COMBINATORIAL NEGOTI-AUCTION WITH

ADAPTIVE BIDDING FOR INVENTORY COST

MINIMIZATION
.

By
Avinash Tripathy (06IM3007)

Under the supervision of

Prof. Mamata Jenamani
INTRODUCTION
 Procurement is one of the major activities in the Manufacturing Resource
Planning (MRP II), which is closely coupled with inventory management.
 Any improvement in this area will have a direct impact on the
performance of the entire supply chain.
 Reverse auction mechanism has proved itself a successful procurement
method when there are several potential suppliers available.
 The large number of available suppliers and the price options helps in
securing the best procurement deal with the most cost-efficient suppliers.
INTRODUCTION
 Combinatorial auctions are pricing mechanisms in which a bundle
of different goods or services (items) is sold/bought in one auction.
 Combinatorial auctions are best suited for selling/buying items that
are complements or substitutes.
 When the items are substitutes, the bidder only wants one of the
items (not more).
 When items are complements, the value of the whole bundle is
larger than the sum of the values of its components separately.
 In reverse auctions, complementarities translate into economies of
scope in the sellers’ production process and hence result in lower
prices for combinatorial bid bundles.
 LITERATURE SURVEY
Combinatorial Choi and Han (2007); Na et al.(2005), Sven de Vries,Rakesh
auctions & Supply Vohray(2000); Chen,R., Roundy,R., Zhang,R., & Janakiraman,G.
Chain procurement (2005).

Multi-Attribute Teich et al. (2006); Biel & Wein (2003); A. Pekeč, M.

E-auctions, Negoti- Rothkopf(2003); Gallien, J.Wein,L.M.(2005); A.M. Kwasnica, et al.
auctions (2005) ;

Synergy of Murray & White(1983); Chernomaz & Dan Levin (2007);

production,
Economies of
scope.
Bidding Policies / Holte (2001);Regan et al. (2003); Mäuller et al.(2006).
Winner
Determination

Auction Inventory Ertogral & Wu (2000); Farahvash et al. (2008);

Models
LITERATURE SURVEY
 Ertogral and Wu (2000) introduce an optimization method that is
implemented for a multi-level, multi-item capacitated lot sizing
problem. They construct an auction-like mechanism to coordinate
production planning for multi-facility supply chain.
 Beil and Wein (2003) study the case when a single manufacturer
uses an open ascending, multi round, multi attribute reverse auction
for supplier selection.

Reverse auctions for cost minimization

LITERATURE SURVEY
 Teich et al. (1996) suggest that the auction should provide support not only
to the bid taker but the bidders. They propose a negotiation based
mechanism to provide decision support to the bidders.
o In a combinatorial reverse auction setting Pekeč & Rothkopf(2003)
propose a mechanism to suggest the right combinations to the loosing
bidders to increase their probability of winning.
o Kwasnica, et al. (2005) solve the above problem by modeling the situation
as a knapsack problem.

Decision support for the bidders

LITERATURE SURVEY
 In the multi unit combinatorial auctions Leskelä et al. (2007) design
a decision support systems for loosing bidders. They suggest a new
price to the bidder for activating his bid. They do not give any
suggestion on adjusting the quantity based in accordance with other
inactive bidders.
 Farahvash et al. (2008) propose winner determination model that
takes the inventory costs into consideration. There model is for a
multi unit single item auction.
 We extend the work of Farahvash et al. (2008) to a multi item
inventory scenario by integrating the winner determination problem
with the buyer’s inventory cost minimization problem. Through this
model, following Leskelä et al. (2007), we suggest right price and
quantity combination to the loosing bidders in a multi unit
combinatorial reverse auction setting.
COMPLEXITY OF WINNER
DETERMINATION PROBLEM IN
COMBINATORIAL AUCTION PROBLEM

• The Combinatorial reverse auction can be formulated as set covering

problem ( Hohner et al. 2003, Narahari and Dayama 2005) which is NP-
complete (Xia et al. 2004, Narahari and Dayama 2005) meaning that a
polynomial-time algorithm to find the optimal allocation is unlikely ever to
be found.

• Therefore, for large problems it can be solved by heuristic methods only.

PROBLEM DEFINITION
 In a typical case of Reverse auction we have the
following scenario.
 The need for Combinatorial Auctions

Buyer Item Quantity

requirements A 100 Reserved
B 70 Price
“P”
C 80

Supplier Bidder A B C Price

Bids Bidder 1 100 20 p1
Bidder 2 60 40 p2
Bidder 3 80 20 p3

In this case none of the bids satisfy the item demand

requirements individually. Whereas bid combinations
may satisfy the total buyer requirement.
The alternatives of the bid combinations.
Bidder A B C Price Trade-off
between profit
Bidder 1 100 20 p1 gained below
the reserved
Bidder 2 60 40 p2 price and extra
100 80 40 p1+p2 holding cost.
Excess inventory
10 units

Bidder A B C Price
Bidder 2 60 40 p2
Bidder 3 80 20 p3
80 80 40 p2+p3
Shortage of 20 Excess inventory
units 10 units

Bidder A B C Price
Bidder 1 100 20 p2
Bidder 2 60 40
Bidder 3 80 20 p3
Trade-off
180 100 40 p2+p3 between profit
gained below the
Excess inventory Excess inventory reserved price
80 units 30 units and extra
OBJECTIVE
Efficient Bid Allocation for the procurer:
 To provide the best combination of bids to the procurer
fulfilling his demand for multiple items.
 Minimizing the inventory cost of the procurer.

 Providing better bids to the procurer with the proceeding

of the auction rounds by new combinations of updated
bids.
Support for the Bidders:
 Providing decision support to the bidders to increase their
chance of winning.
 Exploring better options for bidders to win the bid with
maximum possible profit margin.
OBJECTIVE

To develop an alternate heuristic i.e. Genetic algorithm to solve the problem
in case of large number of bid bundle combinations and bidders.

 Exploring better options for bidders to win the bid with maximum possible
profit margin.

 To propose a new adaptive bidding strategy in multi-round combinatorial

auctions.
PROPOSED
METHODOLOGY
FLOW CHART
PROPOSED METHODOLOGY

 Accepting bids from the bidders.

 Winner determination.
 Generation of a list of active bids.
 Decision Support to the inactive bids.
 Estimation of the cost function of the bidders and
updating the cost as rounds of bids progresses.
 Inclusion of the inventory cost of the procurer into the
decision support.
 Price Support to the inactive bidders.
 Quantity support to the inactive bidders.
 Analysis of the various parameters involved.
PROPOSED METHODOLOGY

Terminology

Active Bids: Bids which have been preferred over other bids as being optimal.
These bids satisfy the demand and price requirements as laid by the procurer.

Inactive Bids: Bids which don’t satisfy the demand requirements. But with
suitable combinations as suggested by the (quantity, price) support with other
bids may satisfy the procurer’s requirements.

Excess Inventory Cost: The cost incurred by the procurer due to acceptance of a
bid bundle which can be procured at a lesser price due to complimentaries in
suppliers production costs but overshoots procurer’ s demand requirements.

Cost Estimate: The estimation of the cost function, total cost of the bidder from
his acceptance of rejection of a bid bundle suggestion.

Auction Rounds: The auction proceeds through rounds. In any round one bidder
can have only one active bid.
 WINNER DETERMINATION PROBLEM
 The winner determination problem is formulated as an Integer
Programming
n ni
problem as follows:
Min  x p
i 1 j 1
ij ij
procure the bids at minimum prices.

n ni

 x
i 1 j 1
ij  1i 1, 2,..N only one bid from a supplier is active

n ni represents if bids on an item in

S .t. xij qik  d k the bundle is satisfied.
i 1 j 1

xij  {0,1}
implies the bid is activated.
xij  1
 The criteria of meeting the reservation price can also be an added
constraint.
WINNER DETERMINATION TAKING INTO
ACCOUNT THE INVENTORY COSTS.
n ni K
Min xij [ pij   qijk hk ] (4)
i 1 j 1 k 1

n ni
S .t. xij qijk  d k k  1,...., K (5)
i 1 j 1
n ni

 x
i 1 j 1
ij 1 i 1, 2,..N (6)

xij  {0,1}

Where hk is the inventory holding cost associated, with the item k.

PARTICIPATION OF INACTIVE BIDDERS
 As per our requirements when the auction proceeds from round 1 to round 2 we
desire to give a chance to the losing bidders to bring them back into the auction.
 For the above objective we require that the new set of bidders should be mutually
exclusive construct a new constraint as follows-

x z
i 1
i i  0 i  1, 2,..N (7) zi is bid status indicator

 Initially at the start of the auction all the bidders have their bid status indicator as
zi=0. After the completion of the round 1 we do the following assignment z i=xi-1.
 After round two is over at least one of the bids which got reformed in the round two
should be included in the subsequent round three else the WDP will give the same
solution as round one.
 So, we do the following operation
 And put the additional bidder participation constraint as
zi  xi 1  1 i  1, 2..N

x z
i 1
i i  1 i  1, 2,..N (8)
CALCULATING ‘SUGGESTED PRICE’ FOR
A NEW BID COMBINATION
 In an iterative auction we seek to decrease total cost to buyer from the current round
(denoted C*) to the next.
 In the beginning of the auction when there are no bids, the buyer's reservation price
can be used instead of total cost.
 We ask the buyer in the beginning of an auction to specify a desired δ bid decrement
(δ>0) in total cost C* from one iteration (bid) to the next. And put up a constraint that
the new total cost of the selected buyers in a round should be less than the updated C*
for that round.
 Calculate new reservation price as Reservation Price’=Reservation Price-δ.
Cut off in cost  Updated Reservation Price  Total Combined Bid price

p =R'- xi pi (9) pi '  pi 

pi
 p (10)
iI

where I represents selected bids x p

iI
i i

 R’ represents the new updated reservation price, x i the current bid status of the
bidder, pi’ and pi the new suggested price and the old price of the bidder respectively.
SUGGESTED QUANTITY FOR A NEW BID
COMBINATION
 In addition to the price, it may happen that a bid combination may not be able to
outbid the previous winning bid due to an excess inventory resulting in additional
costs for the buyer.
 These inventory costs if minimized may reduce the total cost of procurement.
 To mark out the items in which there is an excess inventory.

 We construct a matrix for each of the individual items Y ki and allocate value to it as
Yki  xi k  1, 2..K
 If there is an inventory excess or shortage in item k then for the corresponding
bidders who have requested price and quantity support we assign

Y 2
 The overallki excess inventory in each item is then found as

EI k   qik (11)
i A

A set of all bidder i ' s for s.t . Yki  2

 The new quantity support for the bidder is calculated as follows

qik
qik '  qik   EI k (12)
i A
q
i A
ik

 We use the dual prices of the linear relaxation of the WDP as proxies for the cost
coefficients in a linear approximation of the cost function, which would take the form

K
ci (Qi ,new )   k qik ' (13)
Where μk's are
k 1 the dual prices of the corresponding demand constraints.

 After the total cost of the new suggested bid quantities is determined we calculate the
approximated total cost involved in the combined bids using the dual prices and
determine the overall profit as the difference between the updated reservation price
for that round and the total approximated costs.

  R '  ci
ci
(14) pi '  ci   (15)
c
iI
 is the approximate profit to be shared.
i
 ci and pi’ are the approximated costs and new suggested iprice
I respectively.
 The information on the costs, becomes more accurate as auction
progresses into multiple rounds i.e. the more bids there are from the
bidders in the bid stream, the more accurate the estimate.
 The Cost Estimation table is gradually updated with each round.
With the fixed costs Fi’s and the variable cost ci’s.

F1 F2 F3 F12 F23 F31 F123

c1 c2 c3
 The profits can be shared among the inactive bidders in a bid
combination. This shall encourage them to accept a bid to overtake a
winning active bidder.
EXAMPLE ON AUCTION PROCEEDINGS
bidder item1 item2 item3 price

1 0 260 205 28,435

2 150 0 260 25,761

3 205 370 370 52,273

4 0 260 0 18,657
5 0 0 205 15,622

6 425 260 205 49,675

7 315 0 0 22,560

8 0 315 370 40,655

9 370 370 0 43,743

10 205 205 150 33,937

11 0 0 260 18,222

12 315 0 315 38,060

13 0 370 0 25,646
14 0 0 425 28,017

Procurer 600 600 600

Requirement
FORMULATION OF WINNER
DETERMINATION PROBLEM

n: total no. of items

Let G denotes the set of n no. of items
S: Bundles of items and S⊆G
The total no. of possible bundles is 2n – 1.
N: total no. of suppliers
bi(S) : a bid for bundle S from ith supplier.
xi(S) : 1 when bid of ith supplier for bundle S is selected else 0.
GENETIC ALGORITHM ENCODING

 A brief discussion is now presented on how the chromosomes are

encoded, and how the other operators of GA namely selection,
crossover and mutation are done in the context of the present
problem.
Supplier A B AB BC AC
#
1 1 0 0 1 0
2 0 1 1 0 1
3 0 1 0 0 1
4 0 0 1 1 0
1= the bidder bids for the specified item.
0= the bidder doesn’t bid for the specified item.
The Chromosome Encoding
All the item state configurations from the suppliers are lined up to form the
chromosome.

0 1 1 0 0 1 0 1 0 0 1 0
A B AB A B AB A B AB A B AB

Bidder 1 Bidder 2 Bidder 3 Bidder 4

REPAIRING THE SOLUTIONS

Random generation may produce infeasible solutions.

1)If sum of the product instances is equal to or more than 1, then preserve the
product order configuration.
2)If sum of the product instances is equal to 0, then a random number (r) between
1 and N (No. of suppliers) is generated and for that supplier the product state of
that particular product is changed to one.
REPAIRING THE SOLUTIONS
1 0 0 0 0 1 0 0 1

Here product A and C occur in one or more instances among the suppliers, but
product B didn’t occur at all.
So a random no. is generated between 1-N. (N is the number of suppliers)
Let the random number generated is 3 (r=3)
This means that product ‘B’ has to be ordered from Supplier ‘3’.
That means the product order configuration of supplier ‘3’ has to be changed from
001 to 011.

1 0 0 0 0 0 0 1 1
 CROSS OVER
1 0 0 0 0 0 0 1 0 0 1 0 0 0 0 0 1 0
0 1 0 1 0 0 0 0 0 1 0 0 1 0 0 0 0 0

Parents

Select two parents from the The crossover part is represented in

population. Here the crossover blue and yellow colors
represents crossing over the product
order configuration of a randomly
selected supplier (in this case supplier
no. 1)
MUTATION
0 1 0 0 0 0 1 0 0 0 1 0 1 0 0 0 0 0

Mutation Bits

Mutation is done by interchanging product states between any two suppliers of

the same chromosome. The solutions are then repaired and they are now
added in the population.

0 1 0 1 0 0 0 0 0
FITNESS FUNCTION
 Minimize:
Procurement Cost + Demand Overshoot Penalty
n
Demand Overshoot Penalty =  (a  1.5d ) * M
i 1
i i

di is the demand of the buyer for item i.

ai is the sum of items from the winning bidders for item i.
n is the total number of items to be procured.

 The value of M (i.e. 10000) is kept very large to prevent all the solutions for which
the combined procurement from bidders is more than the demand.

• A safety margin of 50% within the demand is observed to prevent sub optimal
solutions from being discarded.

• Only those solutions are accepted into the mating pool for which the demand for all
the products is met.
ADAPTIVE BIDDING

The profit margin used by the bidder adopting this kind of strategy can be
adjusted constantly according to bidding histories, and finally approaches to
the optimal profit margin in the current market environment.

 Reference record of a bid ‘b’ for a bidder for a bidder i is

(pmb, loseb, winb ).

pmb is the profit margin for bid b, loseb is the number of rounds the bidder
keeps on bidding before bid b is won or dropped and winb is a integer of 0 or 1
denoting whether this bid is won or dropped.

The minimum value of loseb is 0, when the bidder wins the requested resource
bundle at the first round after he submits it.

 A Bidding History of a bidder, denoted as ‘bh’ is the sequence of recent ‘k’

reference records.
 A consistent bidding history of a bidder, denoted as ‘cbh’, is a bidding history
in which all reference records share the same profit margin.

 The expected utility function of bidder i on a consistent bidding history ‘cbh’,

denoted as

uex (cbh)  pmcbh 

 rrb cbh winb
 rrb cbh ( winb  waitb )

where pmcbh is the common profit margin used in this consistent

bidding history, and waitb and winb are the same as in the definition of
reference record.
 Every time when a new consistent bidding history is formed, the profit
margin used by the bidder is increased or decreased according to the
bidder’s 1st and 2nd most recent consistent bidding histories.

The new profit margin is used by the bidder when he bids in subsequent
rounds until the next consistent bidding history is formed.

 The increase and decrease of the profit margin as a positive and

negative adjustment respectively, and use a -1 or 1 variable δ to indicate
the previous adjustment of the profit margin: if δ = 1, then the previous
adjustment is positive, otherwise negative.
pm = η, step = θ, δ = 1 and u = 0.
while auction does not finish do

Use profit margin of pm to bid for the current round

if a new consistent bidding history cbh is formed

Compute uex(cbh).
if u < u’ then
pm = pm − δ × step
else if u ≥ u’ then
pm = pm + δ × step
end if
if pm > pm’ then
δ=1
else if pm < pm’ then
δ = −1
end if
u’ = u
End if
End while.
COST MODEL FOR THE BIDDER WITH
SYNERGY
 The cost for the bidder consists of fixed (Fi)and variable
cost(ci) for an item i.
 The fixed cost of combination of items is greater than that for
a single item.
 F12>F1; F12>F1
 The combined fixed cost is less that the sum of individual
fixed cost.
 F1+F2>F12 ;
 F12+F3>F123 ;
 All bidders are assumed to be “glocal” meaning that they have
production capacity for all three items but they are willing to
settle for any item and unit combination as long as it is
profitable.
REFERENCES
 Na A.,Wehad E., Pinar K. (2005) Bidding Strategies and their impact on revenues.
Revenues and pricing management.
 Choi J.& Han I. (2007). Combinatorial auction based collaborative procurement.
Computer Information Systems.
 Farahvash P. & Altiok T. (2008) Application of multi-dimensional procurement auction in
single-period inventory models. Ann Operations Research 164: 229–251
 Leskelä R., Teich J., Wallenius H., Wallenius J. (2007) Decision support for multi-unit
combinatorial bundle auctions. Decision Support Systems (Vol.43) 420–434.
 Vries S.& Vohray R. (2000); Combinatorial Auctions a Survey.
 Hohner G. , Rich J. , Ng E., Reid G., Davenport A.J., Kalaganam V., Lee H., An C.,
Combinatorial and quantity discount procurement auctions benefit Mars, Incorporated
and its suppliers. Interfaces 33 (2003) 23–35.
 Ertogral, K., & Wu, S. D. (2000). Auction-theoretic coordination of production planning
in the supply chain. IIE Transaction, (32), 931–940.
REFERENCES
o Song J. & Regan A (2003). Combinatorial Auctions for trucking service
procurement. International Conference on Travel Behaviour Research.
o Gallien,J.,Wein,L.M.,(2005) Design and analysis of a smart market for
industrial procurement. Journal of Management Science.
o Biel D.R., Wein,L.M. (2003) An inverse optimization based mechanism to
support a multi-attribute auction. Journal of Management Science.
o J.D. Murray, R.W. White, (1983) Economies of scale and economies of scope in
multiproduct financial institutions. The Journal of Finance.
o Teich, Wallenius, Zaitsev (2006) A multi-atribute e-auction mechanism for
procurement. European Journal Operation Research 90-100.
o Ryzin, V., & Vulcano, G. (2004). Optimal auctioning and ordering in an infinite
horizon inventory system. Operations Research, 52(3), 346–367.
o Chen,R., Roundy,R., Zhang,R., & Janakiraman,G. (2005). Efficient auction
mechanism for supply chain procurement. Management Science, 51(3),467–482.