Auctions as Price Discovery Mechanisms

Auctions as Price Discovery Mechanisms

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Introduction

An auction refers to a process of selling and buying goods and services through allowing individuals to place them on competitive bids as opposed to negotiating on a price. Different bidders give their prices/ value for the items and only one of them wins by placing the highest bid at the end of the set bid time or when all the rest have dropped out of the auction. The auction can be held on a physical location or done online. As bid begins, the auctioneer sets a starting price which is relatively low in order to attract the interested parties. The bidders will then compete for the item/ service, placing increasing prices until only one has set the highest and no other interested party can challenge him. At this point, if the auctioneer accepts the value, the highest bidder pays for the item and have it for himself and the auction is closed. Bidding has majorly been used for items whose prices are not quite defined or are rare to find and the winning bidder sets the price for that item.

The two major types of auctions are the forward and the reverse auctions. In the forward auction, there is only one item and several interested individuals (bidders). The bidders compete for the one item, raising the prices higher and higher until one winner emerges. Forward auction is mostly used and is the most understood by many. It is applicable where the seller wants to get the most money/ value for the item on sale. It is, therefore, suitable for selling of all types of goods and services whether physically or over the internet. In reverse auction, there are several goods of the same type. The buyer seeks the lowest price for the item. The item price is thus lowered to the minimum value. The winning bidder is the one who sets the lowest price. Reverse auctioning, is mostly suitable for companies that procure items for their use. Other types of auctions include Sealed Bid Auction and Vickery Auction.

Origin of Auction

In ancient Greece, at around 500 B.C, women could only be married off through bidding. During the auctioning process, the sell began with the woman considered the prettiest of them all. The prices went down from the highest until the lowest value is obtained, which was more than or equal to the reverse value set. In the event that the men did not get along well with their wives, they could get their money back. Auctioning in the United states was used mostly in selling farm products, slaves and estates. Some selected soldiers were also allowed to sell their plunder by auctioning. The Great Depression period made auctioning grew fast as people auctioned their assets to get money. Improvements in technology has also improved ways of auctioning. People can now take photos of their items and put them online to attract many buyers.

English Verses Dutch Auctions

English Auction, a forward auction and also called Oral Ascending Auction, is the type of auction where an item is put on sale with a minimum price set on it. The competing bidders raise the price higher that the previous, going up until only one bidder with the highest price is left unchallenged (Gus M., Christy L. 2008). At this point, bidder pays for the item, upon value acceptance by the auctioneer. The bid is closed once the payment has been made. This type of bid is commonly applied in selling rare commodities such as art, antiques and wine among others and is the most commonly known type of auction.

Dutch Auctions on the other hand has the auctioneer starts by setting the highest price for the item. He then lowers the bid slowly until a bidder is willing to pay a certain amount, higher or equal to the reverse price set for the item. This type of auction is mostly used with perishable items such as flowers. The auction type is common in Netherlands for selling flowers and other farm produce. Most of Dutch Auctions are open-bid and a few closed-bid.

In Dutch/ Reverse Auctions, the buyer benefits in that they get to buy the price with the least cost possible (Giampietro et al. 2007), unlike Forward/ English Auctions where the seller benefits buy getting the highest value possible for the item. However, due to focus on price, Reverse Auctions has affected the close relationship and partnership that existed between buyers and sellers (Piercy et al. 2007).

The Sealed Bid First Price Auction Verses the Vickery Auction

The Sealed Bid First Price Auction is also called the Blind Auction. Here, the competing bidders simultaneously submit their bids in sealed envelopes. No bidder gets to know the price submitted by the other. The bids can only be submitted once and there is no opportunity to alter the bid price. If the auction is buyer-bid, the highest bidder gets the item at their price while the lowest bidder sell their goods for the price accepted by a buyer in seller-bid auction. This type of auction is majorly used in government tenders, procuring of military assets and foreign exchange among others.

Vickery Auction, named after William Vickery (1914-1996), and also called Second-price Sealed Bid Auction, is similar to First-price Sealed Bid Auction except that the winning bidder pays the second highest bid instead of the winning bid. In the auctioning process, the highest bidder at any given time is to get the item and pays the price of the second highest bidder. The process is repeated until the highest bidder is obtained.

Strengths and Weaknesses

The First-price Sealed Bid Auction lowers levels of cheating during an auction process. This is due to the fact that individual bids are submitted simultaneously in sealed envelopes and also opened simultaneously. Second-price Sealed Bid Auction on the other hand is more vulnerable to cheating. Since the bidders have no idea of the prices of other bidders, the auctioneer can easily place an untrue value for the second highest bid making the winning bidder pay more. The advantage, however, of the Second-price Sealed Bid Auction is that the winning bidder gets to pay less than the price he bids. The lower the winning bid price, the more value for money he gets, unlike the First-price Sealed Bid auction where the winner pays the bid price as is.

Sky PLC Acquisition

Sky PLC, formed by both British Satellite Broadcasting and the Sky Television and formerly known as British Sky Broadcasting (BskyB), is a UK-based broadcaster. Comcast and 21st century Fox have been fighting for the acquisition of the company, both having significant shares with the company. After this prolonged battle, the Takeover Panel announced that this was going to end through an auction. At the point before the auction process, Comcast stood a better chance of acquiring the broadcasting company with 14.75 pound a share bid against 14 pound a share by Fox.

The auctioning process began from the current bids from the two companies and was to go three rounds. Fox, having the lower price was to give an increased price and the second round would see the other bidder make their offer. Each party would make their offers knowing what the other had previously placed. The auction would end in the second round if there was no other offer but the two companies still had the last third round. This kind of auction is an example of English Auction. The interested parties competitively increase their offers until the highest bidder is obtained at the end of bidding rounds or when the others can no longer increase their offers. Comcast finally won the auction with a total of £30.6 billion bid. I think English auction was appropriate for the acquisition of Sky PLC since the previous bids by the interested parties had been known publicly. The sealed auctions could not apply at this point as other parties’ bids are not known and also do not give option to revise the offer. Dutch Auction could not apply as well as it is descending bid kind of auction.

Auctions in Finance

A good example where auction is applied to finance is when a company wants to sell a certain number of shares. In this case, the company will have a set number of shares that is willing to sell and then attracts investors who will indicate the amount of shares they wish to buy as well as the price they are willing to pay for a share. Auctioning is necessary to enable the company sell all its set shares by attracting various investors of different capabilities.

During bidding, the selling company will set a maximum price per share. If nobody is ready to buy the shares for that price, he lowers the price and gets some investors. The seller continues to lower the price until it all the shares are sold out. The price per share is then determined and all the winning will get to buy the shares for that price. The type of auction used here is the Dutch Auction. A maximum price is set per share and the seller keeps lowering it until the winning bidders are obtained. The winners will then buy the shares for the price they had indicated.

Auctions in E-commerce

Auctions are now gaining more applications on e-commerce platform. eBay is a major beneficiary of online auctioning, it capitalizes on the Vickrey auction also referred to as the sealed-bid second-price action since it gives real time bidding. The highest bidder will pay the price of the second bidder. From the respective bidders, they place sealed bids offers in ignorance of other bidders. Vickery auction is used because it eliminates the need for middlemen, reduces the transaction cost and more so it encourages the winning bidder, as he or she pays the lower price (second bid price). Other advantage is that it is suitable for similar goods/services in large quantities.

Auctions in E-gaming

Auction can also be applied in selling of rare video games. Auction is applicable here since the commodity is in demand and is a rare collection thus will be sold through auction in order to attract the highest price possible. An example is the Factory Sealed game auctioned in 1987. It was in 2008 listed among the rarest 25 for Nintendo by Computer and Video Games. The type of auction applicable here is the English Auction. The item has to get the highest price. The bidders will therefore compete, increasing their bid prices until only one bidder remains and no other can challenge his bid. The winner will then buy the item for the highest bid price.

Auctions as Revenue Generators for Not-for-profit Organizations

Not for profit organizations can benefit on auction, either online or physical location auctioning. Online auctioning, due to internet coverage will have a lager audience or reach capacity as compared to physical location auctioning. For charitable organizations to marshal more funds, they should follow the legal requirements of the state. Meeting all the legal issues will ease the fund-raising event and will make it successful. Hiring the services of a third party for purposes for compiling and remitting tax is one of the advantages in that the third party will cater for all the legal issues. However, it will do it at a fee. Other advantages are that it is less expensive and boost of larger audience that can increase revenue.

The main disadvantages of not for profit auctioning is the getting the right audience that is willing to contribute for the event and its time intensive, in that its time consuming. Getting the right item, that can be readily sold, is another disadvantage in that it will require the organization to write a formal memo on what it doesn’t accept as charitable items. Lastly, most of the not for profit auctioning have hidden costs.

Use of Auctions to Better Uncover Value and Increase Revenue

Auctions ensure that a company attracts as many potential buyers as possible and in most times get the most value for their items, especially for rare commodities. Auction also ensure that all the items set for bidding are sold out. I work for a company that acquires and sell traditional and African prints furniture. The pieces of furniture are really pretty and sometimes there are other prints that are attractive but least available. I have over time noticed that customers compete for certain prints and furniture shapes and most make orders long before we acquire the items from Africa.

I think that the company can make more money if they sell the competing commodities through auction. Since we already have a website, the most attractive items can be put on auction and the interested individuals bid for them. The rare furniture shapes and prints will definitely attract many and the items will be sold out at higher prices. The most appropriate auction type to be used will be English Auction. This will ensure that the furniture attract as high prices as possible.

Reference

Gus M., Christy L.(2008). Reverse Auctions: Benefits, Challenges and Best Practices. Carlifonia Journal of Operations management, Vol. 6(1). California State University, Fullerton, CA, Irvine Company, Newport Beach, CA.

Giampietro, C., Emiliani M., (2007). Coercion and Reverse Auctions. Supply Chain Management. Vol. 12(2), 75-84.

Pearcy et al, (2007). A model of Relational Governancein Reverse Auctions. Journal of Supply Chain Management, Vol. 43(1), 4-15.