E-Commerce Pricing as an Auction
Within the past year, the way major advertisers and online retailers approach advertisement and promoted product pricing has changed. Initially a second-price auction – one where the highest bidder for a keyword or PPC (pay per click) promotion pays the second highest bid for that same keyword or PPC promotion – major online advertisers like Google are pivoting from the industry standard of second-price auctioning to a system of first-price auctions for keyword promotions. Amazon, whose “advertisements” focus mainly on promoting products based on the PPC bids of sellers, still uses a second-price auction system. If the advertisements and promotions of large retailers like Amazon are commonly second-price auctions, can that auction system be extrapolated into the actual products that these retailers offer?
The answer to that question lies within Amazon’s algorithm for pricing products. Amazon’s expansive external and internal databases allow it to change product prices every ten minutes on average. While Amazon’s product pricing algorithm factors many market variables into any given product’s price, the price is still driven by a timeless market definition: supply and demand. On Amazon, the buyer pays a seemingly fixed price, but the reality is that those prices are shifting constantly due to Amazon’s pricing algorithms. For any product on Amazon, its price can be described as a complex supply and demand problem where the price of any given product is near the intersection of the supply and demand for that product. The supply, in this case, is dictated not only by the number of sellers selling the product but also by the number of units that the seller is offering. The demand is based purely on the number of customers willing to purchase a given product at a given price where those quantities maximize profit. This means that Amazon sets the initial price of an item at the price it believes will attract the greatest quantity of buyers at the highest price it can attract those buyers at.
How does this all relate to auctions? In a Dutch auction, the price of an item is lowered until a bidder bids on the item and his bid price. Unlike a traditional Dutch auction, Amazon does not price its products significantly above what its customers’ perceived value of that item is since it has gathered and analyzed a significant amount of data about its customers’ purchasing behaviors and is thus able to predict, much more accurately, what customers are willing to pay for a particular item. Amazon also has no incentive to overprice their items – they are a retailer, not an auctioneer after all. This is not always correct, however, since like any retailer, Amazon sometimes fails to predict future supply and demand accurately. If Amazon prices an item too steeply, they must slowly discount products that have few buyers since Amazon carries the same need for inventory turnover as any other retailer. Just like a Dutch auction, Amazon will eventually lower the price of a product until buyers stabilize demand to acceptable standards. This means that while Amazon product pricing may not initially seem like an auction of any type, it is truly a Dutch auction in disguise; Amazon’s auction just decreases in price at a more delayed rate than a standard Dutch auction. Extrapolating this general idea of Amazon’s product pricing being a Dutch auction, it is interesting to note how many auctions exist behind the scenes. While many daily interactions, like buying shoes online, may appear to be fixed prices, many are just auctions in disguise!
References:
First price auction, Second price auction and the one in the middle
https://www.businessinsider.com/amazon-price-changes-2018-8