Taking a test without first doing the homework usually has bad results. Bidding in an auction without preparation also usually has bad results.

More and more companies are being asked (or told) by their customers to participate in reverse auctions. The use of auctions upsets the many years of relationship-building that your sales force have invested in learning about your customers. Your sales personnel are thrust into new and completely unfamiliar arenas. And most importantly, your revenue, profit, market share, overhead support and prestige are all at risk.

In a reverse auction there is one buyer and many potential sellers (government contracts are typically sealed-bid reverse auctions). This contrasts with the more common standard (or forward) auction where there is one seller and many potential buyers.

A buyer contracts with an online auction site to conduct the reverse auction. The buyer sends an announcement to its list of prospective bidders about the impending auction while the auction site sends technical information about user ids, passwords, login and bidding procedures to the prospective bidders.

As a bidder, it is important to remember that the auction site was hired by the buyer and represents the buyer's interests. The information that the site provides is accurate, but incomplete. The site will tell you how to bid, but it will not tell you how to win profitably.

By breaking the auction process down into four steps it becomes more manageable:

• Pre-auction positioning
• Bid preparation
• Auction participation
• Post-auction positioning

Each of these steps has the potential to turn a marginal or unprofitable auction into a profitable auction.

In pre-auction positioning you set goals for the auction, determine whether to participate and how, study the legal and contractual issues, and perform a competitive assessment. Goal setting is the most important component. The obvious goal is to win the auction at a profitable price. However, that is not always the best goal. For example, you might choose as a goal:

• To come in second (or third) while keeping the price high,
• To come in second while driving the price down to unprofitable levels for the winner,
• To bid down to a certain price and stop, regardless of winning position and potential profitability,
• To keep the price high even if you would lose the auction at a profitable price,
• To abstain from participation in the auction.

In a recent auction one of the bidders was the incumbent and felt it had superior quality products and would be perceived by the buyer as a less risky supplier. So the incumbent bidder chose not to come in first, but instead to come in a close second. By doing this, it avoided a bidding war that would have driven the price down too low. Result: Within a week the buyer awarded them a multi-million-dollar contract at profitable prices.

In bid preparation you determine the lowest price for which you are willing to sell your product. To do this effectively you must be able to compute your true marginal cost and identify and value extra-auctions costs and benefits. You don't have to bid down to your bottom price, but you should know what it is. A key area to watch is the over or under allocation of overhead expenses.

In the analysis of extra-auction costs and benefits, you should examine areas where winning or losing can generate unexpected benefits or avoided costs. Some examples include:

• Winning or losing changes your volume discount, rebates and incentives with key suppliers,
• Losing requires laying off personnel with its associated termination costs,
• Winning opens a new account more inexpensively than hiring a sales representative,
• Losing an auction would incur significant public relations expenditure,
• Winning provides the opportunity to sell non-auction goods at excellent margins.

In a recent auction for a long-term maintenance and service agreement one of the bidders realized that the specifications omitted pricing for equipment replacement. The bidder decided that it could bid the maintenance with tight margins and more than make up the profit on the captive, sole source replacement equipment sales. It bid in the auction accordingly. Result: The bidder won the auction over several very large, multi-national competitors.

In auction participation you identify appropriate tactics to use during the auction based on the specific auction protocols and characteristics of the auction interface. Some of the questions you should ask include:

• Does the auction have a hard or soft close?
• Are multiple line items auctioned sequentially or simultaneously?
• Can you see the current low bid?
• Are you told of your current relative position?

The answers to these and other questions can significantly affect your choice of tactics during the auction.

In a recent auction with a hard close and position display, but not price display, one bidder realized that it took 40 seconds from the time a bid was entered until all bidders' screens were refreshed with the new bid. So that particular bidder placed its bids slowly until 45 seconds were left in the auction and then entered a jump bid. Result: It won the auction because none of the other bidders could find the new low bid before the auction ended.

In post-auction positioning you position yourself for the successful sale and prepare for negotiating the terms of the next auction. Many times the low bidder does not get the order, the buyer's specifications are flawed, or the terms and conditions of sale are open for negotiation. Each of these areas provides opportunity for gaining additional profit. You also work with the buyer to revise the structure and protocol of the buyer's next auction to be more favorable for you.

There is no substitute for "doing your homework" before the test. Good luck in your auctions. e

Auctus Development, a client of Leading Edge firm PKF Texas, specializes in consulting on auctions, reverse auctions and other applications of game theory. He can be reached at smaudlin@auctusdev.com. It may surprise you to learn that game theory has applications in almost every business process including contract negotiation, mergers and acquisitions, shareholder force-outs and division of joint and community assets.