1 teck-hua ho april 13, 2006 next class: design of auction format dutch auction (d) (e.g, ) ...
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April 13, 2006
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Teck-Hua Ho
Next Class: Design of Auction Next Class: Design of Auction FormatFormat
Dutch auction (D) (e.g, www.landsend.com )
First-price sealed-bid auction (F) (e.g., US Treasury bills, supply contracts; government procurement (10% GDP))
Second-price sealed-bid (Vickrey) auction (S) (e.g., www.sandafayre.com; NZ’s communication spectrum rights)
English auction (E) (e.g., www.ebay.com ; www.yahoo.com )
April 13, 2006
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Teck-Hua Ho
Auction Principles
I. Economic and Behavioral Foundations of Pricing
II. Innovative Pricing Concepts and Tools
III. Internet Pricing Models
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Teck-Hua Ho
OutlineOutline
Lessons from Auction Simulation ExerciseOptimal bidding and reserve price
Two important auction principles
Economics of Ebay’s Business ModelRevenue model design
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Teck-Hua Ho
Independent Private-value Independent Private-value English AuctionEnglish Auction
Buyers’ valuations (WTPs) are independent of each other (e.g., antique & art, collectibles, Jewelry & Gemstones, etc.) (for own consumption)
In our simulation exercise, buyers’ WTPs for the airline ticket are independent draws from a uniform distribution ([0, 1000])
An open English ascending bid auction
What is the optimal bidding strategy?
What is the optimal reserve price?
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Teck-Hua Ho
Optimal Bidding Strategy (one Optimal Bidding Strategy (one seller)seller) If there is no snipping (auction is closed only when no
bids are submitted for a certain duration), the auction theory predicts that buyers should slowly increase their bids until the highest bid exceeds their WTPs
The open English auction mechanism induces truth revealing of WTPs (price points where bidders drop from the auction)
Revenue = Second highest WTP
Auto Extension: This option for sellers automatically extends the amount of time left to bid by five minutes if someone places a bid near the end of the auction.
http://help.yahoo.com/help/us/auct/asell/asell-01.html
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Teck-Hua Ho
Predicted Versus Actual Bids Predicted Versus Actual Bids and Reserve Priceand Reserve Price
PredictedPredicted
By AuctionBy Auction
TheoryTheory
Actual Actual
BehaviorsBehaviors
Bid as % of WTPBid as % of WTP
(except winners)(except winners) 99%
Reserve PriceReserve Price ? ?
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Teck-Hua Ho
Prices at Each RoundPrices at Each Round
698.7Round 5
807.2Round 4
730Round 3
606Round 2
725Round 1
3rd highest WTP
Price of 2nd item
Price of 1st item
Round 6 800
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Teck-Hua Ho
Expected Seller Revenue (one Expected Seller Revenue (one seller)seller)Let buyer WTPs (independently drawn from an uniform
distribution) are denoted by WTP1, WTP2, …, WTPn-1,
WTPn
Arrange them in an ascending order and denote ranked bids by WTP(1), WTP(2), …, WTP(n-1), WTP(n). That is, we have WTP(1) < WTP(2) < …< WTP(n-1) < WTP(n)
Expected Revenue: WTP
n
nWTPE n
1
1)( )1(
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Teck-Hua Ho
Expected Revenue versus Expected Revenue versus Number of BiddersNumber of Bidders
WTPn
nWTPE n
1
1)( )1(
Expected Revenue versus Number of Bidders
020406080
100
0 10 20 30
Number of Bidders (n )
Exp
ecte
d R
even
ue (%
of h
ighe
st W
TP)
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Teck-Hua Ho
Optimal Reserve Price (one Optimal Reserve Price (one seller) (uniform distribution)seller) (uniform distribution)
Optimal reserve price:
If the reserve price is smaller than the second highest WTP, reserve price has no revenue effect on the bidding process
If it is between the highest and the second highest WTPs, it will force the highest bidder to go beyond the second highest WTP (the point where the second highest bidder drops out).
5002
0000,10
2
Good Unsoldof ValueGood Unsoldof Value
WTP
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Teck-Hua Ho
Predicted Versus ActualPredicted Versus Actual Bids Bids and Reserve Priceand Reserve Price
PredictedPredicted
By AuctionBy Auction
TheoryTheory
Actual Actual
BehaviorsBehaviors
Bid as % of WTPBid as % of WTP
(except winners)(except winners) 99%
Reserve PriceReserve Price 500
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Teck-Hua Ho
Revelation PrincipleRevelation PrincipleRevelation Principle: All buyers (except the winner) end up
revealing their WTPs for the item to the sellers. Put differently, sellers can “discover” distribution of buyers’ WTPs via the auction mechanism. This is not the case for other pricing mechanisms (e.g., seller posted price and priceline model)
Application: Use open English auction to discover the distribution of WTPs and then use seller posted price model to maximize share of surplus
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Teck-Hua Ho
Efficiency PrincipleEfficiency PrincipleEfficiency Principle: The auction mechanism guarantees
that the item always goes to the buyer with the highest WTP in a market. Again, this is not always the case for other pricing mechanisms
(inefficiency = 0% (predicted) versus (actual))
Observation: Auction model is likely to dominate the other price models in terms of total social surplus generated.
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Maximum Possible Surplus Maximum Possible Surplus (MPS)(MPS)
Seller 1 c=0
Seller 2 c=0
Buyer 1 40 Buyer 2 20Buyer 3 15Buyer 4 90Buyer 5 60Buyer 6 50
WTP
MPS = 40 + 90 + 60 + 50 = 240
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Disadvantages of AuctionsDisadvantages of Auctions
Can be stressful for some buyers, especially for end consumers (this can be however solved by proxy bidding). Thus, it is less likely to work for low purchase-involvement product categories
There are more losers than winners (and losers are less likely to revisit the website)
Strategic manipulation (e.g., shilling)
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Teck-Hua Ho
Earnings of individual groupsEarnings of individual groups
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The Winning TeamThe Winning Team
The winning team is:
The prize is:
+ $60
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Teck-Hua Ho
Ebay’s business modelEbay’s business model
Seller Buyer Seller & BuyerPrice Setting Party
Pri
ce O
ver
Tim
e Stat
icD
ynam
ic
ebay.com
http://www.ebay.com/
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Teck-Hua Ho
Ebay’s Current Status in 2004Ebay’s Current Status in 2004
Listings - New listings totaled a record 348.0 million in Q3-04, 48% higher than the 234.6 million listings reported in Q3-03.
Confirmed Registered Users - Cumulative confirmed registered users at the end of Q3-04 totaled a record 125.0 million, representing a 46% increase over the 85.5 million users reported at the end of Q3-03.
Active Users - Active users, the number of users on the eBay platform who bid, bought, listed or sold an item over the trailing 12 months, increased to 51.7 million, a 38% increase over the 37.4 million active users reported in the same period a year ago.
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Teck-Hua Ho
Ebay’s Original Revenue ModelEbay’s Original Revenue Model
M = Total number of items listed per year
Feei = Insertion fee of item i
Comi = Final value fee of item i
Ii = 1 if item i is sold; 0 otherwise
M depends on number of people in the community
Comi x Ii increases with price or seller surplus
M
iii
M
ii IComFeevenue
11
Re
Revenue Levers (or Buttons)
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Ways to Enhance Ebay’s Ways to Enhance Ebay’s RevenueRevenue Increase M
Increase size of community, Enter new markets and product categories Increase turnover (e.g., reduce bidding duration, encourage setting of
buyout prices)
Increase Feei
Encourage more pictures and promotion of items
Increase Comi
Increase average number of bidders / auction (so as to increase seller surplus)
Encourage High-priced items (e.g., electronics, cars)
Increase Ii
Increase average number of bidders / auction so as to increase the probability that the highest bid > reserve price
Encourage a lower reserve price (e.g., the recent increase in insertion fee for reserve price auction)
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EBay’s Revised Revenue ModelEBay’s Revised Revenue Model
Fees to list an item for regular auctions, fees is a function of starting price for vehicles, a function of type of vehicles for real estate, a function of types of properties and listing type
Picture Service Fees—first picture free, additional picture or bigger picture incurs fees
Listing upgrade fees: various options to promote items Final value fees
for regular auction, charged when reserve met, at a function of the closing bid For vehicles, charged when the first bid over the reserve price is placed (regardless
of whether sale is finally made) For real estate, a fixed fee for land/time share where there is successful high bid on
the item and no fees for other type of real estates Reservation Price Fees—charged only if item not sold, a function of reserve
price
M
iii
M
iii
M
ii IRIComFeevenue
111
)1(Re
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Teck-Hua Ho
Ways to Enhance Customer Ways to Enhance Customer ExperienceExperience Bidder Management
Smart search capability to narrow consideration set
Bidding frequency of end customers
Winner Management Trust and safety initiatives
Loser Management: For every winner, there are (n-1) losers. Find ways to get them to bid again: Follow-up emails
Loyalty programs for frequent bidders
Seller Management Lower cost of re-listing the same item (e.g., second try is free)
Loyalty programs for frequent sellers
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Teck-Hua Ho
Recipe for Continued Market Recipe for Continued Market LeadershipLeadership Liquidity, liquidity, liquidity Keep Existing Customers Happy
Increase switching costs (e.g., use Billpoint software to allow sellers to accept credit card on-line)
User strategic partners (e.g., SkyTel Communications) Trust and safety initiatives (increase post-auction satisfaction)
Acquire New Customers New markets (e.g., Canada, UK, China, etc.) New products (especially high-priced items) (e.g., Harvey
Electronics, Inc.; ebay’s plans to expand to higher-end items) Direct acquisition of customers / sites (e.g., exchange.com,
alando.de)
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Teck-Hua Ho
PunchlinePunchline Open English Auction
Revelation PrincipleEfficiency Principle
Ebay’s Business ModelRevenue increases with seller surplusLiquidity promotes lock-in: Keep existing
customers happy and acquire new customersDiversification: New markets and new products
(especially high-priced items)