An efficient reverse auction mechanism for limited supplier base Arun K. Ray * , Mamata Jenamani, Pratap K.J. Mohapatra Department of Industrial Engineering and Management, Indian Institute of Technology, Kharagpur, India article info Article history: Received 13 June 2008 Received in revised form 3 November 2009 Accepted 3 November 2009 Available online 10 November 2009 Keywords: Multi-attribute reverse auction Mechanism design Limited supplier base Repeated game Winner determination abstract Reverse auction degrades the buyer–supplier relationship and decreases the suppliers’ interest to partic- ipate in subsequent auctions. The effect is particularly severe in a limited supplier base. We propose a novel multi-attribute relationship-preserving reverse auction mechanism for a limited supplier base. The mechanism consists of two parts: first, evaluation of suppliers’ utility with an idea of intermittently awarding some business to each one of them as incentive and second, a penalty scheme integrated with winner determination model to deal with the untruthful behavior of the buyer and the suppliers. The mechanism enables healthy competition among the suppliers by retaining them in the supplier base. The simulation study interestingly shows that a buyer derives higher utility by using the proposed mech- anism as compared to the existing mechanism where no incentive is provided to the suppliers. Ó 2009 Elsevier B.V. All rights reserved. 1. Introduction Electronic reverse auctions are frequently used as a medium of organizational sourcing. Companies have been using the electronic reverse auction and other e-sourcing techniques to reduce the pro- curement cost and cycle time. As an instance, GE has achieved 5– 20% reduction in procurement cost using such techniques (Presutti 2003). Our discussion with the e-commerce manager of one of the leading automobile companies in India revealed that 20% of the company’s annual spend is attributed to reverse auction. This sig- nifies well, the potential use of electronic reverse auction by differ- ent organizations around the globe (Smeltzer and Carr 2003). However, business organizations have experienced a deteriorated buyer–supplier relationship due to repeated use of electronic re- verse auction (Daly and Nath 2005, Dani et al. 2005, Smeltzer and Carr 2003, Tenorio 1999). Empirical analysis made by researchers from field surveys have demonstrated that opportunis- tic behavior of the buyer and price based selection mechanism to- gether have significant effect on the buyer–supplier relationship (Amelinckx et al. 2008, Beall et al. 2003, Emilani and Stec 2002, Smart and Harrison 2003, Wagner and Schwab 2004). Techniques such as subsidies for investment, price negotiation after auction, and payment to losing bidders have been suggested for improving buyer–supplier relationship in such auctions (Daly and Nath 2005). These studies indicate that the payoff of the suppliers from the auction is positively correlated to their relationship with the buyer. Based on the interviews conducted with 41 purchasing profession- als who had used reverse auctions, Smeltzer and Carr (2003) re- ported that suppliers may leave the supplier base due to deteriorated relationship. This may lead to insufficient supplier participation. In this context, they have opined as follows: ‘‘... too few suppliers would respond to the reverse auction announcement so a competitive environment would not develop. In theory, only two competing firms (a duopoly) are required to conduct an auction. But economic game theory indi- cates that when only two competitors exist, they are not inclined to participate in either a reverse or a forward auction. Even though only two parties may well be involved in the final stages of bidding, at least four or five viable, competitive bid- ders are generally required to begin an auction.” (Smeltzer and Carr, 2003, p. 484). Another phenomenon occurring in the industry is the supplier base rationalization (Sarkar and Mohapatra 2006). Over the years, it has been observed that organizations are not interested in a large supplier base for sourcing products and services. The idea behind the supplier base rationalization is to decrease the supplier devel- opment cost and to maintain close and workable relationship with a limited number of suppliers by awarding them a substantial amount of business (Parker and Hartley 1997). This leads to a lim- ited supplier base for the business organizations for the procure- ment of needed products and services. Therefore, it may be difficult to use reverse auction in such a scenario. It is important to retain the suppliers in a limited supplier base for two reasons: firstly, to have competition among suppliers and secondly, to have alternative supply sources at the time of exigency. The significance of the limited supplier base in reverse auction has been empha- sized in the literature (Min and Galle 1999, Olorunniwo and Hartfield 2001). Min and Galle (1999) further point out that some 1567-4223/$ - see front matter Ó 2009 Elsevier B.V. All rights reserved. doi:10.1016/j.elerap.2009.11.002 * Corresponding author. Tel.: +91 3222 282271; fax: +91 3222 282272. E-mail address: akray@iem.iitkgp.ernet.in (A.K. Ray). Electronic Commerce Research and Applications 10 (2011) 170–182 Contents lists available at ScienceDirect Electronic Commerce Research and Applications journal homepage: www.elsevier.com/locate/ecra