Sitting atop an old bushel basket, the aroma of aged tobacco wafting through the air, and the loud jumbled racket of an auctioneer rattling off lot prices, was the recollection of my first auction experience. Reminiscing over nostalgic memories of accompanying my grandfather to the American Tobacco Company sale in Reidsville, NC, at the ripe age of 6 years old will be forever engrained in my mind. Not until a graduate school game theory class evoked my long lost love of auctions, did I start thinking about the efficacy of auction marketplaces allocating resources among consumers.
Although auctions have evolved over time, the basic framework still remains consistent with their predecessors. English auctions involve at least two participants where bids occur in ascending order, and the consumer with the highest reservation price and concurrent bid receives the desired item. Dutch auctions, a less frequented form of auction starts with a premium price for an item and descends accordingly. If no potential consumers are willing to pay the initial price; the price declines until the individual with the highest willingness to pay eventually pipes up. Of course several other auction techniques have been explored including, sealed-bid, multi-part, penny, buyout, absolute, etc.
Each type of auction addresses the unique characteristics of the goods or services, the consumer group, and timing, with the end goal of realizing the highest price. Some may argue auctioning is a form of Pigou’s first-degree price discrimination, also known as perfect price discrimination, where the market forces self-identification of the individual with the highest willingness to pay.
The most familiar online auction place, eBay was introduced in 1995 to serve as an intermediary between buyer and sellers. eBay’s auction style is a hybrid model between English and Reserve/Absolute. Sellers post available items, describe the items for sale, and set up selling parameters including starting bid, reservation price (if applicable), and timeline. Consumer’s interested in purchasing the seller’s item bid up the asking price. As time converges on the auction’s maturity date, the consumer with the highest bid wins the right to purchase the product, assuming the seller is amenable to the bid price. The rest of the transaction, procurement, payment, and shipping, involve the buyer and seller.
When I heard the television commercial for QuiBids, a relatively new online auction house, describing how consumers can obtain Apple iPad’s for $16.99 and $25 gift certificates Chili’s Restaurant for $5.00, I was not only shocked but also skeptical. How can a base iPad 2 retailing for $499 in the Apple store sell for a discount of over 90%? Further investigation of the QuiBids marketplace ensued.
The basic model employed by QuiBids is a simple bidding fee auction, also known as a penny auction. Consumers interested in certain items purchase bids in bid bundles. Bid packages go from a starter kit of 100 bids to more advanced bundles with different options. Each right to bid is priced at $0.60. New items on the QuiBids site are introduced and the bidding starts at $0.00 and the timer is product specific. With an account of bids, consumers select items of interest and bid accordingly. Each customer’s bid increases the auction item price by one penny. As the auction progresses the timer ticks down until the 20 second threshold. Once the timer falls below 20 seconds, each additional bid will reset the timer to 20 seconds. For example, if the timer is currently at 16 seconds and an individual bids, the timer increases back to 20 seconds. This bidding process occurs for a set length of time until a target price is achieved and the threshold is decreased to 10 seconds. Eventually the time is allowed to run completely out and the last bidder at time equals zero wins the right to purchase the product at the current price.
Let’s perform an example and look at the benefit derived from both parties in the transaction. QuiBids offers a CHI hair straightener for auction and starts the timer at 30 seconds. Bidders signal their desire to purchase the CHI by incrementing the current auction price by one penny. As the price increases and the timer decreases, a winner of the CHI is eventually identified. Let’s say the end price of the CHI is $9.90. The following analysis will calculate the benefit received by the consumer and the firm, QuiBids.
where n is the number of bids the consumer makes and the maximum reservation price shows the consumer’s pricing point of indifference (basically buying the full retail price for the CHI). This model does not use different Max Reservation Prices based on differing marginal benefit. Assume economic cost, such as opportunity cost and instant gratification is not included in the model. This model does not take into account the cost-benefit associated with consumers losing the auction. If the CHI retails for a price of $120, the consumer’s marginal net benefit of the first hair straightener would equal the following:
Assuming the consumer is rational and will not pay higher than the price point of indifference (aka TB = 0), this consumer would bid up to 183 times. If the consumer only bid 150 times for the CHI and wins the auction, they will receive a TB of $20.10.
where is profit realized from the transaction, and n is the number of overall bids by consumers. If the end auction price in this scenario is $9.90, then 990 bids occurred overall. The profit gained by QuiBids is:
QuiBids will realize a hefty profit margin of 80% for this specific transaction.
It seems if volume continues to populate the QuiBids’ web marketplace, positive profit margins will be captured. The timing mechanism according to the auction item, and frequency of bids ensures that each product is sold for a gain. The QuiBids’ model deems effective at seizing profit and making some more risk-loving consumers better off.
The question at hand asks, how quickly will auction losers become burn out of QuiBids? Can the volume continue to persist? Advertising that iPad’s sell for $16.99 on QuiBids provides an unrealistic true price for what the iPad actually goes for. Not accounting for the costs of bidding leads to false representation of the actual total cost incurred by winning consumers. On average, I believe the total benefit of the winning consumer approaches zero over a large population of auctions.
Does the QuiBids market allocate the good to the person who holds the highest reservation price? This would be a question for further analysis taking away the assumption of fixed marginal benefit across customers, associating risk measures, and persistence variables.