Why Gift Cards are Great for Penny Auction Sites

Most penny auction sites auction gift cards, Bidcactus started with them and the Auction Squirrel loves them, it seems the only site that stays away from gift cards is Swoopo. In fact, I can't remember Swoopo ever auctioning gift cards. But Swoopo aside did you ever wonder why penny auction sites love gift cards? I did, and below are some reasons why gift cards are the perfect product for penny auction sites.

1. No sales tax. It's a cumbersome process to obtain a resellers permit (I'm sure this varies by state and am not sure what the details are in each one) which allows the penny auction site to avoid paying sales tax on the items they buy. And some businesses might not accept the permit, meaning the penny auction site is stuck paying the sales tax - which is hard for an internet business to legitimately pass along to the auction winner. Gift cards purchases are not assessed sales tax because the tax is collected by Uncle Sam when the card is used to make purchases at the store, meaning the penny auction site can avoid any issues with taxes, including paying, collecting, and worrying about in state/out of state.

2. Cheap to ship. Many penny auction sites do not charge shipping, meaning they eat the fees when they send you that 50" plasma that weighs 70 pounds. Gift cards, on the other hand, are cheap and easy to ship, meaning penny auction sites can offer free shipping without breaking the bank.

3. Easy to find. Selling a PS3 requires negotiating a relationship with a drop-shipper or heading to the local Best Buy to pick one up and send it yourself. Running around town finding the goods one needs to fill orders for won products doesn't sound like a lot of fun. However, gift cards can easily be found at the nearest grocery store, all under one roof.

4. Pricing is easy. Calculating the amount saved or other metrics to determine how good of a bargain the winner received requires knowing the price of the auctioned item. This introduces questions like do I use the MSRP or the current price, the Amazon price, the lowest price I can find or is it something else? Prices change all the time, especially on electronics which become outdated quickly when new models become available. Saying that the "correct" price of a gift card is its face value will never get you into any trouble and since gift cards can sometimes be purchased at a discount this means the penny auction site might make a little extra money on the auction. Today Best Buy had $50 iTunes cards for $40. I wonder if The Squirrel stocked-up.

The downside of gift cards is that they aren't as exciting as tangible products, but with points 1-4 above, you can see why most penny auction sites feature gift cards.
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The Auction Squirrel Ships Products

I have been fairly skeptical of The Auction Squirrel since they launched last week for reasons I blogged about here. Namely, I'm getting tired of new penny auction sites that launch yet do nothing different. I know it looks like easy money, but even if it was it no longer is. If there are nearly 100 sites competing with you and you aren't special you have a fundamental business problem. If your plan to address this problem is to call yourselves "new and exciting" or "the best penny auction site" or "the number one penny auction site," you have an even bigger problem. The fact that there are big sites like Swoopo and BidCactus makes it even harder to compete (FYI - I keep mentioning these two because their traffic is 10 times as high as the next closest competitors).

So, needless to say, I was none too excited to see The Squirrel pop-up last Wednesday. However, while their site traffic is low and bidding activity meager, The Squirrel appears to be a legitimate business with no shill bidders and one that actually ships products. I spoke with two people last week who won items on The Squirrel and one person today reported that they received the gift card they won. In the penny auction industry being able to confirm that a site is shipping items and not shill bidding is a substantial victory it its own right.
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The Penny Auction Universe is Expanding

It must have been lonely for Swoopo back around this time last year when they were the only penny auction or "entertainment shopping" site in the US. However, since then dozens of copycat sites have sprung up, 54 to be exact as of my count earlier today. Of these 54 sites, 36 are active, 2 are preparing to launch and the rest are either dead or in a coma.

From an economic perspective, watching the penny auction universe is fascinating, we are witnessing an industry develop in hyper-speed. When there are low or no barriers to entry, as in this industry, new firms can freely enter the market. They do so as long as there are profits (perceived profits that is) to be had. This time last year, Swoopo developed an industry in the United States in which there were highly attractive profit margins. Soon, competitors entered the market. This was relatively easy to do because all that is required to operate a penny auction company is a website and a contract with a drop-shipper (essentially outsourced inventory management). Soon we saw dozens of new penny auction sites. However, there is a point at which the market for penny auctions becomes saturated and profits are reduced until some of the less competitive firms exit the market and profit margins are driven to a stabilization point (equilibrium) where firms neither enter nor exit the market. However, in practice things tend not to work out as cleanly as they are stated in theory. In the penny auction industry we have seen firms exit the market (Hasteno for example), but we do not know if this is due to over-saturation in the market or to operational or personal difficulties encountered by individual firms.

Also, theory assumes market participants to be rational and knowledgeable, a set of qualities human beings often fail to exude. Theoretically we expect new penny auction sites to open only if it makes sense for them from an opportunity cost perspective. Well, in a recession like this, one can argue that opportunity costs are pretty low. I wouldn't be surprised if several of the penny auction sites out there are run by unemployed IT guys who are trying to keep the lights on between business cycles. Also, since it can be hard to tell how much money a site is making, new competitors might enter the market only to find the profit margins are not as high as they expected. I suspect this is what is happening now with some of the sites that have just launched or plan to launch soon.

There is not enough room in this market for 30+ penny auction sites and many will be eliminated, the question is how long can they hold on for before exiting the market. This leads to a problem for the consumer which is that sites that are under stress and slowly going under have a stronger incentive to behave badly. I fear that many of these 30+ sites are going to damage their customers be failing to deliver product, failing to redeem bids or committing outright fraud before they bow out of the penny auction race for good.
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