4. Reverse Auctions
"Reverse auction bidding" or "reverse auctions" is the practice of using the Internet to solicit bids from contractors for a specific project or service. Bids are normally posted anonymously so other potential bidders may view them before making a bid. The entity soliciting the bids accepts the lowest bid made over a specified period of time.
Many utilities and the LMP filed comments on reverse auction bidding. Each utility opposes any rules regulating reverse auctions. The LMP support it. The LMP submitted testimony in support of regulation of reverse auctions, to which several utilities responded. SDG&E, SoCalGas, and PG&E state that they occasionally use reverse auctions. SBC reported developing a pilot program to implement reverse auctions. No other party reported using the practice of reverse auctions although some suggested they may use the procedure in the future.
The LMP oppose the use of reverse auctions by California utilities. They argue that reverse auctions actually increase costs rather than reducing them, largely because bidders start high and only reduce their bids in response to a lower one. In contrast, bidders start with their lowest bid in a more traditional sealed bidding process. The LMP also believe reverse auctions promote adversarial relationship among participants because of the pressure to bid low, sometimes without any cushion for profit or contingencies.
The LMP believe that reverse auctions compromise quality workmanship because of the emphasis on price and because reverse auctions do not typically pre-qualify bidders to screen out poor-quality contractors. The process also puts pressure on bidders to make hurried bids and cut corners by using cheaper materials that may be of an inferior quality. Finally, LMP believe that reverse auctions compromise safety as bidders cut costs by reducing project supervision or the amount of labor to finish a project. LMP's pleading includes copies of several studies and articles that Unions believe affirm their concerns.
Most utilities that filed comments argued that the Commission has before it no evidence that utility practices have or would compromise consumer interests, safety or other public concerns. Some state that existing laws and regulations directly and adequately address safety, service quality and system reliability. Most assert that the Commission has before it no evidence to suggest that reverse auctions have created any problems in California.
SCE states that its contracting procedures have resulted in construction work that meets its expectations or exceeds them. SCE states that it pursues its legal remedies in the instances where problems arise. SCE believes adopting more elaborate contracting procedures would add time and expense to its construction projects without offsetting benefits. SDG&E/SoCalGas state that their reverse auction procedures accommodate rapidly changing market conditions. PG&E observes that the studies to which the LMP refer in making their case suggest that reverse auctions have saved consumers substantial sums.
Cox adds that government contracting rules are in place to assure the public gets good value from a government contract. In contrast, public utilities have an incentive that government does not automatically have to conduct low cost operational practices and provide reliable service.
SBC and Verizon argue that they are subject to the principles of the New Regulatory Framework (NRF), which provides incentives for each to conduct its business in the most cost-effective manner. They believe that reverse auctions are neither unlawful nor unethical but that to require them would compromise NRF principles and increase utility costs. SBC and PG&E suggest that bid shopping may be conducted with a variety of safeguards to promote safety and high quality work.
Wild Goose and Lodi Storage comment that while the Commission may feel compelled to regulate the construction contracting procedures of companies offering monopoly services, the Commission need not concern itself with regulating companies that do not enjoy the benefits of government-sanctioned monopoly power. Sprint similarly argues that competitive companies pursue high quality projects at the least cost because they assume the risk for their operations.
San Gabriel Valley Water Company observes that Commission-regulated water companies are small and have contracting procedures tailored to their individual needs and should not be subject to regulations of large utilities with expansive territories.
Discussion
In considering whether to adopt a rule prohibiting the use of reverse auctions, we are aware of the claims that doing so would establish a form of micromanaging utility operations, that the use of the Internet for real-time auctions may promote more competitive bidding processes, and that such prohibitions may lead to costlier utility projects. These arguments are not trivial; we do not wish to micromanage utility operations, we support more competitive utility operations and we endeavor to support lower project costs to keep utility rates low. We agree with the utilities that both reverse auctions and sealed bids may be conducted in ways that promote bidding by qualified bidders and a diverse population of bidders. We are therefore not concerned at this time that one or the other practice is more likely to reduce the number of responsive bids received or compromise project quality.
On the other hand, we are convinced that reverse auctions may not satisfy the utilities' and our own objectives to keep costs down while promoting quality, safety and fair construction practices. On the issue of costs, reverse auctions may not consistently result in lower prices than sealed bids. Reverse auctions permit bidders to start the bidding high in order to maximize the opportunity for profits. They need only reduce their bids in response to the bids of others. The potential for a utility accepting an artificially high bid in a reverse auction would be especially pronounced where a market for labor, services or supplies is not highly competitive. The prospect of such a circumstance would be higher for construction projects than, for example, in a solicitation for building maintenance. We would also expect limited price competition where a construction project has very specialized elements, for example, using new techniques or technologies. Sealed bid procedures, in contrast, provide bidders a single opportunity to present their best estimate of a project's costs and are therefore less likely to lead to the type of gaming that is possible with reverse auctions. Because bidders do not know the estimates of other bidders, they are more likely to provide their own best estimates of actual costs plus a reasonable profit.
Reverse auctions may also motivate bidders to oversimplify the elements of a complex project and to emphasize price at the expense of other project criteria, such as long term integrity, safety or quality. Construction projects typically have many complex elements, and contracts for their construction cannot be judged on the basis of price alone.
For all of these reasons, we herein prohibit the use of reverse auctions for utility construction contracts. This prohibition shall apply only to those utilities that are respondents to this proceeding. We also direct each respondent utility to submit a report on July 1, 2006 describing how this prohibition has affected their construction contracting procedures, costs and population of bidders. If any party proposes to change the rule after the receipt of these reports, it should file a petition to modify this order. The Commission may reconsider the rule at that time.
