Reverse Auctions: Crusade or Curse?

Reverse auctions (RAs) are one of the latest trends to appear in the procurement of drug development goods and services. Traditional auctions pit buyers against each other to determine market prices for an item or service—the reverse is true in RAs. Through the use of Internet technology, RAs are auctions in which suppliers (not buyers) bid "down" prices for the privilege to provide goods or services to a sponsor company (Figure 1).¹ Reverse auctions are one strategic element of an increasingly sophisticated procurement sourcing program that employs a total systems approach to the entire outsourcing process.²

RA tools capture and incorporate all specifications required for product development in the requests for proposals (RFPs). Negotiations are opened to establish a "fair playing field" to any vendor that is qualified to participate. Application service providers (ASPs) host remote, secure networks and "auction" software (for a fee) that allow outsourcing specialists and vendors an online forum to negotiate bids in real-time for products or services integral to drug and medical device development programs.³

Figure 1. Three phases of bidding via reverse auction.

Who uses reverse auctions?

Initial adopters of the e-sourcing model include titans in the corporate, government, and military fields. As early as 1995, conglomerates including General Electric invited vendors to use electronic bulletin boards to bid for business.⁴ State governments showed fiscal savings of 5% to 15% on contracted supplies by the late 1990s,⁵ and military procurement specialists began seriously investigating reverse auctions in 2000 to formulate policy development and appropriateness for its Air Force supply system.⁶

RA applications in the pharmaceutical development industry are still evolving but use similar electronic Internet technologies to negotiate lower prices among vendors. The practice is increasingly prevalent in many large pharmaceutical companies including Pfizer,⁷ Novartis,⁸ Abbott Labs,⁹ Bristol-Myers Squibb,¹⁰ GlaxoSmithKline (GSK),^11,12 and Johnson & Johnson.

Pharmaceutical organizations exploring RAs initially use them to negotiate favorable pricing for commodities such as office supplies, computers, or chemicals. As corporate experience and sophistication grows, companies move from basic commodities to more complex systems that involve goods and services required in product development.

Reverse Auctions: Usage Guidelines

Notably, Pfizer leads the way with a functional service provider (FSP) model that streamlines processes across its worldwide development organization and reduces development cycle times. Pfizer's model is unique in that it breaks out from commodity acquisitions and targets traditionally outsourced services including statistical programming, data acquisition, data management, central labs, clinical monitoring, and study start-up activities. Pfizer metrics confirm success in pilot projects showing reduced costs, streamlined operations, and high quality. Additional service capacities are soon to be incorporated into the FSP model and will include investigator start-up activities, patient recruitment and retention, and medical writing.⁷

Differences of opinion exist among sponsors and vendors about the benefits, drawbacks, types of necessary communication, and even sense of coercion required to effectively arrange and execute an RA business pact.

Why utilize reverse auctions?

A basic principle of economics teaches that market prices are set as a function of supply and demand. Auctions provide a near perfect model where the principles of supply, demand, and "willingness to pay" play out. Fair market prices are set when the free flow of information is available to both customers and suppliers and enable each to understand forces that act on the market. RAs purport to support and standardize optimized utilization of resources in drug development.

How pharma uses RAs

Pharmaceutical companies use RAs in a variety of ways. Pfizer pits CROs and niche providers into competition for clinical development functions, with the bottom-line price as a heavily weighted factor. Pfizer's global FSP model assumes high-quality deliverables as a basic criterion for entry and exercises a vigilant assessment of potential vendors. Each vendor invited to bid in a Pfizer RA is rated and accepted (or rejected) on global capacity, financial stability, strong information systems capabilities, quality, risk management, a diverse scope of services, and past history and performance.⁷

Pfizer's FSP model abandons traditional project team structures and favors providers with trained, readily available resources in place prior to the initiation of projects. After an RA, Pfizer asset and functional sourcing managers give providers six-month forecasts defining projects and work scope. Pfizer issues work orders that define training time and the number of anticipated hours for the project.

Selected providers are trained on Pfizer systems and have consistent infrastructure investments (network upgrades, training, etc.). Pfizer invests heavily in open lines of communication throughout all geographies and has regular high-level meetings to review performance, resolve issues, and seek process improvements. The FSP paradigm permits rapid study start-up, reduced negotiation cycles, and market transparency.⁷

Most development organizations have not embraced RAs as Pfizer has. Procurement at Johnson & Johnson involves RAs on a worldwide basis to secure best prices and service contracts for a variety of items including automobile fleets, office supplies, chemicals, solvents, and raw materials for the manufacture of its health care and ethical pharmaceutical products. Significant savings and enhanced quality with commodity-type programs have led the pharmaceutical development group to explore the application for preclinical analytical testing and central laboratory services.

Not all pharmaceutical companies use RAs for contract development services. Abbott's first foray into RAs came in 2000 when market conditions required a ramp-up in production requiring specific chemicals. The company chose to work with trusted, existing suppliers to assure product quality, volume, and on-time delivery. As Abbott's experience with RAs grew, new suppliers that met quality criteria and passed Abbott's rigorous onsite audits were invited to participate. The list of commodities (chemicals, solvents, etc.) appropriate for RAs expanded as well.⁹

Novartis also uses RAs to procure commodities. In 2002, the company saved 17% with RAs to procure personal computers standardized to a common platform for worldwide operations.⁸ Alternatively, Bristol-Myers Squibb developed an in-house auction system for bids on commodities and in 2001 conducted 15 RAs worth $60 million. Savings on products (including chemicals, medical dispensers, and printed instructions) ranged from 6% to 10%.¹⁰

GSK's venture into RAs came as an efficiency move when Glaxo and Smith Kline merged in 2001. Using a total systems approach to analyze spending, savings, sourcing, and compliance, GSK conducted 534 RAs in 2003 worth more than $3.8 billion.¹¹ Production materials, capital equipment, information technology, freight services, hotels, office equipment, and even legal services and recombinant DNA are routine commodities acquired by GSK through RAs.^11,12

How reverse auctions work

Auctioning system products run the gamut from simple to complex, and generally include scalability for expansion. The sophistication of systems varies from "simple, do-it-yourself" one-time sites where a Web site is accessed (for a fee), to extremely complex systems integrated into corporate e-business strategies. In more sophisticated models, RAs are but one tool in a fully integrated electronic business exchange that conducts market research, analyzes workflow, and accounts for financial management.⁶

Work scope, adequate and complete information about the service or good to be contracted, and a clear understanding of the static and dynamic market factors that impact goods or services must be rigorously assessed and articulated in the RFPs sent to potential vendors by the sponsor. Opening and reserve prices, extension periods (if any), performance metrics the sponsor organization uses, and a definition of "success" are all included in an invitation to bid.

The typical preparation time from inception to completion and award of business takes 8 to 16 weeks (Figure 2).¹ Bidding vendors are notified of the date and time of the auction, and are given instructions on how to use the technology. A clarification process is held prior to the bid to resolve outstanding questions. The sponsor (in conjunction with the hosting ASP) is responsible for creating reverse auction content, security, registering bidders, ensuring bidder readiness, and contingency planning. Onscreen, sponsor and vendor portals differ on what information is shown during the auction; however, all parties have access to price comparisons.³

Figure 2. Reverse auction purchasing process. Auctioning systems run the gamut from simple to complex and generally include scalability features.

Auctions typically take 30 minutes or less to complete, although timing varies markedly with the simplicity or complexity of the service or good under consideration for purchase. In theory, once the auction is complete and a vendor is awarded the business, no further negotiations of price or bids are accepted off-line—although in actual practice this rarely occurs due to scope or protocol changes.²

Different goals

Sponsor. The key benefit of reverse auctions from a sponsor's perspective is the establishment of a competitive environment, which leads to reduced prices and negotiation times, evaluation of all bids on consistent quality and methodology, process improvements in product development budgets, and a means to set fair market prices.¹ The bidding process is transparent, fair, and uses consistent methodologies to assess price, cost, and value among suppliers.⁵

Sponsors use the electronic systems to track in-house usage and user compliance, pricing, savings, and metrics on vendor performance. Handfield and colleagues² report in a 2002 survey of the pharmaceutical industry that sponsors view reverse auctions as a necessary long-term strategy to remain competitive and not lower purchase prices, consolidate the vendor base, increase competition, and create more disciplined processes. Sponsors choose the lowest bidder in a reverse auction over 60% of the time, and the vendor selected is not always the incumbent.

Vendor. Not surprisingly, vendors find fewer benefits and the creation of obstacles that hamper effective relationships and the chemistry required for exceptional product and service performance.² RAs are inconsistent with a strategic approach to cultivating and managing relationships with a select group of value and performance-oriented providers. The lowest priced provider may be the one most desperate for business at the time of auction, and the auction selection process fails to unmask underlying problems with quality or business practices. Sponsors only realize this when problems surface following the auction.

A "they're all the same" commoditization approach to transactions in order to produce the lowest price denies the sponsor value from a vendor and is ill-suited for purchases where a high probability of scope changes occur before a final study design is complete. The up-front work necessary to analyze costs and profit for pricing ranges is lengthy and offers no real insight into a vendor's cost structure. It therefore provides no real advantage or incentive for vendors to participate.²

The benefit a vendor hopes to generate from RAs is continuity of existing business—or, better yet, new projects and business. Vendors want a fair, transparent opportunity to bid on a sponsor's business. Valuable competitive information on current pricing is obtained and long-term relationships with the sponsor have the potential to be established. Process improvements using the online forum may additionally lead to reductions in a vendor's sales force and/or overhead.^1,7

Improvements needed

Companies and vendors that use RAs cite communication, or rather a lack of communication, as the primary area for improvement.² All stakeholders require large amounts of information. Vendors need a thorough understanding of the auctioning process and methodology and require an opportunity to clarify any queries or gain insight that an incumbent might have. Sponsors must have a thorough knowledge of the economic factors of drug or device development that affect the market conditions under which vendors operate. A very specific RFP and process for change orders is necessary, considering that specifications often shift in scope prior to study initiation. Ultimately, the sponsor should inform bidders of the weighted evidence and reasons why they did or did not win the contract. Otherwise, if price is not the prevailing factor, the credibility of the auction process appears flawed.

Vendors report that the commoditization process hinders provision of the best quality and service delivery performance.² The narrowly defined scope of work inhibits a vendor from bundling or offering alternative solutions and value-added services for sponsors that may expedite clinical trials. Accurate line item comparisons are problematic because standard operating procedures and quality control in clinical development vary widely from vendor to vendor and sponsor to sponsor. These differences are not adequately captured in generic RFPs.

Conclusion

Reverse auctions permit sponsors to significantly cut development costs and time and are increasingly finding their way into pharmaceutical corporations' business strategies. RAs are an element of strategic sourcing strategies that allows sponsors to negotiate low prices for "commodity type" goods or services. However, RAs may create barriers in clinical trial studies where the success of technology-related services depends on close personal relationships and open lines of communication to solve development challenges. Both sponsors and vendors continue to work through the barriers noted with sourcing solutions that ensure projects are awarded at costs the market can bear. Ongoing efforts must be made to ensure that the sponsor–vendor relationship is enhanced and contracts endure following execution of the RA.

Allen R. Gehrke* is senior director of business development, marketing, contracts, and proposals for Clinsys (formerly Target Research Associates), 1800 JFK Boulevard, Suite 1450, Philadelphia, PA 19103, (610) 793-0512, agehrke@clinsyscro.com. Elizabeth Faulkner is director, global pharmaceutical R&D sourcing for Johnson & Johnson Pharmaceutical Research & Development, 1125 Trenton-Harbourton Road, Titusville, NJ 08560. Cindy van Dijk is a freelance medical writer with Scientific Communications, 1022 SW Castilian Drive, Oak Harbor, WA 98277.

*To whom all correspondence should be addressed.

References

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2. R.B. Handfield, S.L. Straight, W.A. Stirling, "Reverse Auctions: How Do Buyers and Suppliers Really Feel About Them?" Inside Supply Management, 13 (11), 56 (November 2002).

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10. A. Gilbert, "Bristol-Myers Squibb Turns to Do-It-Yourself Auctions," Information Week. Available at: http://www.informationweek.com/831/ariba.htm. Accessed on 25 August 2006.

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12. N.A. Hitchcock, "GSK Consolidates MFP Purchase," Purchasing Magazine Online, 13 July 2006. Available at: http://www.purchasing.com/index.asp?layout=articlePrint&articleID=CA6350572. Accessed 24 August 2006.