FEBRUARY 2010
Easy money?
To a certain extent designing a buying process is limited only by the buyer’s creativity but it is important not to get too creative because the wrong design can have serious consequences.
Imagine the following situation:
You, and a number of other eager participants, have been invited to an
auction of a one dollar bill. It looks like a great opportunity to make some
easy money and the rules of the auction look simple enough:
Rules of the auction
1. The highest bidder wins the dollar and pays the price they bid.
2. The 2nd placed bidder wins nothing BUT has to pay their bid as well.
The auction starts and one of your competitors bids ‘one cent’.
You want to win the dollar, so what do you bid?
Easy money?
Rules of the auction
1. The highest bidder wins the dollar and pays the price they bid.
2. The 2nd placed bidder wins nothing BUT has to pay their bid as well.
The auction starts and there is frantic bidding as everybody tries to secure the dollar at a good price. One cent, two cents, five cents...
The price continues to rise and, as the bidding approaches the dollar mark, bidders start to withdraw. Eventually there are only two bidders left and the mood in the room has changed. As the price breaks the one dollar mark, the two remaining bidders realise what they are involved in and are forced to change strategy – they are now trying to minimise losses instead of making an easy buck.
The bidders know that winning the auction (and the dollar) will allow them to offset some of their losses but finishing second means incurring losses and receiving nothing.
This rational analysis is competing with a host of emotions (greed, pride, fear, panic etc.) that are making the participants behave irrationally and bidding continues in a frenzy as both participants try to ‘win’ the auction.
The auction eventually finishes with both parties feeling very sorry for themselves – the winner has made a loss and the second place bidder has made a bigger loss.
Were you one of the last two bidders; did you withdraw earlier or maybe you didn’t even take part?
Theoretically at least, after the first bid of one cent, the best strategy would have been to stay out of the auction
and not bid.
An auction where the best strategy is not to bid is ultimately flawed and this theoretical example illustrates that auction design is non-trivial with poor design leading to unforeseen and unwanted consequences. Luckily, Trade Extensions was founded by some of the leading academics in this field so there are no unwanted surprises with our buying processes.