54 BioPharm MAY 2002

E
-procurement processes have begun to
govern outsourcing practices in many
pharmaceutical companies. This means
that transactions with contract service
providers will be increasingly incorporated
into the e-procurement infrastructure that
sponsor companies are developing.
Most sponsors still are feeling their way
regarding how they will use their
e-procurement capabilities, and an important
area of experimentation is reverse auctions.
Reverse auctions are the opposite, or
reverse, of traditional auctions in which the
seller accepts bids from would-be buyers. In
the reverse auctions that are now commonly
hosted on Web sites, a buyer accepts bids
from several would-be sellers and settles on
the best offer. Goods are bought and sold,
and information is exchanged among buyers
and sellers in a private (hosted by a single
company) or a public (involving many
companies) e-marketplace.
Part of the e-conomy. Online reverse
auctions have been used frequently in the
chemical industry, where huge amounts of
commodities are bought and sold daily.
Reverse auctions also are being used
increasingly for products and services
E-Procurement: Successfully Using
and Managing Reverse Auctions
Today, reverse auctions are perceived more realistically than in years past,
but they still offer many benefits for both buyer and seller
OUTSOURCING OUTSOURCING
Outlook Outlook
Edward P. Moser is a freelance writer for
PharmSource Information Services, Inc.,
703.914.1203, fax 703.914.1205,
info@pharmsource.com, www.pharmsource.com.
Contributing editor Jim Miller is publisher of
Bio/Pharmaceutical Outsourcing Report (B/POR).
PO Box 8163, Springfield, VA 22151-8153,
703.322.4971, fax 703.503.4506,
info@pharmsource.com, www.pharmsource.com.
related to day-to-day maintenance, repair,
and operations requirements. A Forrester
Research (www.forrester.com) survey of
361 businesses found that online auction use
across all industries rose from 17 to 23% of
buyers in the final quarter of 2001 (1).
Reverse auctions have experienced a
boom-and-bust cycle paralleling the dot.com
phenomenon. By the late 1990s, numerous
fledgling online exchanges were targeting the
$1.7-trillion chemical industry and its
50,000 buyers and sellers. By 2001, however,
according to the research and consulting firm
IDC (www.idc.com), many
e-marketplaces had folded while others
continued operating after layoffs and
restructuring. The initial, widespread belief
that online auctions would revolutionize and
even replace the traditional procurement
process now has given way to the more
realistic view that they are sometimes useful
as an adjunct to established modes of buying
and selling. The number of public chemical
industry online exchanges has fallen from
74 to 42 according to a December 2001
Gartner G2 Group (www.gartnerg2.com)
report (2).
Reverse auctions are less common in the
pharmaceutical industry, where highly specialized
goods are exchanged less easily online.
However, auctions have been attempted for
the purchase of chemical raw materials and
early-stage intermediates as well as R&D
materials, both through private auctions and
Inceutica.com (a reverse-auction site for
R&D services that closed last year when it
ran out of venture capital funding).
Reverse auctions can benefit both buyers
and suppliers of goods and services,
according to business analysts, executives,
and users of such Internet-based
procurement tools. However, much
preparation is required to successfully
exploit these online marketplaces.
Moreover, the value of online auctions
depends on industry conditions and each
enterprises needs. Proponents claim that
reverse auctions can provide many
economic advantages, but critics believe that
those benefits are overstated.
This column examines how buyers can
obtain the most benefit from reverse
auctions. An upcoming column will describe
how suppliers should respond in a reverse-
auction situation and how they can
determine the pros and cons of public
compared with private auctions.
The Buyers Perspective
Reverse auctions attract buyers with the
allure of lower prices, a broader supplier
base, and more efficient procurement. Online
buyers often save on purchases of goods
because the nature of reverse auctions tends
to force suppliers to progressively reduce
their asking prices. Carol Rozwell, vice-
president at Gartner G2 Group, said that the
savings on an average purchase at a reverse
auction can be between five and 25%.
AMR Research (www.amrresearch.com)
service director Roddy Martin noted, Some
companies have saved tens of millions of
dollars on reverse auctions. Auctions also
generate valuable pricing data for planning
future purchases.
Reverse auctions can save time. They
can reduce the cycle time of the transaction
significantly, by 5070%, Rozwell said.
56 BioPharm MAY 2002
Although much of the pharmaceutical
outsourcing industry has enjoyed a robust
past 18 months, contract manufacturers
of small-molecule actives and
intermediates are having a bad time. That
segment of the industry continues to be
plagued by soft demand and a large
amount of excess capacity. As a result,
the mood at the recent Informex
(www.informex.org) trade show in New
Orleans was pretty gloomy.
Taking a Hit
Commercial-scale pharmaceutical
chemical manufacturers have been hit
hard by product cancellations and Big
Pharma mergers, which often have
resulted in sponsors doing more work
in house. Unfortunately, in expectation of
a major boost in demand, chemical
manufacturers have just completed a
round of capacity expansions.
At Informex, one chemical executive
complained that just five years ago
sponsors and analysts were issuing dire
warnings of capacity shortages resulting
from swelling product pipelines. The
chemical manufacturers responded with a
capital investment binge, only to find that
the expected demand has not materialized.
Overcapacity usually means brutal price
competition, and the current situation is no
exception. Major pharmaceutical
companies, with their buying power and
procurement sophistication, are particularly
adept at squeezing the last penny out of
the price. Big Pharma has pricing models
that can tell suppliers just where their bid is
too high, one industry representative said.
Several observers also noted that
sponsors are becoming more open to
doing business with manufacturers in
China for early-stage intermediates and
starting materials. Chinese sources offer
significantly lower costs, and their GMP
compliance has been improving.
In the current market, small- to midsized
sponsors are in the drivers seat. Major
pharmaceutical chemical producers are
being forced to work with smaller
companies more than they used to, even
though they perceive them as high risk
because of their small pipelines and lack
of expertise and experience.
The major producers also are having to
scramble to offer kilo- and pilot-scale
development and manufacturing services,
which are in high demand by both Big and
Small Pharma. Research and development
operations at most of the commercial-scale
chemical manufacturers are scattered
among their commercial manufacturing
sites, and few have dedicated
development centers to compete with
companies such as Pharm-Eco
(www.pharmeco.com), Irix (www.sgi.com),
or Seres (www.sereslabs.com). Also,
companies built to pursue multiyear,
multimillion-dollar commercial supply
contracts dont like dealing with $100,000
clinical trial material deals.
Biomanufacturing Capacity
Hard times in the chemical business have
had a direct effect on the willingness of
the major manufacturers of active
pharmaceutical ingredient who now
control the contract biomanufacturing
business to invest in biomanufacturing
capacity. The industry doesnt want a
Jim Millers Outlook
CONTRACT biomanufacturers
dont want to get stuck
with a lot of underused
capacity if the predicted
demand doesnt actually
materialize.
Continued on page 58
Auctions commonly decrease the bidding
process from months down to days. The
Gartner report on chemical-industry auctions
found that online negotiation reduces the
elapsed time by at least 50% by eliminating
the need for phone calls, faxes, and face-to-
face meetings (2).
Furthermore, buyers can widen their
supplier base by posting product
specifications on Internet-based exchanges.
The Gartner report also states that the ability
to identify new suppliers electronically is
valuable especially in a fragmented
international industry such as chemicals and
plastics. With those marketplaces, buyers
can quickly find backup and alternative
sources of supply. Additional benefits may
include reductions in process costs and
accelerated product development, according
to a recent IDC study (3).
High-volume, high-return. Michelle Hincks,
vice-president of marketing for
ChemConnect (www.chemconnect.com),
said that to obtain the greatest benefits from
the auction process the key is to determine
which products should be auctioned.
Reverse auctions are better suited to certain
kinds of products such as high-volume bulk
commodities (methanol, for example).
Among the products commonly bought and
sold are benzene, toluene, ethanol, and
naphtha. The average purchase at one major
chemical auction house is $1.3 million.
Reverse auctions are not as useful with
small quantities, noted Rozwell. Reverse
auctions also are less advantageous for
more-specialized goods. High-price, high-
quality items are dealt with outside the
reverse-auction process, said Martin. The
more highly specialized the product and the
more complex its specifications, the less
likely it could be handled in an auction
(because they are more risk-prone, and their
specifications are more difficult to define).
An exception to this rule is Chemfinet
Services, Inc. (www.chemfinet.com), an
auction house for custom-manufactured
molecules and specialty chemicals. The
company works with more than
1,000 suppliers of complex chemicals, from
intermediates to drug candidates.
Who are the suppliers? Rozwell advises that
to gain a competitive position buyers should
seek exchanges that feature five or more
suppliers. Also, the buyer has an advantage
when suppliers have similar supply
capabilities. Some e-marketplaces enable
buyers to prescreen suppliers for certain
characteristics. For example, a company
concerned about protecting its intellectual
property rights may want to screen suppliers
by their country of origin, and a company
58 BioPharm MAY 2002
the industrys supplier base. Buyers
representing large corporations are using
their leverage to force suppliers into a
bidding frenzy, noted Stec. Before
engaging in reverse auctions, firms should
consider whether they are damaging their
existing supplier relationships, Rozwell
said. Such relationships can require years
and considerable resources to establish.
Emiliani and Stec urge buyers to engage in
collaborative cost reduction with suppliers.
Do Your Homework
Some corporate buyers who are dubious
about the value of e-marketplaces believe
that if they conduct enough extensive
research to make smart purchases from
suppliers, online auctions will be
unnecessary. Certainly, buyers must decide
on a multitude of details before entering an
auction. A great deal of up-front planning
and preparatory work must be accomplished.
The transaction itself, said Rozwell,
takes a small amount of time.
Even after finding potential sources of
supply, buyers still must thoroughly research
prospective suppliers. Buyers must
understand exactly what theyre buying in
an online environment just as they do in a
traditional auction, said Martin. Product
content as well as supply reliability must be
example). Poor product quality as a result of
buying from an untested supplier is another
potential downside. Buyers must have
realistic expectations about moving from
one supplier to another, according to Robert
Emiliani, president of Rensselaer
Polytechnic Institutes (RPI, www.rpi.edu)
Center for Lean Business Management.
Although measuring the price component of
an auction is easy, theres no metric for the
supply relationship, noted David Stec, the
centers vice-president.
You always lose some of the savings
from auctions, upwards of 50%. Buyers
dont understand the total cost of
acquisition, Emiliani said. Costs can rise
further if a new supplier fails to deliver the
product. In such cases an embarrassed buyer
may have to return to the previous supplier,
who will likely raise prices for the privilege.
If it looks too good to be true, it probably
is, states a report by Emiliani and Stec (4).
In addition, establishing, administering,
and finding personnel for a companys auction
program can lead to significant expenses.
Large companies could spend up to
$40 million to establish a private trading
house (5). Registering with a public auction
house also entails new expenses such as
annual subscription fees ranging from a few
hundred to a few hundred thousand dollars.
Vendorcustomer relationships. Moreover,
reverse auctions can put undue pressure on
worried about reliable sources of supply
may want to screen suppliers by corporate
size or years in business.
Reverse auctions do not offer as many
benefits for products with which one or two
dominant suppliers exert market control or if
the supplier base is not fragmented. However,
in markets with few suppliers, buyers have
been known to reduce the suppliers
advantage by restricting the information they
see about one another online.
The Downside
Skeptics of reverse auctions say that price
savings fail to reflect other, less obvious
costs. Such expenses include the time and
effort of resourcing (setting up and fostering
relationships with new suppliers, for
SKEPTICS of reverse
auctions say that
price savings fail to
reflect other, less
obvious costs.
Continued on page 72
repeat of the current [chemical market]
situation in the biotech segment, one
chemical industry executive said at
Informex. The situations are quite similar,
he noted, with much hue and cry at the
moment about the demand for
biomanufacturing capacity, just as there
was about chemical capacity five years
ago. The industry does not want to get
stuck again with a lot of underused
capacity if the demand doesnt actually
materialize.
A recent report by U.S. Bancorp Piper
Jaffray (The Road Ahead for Biologic
Manufacturing, Minneapolis, MN, 22
January 2002, www.piperjaffray.com)
suggests that biomanufacturing
contractors have been wise to move
slowly. The report says that more than
enough capacity is under construction or
is planned to meet the industrys needs
over the next five years. Most of that
capacity is being built by major biotech
sponsors including Immunex
(www.immunex.com), Amgen
(www.amgen.com), Genentech
(www.gene.com), and Biogen
(www.biogen.com) with Boehringer-
Ingelheim (www.boehringer-ingelheim.
com) as the only contractor with capacity
in excess of 100,000 L. The report also
suggests that in the next five years some
sponsors will be active sellers of excess
manufacturing capacity.
The greatest short capacity problems in
the industry recently have been in cell
culture, where the take-off of large-
volume monoclonal antibody products
caught the industry by surprise.
Contractors also have been concerned
that the low yields of tank-based cell
culture make it vulnerable to replacement
by other technologies. However, capacity
in microbial fermentation also has
become tight in the past year or so.
One contract manufacturer that has
decided to make a move is Avecia
(www.avecia.com), which announced a
plan to build a 40,000-L microbial
fermentation facility at its Billingham, UK,
site. The $100 million investment will be
completed in two stages: two 5,000-L
fermentors and associated harvesting and
purification suites will come online in
2003, and two 15,000-L fermentors and
purification streams will begin operation in
2005. (See Info+, page 8, for more
information.)
Jim Millers Outlook (continued from page 56)
72 BioPharm MAY 2002
considered. The Gartner report states,In an e-marketplace, buyers
should deal only with suppliers they know and have qualified (2).
Subsequently, purchasing agents must ensure that suppliers live up
to their commitments.
Knowing the volume of goods to request and setting the floor and
ceiling prices are key decisions for buyers. Even in an online
marketplace, business locale is another consideration. According to
Hincks, some companies wont conduct business with suppliers
from certain regions because transportation costs are too expensive
or because the product doesnt ship well.
Buyers also must decide the best time to hold an auction on the
basis of market conditions, noted Hincks. A buyer should be wary of
auctions when market prices are going up because the auction might
accelerate upward pressure on prices.
Auctions are a two-way street, and buyers must pay heed to their
suppliers needs. They should make sure suppliers understand an
auctions requirements and conditions, including packaging and
shipping arrangements, before they participate. An important step is
writing a comprehensive, well-understood request for quotation that
is clear about such criteria as inventory requirements and raw
material input specifications. If an auction makes last-minute
changes, all suppliers must be promptly informed before the auction
begins. Obviously, buyers must remember to exclude from reverse
auctions the suppliers with whom they have long-term supply
agreements.
Analysts say that for a buyer to gain a quick win at the suppliers
expense is self-defeating. Is it really all just about money? asked
Martin. The long-standing buyersupplier relationship is the big
question. Martin advised that buyers should ask themselves these
questions: How can I incorporate content into a reverse auction?
How can I be sure to get a good price in addition to the service and
support I usually get from my regular suppliers? In short, the
buyer needs a supplier strategy (for example, a strategy for choosing
a reliable, cost-effective supplier), noted Martin. The emphasis on
reducing transactional costs (common during the early days of
reverse auctions) to the exclusion of much else has largely
fallen aside. The goal for todays buyers may be not to get the best
price but to get a fair price from the supplier of choice.
References
(1) Forrester Research and the U.S. Institute of Supply Management, Research
Report on E-Business, January 2002.
(2) Gartner G2 Group, ChemConnect Users Exploit Tactical Opportunities,
research note, 4 December 2001.
(3) IDC, A Case Study of E-Marketplaces for the Chemical Industry, company
bulletin, November 2001.
(4) R. Emiliani and D. Stec, Realizing Savings from On-Line Reverse
Auctions, Supply Chain Management, 7(1), 1223 (2002).
(5) Big OEMs Prefer Private Platforms: But Public E-Markets Will Carve Out
a Role, Purchasing, 22 March 2001, www.manufacturing.net/pur.
Edward P. Moser
E-Procurement continued from page 58
Info #5