Reverse auctions no panacea for purchasing

By HASTINGS PUCKETT,

Earlier this year, the state Legislature passed legislation that will require, beginning in January 2018, most governmental agencies to utilize reverse auctions when purchasing goods and services. The legislation was hailed as a means to set more responsible purchasing practices by governmental agencies and to save taxpayer money. Like most citizens, I wholeheartedly support saving taxpayer money and enacting responsible purchasing policies within our government. However, requiring use of a reverse auction model will not only not save taxpayer money, but will actually end up costing more taxpayer money in many situations. By design in a reverse auction format, bidders always open bidding at an artificially high level. As each round of the auction progresses, bidders lower their bid to a level in which they are either declared the low bidder or they have reached their “floor” and stop bidding. Given that the bidding starts higher than it should, the winning bidder almost always wins the bid at a price higher than what their “floor” would have actually been. In the end, the purchasing entity leaves money on the table while the winning bidder leaves almost no money on the table.

 

To illustrate, take a look at the results of an MDOT sealed bid auction (current state purchasing method) from October 13, 2017 for two classes of heavy equipment. 

 

Backhoe Loader (price per machine/8 machines in the package)

 

Bidder A, $92,242

Bidder B, $91,364

Bidder C, $90,999

Bidder D, $83,000

 

As the results show, the lowest bidder was Bidder D at $83,000. The second lowest bid was Bidder C at $90,999, $7,999 higher. In a sealed bid scenario, each bidder leads with their best offer because they know there won’t be any opportunity to change the bid.  Had the above example been structured as a reverse auction, Bidder D would have likely opened bidding in the mid $90 thousand range knowing that, after each round of the auction, bidders would have reduced their bid until the next lowest bidder (in this case, Bidder C) reached their “floor” ($90,999) and stopped bidding.  As a result, Bidder D would have only had to reduce the lowest bid to $90,500. When no other bidders continue to present lower offers, the auction ends and the winner is declared.  So, in this example if MDOT had utilized a reverse auction for the backhoe loader, they would have paid $90,500 versus $83,000 via the sealed bid process, a difference of $7,500 per machine or $60,000 for the eight machines in the package.

 

Wheel Loader (price per machine/3 machines in the package)

 

Bidder A,  $172,498

Bidder B,  $171,326

Bidder C, $158,300

Bidder D, $149,400

Bidder E, $139,750

Bidder F  $139,587

Bidder G  $138,109

Bidder H $137,449

Bidder I  $130,900

 

In the above bid, the low sealed bidder was Bidder I at $130,900.  The second lowest bid was Bidder H at $137,449, approximately $6,500 higher. Had this bid been a reverse auction, Bidder I would have only had to lower their bid to $137,000 to close the auction when nobody else lowered their bid (because they had hit their “floor”).  So MDOT would have paid approximately $6,000 more per machine x three machines or $18,000 more using a reverse auction bid method.

 

In this single example, had MDOT utilized reverse auctions as will be required beginning January 1, 2018, it would have cost taxpayers approximately $78,000 more. This is just from one set of bids on one particular day. Governmental agencies across the state are making significant purchases every single day. Over the course of a year, the impact would be staggering in terms of how much more it will cost taxpayers when reverse auctions become required in January.

The second problem of requiring governmental agencies to make purchase decisions solely based on the lowest up-front cost is not in the taxpayer’s best long-term interest. In the above wheel loader example above, there were nine (9) bidders and a $42,000 spread between the low bidder and the high bidder.  My company, Puckett Machinery, was Bidder A and we bid a Caterpillar wheel loader that met the specifications. We bid it at our lowest possible number and it was $42,000 higher than the winning bid – based on up-front cost. The irony is that, in the private sector, our company has more than 50 percent market share in wheel loaders and Bidder I has less than five percent market share in wheel loaders despite being dramatically cheaper on up-front costs.  

Because the private sector tends to be more thorough and comprehensive in their evaluation of all of the costs (expected life, resale value, productivity, parts and service availability and support, etc) associated with buying a piece of equipment (or any other capital good), they don’t typically buy based solely on the up-front sales price. Any smart consumer knows the best value is not necessarily the cheapest up-front cost. In many cases, the cheapest product at the point of sale is actually the most expensive product when considering all costs over the full life of the asset.

In summary, I believe the intentions and motives of the legislators who drafted and supported this legislation were pure, but the solution of requiring reverse auctions for all purchases will result in many unintended consequences that will cost taxpayers tens of millions of dollars annually. Moreover, this forced form of purchase fails to address some of the root causes that make our governmental purchasing system less responsible. I encourage state lawmakers to amend the law and make reverse auctions an optional form of purchase. This will allow the purchasing entity to evaluate whether or not a reverse auction is the best method based on the particular product or service being purchased. I also encourage lawmakers to look at additional solutions to improve our governmental purchasing process as we all support transparent and responsible purchasing by our government.

Hastings Puckett, a Northsider, is president of Puckett Machinery.

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