Average Bid Auction vs. Low Bid Auction
https://pdfs.semanticscholar.org/397e/d140ce9d6248d13b8843eae1af9e6a3d445f.pdf
Besides the first price and second price auctions, many places around the world, like Italy and Taiwan, adopted a different type of auction — average bid auction. In this method, “the contractor whose price is closest to the average of all bids submitted” is awarded. To be more specific, the winner has the bid satisfying a certain relationship with the average of all bid prices. Different bidding methods use various criteria to determine the winner. Some methods will eliminate outstanding bids far from the average before calculating the final average. Other methods will select the contractor whose bid is closest and less than the average. Now the question is how should we bid in average bid auctions? Similar to low bid methods, each contractor has a cost estimate m, which is the minimum value they can bid for without losing money. Additionally, let’s define m to be the profit or markup. The optimum markup can give the highest probability of winning. In fact, the maximum probability of winning occurs at the mean of m, irrespective of the number of opponents. This means, regardless of the number of opponents, one should always bid the mean bid-to-cost ratio. This makes sense because the cost c does not vary much across competitors, so the markup m becomes the crucial factor. The paper elaborates more on the calculation of mean of m, which requires statistical estimation based on distribution and variances.
Compared to the ascending bid and descending bid that we learned about in class, the average bid method is rather uncommon in the U.S. As the authors point out, some drawbacks are associated with low bid method, namely unrealistic prices and accidental prices. These situations often result in disputes during construction, like schedule delays and poor quality. However, its main advantage is to “force contractors to continuously try to lower costs by adopting cost-saving technological and managerial innovations.” Therefore, low bid auctions sound like pure competition in the industries. A similarity between these types of actions is the interdependence between all bids when deciding the winner. In first bid auction and second bid actions, the decision is based on how high one’s value compared to other bidders. In average bid auction, the decision is based on the value and variability of other bids. It is worth noting that, in first and second bid actions, only the bids higher than own bid would influence the decision. Whereas, in average bid auction, every bid can fluctuate the final average and thus influence the final winner. This is why average bid methods are much more difficult to model than other auctions.