Penny Auctions vs. Traditional Auctions
http://online.wsj.com/article/SB10001424053111903392904576512280986981242.html
This article from the Wall Street Journal describes the growing number of penny auction sites. Websites such as Bidcactus and Quibids are making a name for themselves but still have a long way to go before they will reach eBay’s level of fame, if ever. The sites advertise the low winning bids: an iPad2 for under five dollars, a $250 gift card for under $30, and a Kindle for only $5. The “low” prices may entice onlookers into joining the sites, but understanding the procedures behind these auctions will reveal just how normal those prices are and that the price paid is not necessarily the money these websites make. This then begs the question:what makes a penny auction so different from a traditional one?
A traditional auction is fairly simple to understand. Say there is an item with a current bid and a BIN (buy-it-now) price. We would value the item some amount “n” and define our payoff as the difference between our “n” and the price we paid. Initially, we compare “n” and the BIN price. If “n” is greater than the BIN price we can just bid that amount and net a positive payoff. Otherwise, the auctions functions just like an English auction; we stay in if the current bid is below “n” and drop out once it is exceeded. Note that although we are allowed multiple bids, but the only bid that matters is our last. The payoff is n – p.
A penny auction also contains the previous two components, a current bid and a BIN price. Like before, if our value “n” exceeds the BIN price, then we can simply purchase the item right there and then. However, the difference is that each bid costs money, so payoff is defined as the difference between “n” and the sum of the winning bid and the total price of the bids. Furthermore, once a new bid is made, the round resets, unlike the traditional auction where the single round continues. Our payoff is n – (p + kq), where k is the number of bids and q is the price per bid.
Let’s analyze an example: Say we wish to buy a high end gaming laptop valued at $2000. The current bid is $50, and the minimum increment is $.01, and the price of a bid is $.60, like in the article. Let’s say, despite there are ninety-nine other equally-capable people online, the chance of winning any arbitrary round is 1%. (the actual chance would be much lower). If we bid in one round, we can approximate the estimate the payoff with Payoff ~= .01(+1950) + .99(-.60) = 18.906. This formula is very simplified and the actual formula should be recursive and take into the account the possible payoff of the next round. This is because the payoff of the next round is supposed to be embedded into the 99% chance of not winning the current round. Regardless, because the payoff is always positive, we are expected to bid. The flaw here lies in that probability is very unreliable, we are not guaranteed to win the auction after 99 failures (and a subsequent loss of $59.40). But it is the thrill, however, of knowing that the win would definitely offset the small price of the bids that encourages people to take the chance. The same reason is why people gamble in the lottery. The only sure piece of advice is: if you partake in a penny auction, bid in the last millisecond and pray everyone else suffers a power outage.
One last thing to note is the business model behind the auctions. Sites like eBay charge two fees: an insertion fee for listing an item, and a final value fee, a fraction of the winning bid. An example in the article, though, is the Nikon D90 camera which generated $7800, which can be found for $750 elsewhere online. Sure the winner of the auction scored a bargain, but the true winner was Beezid.com, which hosted the auction. Thus as a seller, penny auctions are definitely the way to go in terms of profit.
Thanks for the post on penny auctions.
My name is Josh and I manage a website called the Penny Auction List. As you stated in your post, the odds of winning aren’t always in your favor, but there are some strategies that seem to be more effective than others.
If you’re interested in digging deeper into the business model, I’d be happy to send you a copy of my book “Penny Wise: The Complete Guide to Saving Money with Online Penny Auctions.” The book was co-authored with an award-winning journalist and talks about the business, research and bidding side of these sites.
I’d be happy to address any additional questions you might have as well.
Josh