Game Theory and how to improve e-Auction value delivery

Sunny Agnihotri Blog, Procurement

Much has been written about the decline in savings from the long-term use of e-auctions. The law of diminishing returns is often quoted as applying to e-auctions in just the same way as any other sourcing strategy. So what can you do about it? After all e-auctions are a very efficient way of sourcing low-to-medium value/risk products, which could otherwise be very time consuming. Well one way to approach this dilemma is to change the rules of the game. And this is where an understanding of “game theory” can be useful.

What is game theory and how can it help us?

In essence it is the application of mathematics to analyse and devise strategies for dealing with competitive situations, such as an auction. It assumes the participants are intelligent, rational thinkers and will apply a logical approach to determine their best course of action. By understanding how opposing parties think and behave in a competitive situation we can determine a better approach.

Let’s imagine a traditional English auction that allows bidders to submit any price, so long as it is lower than the previous bid. The winner is the lowest bid once all bidders have finished submitting bids. We might think this means we will always get the best (lowest) price. Not so…in fact there is much evidence to suggest we rarely get to the lowest possible price because to flush out the lowest possible price relies upon there being another bid which is marginally higher.

That’s why there are alternative types of e-auctions, such as the Dutch auction. This type of auction starts at a pre-determined price, set by the buyer, and then moves up in increments, until someone is prepared to submit a bid. Theoretically this should mean the seller with the lowest price will always win and the buyer will always get the lowest possible price. Again, this is not always the case.

We know the world is not a perfect place, where bidders are always rational. There may be occasions when a supplier is desperate to retain a customer or win a new customer. In such circumstances it is not unknown for a supplier to submit a bid below their pre-agreed lowest price….so in an English auction they still have the possibility to do this, whereas in a Dutch auction there is no “second” chance – it’s take it or leave it.

This is just one example of how an understanding of game theory can improve your returns from e-auctions. And there are many other variables that can affect performance, like the number of bidders, bid timing and bid increments. In most e-auction systems these are all variables that can be determined by the buyer.

In conclusion, if you are seeing diminishing returns from your e-auctions don’t think there is nothing you can do about it. If you’d like further help, 4C have considerable experience of e-auctions and how to tip the scales in favour of the buyer.