EVEN though it’s the largest auction institution in world history, at first glance eBay seems like an internet version of the traditional “English” auction, where bidders cry out competing bids, with the seller ultimately getting the value proclaimed in the highest bid. That means if you outbid everyone, offering £200 for, say, a first edition of The Grapes of Wrath, then that’s what you’ll pay for it, right?
Wrong: eBay is a “second price” auction, in which the winner pays out not their own winning bid, but the second highest bid (plus a small amount extra, which is the smallest price increment allowed in the bidding). So if our seller gets three bids for £1, £20 and £200, they will take home only £20. Yet many people who bid regularly on eBay don’t realise this or understand that the posted price at any moment is not the highest price bid so far, but the second highest. It’s not the “price to beat”, which remains invisible because it isn’t posted.
Why does eBay use this peculiar form? This is one of the major questions that Princeton University computer scientist and eBay enthusiast Ken Steiglitz tries to answer. In Snipers, Sharks & Shills, he gently and effectively explores the economic theory of auctions with stories, examples and, mercifully, no equations.
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In the end, he suggests, the second price format helps to encourage early bidding, which makes auctions lively and fun, and keeps people coming back for more. For this reason, it may be largely responsible for giving eBay a virtual monopoly over auctions on the internet.
According to auction theory, anyone bidding early in an auction – that is, long enough before the closing time that others have plenty of time to respond – gives valuable information away to other potential bidders. For example, early bids can signal how much a bidder values a particular item. Other bidders can use this information and make those early bidders suffer – either by paying more than they needed to, or by being outbid for items they want.
This is where the second price format helps. If the highest bid is hidden, it tells no one anything. As a result, early bidders can express their desires without being punished so severely. The logic seems to work, as many eBay bidders do bid early: auctions often kick off with a cluster of early bids, and end with a frantic rush of late bids just before closing.
The book does a lot more than just explain why eBay works the way it does, however. As promised in the subtitle, Steiglitz also explores the quirks of human behaviour in auctions, both on eBay and elsewhere, which have as much to do with psychology as with brute economic logic.
For example, while the second price format weakens the disadvantages of early bidding, it doesn’t eliminate them. Logically, the best strategy is to “snipe”: to hold back and bid only at the very last moment. The fact that many people do bid early, often kicking off competitive bidding wars, shows that many of us are far from the rational automatons of economic theory. Many people bid early in an attempt to intimidate others, though this tactic rarely works, or they spitefully bid more for an item than they “should” (more than they really value it) just to prevent someone else from winning.
As Steiglitz points out, drawing bidders into competition is precisely the aim of popular selling tactics, both legal and otherwise. Sellers often use low opening bids to attract bidders with the lure of possible bargains. More deviously and illegally, it seems that eBay is routinely influenced by “shills” – fake bids placed by a seller or a seller’s accomplice that drive prices up.
In one US case prosecuted by the FBI, three men were convicted after using over 40 fake eBay user IDs with false registration information to boost the price of the paintings they sold by hundreds of thousands of dollars.
Steiglitz’s book is an admirable achievement: a short, readable account of the economic theory of auctions that doesn’t pound the reader into stupefaction with equations or some of the other dry-as-bones notions (utilities, risk aversion and diminishing returns) economists often invoke. Wonder what I can really get for that Grapes of Wrath?
Snipers, Shills & Sharks: eBay and human behavior
Princeton University Press
