I have worked in the automotive aftermarket parts industry for
thirteen years and have witnessed many changes within the industry. The most
recent change took place in October 2013, when State Farm Insurance Company
introduced an online parts ordering system called PartsTrader. The system is designed
to force auto body repair shops to purchase parts from suppliers in an auction
type environment. The auction is set up as a first-price, sealed-bid auction where
each supplier submits a bid at the price they are willing to supply the parts
to the repair shop for. The winner of the bid agrees to supply the parts to
the repair shop for the amount they bid.
This auction style purchasing allows State Farm to reduce their cost on
the parts supplied for insurance claims.
The question arises, does the economic theory of auctions we
read about in our text book actually work in the real world? In the case of
PartsTrader the answer is yes. For State Farm it is allowing them to lower their
costs on insurance claims. As a supplier in the auction system, our optimal
bidding strategy has been to bid less than our perceived value for the
products. This is consistent with the recommendations for a first-price, sealed
bid auction. Following this strategy has allowed us to win bids we otherwise
would not have won. However, because our marginal costs are higher compared to
other suppliers in the market, we often lose sales we would have earned outside of the auction. For a supplier, who has a low marginal cost, the auction
system works to their advantage because they can bid lower than other
suppliers. Bidding low and maintaining low marginal costs allows a supplier to win jobs they otherwise would not have been able to outside of the auction system.
Although State Farm is the only insurance company to utilize an auction based ordering system, it is likely that others insurance companies, due to the success of PartsTrader, will make the switch to auction based ordering systems.
3 comments:
Jim Craig: 100/100 (I think a writing prof might take off for "... each supplier submits a bid at the price they are willing to supply the parts to the repair shop for.", but I think for our purposes it's acceptable).
I like the real life example that your firm attempts to underbid on first price sealed bid auctions. I kind of wonder why State Farm uses them: they're a big company with plenty of people who would understand the drawbacks. Perhaps it's a convenience.
I have no hard evidence to back this up, but I suspect that the theory of auctions is probably the single most financially important contribution of economics for society as a whole. I have heard estimates that billions of dollars have been saved by following theoretical suggestions for how to make auctions work more efficiently. This has come from government actions like managing cash flow through bond auctions to selling/leasing publicly held assets. Also, auction technology has been a huge hit in the internet commerce sector, where it's fairly common for firms to employ chief economists who often come out of an auction background (who knew? those specialists were barely employable 30 years ago when I was in graduate school).
One of the things I like about this blog is that I get to hear real life situations about the application of economics in industries that I am not working in (Thank you Dr. Tufte!). This also helps me to look at my industry for similar applications. I work for a SaaS company that provides investment portfolio accounting and analytics. When businesses are looking for a new provider they issue an RFP (Request for Proposal). Essentially, this is a statement telling the industry that they want bids on how much each provider would charge based on the assets and complexity of their portfolio. This is also similar to a first-price, sealed bid auction except the winner of the bid is not the highest price but the highest value as determined by cost and product offerings. Until today I never thought of this process as an auction.
LightningMcQueen: 50/50
Thank you for the compliment. I like doing this a lot too, but it's a lot of work, and difficult for me to assess how much is learned from it.
I like it too, because I get to hear about businesses I know little about. Your case is a good example.
Here's what I wonder. If you just realized that your firm is bidding in first-price sealed bid auctions, do you think there's people on the other end who don't realize that's what their RFP's are? And if they don't, does this mean there are possibilities for them to improve their performance with different auction mechanisms?
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