The Case Against Reverse Auctions

So you've been bitten by a reverse auction. Should you turn around and do the same to your suppliers, making up the difference by forcing them to cut costs?

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Small companies are increasingly holding their own reverse auctions, according to Jemin Patel, CEO of HedgeHog, a Carmel, Indiana, company that sells auction software. But before you rush to set one up, Bob Emiliani wants you to know that he thinks they do as much harm to buyers as they do to suppliers.

Emiliani used to run reverse auctions for jet engine manufacturer Pratt & Whitney. Now a professor at Central Connecticut State University, Emiliani warns that "reverse auctions are like a crash diet" for companies--a rapid and unhealthy way of trimming costs.

Reverse auctions, he argues, lead suppliers to cut their margins at the expense of quality and innovation. Prices go down per unit, but Emiliani believes the savings are often offset by hidden costs, such as more returns, greater warranty claims, and a larger volume of customer service calls.

Worse, suppliers have no incentive to improve their products and, in fact, may be tempted to retaliate by neglecting quality or raising prices on other items. "People characterize reverse auctions as a best practice," says Emiliani, "but you can't just send the blueprints to the next guy and expect the same quality."

Emiliani advises companies eager to cut costs to look instead at the legendary Toyota model (NYSE:TM). That model calls on companies to work with their current suppliers to find cheaper ways of doing business.

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Max Chafkin

Senior writer Max Chafkin has profiled companies such as Yelp, Zappos, Twitter, Threadless, and Tesla for the magazine. He lives in Brooklyn, New York.

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