Applications of flexible pricing in business-to-business electronic commerce

IBM Systems Journal,  July, 2002  by M. Bichler,  J. Kalagnanam,  K. Katircioglu,  A.J. King,  R.D. Lawrence,  H.S. Lee,  G.Y. Lin,  Y. Lu

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Supply-chain partners can also use dynamic pricing to reduce excess inventory in the supply chain. Excess supply created as a result of over-prediction of demand can be reduced via coordinated actions (e.g., discounted prices and the use of special auctions with low reservation prices) across the supply-chain partners. Because demand and supply planning have inventory implications for all parties in the chain, pricing policies to eliminate unwanted inventories will have to be coordinated across all parties as well.

Similarly, during supply-chain execution, companies that can coordinate information with their supply chain partners will have significant advantages over the competitors that lack such coordination, particularly in advanced e-marketplace environments. As an example, consider a marketplace for computers that gives advanced configuration possibility to buyers. In such a marketplace, a manufacturer disconnected from its suppliers may lack competitive power, even if it is able to generate real-time ATP to quickly respond to buyer bids. If there is demand in excess of planned supply, companies that do not have real-time connectivity with their suppliers will not be able to respond to such revenue opportunities. On the other hand, a manufacturer that has real-time coordination capability with its suppliers can check its suppliers' ATP (price, quantity, delivery date), plan the desired configuration, project when it can deliver, calculate the total cost of all components and the cost of assembly, and finally generate an asking price "on the fly."

The following two sections contain examples of the methodologies discussed here. The next section describes an example of multidimensional procurement auctions, and the following section discusses several examples of flexible pricing on the sell side.

Price negotiations for procurement

Although there exist several alternatives for price negotiations, auctions have emerged as the most popular mechanism for implementing negotiations in the context of electronic commerce and are the focus of this section. Auctions achieve high rates of Pareto efficiency, (26) and exhibit rapid convergence to equilibrium, which is important in a business context. These features are very attractive in a procurement context where large companies are buying, both directly and indirectly, materials from suppliers that are dependent on them for a significant portion of their revenue. In such settings, the buyers institute private auctions as the price negotiation mechanism for procurement and require suppliers to participate in the process as part of the business relationship. Procurement auctions take the form of reverse auctions with a single buyer and a set of precertified suppliers negotiating within the context of a private exchange.

Decision support for procurement. The business process and essential functional requirements for auction-based price negotiations are illustrated in Figure 3. The procurement manager (buyer) initiates an auction by sending a request for quote (RFQ) to various select suppliers. The RFQ specifies the item(s) that the buyer intends to purchase, and the responses (or bids) to the RFQ provide an indication of the supplier's ability to satisfy this demand and at what cost. As discussed below, evaluation of these bids can require sophisticated analysis in order to determine the optimal bid, subject to certain business rules as constraints.