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One of the more intriguing concepts to emerge from the Internet bubble at the turn of the millennium and become accepted practice is the reverse auction. Prevalent outside of healthcare, reverse auctions have managed to generate growing interest among healthcare providers and suppliers.

Sunnyvale, CA-based Ariba Inc. represents one of the key players in the reverse auction and strategic sourcing software market, making inroads into the healthcare industry. West Penn Allegheny Health System, Pittsburgh, PA, is one of the early adopters of Ariba’s technology and capabilities in the healthcare market, disrupting its corporate contracting status quo and generating significant savings for the organization.

To help Healthcare Purchasing News readers better understand some of the basics and nuances of reverse auctions and clear up any foggy notions, Senior Editor Rick Dana Barlow posed a series of fundamental questions to Dave Zimba, vice president, corporate contracting at West Penn Allegheny, and Christopher Merchant, director, strategic sourcing, at Ariba, asking them for strategies and tips on getting started and achieving success.

The reverse auction is an ‘interactive’ process related to the price component. The reverse auction simplifies this process within a defined period of time rather than complicating and elongating it as it is in the traditional process. The reverse auction provides immediate feedback to sellers on the pricing component and enables them to provide a continuous stream of pricing offers as appropriate. In the end, the market establishes the market price for the defined set of requirements, independent of what they may or may not traditionally offer.

Ultimately, this new process changes the use of price as a decision-making device due to apple-to-orange comparisons of various seller offers to price being used as a discriminator among sellers that meet or exceed a set of clearly articulated requirements of service, quality and value.

The healthcare provider industry should embrace this process because it enables a far superior and more collaborative approach among sellers and buyers. It provides critical feedback to buyers as to the market’s acceptance of their requirements. It provides critical competitive feedback to sellers on the relative offer. It enables the use of four critical components of value: service, quality, value-adds, and price, to be equally considered. It allows the industry to define its requirements, facilitating the market’s ability to achieve them and enables the industry to buy only what it wants, not what it is offered.

MERCHANT: In the U.S., healthcare facilities have traditionally lagged other industries in adopting spend management best practices. Whereas most industries’ primary motivation is to maximize profit, healthcare facilities strive to improve patient outcomes. Profitability is a secondary or tertiary objective. And this has had some far-reaching and negative effects on healthcare facilities’ ability to successfully manage their sources of supply.

There are three primary benefits that healthcare facilities can drive through reverse auctions. The first is a favorable shift in the buyer/seller dynamic. Currently, most healthcare facilities live at the mercy of their suppliers. Suppliers create the overall supply packages of product and service and define terms to the buyers. This leads to many negative outcomes in the healthcare market, with buyers not exactly sure what they are going to get and how they are going to get it. By implementing an auction program, hospital-based buyers can inject significant rigor into the sourcing process, which will require sellers to act on buyers’ terms.

The second benefit is an increase in service levels, as best-in-class auction programs clearly establish [service level agreements] that both define and enforce service requirements from all suppliers. And a third benefit is price compression. Plain and simple, open competition drives prices down. Healthcare facilities that implement auction programs typically achieve 20-25 percent savings in the products and services on which they focus. These direct cost savings can free up hospital resources to invest in other areas to improve overall patient care.

MERCHANT: Reverse auction technology has evolved such that any product or service area with two or more potential suppliers can be addressed through the auction process. However, some categories are easier to address than others. Healthcare facilities that are interested in beginning to develop an auction capability should consider a three-phased approach to addressing their spend:

Phase 1: Gain early wins by focusing on products that are true commodities, where the ultimate end users are relatively indifferent to the products chosen, and service requirements are relatively non-complex. Ariba’s healthcare customers have typically started to build their auction programs by focusing on categories like bed linens, sterile gloves, or general office supplies.

Phase 2: Drive greater interest in the program by focusing on products that have higher service requirements or required technical specifications, but still have relatively indifferent end users. In this phase, Ariba helps its customers significantly broaden their category focus to include things like arthroscopy and imaging equipment purchases, general IT hardware and contrast media.

Phase 3: After achieving significant results through the first two phases, healthcare organizations can then begin to focus on items that are more differentiated, have more elaborate service requirements, and whose end users have significant input to vendor selection. Typical categories that might be pursued in this phase include: orthopedic implants, custom stents, and the pharmaceutical portfolio.

Unfortunately, most healthcare facilities do not currently follow a rigorous strategic sourcing process. In contrast, vendors typically dictate terms to healthcare facilities, and end users often choose the vendor, before price and value have even been negotiated. Therefore, the biggest challenge for most healthcare facilities is not implementing a reverse auction tool, but changing their business process to embrace true strategic sourcing.

MERCHANT: Best-in-class reverse auction technology includes process-based functionality that enables healthcare organizations to design and implement step-by-step instructions for executing their sourcing processes. This advanced software and supporting services that accompany it can act as both a training tool for employees who are new to the process and technology, as well as a knowledge repository for future sourcing activity. For instance, a healthcare facility can establish a specific process and template for executing a reverse auction for hospital-specific MRO items. Then every time an MRO-based project is launched, the end user simply accesses the established template, which contains all of the relevant information.

In contrast, reverse auctions require rigor. Specifications must be exact and detailed so all supplier quotes are comparable. Vendors must be selected based on capabilities, not relationships with hospital members. And timelines must be clearly established and managed so that vendors are able to quote accurately and efficiently. Injecting this level of rigor into sourcing practices typically proves to be the most difficult aspect of executing a reverse auction program.

ZIMBA: Getting end-users to think about valid requirements. In the old process they did not have to think because they were presented with offers. Sellers that don’t or won’t participate in the process. Educating sellers and buyers on the process. Inertia. Fear of change.

MERCHANT: Ariba has consistently helped its healthcare customers identify an average of 23 percent savings across a broad range of categories. Since reverse auctions are not only about savings, the low bidder does not always win the business. Typically, Ariba’s customers have seen implemented real savings of 19-20 percent, which includes all costs of conducting the auction. There are also other soft benefits that healthcare facilities can expect to realize, such as reduced sourcing cycle time, increased sourcing process rigor and overall process fairness.

ZIMBA: I don’t know if there are any hidden costs above and beyond the traditional process. Actually I think it reduces some hidden costs such as travel, paper, binders, and meetings.

ZIMBA: Price is the wrong answer! It is not about price because lowest price does not always win. Best total value wins. Speed, requirement setting, customer satisfaction, seller collaboration, and the use of price as a discriminator are the right reasons.

ZIMBA: Pick a company that knows strategic sourcing. It’s not about the software, it’s about the process and the application of the software. When choosing the software, pick a company that can help with vendor support, event oversight, event independence, and event connectivity. Choose software that enables sourcing creativity for events other than reverse auctions including RFI, RFQ, RFP.

ZIMBA: If readiness or ability to switch are your concerns you should not do a reverse auction. While you can use a factor of these costs as a part of decision-making, you cannot continuously handicap non-incumbents. Otherwise, you will risk validity of the market and create seller concerns about your sincerity. If you have a market where all sellers equally meet or exceed your requirements for service, quality, and value adds you must in the vast majority of events award the price discriminator. The worst thing that can happen to the industry and to others that use this process is to have buyers run events and never switch.

So it becomes less a question of whether or not the value is there, and more a question of internal accounting to determine how that value gets allocated back to the correct budgets so that no individual department is made worse off by the reverse auction process. Given the savings that are typically on the table, Ariba’s customers often devise financial accounting mechanisms to make sure that all departments that incur costs due to the reverse auction process, also get budgetary relief by participating in the realization of the savings that are identified through the auction process.