Tuesday, July 21, 2009

Credit where it's due

Rumor has it that Swoopo is changing its model.

Right now, when you make a bid and you don't eventually win the auction, that's the end of it. Any money you spent buying the right to make the bid is lost.

The rumored change is as follows: if you bid on an auction and lose, the money spent on the bidding can be used as a credit towards purchasing the product at list price.

This is a game-changer, and not in a good way. Let me explain.

Say Bob is bidding on MP3 player listed at $100. The player is "worth" $75 to Bob -- if he had the opportunity to buy it for $75 cash, he'd snap it up. It's a standard $1/1¢ auction - a bid costs $1, the bid-level goes up by 1¢ with each.

Bob and Sam are the only bidders and they've bid it up to $0.50 -- each of them has bid 25 times and Sam is currently leading. Should Bob bid again?

His choices are conceding the auction and then spend $75 (plus his 25 expended bids, which are unrecoverable anyway) to buy the MP3 or bid and spend one more dollar. If he wins, he gets the player for $0.51, which is great; if he loses, he's no worse off. Sure, he spent a dollar, but the product that would have cost him $75 is now only $74.

And the situation stays the same for the next 74 bids too. Either Sam gives up or Bob just throws in another bid. If Sam is stubborn enough, the auction eventually gets to $2.00 and Bob gets the MP3 for free and Sam wins by paying the $2.00. (Of course, the two of them are out $100 apiece for the bids.) This race becomes inevitable as soon as Bob passed the 25-bid point, where the difference between the list price and Bob's maximum price has already be spent.

But look at the effect on Sam! If the MP3 player was worth $65 to him, he would have been better off just quitting at the 25-bid point, if only he knew about Bob. True, Sam doesn't know about Bob, but after a few of these punishing contests, he'll start to figure out that something is wrong. And he won't want to play any more.

These races might become very common. All it takes is for several bidders to spend their way into the zones that the sunk cost covers all the difference between list and their personal valuations of the products. When the races are common, the low purchase prices that make penny auctions so desirable become correspondingly rare.

Of course, Swoopo could avoid this problem by setting the "list" price unreasonably high, so almost no one would every have enough expended bids to make it worthwhile to buy the product -- but that would undermine whatever value the policy might have.

Another way to soften the effect would be to allow partial credit. If you spend $40 on bids for this auction, you get a $20 credit. This isn't nearly as disruptive (if I am really analyzing the situation correctly), but may not be as attractive for other reasons.

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