Applying Reverse Auctions to Energy Procurement
May 17, 2013

Making energy suppliers compete in real time online to drive down costs and maximize savings.

Introduction

The internet age has helped foster the development of a variety of procurement tools.  Spurned further by a tightening economy and the need to find more savings and become more efficient, e-procurement is now entrenched in the buying and selling process for many businesses. One such tool, born out of this and increasingly popular, is the reverse auction.

Forward Auction

In a traditional forward auction, a supplier will bring a product to auction where it is bid upon by numerous interested buyers. These buyers conduct research and investigate the product on sale, and then drive up the product price by continually outbidding the other buyers.

In the end, the buyer who bids the highest price, wins the auction and gets the product, while the seller gets the maximum revenue for their product.

Reverse Auction

Reverse auctions turn the more well-known traditional forward auction upside down.

The buyer starts the process by seeking out sellers of a particular product. Interested sellers then begin bidding against one another with successively lower bids. The seller who provides the lowest price generally wins the bid. This allows the buyer to get a product that best fits their needs at the lowest possible price, while the seller gains quick and easy business.

During the auction, sellers are able to see the dollar amount of the top bid, but they cannot see who is offering the bid. This is being seen in real time. Knowing there is a strict deadline (between 10-15 minutes) sellers will quickly push out their lowest prices. The reverse auction process has built-in safeguards to keep suppliers from gaming the system. The reverse auction platform also keeps a record of the entire process for documentation.

difference between reverse and forward aution

Applying Reverse Auctions to Energy Procurement

One area that has become very conducive for the reverse auction platform is energy procurement.  There are a few reasons for this:

  1. Energy, whether it’s natural gas or electricity, is a product that is not easily differentiated between suppliers. Gas is gas and electricity is electricity, regardless of who sells it. This lessens the likelihood of the buyer choosing something other than the lowest price, which encourages suppliers to drive prices as low as possible.
  2. Reverse auctions allow bidding to take place in real time, and considering the volatility of energy markets, they can be very valuable to both buyer and seller. The traditional Request for Proposal (RFP) systems used to bid out energy doesn’t allow suppliers to fully consider market conditions as they move. Uncertainty over when other suppliers will bid or when a buyer will purchase, forces suppliers to protect themselves with the price they provide, which keeps the buyer from receiving the lowest price the market may dictate. By bidding in real time, suppliers can better consider the current market conditions and will know by the end of the auction whether they have won the bid or not. This reduces their risk in offering a price, something that can help lower prices for the prospective buyer.
  3. Since energy costs can be a significant expense for many organizations, the incentive is to reduce these costs as much as possible. For the reasons outlined above, reverse auctions have been able to do this for energy, helping many organizations save thousands of dollars in energy costs.

Reverse auctions allow bidding to take place in real time, and considering the volatility of energy markets, they can be very valuable to both buyer and seller

Making Reverse Auctions Successful

Despite the promise reverse auctions hold for reducing prices, especially energy prices, they are not perfect for every situation and must be organized carefully to maximize savings.

  • Avoid confusion. It is important that proposals are well thought out and carefully worded by someone with knowledge of the industry. This ensures that potential bidders know what they are bidding on and that the buyer receives what they are looking for. Confusion from suppliers may lead them not to bid, or perhaps to be more cautious with their bids.
  • Timing: Monitor the market. The reverse auction may provide the lowest price at a given moment, but that doesn’t mean that that was the right moment to achieve the best price. The market must still be monitored and studied to determine the best time to conduct the reverse auction if maximum savings are to be achieved.
  • Don’t Deter Healthy Competition. If a product is requested that has many detailed specifications, it may not have an adequate number of bidders to promote savings. Suppliers that are unable to provide certain elements likely won’t bid, and without healthy competition reverse auctions tend to fizzle.
  • Testing the Waters. It doesn’t hurt to get an idea of what to expect in a reverse auction before actually starting an auction. By using a preliminary bid or request for proposal (RFP), one can gauge supplier interest, general market conditions, and even finalize contract terms and language. This improves the efficiency of the reverse auction process, and helps remove some of the risks for both you and the suppliers.
  • Bigger is Better. When applied to energy procurement, reverse auctions are clearly more beneficial to larger organization than smaller ones. Suppliers are simply more willing to participate and provide lower prices to larger customers. It is likely that smaller customers will not draw the interest of as many participating suppliers in a reverse auction; suppliers stand to make significantly less when taking a smaller profit from minor quantities than for larger ones. Thus, the competitive pool of suppliers dwindles, and without adequate competition, savings will be reduced.

Summary

Reverse auctions are very well-suited for the energy procurement market, but they are not suitable for small or medium electric and gas loads. Buyers from large organizations are best suited to benefit from reverse auctions.

Reverse auctions work best for the benefit of both buyers and sellers when there is a substantial quantity of healthy competition. Because energy does not change as a result of who supplies it, suppliers are driven to provide bids quoting their lowest possible prices to win over potential buyers. The seller benefits by gaining business from large-scale buyers relatively quickly and easily.

Proposals must be clear and should be written by an industry expert. Continuously monitoring the market will determine the correct timing to conduct the reverse auction to achieve maximum cost savings.

Contact us to discuss how our Reverse Auction can help you procure your energy at the lowest possible price.

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