Reverse Auction Bidding
A lot of people in the construction industry are trying to put a stop to a bidding procedure known as a reverse auction. The Target retail store chain in particular has become infatuated with the method for its building projects. In fact, the reverse auction began in the retail industry as a way to procure commodity items. Then some wizard in the bean counting ranks decided it could work just as well in acquiring construction bids. It goes like this.
After defining the scope of work, the general contractor or construction manager on the project invites selected subs to participate. However, the GC/CM has no say over subcontractor pricing. Subcontracts get awarded solely on the basis of the low bid in a subsequent reverse auction. Here is how a Target project in the Phoenix area got bid via reverse auction using the Internet.
Subs used normal estimating procedures to prepare their bids. At an appointed bid time, the owner operated a Web site with passwords provided to pre-qualified bidders. The owner initiated the online reverse auction with a starting bid price based on previous projects of its kind. The subcontractors then submitted bids at progressively lower increments of at least 1 percent. The bid time was limited to 30 minutes. However, if a bid was placed within the last two minutes of the 30-minute window, a three-minute time extension was added. This allowed the other bidders an opportunity to re-bid the job. Time extensions continued until no more bids were placed within a three-minute period.
Bid shoppingThis is a transparent form of bid shopping. Bidders can see competing prices, although they don't know who is placing the bids (only the owner knows who's who). Thus, pressure builds to keep sharpening the pencil. Bottom feeders who in a blind bid situation might underbid competitors by 15 to 20 percent, can instead keep shaving their price in 1 percent increments until all sensible contractors give up. They would likely leave less money on the table this way-and thus perpetuate their wretched existence longer than they could in the blind bid world. This is perhaps the ugliest aspect of the reverse auction.
But one mechanical contractor who's participated in the Phoenix bidding and is no big fan of the reverse auction, points out that it's not entirely negative. According to Mark Giebelhaus, of Marlin Mechanical Corp., of Phoenix, a positive aspect is that because the GC can't control the bidding process, it's in his interest to be choosy about the subs he invites to participate. That's because the owner has already committed to the GC and doesn't hold him responsible for the subs' pricing but most certainly will for his performance. Giebelhaus noted that in the Target reverse auction, his company participated in (and won), only three plumbing subs were involved, compared with 15 to 20 that might normally chase such work in an open bidding process.
This is certainly an attraction. When more than a dozen bidders go after any job, it's virtually certain the winning bid will be a mistake. Good contractors prefer to participate in pre-qualification bidding that eliminates the jokers from the deck. But this doesn't happen with every reverse auction. In fact, many good subs refuse to participate in reverse auctions. This lowers the caliber of competition from the start.
The dynamics of the Phoenix bid saw only five bids ventured in the first 30 minutes as the three plumbing contractors played their cards close to the vest. Then came a flood of 22 bids in 37 minutes of time extension. Marlin hit its bottom line number (the lowest they were prepared to quote for this particular job) at one hour and four minutes into the bid. Nobody went any lower, and they landed the job at a price they could live with, although barely.
In this case, all's well that ends well. Nonetheless, Giebelhaus is not real enthused about the procedure. It worked out OK this time because the owner had selected a quality GC, who in turn selected quality subs to participate. Also, the opening bid price established by the owner was not unreasonable. Turn any of those factors around and the wisest course might be to walk away from the auction.
"It was an interesting experience," says Giebelhaus. "However, I think it would be more fair to subs if they each merely submitted what amounted to a sealed bid on the Web site, with low bidder the winner.
"Would we do it again? Probably with this GC but probably not with most other GCs."
Wrestling with pigsMaybe the real lesson is, given a quality GC and high-caliber competition, almost any bidding process can work out OK. But as the saying goes, when you wrestle with pigs in the mud, the pigs love it and you end up getting dirty.
From all that I've heard about reverse auctions, the situation described here for the Phoenix job may be the exception rather than the rule. All of the factors that made things work out well-a quality GC, quality subs, a reasonable starting bid price-aren't necessarily present in most reverse auctions. As noted earlier, many good contractors shy away from reverse auction bids. And the owner doesn't always start the bidding at a price high enough to allow bidders to make some money, especially after the auctioneering runs its course.
The underlying purpose of a reverse auction is, like any other form of bid shopping, to compel contractors to sharpen their pencil points until they resemble hypodermic needles. Reverse auctions may work OK in buying commodities but construction is far from a commodity.
Perhaps the most disturbing thing about reverse auctions is that it does treat construction as a commodity, as if all providers were the same and only the price differential between them is important. It ignores the fact that it's in an owner's best interest to seek not the lowest price but the best price for a given project. The best price requires evaluating the performance capabilities of GCs and their subs, and determining whether lower bids may end up costing more in the long run. Computerizing a reverse auction takes those subjective factors out of play.
Contractor coalitions in Minnesota, Texas and California have lobbied successfully to restrict reverse auctions in their jurisdictions. Other states are working on similar restrictions. Also, legislation has been introduced in Congress once again to prevent bid shopping. H.R. 1348, introduced by Rep. Paul Kanjorski (D-Pa.), includes provisions for eliminating reverse auctions for federal construction.