What is a Japanese Auction?

We have just implemented Japanese Auction capability in our software at the recent request of a customer of ours.  Despite our procurement consultancy past, this is an auction format of which we have very little prior experience.  In fact, how much knowledge and experience is there in the general purchasing community of this approach to negotiation?

For those who are not familiar, here is an excerpt from our website of the Japanese Auction process:
“The Host states an opening price and participants have to accept that price level or withdraw from the auction.  Acceptance indicates that the participant is prepared to supply at the stated price.  When all participants reply to a certain price, the software lowers the price level by a pre-determined amount and again asks participants to accept or decline at the new price level.”

The process continues in this manner until all participants have ‘opted out’ of the auction.

As you can see, the approach can be very effective at establishing the final price for each participant in turn, regardless of the market competition.  Consequently the approach can be adopted in situations where market liquidity is very low or markets which are dominated by a handful of major players, such as dairy or utilities.  The Japanese Auction can even be used for a single-source negotiation, which was the major reason our customer favoured the Japanese Auction, ever since they used it to negotiate a significant cost reduction with just a few keen participants involved.

Other situations where the Japanese Auction can be used effectively are when there are large cost differences between bidders, despite both quoting for the same specifications.  With your typical Ranked Auction, the participant in first place will unlikely be challenged, even though they may have built in some margin to play with.  However, utilise the Japanese Auction and even that participant will be asked to improve their offer.

So far we have outlined a reverse Japanese Auction, i.e. where the bidding comes down in value upon each round.  However, we have encountered situations where a Japanese Auction can be used in an upward price direction, such as the negotiation of rebates amongst your supply base.  Since it is fairly meaningless to give suppliers market feedback on their rebates, as each supplier could be contracted for different goods and services and different spend levels, the Japanese Auction presents itself as a superb way to negotiate with each supplier individually, yet concurrently in a single auction.  For example, in Round 1 the suppliers are asked whether they agree to a rebate of 0.5% of full year spend, with an answer of “Yes / No”.  For those who reply favourably, they are then asked in Round 2 whether they agree to a rebate of 1.0% and so on.  There is a huge efficiency saving compared to the traditional way rebates are negotiated, as well as the potential for far greater results.

There are of course challenges to Japanese Auctions.  Firstly, they are not widely known about, which means that participants will require a greater degree of hand-holding and reassurance.  Secondly, they offer little to the participants in the way of market feedback.  Nevertheless, post-auction you can certainly provide feedback at your own discretion and to whatever extent you wish.  Thirdly they operate in a rigid manner, with participants only able to accept or decline each price level rather than to come in at their own price level.  It may mean that some participants have to wait a little longer to submit their final offer but the goal of establishing the market price is still achieved.

If anyone would like to know more, please feel free to contact us and we would be happy to take you through a web demo to show you how it works.

About: Market Dojo provides accessible eSourcing software.   Find out more at www.marketdojo.com