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, [email protected].

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 supplier’s 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 costsavings, 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

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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 supplier’s attitudes and strategic position vis-à-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 organization’s name to preserve confidentiality.

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We accomplish this via a quasi-experimental design conducted in the supply chain of a major industrial manufacturer. We consider how the firm’s use of an open or sealed-bid auction across a variety of product categories impact (i) financial performance (i.e., the buyer’s cost savings from the auction), (ii) supplier perceptions of the buyer (i.e., suspicions of opportunism), and (iii) the supplier’s 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 3050% of a firm’s 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 supplier’s performance in these areas creates a direct impact on the buyer’s 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

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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 we’ve 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,

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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

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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 supplier’s 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

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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 competitor’s 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 buyer’s 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 supplier’s lot bid, while a line connects the lowest bid at any point in time. The buyer’s 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 buyer’s 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

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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 buyer’s 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 party’s 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

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idiosyncratic investments. We also consider how cost savings may differ among open and sealed bid auctions and among new or current suppliers. THE SUPPLIER’S 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 selfinterest 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

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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 supplier’s suspicions that the buyer is acting opportunistically, since the supplier typically cannot verify the buyer’s opportunism. Understanding the supplier’s suspicion is critical, as it involves a negative ascription about the buyer’s 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 supplier’s 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

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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.

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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 supplier’s 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 buyer’s 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 buyer’s decision to use an electronic format would increase the incumbent supplier’s opportunism suspicions relative to the new supplier. P2: Opportunism suspicions are higher for current than new suppliers who participate in auctions.

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THE SUPPLIER’S 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 supplier’s 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 supplier’s 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 supplier’s incentive to make idiosyncratic

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investments into the relationship is reduced, as the payback from making idiosyncratic investments is unlikely to be realized over time. P3: The supplier’s 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 supplier’s willingness to make idiosyncratic investments is lower for current than new suppliers who participate in auctions.

THE BUYER’S 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

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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 bidder’s 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 buyer’s 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 supplier’s 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 supplier’s 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 supplier’s bid although the lowest

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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 Campbell’s (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

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

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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 firm’s specific relationship with the buyer and directed the suppliers to a university website that stated that the researchers were studying the

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buyer’s 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, vicepresidents, and even owners of the supply business who handled large customer accounts such as

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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.

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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 respondent’s 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 respondent’s 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 firm’s willingness to work with [the buyer firm],” “The degree to which your firm trusts [the buyer firm],” or “Your firm’s 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.

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Collectively, there is some confidence that the selected respondents were knowledgeable about their firm’s 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 supplier’s 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 supplier’s suspicion of opportunism of the buyer is measured in a four-item scale that reflects the buyer’s 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 one’s responsibility and shirking. A complete listing of the scale items is provided in Appendix 2. The supplier’s 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 aren’t engaged in opportunism most of the time. This is partly due to the fact that managers are well socialized

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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 supplier’s 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 supplier’s 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