer service and the cost of changing vendors, into their negotiations. The auction reflects more of the variable factors used to make a true purchase decision. Taking multiple factors into account helps buyers find the suppliers who will best meet their needs.

4) What is the means of communicating the bids?
Historical methods include yelling out, submitting sealed written bids, shaking the auctioneer's hand and squeezing his fingers in a prescribed manner, whispering, raising a bidding paddle, and signaling by tugging on your ear. Today, bidders are using their "faceless" computers, obviating the need for such blatant bidding practices. Internet bidding can take place from anywhere, anytime an auction is held.

5) Who is allowed to bid?
Some auctions, such as those held on eBay, are open to all. Other auctions are strictly by invitation only. Today, open auctions are more likely to involve simple, transactional goods and are more typical of business-to-consumer (B2C) or consumer-to-consumer (C2C) transactions. Invitation only, or closed, auctions are more likely to be used for B2B transactions that are more complex in nature. For example, when factors such as quality and service are involved, buyers like to pre-screen sellers. Auctions for goods that provide a competitive advantage, goods that may involve liability or security issues, or goods that are specialized enough that the seller has a good idea of the likely bidders call for invitation-only auctions.

6) What is the time frame of the auction?
Auctions may take months or minutes. One of the oldest varieties of auctions involved a circle of people gathered around a burning candle. The winner put in the highest bid before the flame went out. B2B auctions generally last a few hours. The most important thing to consider regarding time frames today is whether it is an event or recurring auction, or involves dynamic pricing. Event auctions are generally used for categories of goods and services that require a long-term contract. For example, a buyer may auction off the purchase of 10,000 PCs over a two-year period. Recurring auctions are more like short-term contracts. They are typically used for ongoing transaction purchases, or "batch" type buys. For example, a buyer might auction off the purchase of circuit boards needed for current production. Recurring auctions can be set up to occur at pre-determined intervals throughout the year. If you are using dynamic pricing, you are making more on the spot decisions. In other words, when you need it, you buy it. Dynamic pricing is transactional as opposed to contractual, and is based on price-only as opposed to total cost.

7) What do bidders know about the bids of others?
In the traditional English or "open-outcry" auction found at an auction house like Sotheby's, bidders generally know both who they are bidding against and the exact bids of their competitors. In today's online auctions however, bidders generally do not know who the other bidders are, but do know how their own bids compare to the best bid. Online bidding ensures a certain "faceless" form of competition. Using the World Wide Web, bidders can place bids anonymously, from anywhere in the world, anytime they participate in an auction.

8) Is the auction for one item or many homogeneous items?
An auction house like Sotheby's generally auctions one item at a time. But technology now facilitates the sale of both one item and many homogeneous items.

So, how do common auction types fit along these dimensions?

Upward auctions, also known as ascending price auctions, are commonly used for B2B auctions today. Price moves up over time, until one of many buyers (who are the bidders in this case) wins the item(s) from one seller. The means of communication is generally a computer - via the Internet or a software application. These auctions may be open to all or invitation only. While many upward auctions targeting consumers may be available for bidding for several weeks, most business-to-business auctions last for a pre-determined number of hours. In all cases, knowledge of other bidders is limited. A very limited number of auction providers offer total cost functionality. One variety of upward auctions is a surplus auction, where an auction is held for surplus goods. Upward auctions may be event, recurring, or dynamic pricing.

Today's upward auctions are derived from traditional English auctions, also known as ascending price auctions. Like upward auctions, English auctions involve many buyers driving price up. English auctions are commonly used for B2C or C2C goods such as art or wine. The means of communication varies from yelling out, raising a bidding paddle, signaling by pulling one's ear, or writing bids. These auctions are price only and bidders frequently have full knowledge of other bidders. The time frame and allowed bidders vary. English auctions where yelling out is the primary means of communication are also known as open-outcry auctions. One variety of an English auction is an open-exit auction, where bidders must publicly announce that they are dropping out when the price gets too high. Another variety of upward auction is the silent auction, where successively higher bids are written down.

Downward, also known as descending price or reverse auctions, are commonly used for B2B auctions today. They differ from upward or English auctions in that the price goes down as one buyer receives bids from many sellers. Downward auctions are increasingly helping buyers determine the best bids that suppliers will make in order to win the buyer's business. Like upward auctions, the means of communication is a computer, the auctions may be open or invitation-only, the auction lasts for a predetermined number of hours, knowledge of other bidders is limited, and the auction may feature total cost. Downward auctions may be classified as event, recurring or dynamic pricing.

In Dutch auctions, bidding starts at a very high price and stops when a buyer is willing to buy at that price. Price goes down until one of many buyers claims the items. Dutch auctions are typically held for many homogeneous items, and bids and bidders are generally known to all. The Dutch auction began in the Netherlands as a means of auctioning flowers and produce. The financial community calls the first-price sealed bid auction a Dutch auction, which can cause confusion.

Sealed bid auctions are characterized by sealed written bids. There are many buyers. Price movement is haphazard - it may go up or down over time depending upon the order and amount of the bids received. These auctions are generally invitation only and price only. With sealed bid auctions, bidders cannot see the one-time, written and sealed bids of others. First-price sealed bid auctions are sealed bid auctions for a single item, where the single unit is sold to the highest bidder. Discriminatory auctions are sealed bid auctions for many homogeneous items, where bids are sorted from high to low and then awarded to the highest bidder(s) until the supply is exhausted. Vickery auctions are like sealed bid auctions, only the good is awarded to the highest bidder at the price equal to the second-highest bid. With the Vickery auction structure, bidders tend to adjust their bids upward because they know that they will not pay the highest bid.

Fortunately, using auctions is much easier than remembering the names and properties of all of the auction varieties. More and more companies are finding that Internet auctions can help them to make significant reductions in the time and cost of corporate purchases. With the advent of the Internet, auctions are becoming ubiquitous. It's not a matter of if companies will employ them, but when.

A list of sources used in this document is available from A.T. Kearney Procurement Solutions.