Reverse Auction Nightmare

By Joe Salimando

Published In January 2004

Reverse auctions (RAs) and construction shouldn't mix. Almost everyone involved in the business agreeswith the exception of some large clients. Unfortunately, subcontractors (and even general contractors) live under an updated version of the Golden Rule: "He who has the gold makes the rules." When the customer wants to procure its project via an RA, that is the way it is going to be done. Your options as a contractor are to participate, and thus have a chance at "winning" the job, or not.

A "worst case" analysis was presented several years ago by Tomas Hernandez Jr., the technology columnist for Building Design & Construction magazine. He wrote about an RA for a telecom project in Harrisburg, Pa., in which project bidding, conducted online and in real-time, took the project cost down several hundred thousand dollars in less than two hours.

A great deal of construction industry effort is being invested in opposing RAs right now. The primary goal is to keep the federal government from deciding that procuring construction work via this method is worth a try.

NECA, the Associated General Contractors of America, the Mechanical Contractors Association of America, and others are against RAs. For a NECA position paperwhich classifies these things under the heading of "bid shopping"see www.necanet.org/pdf/position_papers/Anti-bid_shopping.pdf.

Good for commodities?

A standard argument is that RAs might not work for construction, but they do for purchasing commodities. This argument is not accurate. RAs do not work for commodities, either.

Consider a company that buys 500 tons of sand every week. Should it do that with an RA? After all, you find a lot of sand on beaches. Is anything more of a commodity than sand?

A company using 25,000 tons of sand per year won't inventory the sand; 100 tons must be delivered daily, at a specific time. The sand must meet specifications. The plant's machinery can tolerate a limited amount of "pollutants" in the sand. There are penalties for missing delivery times. Weekly laboratory checks of sand quality must be performed by specified third-party labs.

One could go on from here, no doubt, with the help of a sand buyer. Does this sound like a commodity to you?

Nightmare mutation

A debate on RAs took place in October, at McGraw-Hill Construction's "Outlook '04" conference. The star was Robert Cassab, of Lend Lease Global Marketsa real estate giant based in Australia. With $57 billion of assets under management, Lend Lease represents a list of prestigious clients in construction projects worldwide.

Lend Lease has created a two-step RA process. Contractors submit bids and are prequalified (using several factors) in the first round. Those selected are told to compete not by lowering their profit margin, but via innovation. Here's the key: Contractors must have their innovative ideas "qualified" by Lend Lease. No dollar figure need be submitted, but the innovations must pass muster. If they do, the contractor can lower its price in final bidding.

Lend Lease's clients get savings, Cassab claimed, while winning contractors get higher margins. It sounds good, but there's a catch.

Some in the audience were appalled. Lend Lease's process works to take ALL innovative ideas (even those of losers) and passes them on to Lend Lease's engineers.

In response to this critique, Cassab said his company would not share ideas from losing bidders with the winner. Lease urges its clients to pay all of the bidders a fee for their "innovation" time, he said; but when they do, all ideas submitted (even those of losing bidders) become the client's property.

Is it easy to forget a good idea once one has heard it? Ethically, a Lend Lease engineer who hears a great electrical construction innovation from a losing bidder on Project A probably would not share it with the winning bidder on Project A. But what could stop Lend Lease from implementing that idea on all future projects?

For some, it seemed that Lend Lease now has an "innovation funnel," capturing great ideas from all kinds of construction contractors, whether or not they win work via the Lend Lease RA process ...

It would seem that the Lend Lease variant is worse than a standard low-price-wins RA. It uses the RA process to strip construction contractors of their ideas and innovationstheir intellectual property.

As audience members realized this, Cassab was asked several questions. His answers:

Companies that participate once often come back. Of course, everyone in construction knows there are certain companies that pursue dumb paths ... at least for a while.

This process is not just used on larger projects; it works on projects priced as low as $30,000 to $100,000. It is also used for materials procurement.

Lend Lease has brought this method to the United States. No one ran screaming from the room. However, Cassab's audience realized that we all had just heard "the other shoe" drop in the ongoing RA nightmare. EC

(Total 10 marks) Next two questions are related to the article given below. After reading the article you answer following questions.

1. (3 marks) What is the special form of reverse auction (RA) scenario presented in this article?
2. (7 marks) "The presenter" called RA was a success. But, the author believed that it was not. Write in your own words about both sides of the argument. Which side you would take in this argument and why.