Online Auctions: What's the Big Deal?


By John Parkinson Every now and again I come across an idea that's simultaneously brilliant in theory, yet hard to understand how it can possibly work in practice. Here's the latest.

By now, most people know how an "auction" works. You compete with other bidders who want something to establish who will pay the most for it. On sites like eBay the bidding is free - and the winner pays the seller for whatever was being auctioned. eBay takes a small listing fee and a percentage of the final price from the seller (other auction processes charge the buyer the percentage) .

It costs nothing except time and perhaps some frustration to be a losing bidder. Price discovery is pretty fast - with bids increasing by a significant amount at each stage. Items tend to fetch close to their market price, so long as there are enough knowledgeable bidders. Pretty straightforward and easy to understand why it works - indeed auctions like this have a long history in human commerce.

But, recently there have been a surge of "auction" sites that work differently. Items are offered by the site operator at very low starting prices, typically $0.01 and for a fixed period of time - typically 90 minutes. Prices increase very slowly - $0.01 at a time. Participants pre-purchase a set of "bids" - usually for about $0.75 each and in tens or hundreds at a time. Every bid raises the price by the same small increment. When the time gets down to 30 seconds to go, every bid resets the time to 30 seconds.

To win, you must be the highest bidder and remain uncontested for the full 30 seconds. The bait is the possibility of getting a fairly expensive and desirable item at a very low price.

This seems like an equally straightforward process, but let's do some basic math. If the bid increment is $0.01, it takes 100 bids to raise the price by $1. But a bid costs the bidder $0.75, so the auction site (which, remember, has already sold and been paid for the bids) "earns" $75 for each $1 raised.

So long as you have enough bidders (actually just two will do) who want a "bargain" the auction site will rapidly "earn" many times the value of the item being "auctioned". Take an $800 iPad 2 (a popular item on many sites that attracts a lot of bidders). To get the price to reach $100, it takes 10,000 bids at $0.75 each. That translates to $7,500 in "earnings" for the site. Although the winning price was "only" $100, the winner may have paid as much as $3,750 to get the item.

Now you'd assume that no one would be that stupid - and in general you'd be right. But every loser paid for some of the winner's great deal, and when I looked at the actual activity on several sites I saw people who paid much more than the winning price to participate and still lose - because they ran out of bids (or maybe they finally got smart). And there's no telling where the bidding will end. One "90 minute" auction I watched for an unlocked iPhone 4 went all the way to $890 (within $20 of the "retail" price) and took almost two days to complete. That's 89,000 bids at $0.75 a bid - $66,750 in bids to fund one person's saving of $20.

So, this isn't really an auction. It's more like a cross between an auction (the competitive bidding process) and a lottery (concentration of value from many small players buying tickets to fund one big winner). But lotteries are regulated and must pay out most of their net accumulated ticket sales in prizes. These new auction sites aren't regulated at all (as far as I can see) and generally aren't obligated to do anything but hoover up peoples' cash. And there can only be comparatively small winners.

There are more and more sites like this popping up (thanks to the cloud, it's fast, easy and cheap to set up a web site with everything you need) and they seem to be getting a lot of traffic. They even offer "bid buddies" to automate the bidding for you and spend your money even faster - so that you won't "miss" the opportunity to get a "bargain" during those endlessly repeated final 30 seconds of action.

Now, I'm not a great believer in protecting people from their own economic (and arithmetic) ignorance and "caveat emptor" is as true today as it was for the Romans. But, I can see no way that this model can persist before the site operators run out of arithmetically challenged suckers.

Then again, I don't buy lottery tickets either, and lotteries are in no danger of going out of business, so hey, you never know. In the meantime, I really wish I'd:

  1. had this idea first and
  2. talked myself into believing it could actually work.


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