Adapted from “Negotiations versus Auctions: New Advice for Buyers,” first published in the Negotiation newsletter, August 2007.
Economists have long advocated auctions as an effective means of increasing value. Yet recent research contradicts this conventional wisdom. In fact, as compared with negotiations, auctions can actually raise prices in procurement contracts. Suppliers tend to prefer negotiations because they offer greater price confidentiality and a better chance of building close, long-term customer relationships than auctions. These factors give suppliers an incentive to offer their best prices via negotiations, not auctions.
In fact, in his research, Harvard Business School professor Ian Larkin has found that businesses that procure via auctions pay 3% to 5% more than those that enter exclusive negotiations with only one vendor. To understand why, consider that procurement is just part of your business, while selling to customers is all of your supplier’s business. Your supplier is likely to be concerned about the signals that deals achieved through negotiations or auctions send.
Over time, your organization is likely to deal repeatedly with the same subset of potential suppliers for certain transactions. Whether you choose to engage with these suppliers via auction or negotiation sends them a very different signal of your view of their role in your business.
From the supplier’s perspective, a request for a procurement bid suggests that you see your potential suppliers as largely equal. It is easy to understand why suppliers regard customers who take this route less favorably than they do those who instead choose to maintain relationships through discussions about product needs and the supplier’s ability to meet these needs. Suppliers are less likely to give cut-rate prices if the relationship seems less valuable to the customer over the long term.
On the other hand, vendors are often willing to give very large initial discounts to new customers who appear to view the sale as the start of a long-term relationship. You can motivate suppliers to offer their best price by starting the relationship as a conversation, not a competition. If they feel they have a real chance to show their capabilities and points of differentiation, they’ll be more likely to offer discounts in the hope of gaining repeat business.
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