The Hidden Message Behind “Skip Bids” in Auctions

Skipped auctions do not always result in lower revenue for the seller. Image: Shutterstock

NOTNot every auction is run by a fast-talking man holding a gavel.

Some of them are organized discreetly, online, by bidders who are not individuals but entire companies. And often what is bought and sold are intangible items, such as online advertisements or shares, licenses for mobile phone services and electricity rates.

In fact, auctions – and understanding how they work – are so important that in 2020 two specialists in auction theory won the Nobel Prize in Economic Sciences. (Their research helped the U.S. Federal Communications Commission create a new way to auction radio frequencies, which generated billions of dollars in sales.)

In my recent research, I look specifically at what is called “jump bidding” in “English auctions”: when a bidder, instead of gradually increasing the offer price, suddenly increases the price significantly . This is often used to intimidate other bidders, signaling that the bid has a high value and that the informed bidder is therefore willing to take the risk of increasing their bid.

I’ve found that this tactic works: bidders who use this “signaling method” tend to pay a lower price than the seller hoped to earn in revenue. Accordingly, I recommend that in auctions where transaction costs are low, government entities and businesses prohibit skip bidding in order to get the most out of their auctions.

Underlying messages among bidders in “English auctions”

Skipping auctions can only take place in an ascending auction, more commonly known as an “English auction”, in which bidders interact with each other by increasing the price. (This is opposed to “sealed envelope auctions”, in which bidders place their bids privately in sealed envelopes and cannot compete with others by increasing their bids.)

In English auctions, each bid made may contain underlying information, interpreted as if the bidders were saying: “Here is the value of the item based on my expertise and analysis.” » Bidders can make decisions based on how their competitors act during the process. In this way, allowing participants to outbid (instead of limiting the increase in price from round to round) allows them to send each other encrypted messages, which can lead to a quicker end to the round. bid. However, from the seller’s point of view, a quick sale is not always beneficial: the longer an English auction lasts, the more likely the seller is to get a higher price for their item.

Also read: Some find bidding intimidating: Tushar Sethi from AstaGuru

The effect of skipped auctions depends on transaction costs

However, skipped auctions do not always result in lower revenue for the seller. In auctions where the transaction cost is high, skipped bidding could actually encourage more companies to participate.

Transaction costs refer to the costs incurred during the auction – for example, the time and human resources required to monitor the results of each round, decide how much to bid, and submit the corresponding bid. Because skipped bidding speeds up the auction, resulting in fewer rounds, a bidder who anticipates high transaction costs is more likely to commit if allowed to outbid – in other words, he can anticipate fewer turns. And a high participation rate can generate higher revenue for the seller.

It is in auctions with low transaction costs that companies should be wary of using skip bidding to end an auction prematurely. These types of fast, dynamic auctions are more common these days, especially in auctions involving online advertising space (ascending auctions with multiple items, instead of just one), where AI and algorithms are used by companies to reduce their transaction costs. . Therefore, removing skipped bidding in these contexts could encourage participants to bid more competitively and generate higher revenue for the seller.

I am often asked: are bidders actually using this tactic to “play the game” (i.e. signal other bidders and get a lower price) or could such price increases be attributed to things like ego or just showing off?

Since the majority of bidders are typically businesses and often use outside advisors for auctions, there is too much at stake for bidders to make decisions based on anything other than justification. Companies jump on their offers because they are convinced that it could benefit them.

(This article is reprinted with permission from IESE Business School. www.iese.edu/ Views expressed are personal.)