Collusion in Ascending Bid Auctions
https://insight.kellogg.northwestern.edu/article/going_going_wrong
Around the world auctions are an extremely common way that people do business. In ascending bid auctions, one potential buyer bids and then other potential buyers are asked if they want to raise the bid. It can be shown that the dominant strategy for each buyer is to bid up until they reach how much they think the item is worth and then stop. This ensures that they do not pay more than the item is worth to them and that they don’t risk losing out on a potential profit by stopping too early. This makes ascending bid auctions attractive for sellers who don’t know how much they can ask for an item because it ensures that the item will be bought close to the top of evaluations of all the potential customers.
However, a study by the Kellogg School of Management has found that a different strategy often emerges that sellers should be very wary of. In a study where participants were given random values for items and each person had a unique favorite, the buyers began to collude. After a couple of rounds each person started winning their item at the minimum bid price because everyone realized that they would all get the most profit if they only bid for the item they valued the most. For this collusion to occur it requires that everyone knows how much their competitors value the items at, but it is not hard to see this occurring in some situations. This knowledge could occur if the buyers had a chance to talk before hand or if they knew of certain preferences among each other. The federal communications commission holds auctions for broadcast frequencies and in one instance a compony won four licenses for a dollar each. The licenses were easily worth more than that raising the question of whether collusion was at play.
This is clearly something that auctioneers should be vary wary of as it can significantly cut into profits. One possible format change that has reduced collusion is a descending bid auction where an auctioneer lowers the price until someone says, ‘I want it at this price’. However, this doesn’t cause the same competitiveness among buyers as an ascending bid auction. Whatever the situation it is important to think carefully about the type of auction you choose as it can have a significant impact on profits.