Following the new millennia, it is said that auctions became popular to both the government and the e-commerce world. An auction is the process of bidding over a certain product. Whoever has the highest or lowest bid will get it. Auctions are done to sell over licenses for operations of different products, for example mobile phones licenses and taxi medallions. This also goes to radio spectrum licenses. However, auctions can either come out good or bad. According to Klemperer (2002), designing a good auction is mainly based on “elementary economics”. Poorly designed auctions can lead to “fiascos”, since the revenues did not reach the expected.
Klemperer (2002) also listed key factors to consider in designing an auction which concerns collusion, deterrence of entry, and predation. These problems are apparent with ascending and uniform-price auctions. Collusion happens when participants conspire to avoid the increase of bidding prices. Collusion is apparent with standard auctions wherein multiple products are sold and each being auctioned independently. Objects do not end up getting sold unless someone bids over it. Nonetheless, collusion can also happen to uniform-price auctions wherein bidders bid for the lowest price that they will pay for a good. It is also a problem for auctioneers to attract bidders. Fewer bidder increases the risk of the auction becoming unprofitable and inefficient.
In addition, entry deterring happens when a bidder is considered to be at the highest ranking and firms think that ‘this’ bidder, even if outbid from the start, will just top the price. Another problem is the “winner’s curse”. It is the danger of overbidding from the actual value of a product. Bidders tend to be more cautious in their bidding and the more aggressive ones, or those who have the means to afford an overbid, wins. Since high ranking bidders or powerful firms develop a “reputation for aggressiveness”, it becomes a strategy for predatory behavior. This results to firms, especially the small ones, having “little incentive” in the auction and would just deter to enter. Rivals of these powerful firms become unwilling to participate in auctions, as well.
There are also other pitfalls that can result to a disastrous auction. This may be a result of scanty reserve price, serious political problems, loop holed and not credible auction rules, and unstable market structure. Although there pitfalls, there are solutions on how these problem can be countered and can make auctions stable and efficient. Klemperer (2002) enumerated some that can go against collusion and predation such as, making ascending auctions tougher; using sealed-bid auctions; using the Anglo-Dutch auction; and enforcing antitrust.
One disadvantage of ascending auctions to practical auction design is that it is susceptible to collusion between bidders, be it explicit or implicit. It is possible for participants to implicitly decide, at an early stage of the auction, which among them will win the bidding and will stop pushing the price of a product any higher. It can also enable collusion in a way that “punishment” between rival companies happens. This comes out as a high bid retaliation of a company to another. Entry deterrence also becomes apparent with ascending auction. It is presumed that the bidder who “values winning the most” will win. It is said the topping an opposition for such bidders is not a problem. As mentioned earlier, believing in the “winner’s curse” is also a disadvantage to ascending auctions because weaker bidders may not participate as they cannot cover losses from overbidding. Since this result to the aggression of powerful firms, it becomes advantageous for “effective predatory strategy”. Repeated ascending auction and scanty reserve prices allow for even more development of this strategy. Likewise, the blockage of weaker firms in entering auctions helps the powerful ones to collude. It is also particular that bidders break the rules of the auction. However, ascending auctions is more likely to “allocate prizes” to those who value an item more. This is one advantage of ascending auctions. It is also more likely for bidders in this auction to win an “efficient bundle”.
In a sealed-bid auction, bidders instantaneously give their best and final offer and pay this amount. Like the ascending auction, bidders can collude to an agreement and the auction becomes unprofitable. Sealed-bid auctions sometimes results to the embarrassment of bidders. Since bids are opened and the winner’s bid is announced at the end of the auction, it can happen that the winner overbids to a certain product. Another disadvantage is that sealed bid auctions are more open to the auctioneer’s changes in the rules. Although there are disadvantages in this kind of auction, one advantage is that bidders are unable to retaliate against those who do not collude with them. It also encourages for more bidder since winning is a bit uncertain in a sealed-bid auction. Some bidders aim in entering an auction is to resell making this type of auction more attractive to them. It also discourages “consortia”. This is because independent bidders aim for competition and this type of auction makes way for that. Consortia are not formed which makes way for much more competition and profit.
A solution from getting caught-up from choosing between ascending and sealed-bid auction is a combination of the two or known as The Anglo-Dutch Auction. In this type, an ascending auction will first commence until two bidders are left. Then, the two bidders will be asked to give their final offer which should not be lower than the asking price from the first step of the auction. This is more commonly used to house sales, but the processes are specified in advance.
Auction literatures are also used for “practical auction design”. As listed in Klemperer’s work, it focuses on distaste; correlation of information; constraint of budget; and complementarities risks. The auction theory has been applied to several branches of auction-related businesses, but has actually less use for designing one. It becomes unimportant since problems arise from “market power”. Based from all the problem that may arise from an auction suggests that design becomes, somehow unimportant. However, this is only applicable to events where there is a large number of potential bidders and entry to the auction is easy.
In summary, even if there are a lot of drawbacks such as collusion, entry deterring, and predatory behavior. Most of these auctions still worked well because of the solutions presented. Auctions can be formed stronger using these solutions. Klemperer (2002) fully stressed that “auction design is not ‘one size fits all’”. Everything lies on the circumstances and other factors that can affect an auction.
Reference:
Klemperer, P. (2002). “What Really Matters in Auction Design”. Journal of Economic Perspectives, 16(1) 169-189. Retrieved from http://cramton.umd.edu/econ415/klemperer-what-really-matters-in-auction-design-jep-2002.pdf
