THE IMPACT OF ONLINE, REVERSE AUCTIONS

ON BUYER-SUPPLIER RELATIONSHIPS

Sandy D. Jap**

July 2001

* This work was supported by research grants from the EBusiness@MIT Center, Leaders for
Manufacturing Program, and MIT-Ford Alliance. Special thanks to the buying organization,
buyers, suppliers, and auctioneers for their cooperation throughout the data collection process.
Thanks also to John Lynch, Nader Tavassoli, and Joe Urbany, for helpful comments.

** Sandy Jap is Associate Professor of Marketing at the Goizueta Business School at Emory
University. Her address is 1300 Clifton Road, Atlanta, GA 30322. Phone 404.727.7056, fax
404.727.0868, Sandy_Jap@bus.emory.edu.
 THE IMPACT OF ONLINE, REVERSE AUCTIONS
ON BUYER-SUPPLIER RELATIONSHIPS

ABSTRACT

Increasingly, buyers are turning to the use of online, reverse auctions in their negotiation
activities with suppliers. How does the use of these price competition mechanisms impact
buyer-supplier relationships? We consider this question in the context of a quasi-experiment
involving six reverse auctions conducted in the supply base of a major industrial buyer. The
results indicate that online, reverse auctions increase both new and incumbent suppliers beliefs
that the buyer would act opportunistically toward the supplier, particularly when open bid
auctions are used. Paradoxically, the suppliers response to online auctions is to increase its
willingness to make dedicated investments toward the buyer; this is true of both new and
incumbent suppliers regardless of the auction type. Although these auctions can yield cost-
savings, the savings are category specific and not systematically related to an open or sealed bid
format. Implications for the use of reverse auctions in industrial sourcing activities are
discussed.
 THE IMPACT OF ONLINE, REVERSE AUCTIONS
ON BUYER-SUPPLIER RELATIONSHIPS

INTRODUCTION

New emerging Internet technologies are promising industrial buyers and their suppliers

substantial transactional efficiencies in their sourcing activities. In fact, it has been estimated

that these efficiencies could potentially carve more than $1 trillion from the $7 trillion annual

spend on components, supplies, and services worldwide (USA Today, 2/7/00, B1). However,

these technologies also bring new dynamics to industrial purchasing contexts and the impact of

these new dynamics is not understood well.

Consider the growing use of online, reverse auctions in industrial sourcing activities.

These auctions have been dubbed reverse to reflect the fact that sellers bid instead of buyers,

and the prices are bid down instead of up. These auctions have become a standard component in

the ECommerce toolkits of companies such as Ariba, CommerceOne, Oracle, B2E Markets, and

a variety of vertical hubs. Many of the top Fortune 50 firms regularly employ online auctions in

their sourcing activities and the United States military has made long-term commitments to use

reverse auctions in present and future sourcing activities. The leading provider of online

auctions is Freemarkets, Inc. Since its inception, the firm has put approximately $10 billion of

sales volume into 9,200 auctions, creating $2.7 billion in savings for industrial buyers such as

United Technologies, Pepsico, Raytheon, and Shering-Plough. These auctions have been

conducted in 30 languages and involved over 150,000 suppliers worldwide.

Another impetus for the use of these auctions is the potential process savings associated

with them. The typical purchasing process involves mailing request for proposals to potential

buyers, followed by printed responses, manual reviews of the proposals and ongoing

negotiations. The average length of this process is approximately six weeks. An online reverse

1
auction dramatically reduces the negotiation process time, with the bidding occurring over a span

of a few hours.

Buyers believe that this price competition mechanism is efficient producing greater cost

savings and reducing the negotiation process relative to past approaches to procurement. While

this may be true, emerging anecdotal evidence suggests that for many suppliers, the online

auction experience can be extremely disturbing:

I am the general manager of a small manufacturing company and I appreciate the opportunity to express my
views concerning e-auctions. We are a supplier and very recently had this experience with our major
customer. To sit for five hours and watch business that you have developed, maintained and serviced for
forty years being carved up and slowly disintegrate is a very traumatic experience. Are we seeing the
demise of a purchasing staff and sales force, as we know it today? Jack Bailey (Purchasing, June 15,
2000)

[The buyer]1 talks about the relationship being a partnership and this [the auction] really takes that away.
There is not a partnership there at all. What they do is take your existing business that you have worked
very hard to achieve and maintain. You work with them to give them cost reductions over the years and
they send it out across the board for a competitive bid. I just do not think that is fair. -- Supplier who
participated in the open bid auctions in this research

Thus, while the use of price competition mechanisms such as online auctions may be efficient

from a pricing and process view, there remains the possibility that it may carry grave

consequences for supplier attitudes and perceptions of the buyer. This is the motivation of this

research.

In this research, we consider the use of online reverse auctions in direct materials

purchasing contexts and ask questions such as: How does the use of open or sealed bid reverse

auctions impact supplier bidding performance and motivation? Are suppliers motivated to serve

the buyer better? How does it affect a suppliers attitudes and strategic position vis--vis the

buyer? Do the effects differ for incumbent and new suppliers? While it is too early to know the

long-term effects of the repeated use of these auctions on buyer-supplier relationships, we can

examine the basic effect of various types of auction formats in the short-term.

1
Throughout the manuscript, [the buyer] indicates places where we have removed the organizations name to
preserve confidentiality.

2
 We accomplish this via a quasi-experimental design conducted in the supply chain of a

major industrial manufacturer. We consider how the firms use of an open or sealed-bid auction

across a variety of product categories impact (i) financial performance (i.e., the buyers cost

savings from the auction), (ii) supplier perceptions of the buyer (i.e., suspicions of opportunism),

and (iii) the suppliers strategic position and motivation toward the buyer (i.e., willingness to

make idiosyncratic investments). Thus, we consider the immediate impact of an online reverse

auction event on the buyer-supplier relationship, with the goal of detecting early warning signs

and opportunities for the firm as it decides how to best employ these auctions in its sourcing

activities.

Some might argue that relational consequences do not matter for many purchasing

activities, such as the procurement of indirect materials those products that are not used

directly for production purchases, such as office equipment, maintenance, repair and operating

(MRO) supplies, etc. And indeed, tremendous savings have already been demonstrated in this

area. However, the purchasing of direct materials used in production, which may account for 30-

50% of a firms total purchases, typically involves more complex supplier arrangements. For

these purchases, product quality, value-added services, timely delivery and supplier

responsiveness are also important, as the suppliers performance in these areas creates a direct

impact on the buyers ability to successfully meet the demands of its downstream customers. In

this research, we will focus on the use of online reverse auctions in the sourcing activities of

direct materials, as this is the area where relational consequences carry important implications.

In doing so, this research makes several contributions. It informs our general

understanding of the types of auctions commonly used in industrial purchasing contexts and

provides a systematic, empirical test of the extent to which these auctions impact supplier

3
attitudes, strategic intentions, and cost savings. The research also provides important

implications for how the firm ought to diffuse the use of online reverse auctions into its supply

base and gives insight into how buyers and suppliers might organize and manage their electronic

procurement activities. As firms increase their reliance on and use of reverse auctions, these

auctions are quickly becoming a strategic choice of the firm, worthy of study in its own right.

By examining the initial impact of auctions on supplier attitudes and perceptions we recognize

the possibility that these events may plant seeds of discord in buyer-supplier relationships.

The paper is structured as follows. In the next section, we describe the types of online

reverse auctions that may be used in industrial sourcing activities. We then develop propositions

relating how supplier attitudes, motivation, and performance may vary across open or sealed bid

auctions and for new or current (incumbent) suppliers. The following section describes the

research setting and empirical examinations of the propositions in the context of six reverse

auctions conducted with the cooperation of a host firm. The paper concludes with a discussion

of results, limitations, and managerial implications.

ONLINE, REVERSE AUCTIONS

DIFFERENTIATING CHARACTERISTICS

Before we develop propositions regarding the impact of online reverse auctions on

interorganizational relationships, it is important to recognize that the online auction phenomenon

is a fundamentally different phenomenon both substantively and theoretically, than anything

weve seen in the past. Online auctions differ from manual auctions in several ways. First, the

speed of information in online auctions is rapid, with instant communication and feedback.

Second, the cost of contact among bidders is greatly reduced via the use of a knowledgeable

intermediary, a third party auctioneer who introduces qualified new suppliers to the buyer,

4
manages the interactions with suppliers, and leverages its own product or industry specific

knowledge in the process. Also, geographic and temporal convenience is increased, as

asynchronous bidding is possible and bidders are able to participate from all over the world.

Third, online auctions represent a significant compression in negotiation time and preparation.

Instead of protracted negotiations through the phone, fax, and email over weeks and months, the

negotiation of multiple product lots occurs within the course of a few hours. Finally, the online

auction preserves bidder anonymity, by not allowing the bidders to know the identity or number

of other bidders in the auction process.

Online reverse auctions are also differentiated from the auctions studied in the economics

literature in several ways. First, the products that are auctioned in many industrial contexts are

differentiable on attributes other than price. This is particularly true in the sourcing of direct

materials and components. Aspects such as product quality, supplier reliability, and value added

services are important in the purchase decision. Second, many industrial auctions do not

necessarily determine the winner. Unlike the auctions examined in the theoretical literature,

there is no explicit commitment to determine the winner on a first- or second-price basis. The

buyer has full latitude to select the winning supplier on any basis; the only explicit commitment

that the buyer makes is to award the contract to one of the participants. Thus, the online auction

is a mechanism that stimulates price competition (in varying degrees) and clearly and quickly

delineates all suppliers on the basis of price, but it does not necessarily determine the ultimate

winner of the purchase contract. The third difference involves the interdependence among

product lots in online auctions. In many auctions, suppliers bid on multiple product lots in a

sequential fashion. Each lot may contain varying numbers of individual parts. Hence, a plastics

auction may involve four lots of ten parts each. The bidder must consider not only the individual

5
prices, but also its capacity to accommodate all or some of the lots. Thus, there is an

interdependency among lots that the supplier must take into consideration in its bidding efforts.

And finally, bidders in industrial auctions typically do not know how many bidders it is bidding

against in any one event. In contrast, many of the auctions examined in the economics literature

will: (i) involve commoditized products, (ii) provide well-defined rules of allocation, (iii) are

typically independent events and (iv) assume that each bidder knows exactly how many other

bidders are bidding against him/her. The characteristics enable the bidders to define and

determine the optimal bidding strategy. In industrial contexts, this process becomes much more

complicated. Moreover, the theoretical literature does not consider the context in which these

auctions exist, despite the recognition that this is a critical issue for future research:

The auction models are partial equilibrium models. The role of the price system in coordinating the actions of
different people cannot be understood except within a general equilibrium system. How to embed bidding
models in a general-equilibrium context remains an open question. Questions of the existence and social
optimality of competitive equilibrium with informational asymmetries await the resolution of this question.
R. Preston McAfee and John McMillan (1987)

Collectively, these differences imply that the online, reverse auctions that occur in the

marketplace is a fundamentally new phenomenon in industrial sourcing and its impact on the

interorganizational context is not understood. And while some aspects may appear similar to the

auctions studied in theoretical literatures, one needs to be very careful about generalizing from

these literatures to industrial contexts.

In this research, our goal is to illuminate the relational impact of these online auctions in

industrial settings. We explore these possibilities via a set of propositions that describe the

differential effects of online open and sealed bid auctions on the suppliers suspicion of

opportunism, willingness to make idiosyncratic investments, and cost savings. We draw on

relevant literatures in economics, marketing and psychology as well as our own experience and

depth interviews with the buyers, suppliers, and auctioneers in the field study. The theoretical

6
literature illuminates the motivational and strategic concerns of the participants while the field

interviews identify the specific organizational characteristics that constitute the sourcing context.

THE AUCTION PROCESS

While there are many different types of auctions, we focus on the use of one-sided sealed

and open bid auctions. One-sided refers to the fact that there exists a single buyer and multiple

sellers. In the sealed bid auction condition, the buyer posts a request for purchase (RFP) to a

website and invites specific suppliers to view the RFP. The suppliers are given a due date for

their bids (typically several weeks later) and are told that a winner would be subsequently

selected. In this research, the sealed bid event involves a single round of bidding; suppliers are

not able to view their competitors price bids only the buyer views the bids. In the open bid

auction condition, suppliers are able to view the price bids of every competitor and have the

opportunity to bid against their competitors in real time. In this process, the auctioneer sends an

invitation to participate along with the buyers RFP to the supplier. The open bid auction takes

place after the suppliers have had sufficient time to view the RFP and formulate a quote. In this

auction, bids are submitted for the buyer and all suppliers to view and the price falls successively

until one bidder remains.

Figure 1 contains an illustration of what suppliers would see in the open bid condition.

Bid amounts are plotted on the vertical axis and time is plotted on the horizontal axis. A

diamond indicates a suppliers lot bid, while a line connects the lowest bid at any point in time.

The buyers posted reserve price is the price at which it would be willing to move the purchase

contract from an incumbent to a new supplier. This is essentially the buyers switching cost,

reflecting the risk that the buyer faces in moving the business. A scheduled and actual closing

time is indicated as well. The open bid format utilizes a moving end-time (a soft close) for each

7
lot; this means that if there is a bid within the last minute of the closing time for the lot, the close

time will automatically extend for 2-5 minutes more to allow other bidders to respond. This will

continue until the close time is reached with no bidding activity in the minute prior. The pattern

of bids in Figure 1 indicates that most activity occurs close to the scheduled closing time. At this

point, bidding becomes aggressive and the price falls dramatically over the next 30 minutes. It is

also worth noting that there are bids being made above the reserve line throughout most of the

auction. These represent price concessions by suppliers who may not be willing to bid at the

market lead. Since the buyer has not committed to taking the lowest price, these suppliers hope

to remain in the buyers consideration set by signaling a willingness to make some price

concessions, while relying on their non-price value to justify their inability to offer the lowest

prices in the market. Hence, while the open bid auction involves a dynamic competition on

price, it is also an important signaling mechanism whereby all suppliers can make decisions

regarding price concessions in real time.

DEVELOPMENT OF PROPOSITIONS

The emergence of online, reverse auctions represents a new area of inquiry in the

development of interorganizational relationship management theory. In practice, these auctions

do not occur in a vacuum, they are deployed into settings in which the buyer and supplier have

developed an ongoing, dynamic relationship. The marketing literature on interorganizational

relations has shown this to be a critical context variable that shape each partys behavior,

perceptions, and choices in systematic ways over the course of an exchange (cf., Boyle, Dwyer,

Robicheaux, and Simpson 1992; Brown 1981). In this section, we draw on research in the

interorganizational literature, most notably the transaction cost economics (TCE) framework, to

identify a critical set of dependent variables: opportunism suspicions and willingness to make

8
idiosyncratic investments. We also consider how cost savings may differ among open and sealed

bid auctions and among new or current suppliers.

THE SUPPLIERS OPPORTUNISM SUSPICIONS

TCE has played a prominent role in the development of the interorganizational

relationship literature in marketing (see Rindfleisch and Heide 1997 for a review of its impact on

the literature). The fundamental assumptions of TCE involve human behavior (i.e., bounded

rationality and opportunism) and aspects of the transaction (i.e., idiosyncratic investments and

environmental uncertainty). TCE maintains that since human beings are bounded in rationality

and capable of opportunism some of the time (that is, under the right circumstances), it is

difficult to know who would refrain from being opportunistic ex ante. Therefore, the firm (e.g.,

the supplier) must forecast opportunism and decide whether to tolerate it, build a governance

structure to limit it, or abandon the proposed transaction altogether. If idiosyncratic investments

exist within the exchange relationship, then the firm is subject to a hold-up potential that can be

exploited by its exchange counterpart (e.g., the buyer) (Klein, Crawford and Alchian 1978;

Williamson 1996). Therefore, the firm should consider what type of governance structure would

reduce these risks to acceptable levels, as eliminating opportunism is typically infeasible or

prohibitively expensive.

Opportunism is an explanatory mechanism that distinguishes TCE from alternative

approaches such as agency theory or the resource-based view of the firm. It is defined as self-

interest seeking with guile, synonymous with misrepresentation, cheating and deception,

subsuming a range of (mis)behavior known in diverse literatures as adverse selection, moral

hazard, shirking, sub goal pursuit, unofficial rewards, managerial discretion, agency costs, taking

advantage of circumstances, and free riding (Williamson 1996a). It is also a construct that has

9
received considerable attention in recent years (Brown, Dev and Lee 2000; Wahtne and Heide

2000). In practice, it involves several elements: (i) distortion of information, including overt

behaviors such as lying, cheating and stealing, as well as more subtle behaviors such as

misrepresenting information by not fully disclosing, and (ii) reneging on explicit or implicit

commitments such as shirking, or failing to fulfill promises, and obligations. Opportunism is the

equivalent of bad faith, the implication being that the party that is opportunistic is not

trustworthy.2

In this research, we focus on the suppliers suspicions that the buyer is acting

opportunistically, since the supplier typically cannot verify the buyers opportunism.

Understanding the suppliers suspicion is critical, as it involves a negative ascription about the

buyers character. This inference conditions how the supplier behaves (cf., Rusbult, and Van

Lange 1996); in particular, when the supplier suspects the buyer, the supplier will hold back

from the relationship, not wanting to risk being the victim of further opportunism (Ping and

Dwyer 1992, Williamson 1985, 1993). It might also motivate the supplier to use additional

safeguards (e.g., contracts, incentives, or monitoring) to protect and enforce the exchange, which

has a direct impact on the governance and structure of the buyer-supplier relationship.

Sealed versus open bid auctions. We expect that the suppliers suspicion of opportunism

will be greater in online, open bid auctions relative to sealed bid auctions. This is because the

level of price competition is significantly greater and more explicit than in the sealed bid auction.

The fast-paced, dynamic nature of the bidding process, along with the need to quickly respond to

the bids of competitive suppliers creates a tense negotiation environment that pressures suppliers

2
We note that the opportunism construct is not merely a form of distrust. Trust is a broad, meta construct with
many facets and levels; scholars across multiple disciplines do not fundamentally agree on the meaning of trust
(Rousseau, Sitkin, Burt and Camerer 1998). Opportunism is more delimited and behavioral in nature. It is
observable by the supplier and grounded in specific actions. It should create reduced attributions of trust.

10
to vigorously cut prices. When a buyer chooses to hold an open bid auction over a sealed bid

auction, it increases the bargaining costs of the supplier, making the renegotiation process so

disagreeable to suppliers that they will accede to a renegotiation rather than persist with their

current pricing levels (cf. Masten 1988). Thus, in the suppliers view, the buyer uses the open

bid format as a means to force additional price concessions from the supplier. This represents a

form of opportunistic rent seeking behavior on the part of the buyer. It is worth noting that price

competition is a common aspect of industrial sourcing negotiations; it exists in the sealed bid

auctions. However, it is the compressed time frame of open bid auctions that creates a stressful

context for the supplier. In our interviews with them, many suppliers complained that the format

prevented them from careful consideration of their price bids and gave them a sense of being

out of control. Hence, we make the following proposition:

P1: Opportunism suspicions are higher in open than sealed auctions.

New versus incumbent suppliers. Opportunism suspicions may also differ among new

and incumbent suppliers. Incumbent suppliers have a rich history of exchange with the buyer.

They understand the buyers needs and constraints, and may have developed intangible aspects

such as trust, implicit understandings, or relational norms that are valuable for governing and

improving the efficiency of the exchange. This history represents an important switching cost

that has enabled incumbent suppliers to earn higher prices from the buyer relative to new

suppliers. In an electronic context, incumbents are unable to express the value of their past

experience, which significantly reduces their bargaining power. Hence, we would expect that the

buyers decision to use an electronic format would increase the incumbent suppliers

opportunism suspicions relative to the new supplier.

P2: Opportunism suspicions are higher for current than new suppliers who participate in auctions.

11
THE SUPPLIERS WILLINGNESS TO MAKE IDIOSYNCRATIC INVESTMENTS

Idiosyncratic investments are tangible (e.g., plant equipment and machinery, tooling, and

design systems) or intangible (e.g., human resources, training) investments that are non-fungible

to the relationship. This means that they are difficult for the supplier to redeploy elsewhere if the

relationship is terminated. Hence, they are a risk that the supplier takes on behalf of the buyer to

enable the creation of superior value, improved coordination, scale economies, and the

facilitation of joint value. Like general-purpose investments, idiosyncratic investments enhance

strategic outcomes because they raise the effectiveness and efficiency of at least one, if not both,

parties in an exchange (Dyer and Singh 1998; Heide 1994; Lusch and Brown 1996; Noordeweir,

John, and Nevin 1990). However, idiosyncratic investments play an additional role. They

impose costs in the event that the relationship is prematurely terminated. Hence, they are

credible signs of a suppliers commitment toward the buyer (Anderson and Weitz 1992) and can

have a stabilizing effect on the relationship.

Sealed versus open bid auctions. We expect that the suppliers willingness to make

idiosyncratic investments should be lower in open bid auctions, relative to sealed bid auctions.

This is because the rapid, dynamic nature of price competition in the open bid format creates a

stronger emphasis on price reduction relative to the sealed bid format. When buyers focus on

price in the short-term, they foster a market governance structure with their suppliers. In such

exchanges, the focus is on discrete transactions; roles are narrowly defined, planning over time is

limited, and incentives are tied directly to the completion of a contract or payments (Heide

1994). In short, this type of exchange relationship does not foster the creation of joint value or

mutual benefit in the long-term. As such, the suppliers incentive to make idiosyncratic

12
investments into the relationship is reduced, as the payback from making idiosyncratic

investments is unlikely to be realized over time.

P3: The suppliers willingness to make idiosyncratic investments is lower in open, than sealed bid
auctions.

New versus incumbent suppliers. As buyers turn to the use of online auctions in their

sourcing activities, we expect that the motivation for incumbent suppliers to make idiosyncratic

investments will be reduced relative to new suppliers. This is because the incumbents

differential value their knowledge of the buyer and its specific needs is not readily expressed

in electronic contexts. The online bidding format only expresses price information; there is little

opportunity to express potential value-added activities and processes that could be created via the

use of idiosyncratic investments. Incumbent suppliers are in a better position to help the firm

expand the pie of joint benefits. However, as the firm turns increasingly to the use of online

auctions, these opportunities become more difficult to explore and develop. Additionally, as the

negotiation becomes focused on price in the short-term, there is little incentive for suppliers to

create long-term investments with the buyer. Because of this, we anticipate that:

P4: The suppliers willingness to make idiosyncratic investments is lower for current than new suppliers
who participate in auctions.

THE BUYERS COST SAVINGS

A chief concern of the buyer is the cost savings, defined as the percentage reduction in

price from historical costs. This is an important number in industrial procurement, one that

many firms use in evaluating the buying function. Does a sealed or open bid auction yield higher

savings? There is a large literature in economics that considers this question in auctions with

well-defined parameters (i.e., specific allocation rules, revealed number of bidders, single

commodities, etc.). The results of this literature indicate that when the bidders have common or

affiliated values, the open bid auction format will produce greater cost savings than a sealed bid

13
auction. When bidders values for the contract are common, it means that the value of the item is

the same to all bidders, but different bidders have different information about the underlying

value. These characteristics are true of industrial sourcing auctions. There exists a true value for

the contract namely the worth of the contract in the market. However, no one knows this true

value and each bidder has a different guess about how much the item is objectively worth. In an

open bid format, the bids partially make public each bidders private information about the true

value of the contract. Hence, each bidder is able to learn from the bidding process and adjust

their bid closer to the true value of the contract. Thus, we expect that:

P5: The buyers cost savings are greater in open than sealed events.

New versus incumbent suppliers. What type of supplier provides greater savings new

or incumbent suppliers? The auction literature is silent on this issue. We believe it is an

empirical question and that there are three possible outcomes. On one hand, one could argue that

new suppliers should be more aggressive than incumbents, as they gain not only a purchase

contract, but also the opportunity to potentially remain in the supply base for the long run.

Alternatively, it could be argued that current suppliers should be more aggressive than new

suppliers as the incumbents have much to retain. These suppliers have built a history of

exchange and learning with the buyer that allows for opportunities to provide value in unique

ways. A third possibility is that both effects operate simultaneously, such that no empirical

differences are observed. In light of this, we reserve prediction on the direction of this result and

examine the empirical outcome in a later section.

METHODOLOGY

RESEARCH SETTING

The research was conducted from 1999-2000 in the supply base of a major automotive

supplier of car components. Over the course of a six-month period, the company put

14
approximately $100 million worth of purchase contracts into three open and three sealed bid

auction events in various product categories. The sealed bid auctions were conducted for

transportation, semiconductors, and non-production parts, while the open bid auctions were held

for plastics, metal parts, and electrical parts. None of these products were pure commodities,

such as MRO supplies, or highly customized strategic parts; all of the products were used in

production or directly for parts used in production. Hence, the product categories are

representative of the vast majority of industrial purchases that are typically made in the

marketplace today and represent categories in which supply relationships are valuable and

product differentiation is possible. Table 1 overviews the number of bidders and the number of

product lots up for bid in each auction. These lots varied in the number of parts that comprised

each one; they might be grouped according to the processes required to make the individual parts

or according to the capabilities of various suppliers to produce them. In the transportation event,

each lot represented a specific route. The division of lots is a subjective decision on the part of

the buyer, who knew each suppliers production capabilities and understood the production

processes behind each part.

Since direct expenditures are often differentiable on non-price characteristics, the buyer

prequalifies a list of viable suppliers prior to the event. This process may involve personal visits,

interviews, market research, and a lengthy questionnaire assessing the suppliers quality

certifications and production capabilities. The buyer then invites a subset of suppliers who are

qualified to take the business to bid in the auction. All of the auctions are conducted by a third

party auctioneer who trained the suppliers on the use of the online interface and informed them

of the event rules: (i) The buyer was committed to selecting a winner from each event, on any

basis; the buyer will take into consideration all aspects of the suppliers bid although the lowest

15
bid is not necessarily guaranteed to win the contract, (ii) the buyer was prohibited from bidding

against the suppliers in the auction process (an unethical practice known as shilling), (iii) all

competitors were viable, pre-qualified sourcing options for the buyer and (iv) the supplier bids

were legally binding. The suppliers are not told whom they will be competing against or how

many suppliers will be bidding against them. Since the suppliers in the open bid auctions have

virtually no experience with these formats, the auctioneer will train them to use the online

interface and will coach the suppliers to understand their cost structures prior to the auction.

This is done as part of the supplier training with the web interface. The auctioneer also helps the

supplier to identify and understand relevant costs and work through various scenarios, to help

mitigate the pressure of the real-time bidding decisions.

DATA COLLECTION

We implemented a quasi-experimental design around the auction events that included an

array of controls, including the use of (1) pretest and posttest measures from the same panel of

suppliers in the treatment group, (2) control groups, and (3) replication of the auction event

across multiple product categories. Using Cook and Campbells (1979) notation, we depict the

design in each product category as shown in Figure 2. Measurement activities are denoted by O,

X denotes treatment activities, and the dashed line distinguishes between treatment and control

groups. Identical measurement instruments (O) were fielded before (O1) and after (O2) the

treatment (an open or sealed bid auction) and in the control group. We refer to these surveys as

the pretest, posttest, and control surveys respectively. We initially tried to administer the control

group survey twice, to correspond to the pretest and posttest surveys, but found that there was no

noticeable change over such a short time period (i.e., a week).3

3
Also, suppliers reacted negatively to completing the survey twice with little change of their circumstances in
between.

16
 The measurement instruments web-based surveys contained measures of the key

dependent variables of interest that were expected to change as a result of the treatment. This

design was replicated in six product categories. Since this is a field setting, we were unable to

control the number of suppliers, lots, or product types in each event. We were only allowed to

survey suppliers before and after the event, conduct post-auction interviews with suppliers, and

interview buyers throughout the process.

Procedure. In each product category, in-depth interviews were conducted with the

buyers to get a better understanding of the exchange context, the composition of the supply base,

and the expectations and strategic intentions of each auction. These buyers provided the names

and contact information of the suppliers who have been prequalified and invited to participate in

each event (i.e., the treatment group). They also provided the names and contact information of

comparable suppliers who would not be invited to the event (i.e., the control group). In any

negotiation process, buyers do not typically involve their entire supply base. Usually, a subset is

selected and the number of suppliers in this set is typically the number that the buyer feels

necessary to stimulate price competition. For the purpose of this research, the buyer selected a

subset of the supply base that it felt was equivalent to the treatment group (in production

capability, price competitiveness, product offerings, etc.) and provided these names to the

researchers for the control group. These buyers understood the purpose of the control group

within the research design and carefully selected the participants in this group accordingly.

Suppliers in the treatment and control group were sent an email invitation one week prior

to the event from the researchers. The invitation specified that the individual respondent should

be a person who is knowledgeable about the firms specific relationship with the buyer and

directed the suppliers to a university website that stated that the researchers were studying the

17
buyers relationship with its suppliers. It also guaranteed individual anonymity to the buyer and

reassured suppliers that all responses were to be viewed only by the researchers. For suppliers in

the treatment group, the invitation also specified that the respondents should be a person who

would participate in the upcoming bid process. Suppliers in the control group were not told that

the buyer was hosting a competitive bid event in their product space; they were merely asked to

participate in a study on buyer-supplier relationships.4 The survey directed the supplier to

complete all items in reference to the specific buyer. In each product category, we monitored the

activities of the buyer to insure that no major events or initiatives (e.g., retroactive charge backs)

occurred with the treatment or control group during the period of data collection that might

disrupt or significantly alter supplier perceptions and attitudes of the buyer. The suppliers in the

treatment group were sent an email invitation from university researchers to complete the

posttest survey within one week after the auction event.

Respondents. Thirty three percent of the suppliers in both the treatment and control

groups were new suppliers while the remainder was current suppliers. The suppliers in the

treatment and control groups are similar in terms of annual sales (mean $356 million, min

$445,000, max $4.9 billion) quality levels, and capabilities, and consisted of both prospective

new and current suppliers. We also verified that the suppliers in the treatment and control group

were comparable in terms of intangible aspects of their relationship with the buyer such as: goal

congruence, overall satisfaction with their relationship, and perceived dependence on the buyer.5

No significant differences were found. Respondents were typically senior executives, vice-

presidents, and even owners of the supply business who handled large customer accounts such as

4
Since the buyer was only experimenting with the use of auctions in its supply base, it did not publicly announce the
electronic events to the supply base. In fact, the buyers went to great pains to be sure that the suppliers in the control
group were not told that other suppliers in the base had been invited to bid on the sourcing contracts.
5
The scales for these items are listed in the Appendix.

18
the buyer. These individuals also had the authority to make the price concessions that may be

necessary in an auction and determined major investment decisions toward the buyer. At the

time this research was conducted, online auctions and electronic bidding were not pervasive in

the marketplace. Hence, suppliers had virtually no experience with these formats.

The control group was comprised of 87 suppliers; 50 of these suppliers completed the

survey, yielding a response rate of 57%. Sixty-eight of the 154 bidders completed the surveys,

yielding a response rate of 44%. Thirty-three of the 68 respondents were in the open bid

auctions and 35 were in the sealed bid auctions. Twenty-eight of the 68 respondents were new

suppliers and 40 were incumbents.

Respondent competency. Since several of the propositions rely completely on the

perceptions of suppliers, it is important that the respondents are competent to report on these

aspects. It is also important to minimize the effects that differences in respondent knowledge,

position, and perceptions may have on their responses by using global and specific measures of

his or her competency and knowledge of the phenomena under investigation. The global

measure was the respondents tenure with a firm. The respondents averaged 6.3 years of

experience in their area and had been with their firms 10.7 years on average.

The respondents knowledge of major issues in the relationship with the buyer was also

assessed via a battery of specific items at the conclusion of the pretest and control questionnaire

(cf., Jap 1999). The respondents were asked, How knowledgeable are you about the following

aspects? Below were listed items such as Your firms willingness to work with [the buyer

firm], The degree to which your firm trusts [the buyer firm], or Your firms willingness to

invest in a customer. Responses were indicated on a 7-point Likert scale (1=Not Very

Knowledgeable, 7=Very Knowledgeable). The average response to these scales was 6.4.

19
Collectively, there is some confidence that the selected respondents were knowledgeable about

their firms relationship with the buying organization and competent such that they were

probably not making up answers to the items and likely to have been relatively involved in

completing the survey.

Measurement. The suppliers opportunism suspicions refer to bad faith attributed to the

counterpart. To discern how bad faith is perceived in the field, and how it should be worded in

survey format, multiple pre-study interviews with buyers and suppliers in other industrial

product categories were conducted. Based on these interviews, the suppliers suspicion of

opportunism of the buyer is measured in a four-item scale that reflects the buyers specific

opportunistic behaviors (i.e., reneging, lying, falsifying information) as perceived by the

supplier. Consistent with the definition of opportunism, this scale reflects (i) distortion of

information such as making false accusations and providing false information, and (ii) reneging

on ones responsibility and shirking. A complete listing of the scale items is provided in

Appendix 2. The suppliers suspicions of opportunism have a mean of 2.94 (sd 1.40) ranging in

value from 1 to 7; the Cronbach alpha coefficient for this scale is .79.

The mean value reflects the relationship context of a powerful, buyer and a lower tier

supplier. In the automotive industry, higher tier buyers exercise their power over suppliers on a

regular basis, to serve the buyers ends. Thus, it is natural that the suppliers would have a

significant level of ongoing suspicion of opportunistic behavior on the part of the buyer.

However, there are also theoretical reasons why this value would not be particularly high.

Williamson (1993) notes that firms tend to engage in business-as-usual, and arent engaged in

opportunism most of the time. This is partly due to the fact that managers are well socialized

20
and governance structures have been put in place earlier to mitigate opportunism. It is also the

case that if opportunism is too high, the supplier would likely not exchange with the buyer at all.

The suppliers willingness to make idiosyncratic investments is a modified version of the

scale developed by Cannon (1992), and reflects tangible and intangible investments that would

be difficult for the supplier to move out of this relationship and into another one. The four-item

scale indicates the extent to which the supplier is willing to make investments in training,

production procedures, equipment, tools, and capacity specifically to accommodate the buyer.

The suppliers willingness to make idiosyncratic investments has a mean of 4.50 (sd 1.68), with

values ranging from 1 to 7; the Cronbach alpha coefficient for this scale is .87. The correlation

between this construct and opportunism suspicions is .12 (p<.17).

The measurement properties of these two scales are assessed via a confirmatory factor

analysis conducted with maximum-likelihood estimation methods in LISREL 8.03 (Jreskog and

Srbom 1993). The estimated measurement model of the two latent factors, each with four

observable indicators, has a chi-square fit of 38.93 with 19 df (p<.00). The comparative fit index

is .92, the incremental fit index is .93, and the Tucker-Lewis fit index is .89. All the factor

loadings and measurement errors are in acceptable ranges and significant at =.05, providing

evidence of convergent validity. Discriminant validity among the constructs is stringently

examined using the procedure recommended by Fornell and Larcker (1981). The pair of

constructs passes this test, demonstrating discriminant validity between the latent factors.

ANALYSIS OF PROPOSITIONS

The field experiment is what Cook & Campbell (1979) would refer to as a

nonequivalent design. This refers to the nonrandom selection process, which implies that the

expected values of at least one characteristic of the groups are not equal even in the absence of a

21
treatment effect. Therefore, in order to obtain a reasonable estimate of the treatment effect, the

analysis must properly recognize and account for the effects of these initial differences. We do

this in two steps. In the first step, the respondents in the pretest and control group are compared

in terms of their demographics and intangible aspects as mentioned above. No significant

differences were found. While this suggests that the groups are equivalent, the groups still might

have large expected differences on other variables that may affect the posttest scores. We

account for these differences in the second step of the analysis, in which we use a between

subjects nested design analysis to examine the propositions in the treatment group. The auction

type is specified as a fixed factor and the product category and supplier responses as nested

random factors. We then estimate the following equation in which the pretest measure is used as

a covariate to adjust for initial differences between groups:

Posttest = Treatment + Product(treatment) + Respondent(treatment, product) + Pretest

where:

Posttest = the posttest score on the variable of interest

Pretest = the pretest score on the variable of interest
Treatment = the treatment effect for open/sealed auctions or new/current suppliers
Product(treatment) = the effect of product differences nested within each treatment effect
Respondent(treatment, product) = the effect of individual respondent differences nested within each product and
treatment type

This analysis of covariance (ANCOVA) matches the pretest value to the predicted posttest value

for all levels of the treatment and examines the differences between them. Hence, a statistically

significant treatment effect would suggest that one level of the treatment would have

significantly outperformed the other level controlling for differences in the pretest scores. We

also assess the extent to which differences exist across product categories (e.g., differences in the

value of the purchase contract, number of bidders, response rates, and number of lots). A

significant effect of Product(treatment) indicates a significant difference among the product events

nested within auction type. By matching the pretest measure to each posttest measure, the

22
ANCOVA has more power to detect true differences in the treatment effect than an elementary

analysis of variance (ANOVA), which would consider only the posttest responses.

Examination of P1. The first proposition considers whether opportunism suspicions

differ in open and sealed bid auctions. Figure 3 displays the plot of these means across events.

The pretest mean in the sealed bid auction was 2.38 (sd=1.02) and the posttest mean was 2.84

(sd=.99). We conduct a test of paired comparisons among each respondents scores to take into

account the correlation that exists among the scores. This indicates that the mean change in

these scores is significantly different from zero (t=2.63, =.01). In the open bid auction, the

pretest mean was 2.64 (sd=1.27) and the posttest was 4.29 (sd=1.17); the mean change in paired

comparisons of these scores is significant (t=4.22, =.00). The ANCOVA indicates that there is

a significant treatment effect of auction type (F1,4 = 16.21, =.05), suggesting that the increase in

scores in the open bid auction is significantly greater than in the sealed bid auction. It also

indicates no significant differences (F4,61 = 1.35, ns) across the various product categories.

Collectively, this indicates support for the first proposition that opportunism suspicions will be

higher in open than sealed bid auctions.

Is the difference in opportunism suspicions due to a self-selection bias? Since

opportunism suspicions were high in the posttest group in open auctions, we consider the

possibility that a self-selection bias may have occurred: that suppliers who responded to the

posttest might be potential sore losers of the auction. If a self-selection bias is operative,

suppliers who offered up lower savings in the open bid auction would be more likely to respond

to the posttest than suppliers who offered higher savings to the buyer. A t-test of the savings

provided by suppliers who responded to the pretest and posttest survey revealed no significant

23
differences (t= -.78, p<.44) in cost savings offered by suppliers, suggesting that it is unlikely that

a self-selection bias is operative in the results.

Is the difference in opportunism suspicions due to the auction process? We proposed that

suppliers view the open bid process as an unfair (from the suppliers perspective) means by

which the buyer gains concessions from the supplier. We explore this possibility further via

several control items that are included in the posttest survey to capture the suppliers direct view

of the auction process. Suppliers indicated their response to these items using a scale of

1=strongly disagree, 7=strongly agree. One item stated: This process will reduce my chances of

earning a fair margin on the business. The suppliers in the open-bid auctions average a

response of 4.8, while suppliers in the sealed-bid auction have a mean response of 3.0. The

difference between the means is significant at alpha .05.

Another item stated: This process does not give a supplier a fair opportunity to bid on

business. Suppliers in the open-bid auction have a mean response of 4.1 while suppliers in the

sealed-bid event have a mean response of 2.7. Again, the difference in means is significant at

alpha .05. Both of these items reflect the sense of exploitation that is associated with the auction

process. Together, they suggest that suppliers in the open-bid auctions view the auction process

as exploitative, relative to suppliers in the sealed bid process as was initially proposed.

Additional indicators of opportunism suspicions. Following the auction events, we

conducted interviews with the suppliers to assess their perceptions of the event and the buyers

intentions in the event. Their suspicions of opportunism were vividly demonstrated in their

responses, which underscored their beliefs that the buyer purposefully selected a price

competition structure that was unfair. Three themes were evident. The first is that suppliers

24
believed that the buyer is using the open bid format as a means to survey the market pricing

without any intention to award the business:

All they were going to do was just feel out what the numbers were going to be. Lets say theyre
looking at someone in Brazil or some Korean firm out there. At this point in the junction, they
werent going to go with those guys based on what they were. So all these guys were throwing
low bids, but it had no meaning as to what was going on. -- Supplier in open bid auction

The second theme indicates that suppliers believed that the buyer had created false competition

by including non-viable bidders:

I didnt think the competition we were dealing with in the atmosphere we were quoting really had
the wherewithal that we had to supply the parts and do the things we had to do.
Supplier in open bid auction

The third theme that emerged from these interviews is the suppliers belief that the buyer was

shilling their bids in order to artificially create competition so as to push the price down farther.

Collectively, these themes indicate that suppliers believed that buyers used open bid auctions to

survey prices and create false competition with the intent of gaining additional price concessions

and eroding any existing margin. The irony here is that the exact opposite was true. We

observed buyers and the auctioneer regularly informing suppliers that the purchase contract was

real and that a winner would be selected. Suppliers were told (several times) that all of the

participating suppliers were prequalified, viable alternatives to the buyer. The buyer was willing

to resource, or move away, the business from an incumbent supplier to another supplier.

Suppliers were also assured by the auctioneer that the buyer was not allowed to bid against them.

It is worth noting that despite the buyer and auctioneers best efforts to communicate otherwise,

suppliers persisted in their beliefs that the buyer was using the open bid format opportunistically

against them. While suppliers may never have the opportunity to verify their suspicion, their

statements clearly reflect their negative attribution process and negative ascriptions about the

buyers character.

25
 Examination of P2. The second proposition considers differences in opportunism

suspicions among new and incumbent suppliers. The pretest mean of new suppliers is 2.36

(sd=1.30) while their posttest mean is 4.19 (sd=1.38); a test of paired comparisons of the

differences in each respondents scores indicates that the mean change is significantly (t=3.87,

=.00) non-zero. For incumbents, their pretest mean is 2.61 (sd=1.03) while their posttest mean

is 3.10 (sd=1.03); the mean change in paired comparisons is significantly (t=3.05, =.00)

different from zero. These means are depicted in Figure 3. The ANCOVA indicates that the

overall effect between new and incumbent suppliers is not significant (F1,9=2.19, ns) and the

differences among product categories is also not significant (F9,56=2.60, ns). Hence, while we do

observe an increase in opportunism suspicions, this increase does not differ for new or

incumbent suppliers.

Examination of P3. The third proposition considers the suppliers willingness to make

idiosyncratic investments across auction types. The means for this variable across auction types

is plotted in Figure 4. In the sealed bid auctions, the pretest mean of the suppliers willingness to

make investments is 4.13 (sd=1.67) and the posttest mean is 4.86 (sd=1.23); a test of paired

comparisons across respondents indicates that the mean difference is significantly different

(t=4.46, =.00) from zero. In the open bid auctions, the pretest mean is 4.89 (sd=1.34) and the

posttest mean is 5.32 (sd=.90); this mean difference is also significantly different (t=3.14, =.00)

from zero. The ANCOVA indicates that the treatment effect of auction type is not significant

(F1,4 = 1.95, ns), suggesting that the mean increase does not differ across auction type. There are

also no significant (F4,61 = .03, =.05) differences in means across the product categories.

Collectively, this suggests that although suppliers willingness to make idiosyncratic investments

increases overall, there is no significant difference in this increase across auction types.

26
 Why does willingness to make investments increase? Posttest interviews provide some

speculative answers. In the sealed-bid auctions, suppliers viewed the process as an improvement

over the manual processes of the past. They interpreted the electronic bidding process as a signal

that the buyer was informed about recent technological developments and actively contemplating

how these advances could be used to improve the efficiency and productivity of their exchange

with suppliers. This might also reflect a mutual orientation, in that it could potentially improve

the returns to both exchange parties. A mutual orientation on the part of the buyer increases the

suppliers willingness to make dedicated investments toward the buyer, because it provides an

assurance that the supplier would receive a fair return from such investments (Heide 1994). This

may explain the increase in willingness to make investments among suppliers in the sealed-bid

condition.

In the open-bid auctions, suppliers also increase their willingness to make idiosyncratic

investments, but for very different reasons; their statements could be classified under three

themes. The first theme is that they are more willing to make investments because the open-bid

format reveals new information about their competitors that had never before been revealed. As

the prices dropped, suppliers realize that their competitors may have cost advantages that are

enabling them to sustain lower prices and offer price concessions. Hence, investments might

enable a supplier to reach the scale efficiencies necessary to match competitive price levels. This

reasoning is consistent with the theoretical literature on investments in interorganizational

relationships.

The second reason is that dedicated investments signal a credible commitment on the part

of the supplier, signaling a desire to remain in the buyers supply base in the long run (cf.,

Anderson & Weitz 1992). The third theme that emerged is that suppliers view idiosyncratic

27
investments as a means by which they can create an imperfect market with the buyer, where

auctions are no longer a meaningful mechanism for negotiation. Mastens (1988) remarks are

pertinent:

Once the die is cast and physical or human capital has been specially designed or located for a particular
use or user, only imperfect market alternatives exist and both the buyer and seller are effectively locked
into a bilateral monopoly relationship within the bounds set by those imperfect alternatives. -- p. 186

Hence, when non-fungible, dedicated investments exist, pure pricing mechanisms such as

auctions are inappropriate for negotiating contracts because such investments have no value

outside of the specific buyer-supplier relationship. If investments are nonspecialized, the

exchange is best regulated by the buyers ability to turn to alternative suppliers to regulate price.

In this manner, suppliers view idiosyncratic investments as a means by which they alter the terms

of the exchange, maintain a voice in how the negotiations should be executed between the

parties, and escape the possibility of having to participate in auctions on a regular basis into the

future.6

Collectively, these results indicate the surprising result that the buyers use of reverse

auctions has the overall effect of increasing the suppliers willingness to make dedicated

investments toward the buyer. However, the motivation behind this overall effect may be

significantly different across sealed or open bid auctions. In both cases, the supplier is signaling

a willingness to work with the buyer in the long run to develop mutually beneficial outcomes.

This result is an important opportunity that should be recognized and managed by the buyer.

Examination of P4. The fourth proposition considers differences in willingness to make

idiosyncratic investments across new and incumbent suppliers. The pretest mean of new

suppliers is 5.18 (sd=1.18) and their posttest mean is 5.26 (sd=.95); paired comparisons of the

6
It was not atypical for buyers to receive calls from suppliers prior to an open bid auction. In these calls, suppliers
would express concern over the bid format and inquire whether the buyer anticipated using such auctions on a
regular basis.

28
differences in each respondents scores indicate that the mean change is significantly (t=2.24,

=.03) non-zero. For incumbent suppliers, the pretest mean is 4.03 (sd=1.64) and their posttest

mean is 4.96 (sd=1.18); the mean change in paired comparisons of these scores is significant

(t=5.18, =.00). The means for both new and incumbent suppliers are plotted in Figure 4. The

ANCOVA indicates that the treatment effect of auction type is not significant (F1,9 = 1.16, ns)

and the differences across product categories is also not significant (F9,56 = 1.19, ns). These

results indicate that although suppliers willingness to make idiosyncratic investments increase

overall, the increase does not differ significantly across supplier types.

Examination of P5. The fifth proposition considers the difference in cost savings across

open and sealed auctions. The unit of analysis for testing this proposition is the lowest bid of

each lot, which reflects the percentage cost savings over historical cost. The cost savings of each

lot is then averaged with the savings of the other lots within the same auction type to produce a

mean savings for the auction type. Hence, 21 lots produced varying cost savings percentages in

the open bid auctions and these are averaged together to produce the average cost savings in the

open bid auctions. Since this information is extremely sensitive, we are prohibited from

revealing the absolute magnitude. However, we reveal the relative magnitude, by indexing the

average savings of the two auction types to 100. The sealed bid auction savings can then be

reflected as 79, and the open bid auction savings reflected as 121. The ANCOVA indicates a

non-significant treatment effect (F1,4=1.54, ns) and significant (F4,101=4.94, =.00) across

product categories. Collectively, this indicates that although the savings across auction types

does not differ, there is significant variation across product categories.

We also examine the differences in savings offered by new and incumbent suppliers. In

this case, the unit of analysis is the individual suppliers bid. We average the percentage cost

29
savings offered by new suppliers and the percentage offered by incumbent suppliers; they differ

by less than one percentage point. The ANCOVA indicates a non-significant treatment effect

(F1,5=.53, ns) and significant product effect (F5,101=5.75, p<.001). These results indicate that

differences in savings are due to differences across product categories and do not vary

systematically across auction types.

DISCUSSION

This research considers the impact of online, reverse auctions on buyer-supplier

exchanges. The results of a quasi-experiment indicate that although these auctions can yield

cost-savings, the savings are category specific and not systematically related to an open or sealed

bid format. Online, reverse auctions also increase both new and incumbent suppliers beliefs that

the buyer would act opportunistically toward the supplier, particularly when open bid auctions

are used. Paradoxically, the suppliers response to online auctions is to increase its willingness

to make dedicated investments toward the buyer; this is true of both new and incumbent

suppliers regardless of the auction type. Together, these results indicate that reverse auctions can

have complex, relational effects on the supply base in direct procurement activities.

THE SUPPLIERS OPPORTUNISM SUSPICIONS

It is clear from the results that suppliers suspicions of opportunism are heightened after

an auction event. The increase in suspicion is greater for suppliers who participate in open-bid

auctions than in sealed-bid auctions. Suppliers view the open-bid process as exploitative and

unfair, core characteristics of opportunistic behavior. After the event, suppliers voiced their

resolution to avoid participation in such events and underscored their negative view of the

process:

In the future, we would never play this game again. Well play it, but what will happen is well be even
more adamant as far as to what our prices are. It wasnt a very professional way to handle the business.
-- Supplier

30
 The suppliers inference of opportunistic behavior on the part of the buyer is critical

because it will affect the suppliers view of exchange governance. In the future, they may

demand more explicit contractual assurances or contingency agreements in order to safeguard

their returns. They may become more cautious with the buyer, holding back from the

relationship, not wanting to risk being the victim of further opportunism. In order to maintain

the lower pricing scheme, they may be forced to reduce quality, value-added services, or overall

responsiveness to the buyer. These non-tangible aspects might also be withdrawn as an act of

retaliation against the buyer. Hence, the suppliers suspicion of opportunism may motivate it to

respond in kind in a tit-for-tat fashion (Axelrod 1984). In this way, inferences of opportunism

behavior might send the exchange on a downward trajectory, if they are not addressed and

remedied.

Consider the telling example of General Motors (GM) and Fisher Body, as recounted by

Klein (1988) and Klein, Crawford, and Alchian (1978). They examine the circumstances leading

General Motors (GM) to suspect that its sole supplier of car bodies, Fisher Body (FB), was

taking advantage of small-numbers bargaining to inflate prices. FB held GM-specific assets that

made it the sole supplier. FB assured its customer that its prices were fair reflections of its cost,

as per contract. General Motors believed otherwise. Suspicion of opportunism created an

acrimonious relationship. It was resolved by vertical integration. As Fisher was an independent

firm, GM had to acquire its supplier before it could examine operations and recordsonly to

learn that there had been no opportunism. Thus, suspicions of opportunism can have a poisoning

effect on relationships if left unchecked and unaddressed. The results of this study indicate that

the seeds of suspicion are put in place and flourish in the context of an open-bid, reverse auction.

31
 The results also indicate that opportunism suspicions are heightened for both new and

incumbent suppliers. It may be that the auctions signal the buyers price orientation over the

creation of value. Over 50% of the suppliers in our post-event interviews saw the inability to

express intangible product attributes and rich information as a disadvantage to electronic bidding

mechanisms. A price orientation also precludes the possibility of a relational orientation in

which the buyer and supplier strive for the creation of joint value; instead it fosters an

adversarial, competitive approach to sharing the pie, with each party focused on obtaining a

larger share. Hence, the use of online, reverse auctions can be antithetical to the development of

successful, long-term business relationships.

THE SUPPLIERS WILLINGNESS TO MAKE IDIOSYNCRATIC INVESTMENTS

One surprising result from this research is the increased willingness of the supplier to

make idiosyncratic investments toward the buyer; this holds true for both new and incumbent

suppliers regardless of whether the auction is open or sealed bid. This is a surprising result that

runs counter to what TCE would predict. Theory would suggest that an auction would heighten

the risk of making idiosyncratic investments, the empirical results suggest the opposite,

indicating that the auction process motivates suppliers to make idiosyncratic investments.

Subsequent interviews with suppliers provide some tentative explanations, although

future research is necessary to investigate these explanations more fully. In sealed bid auctions,

suppliers appear to favor the format over the manual approach, as it offers efficiencies in the

communication and negotiation process. In open bid auctions, suppliers view the investments as

a means by which they can: (i) reach competitive pricing levels and provide a value-added

product offering, (ii) gain bargaining leverage by returning to manual negotiations, and (iii)

signal their commitment to the buyer. These suppliers expect that the buyer would see the signal

32
and value their productive capability enough to award the business to them. In this way,

idiosyncratic investments can build the relationship between a buyer and supplier, expand the pie

of benefits between them, and stabilize their joint returns into the future. It is clear from their

remarks that the suppliers desire to maintain a viable position in the buyers supply base in the

long run, and they believe that such investments would enable this goal.

THE BUYERS COST SAVINGS

Another key result of this research is the finding that cost savings do not systematically

differ across auction type. Instead, the creation of cost savings in direct expenditures goes

beyond the choice to use an open or sealed bid auction. This suggests that additional work is

necessary to understand the circumstances under which cost savings are created. Since this

research only involved the use of six auctions it was impossible to investigate more fully how

differences in the number of bidders, lots, size of the purchase contract, or other characteristics

of these auctions might have been systematically related to the level of savings generated in each

event. The implication is that the use of online reverse auctions in direct sourcing activities may

be a complex decision, the success of which depends on a variety of conditions yet to be

identified and understood.

Collectively, the results paint an intriguing picture of supplier reactions and financial

implications of online reverse auctions in the procurement of direct materials and expenditures.

The achievement of cost savings in these auctions can be a complex proposition. And supplier

attitudes and strategic propensities are also mixed. On one hand, both new and incumbent

suppliers view the buyer as being increasingly opportunistic and these beliefs are heightened in

open bid auctions. Despite this, both new and incumbent suppliers are willing to increase their

dedicated investments toward the buyer. Perhaps this is a rational strategy for suppliers. They

33
are making both short-term and long-term choices; a short-term choice to participate and drop

price in order to stay in the game, and a long-term choice to make the investments necessary to

insure their presence in the supply base for the long run.

LIMITATIONS

This research has some limitations. It is very specific in its scope, considering only two

types of one-sided, reverse auctions in the sourcing of direct materials. The observed effects

may not generalize to alternative reverse auction formats or the procurement of indirect

materials. It is also not clear whether the observed effects will be long-lived, since

measurements were taken after only one auction event and not after repeated events. To the

extent that we witness any noticeable changes at all in supplier attitudes and perceptions is

remarkable, given that these constructs are typically quite stable over time. This means that the

auction experience had a fairly significant impact on suppliers in the short-term. However, we

are limited in our ability to determine how and if this effect would change as the supplier

experiences more auctions over time.

Since this was a field experiment, we had limited discretion as to its design and level of

control. For example, we would have liked to have conducted both sealed and open bid auctions

within the same product category, as this would have enhanced comparability across bid formats.

However, the firm was not able to accommodate this aspect. Another shortcoming of conducting

a field experiment is that it is not a pure test of auction theory. We are not able to replicate the

conditions of the theoretical literature or know for sure whether the participants hold common or

private values, the way that we would in a laboratory experiment. On the other hand, this

research has the advantage over laboratory experiments in that it involved experienced

34
professionals with larger, real sums of money at stake. These characteristics alone may result in

fundamentally different behavior than might be observed in a laboratory.

IMPLICATIONS FOR MANAGEMENT

One disturbing result is the finding that open bid formats will heighten both new and

incumbent supplier suspicions of opportunism. If these suspicions stabilize in the long-term,

they may have a very detrimental effect on the relationship. When a supplier believes that the

buyer is acting opportunistically, there is decreasing motivation to make the exchange successful

through information sharing or joint collaboration to develop mutual benefits. If the supplier

believes that the buyer is being opportunistic, it is less likely to formulate constructive responses

to problems in the relationship and is more likely to have frequent problems over time because it

may feel that the effort, time, and energy required to solve such problems would not have a long-

term payoff. Suspicions of opportunism may thus cause the exchange relationship to take a

dysfunctional turn. Hence, auctions should not be relied upon as a dominant form of negotiation

in the sourcing of direct materials, since repeated use may increase opportunism suspicions and

lead to a long-term, stable attribution that could have an undermining effect on the exchange

relationship.

Instead of relying on auctions to deliver long-term cost savings, the firm should think

more strategically about the use of auctions. The results from this research indicates that

auctions heighten suppliers willingness to make the investments necessary to become more cost

competitive and remain in the supply base in the long run. These investments play a key role in

long-term sourcing strategies, as they promote relational stability, enable scale efficiencies that

reduce costs, and are a means by which buyers and suppliers can jointly create sustainable

competitive advantages and expand the pie of mutual benefits.

35
 One implication of the results of this research is to use auctions as an initial step in the

development of a long-term strategic partnership, this would (i) capitalize on the suppliers

willingness to make the necessary investments, (ii) provide the buyer with an assurance that it is

working with a supplier with competitive pricing, and (iii) may mitigate the growth of

opportunism suspicions in the long run. This means that auctions may be useful as a screening

device to determine market pricing, but should be followed by long-term, sourcing arrangements

that are responsive to the attitudes and outlooks that suppliers develop during the course of the

auction process.

Another key implication is that the supply base may not be able to provide constant price

reductions over the long-term. Over time, the rate of price reductions should stabilize or be

reduced. As prices lower, suppliers may have to exit the industry because of their inability to

compete or they may consolidate in order to reach the scale economies to support lower prices.

This reduces the number of alternative suppliers for the buyer and shifts power to suppliers.

DIRECTIONS FOR FUTURE RESEARCH

This research has demonstrated the impact of online, reverse auctions on the buyer-

supplier relationship, particularly the suppliers opportunism suspicions and willingness to make

dedicated investments toward the buyer. Future research might consider what types of auctions

would preserve the suppliers willingness to make idiosyncratic investments while reducing its

belief that the buyer is acting opportunistically. For example, it may be that auction formats that

reveal less information, such as those that reveal only the lowest market bid, might have very

different effects than what is observed in this research.

More work is also needed that gives insight into the circumstances that create cost

savings. Are there specific characteristics of the supplier, conditions in the supply base or

36
aspects of the buyers sourcing strategy that yields significant savings? What role does the

number of bidders, number of lots, or size of the purchase contract play in motivating how

suppliers bid in various type of auctions? These questions should be considered across many

more auction events than were studied here.

The results of this study also raise the question of how the use of these auctions affect

supplier behavior over time. Do buyers observe a reduction in quality and service over time?

What other effects do they have on supplier motivation such as commitment, trust, and

expectations of continuity? Experimental evidence from common value auctions suggests that

market learning may occur as bankruptcies drive out the aggressive bidders and more

aggressive bidders earn lower than average profits. Garvin and Kagel (1994) observe that, over

time, bidders begin to self-select out of future auctions. They also respond to repeated losses by

bidding less. Whether this result generalizes to the marketplace is an open question.

Finally, this research is the first field experiment in the marketing literature on

interorganizational relations. Although such experiments are pervasive in other areas of

marketing (e.g., advertising), interorganizational researchers have made little use of them. We

view the emergence of internet technologies as an enormous opportunity for interorganizational

researchers to be more visible to the marketplace, providing guidance and insight to the

questions that firms are struggling with. Their search for solutions represents a prime

opportunity for researchers to find and test unique predictions, conduct longitudinal tests and

experiments that will better enhance our understanding of this critical aspect of marketing

strategy.

37
 FIGURE 1
OPEN BID AUCTION

38
 FIGURE 2
QUASI-EXPERIMENTAL DESIGN

================================
O1 X O2
-----------------------------------------------

O1

O represents measurements
X represents treatment activities

The treatment group is represented above the

dashed line while the control group is below.

39
 FIGURE 3
OPPORTUNISM SUSPICIONS

Opportunism Suspicions Across Auction Type

Very 7
Likely
6

5
4.29 Sealed Bid
4
Open Bid
3 2.84
2.64
2.38
2

Very 1
Unlikely Pre Post

Note: the circled effects are significantly different at =.05

Opportunism Suspicions Across Supplier Type

Very
7
Willing
6
5.32
5 4.89 4.86
4.13 Sealed Bid
4
Open Bid
3

Very 1
Unwilling Pre Post

40
 FIGURE 4
WILLINGNESS TO MAKE IDIOSYNCRATIC INVESTMENTS

Willingness to Make Investments by Auction Type

Very
7
Likely
6

5
4.19 Current
4
New
3 3.1
2.61
2.36
2
Very
1
Unlikely
Pre Post

Willingness to Make Investments by Supplier Type

Very
7
Willing
6
5.18 5.26
5 4.96
Current
4 4.03
New
3

Very 1
Unwilling Pre Post

41
 TABLE 1
OVERVIEW OF AUCTION EVENTS

Auction Product # Bidders # Lots

Sealed Transportation 72 81
Non-production
services 8 2
Semiconductors 7 3
Open Plastics 12 10
Electrical parts 35 5
Metal parts 20 6

Totals 154 105

42
 APPENDIX 1
SCALE ITEMS

is Cronbachs Coefficient Alpha

The Suppliers Suspicions of Opportunism (=.79) Mean=2.94 sd=1.40, min=1 max=7

How likely is it that [the buyer firm] would do the following:
Make false accusations.
Provide false information.
Be unwilling to accept responsibility.
Expect your firm to pay for more than their fair share of the costs to correct a problem.
1=very unlikely; 7=very likely

The Suppliers Willingness to Make Idiosyncratic Investments (=.87) Mean=4.50 sd=1.68, min=1 max=7
In working with [the buyer firm], your firm may have opportunity to make investments in time, energy and/or
money specifically to accommodate them. These investments would be lost if your firm switched to another
customer.

Just for [the buyer firm], we would be willing to provide dedicated

Training for buyers
Production procedures
Capital equipment and tools
Plant capacity
1=strongly disagree, 7=strongly agree

The correlation between the constructs above is .12 (p<.17)

Willingness to Collaborate (=.81) Mean=5.08 sd=1.48, min=1 max=7

How willing is your firm to do the following for the buyer? (1=very unwilling; 7=very willing)
Participate in product design efforts
Work together to exploit unique opportunities
Work on joint projects tailored to their needs
Look for synergistic ways of doing business

Satisfaction with the Relationship (=.87) Mean=4.40 sd=1.46, min=1 max=7

Our relationship with them has more than fulfilled our expectations.
We are satisfied with the outcomes of our relationship.
Our relationship with them has been a successful one.
1=strongly disagree, 7=strongly agree; them refers to the specific buyer.

Suppliers Perceived Dependence on the Buyer (=.90) Mean=3.34 sd=1.73, min=1 max=7
If our relationship were discontinued with them, we would have difficulty making up sales volume.
It would be difficult for us to replace them.
We are quite dependent on them.
1=strongly disagree, 7=strongly agree; them refers to the specific buyer.

43
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