Everyday Economics

My Way to the eBay

An economics professor’s strategy for winning online auctions.

According to the voice on the radio, we should all be worried about “compulsive gamblers” who spend several hours a day playing slot machines. I can’t figure out what the voice was thinking. Nobody who spends several hours a day playing slot machines can be called a gambler. Gambling is about risk and uncertainty. Sit long enough in front of the slots, and you’ll lose your money at an entirely predictable rate. That’s the very opposite of gambling.

Here’s what a gambler does: He takes a large fraction of what he’s got and risks it on a single spin of the wheels. You don’t see much of that in the casinos. Instead, you see folks lugging around buckets filled with quarters, parceling those quarters out one at a time. There’s a name for that strategy: It’s called diversification, and its purpose is to eliminate risk. The more time these people spend at the slot machines, the less they’re gambling.

Now, I’m willing to believe this behavior can become compulsive, but there are still distinctions worth maintaining. These people aren’t addicted to gambling. They’re addicted to sitting in front of slot machines.

Likewise, I’m not addicted to shopping; I’m addicted to eBay–the hottest auction site on the Internet. I know this because my bidding strategy, which would appear insane to any casual but thoughtful observer, makes sense only in the presence of a compulsion to spend as much time as possible monitoring my auctions.

Most eBay items are sold in “second-bid” auctions, which means the high bidder gets the item and pays the amount of the second-highest bid (I’ve left out a few complications that can be ignored here). Ordinarily, there is only one sensible strategy in a second-bid auction: Bid the highest amount you’d be willing to pay; then sit back and wait to see if you’ve won.

In a standard English auction, where the high bidder pays his own bid, bidders usually try to “lowball”–that is, to bid less than they’re willing to pay, in the hope of walking away with a bargain. But there’s no reason to lowball in a second-bid auction, because the amount you pay is independent of the amount you bid. If the antique royal blue water pitcher is worth $300 to me, I should bid $300, not $250. (If you’re not convinced, click for a detailed explanation.)

Moreover, the same reasoning says that it makes not a shred of difference whether I bid early or late. So, why do I repeatedly find myself bidding furiously in the last five minutes of an auction and submitting three different bids in succession when one should suffice? Either I’m behaving irrationally or my analysis of bidding strategy contains an invalid assumption. For that, there are several candidates.

First, I assumed that I start off knowing what I’m willing to pay for the water pitcher. But maybe that’s wrong. Maybe I learn what I’m willing to pay by observing the progress of the auction. eBay lets me observe the number of bidders, the identity of the highest bidder (so far), and the amount of the second-highest bid (so far). When 10 new bidders jump in, or when a bidder I respect moves out in front of the pack, I might revise my valuation and submit a new bid.

O f course, that explanation works only if I care about the other bidders’ opinions–say, because I think they know more than I do or because I’m trying to predict what kind of resale market I might face someday. For me, though, the resale market is irrelevant; I never resell anything, thanks to the same obsessive traits that keep me on eBay in the first place. (On the other hand, maybe I do care about resale prices, because I like knowing that my possessions inspire envy.)

If I can learn from other bidders, then they can learn from me–which is the second reason I might want to deviate from a simplistic “bid and wait” strategy. I bid low at first to convince my competitors that the item isn’t worth much. Then I jump in with a higher bid at the end, hoping that at least some of those competitors are away from their computers and unable to respond.

So, bidding should be leisurely when bidders have little to learn from each other (say, when they’re bidding on a new computer that’s been widely reviewed) and intense when some bidders are far more expert than others (say, when they’re bidding on a heart defibrillator for home use). That’s a nice testable hypothesis. Unfortunately, it seems to have failed its first test. When one of my colleagues used eBay to sell an outrageously expensive (i.e., over $1,000) bottle of Bordeaux wine, three bidders submitted eight different bids in the first three days. Now, if somebody is willing to pay $1,000 for a bottle of wine, I’m inclined to guess that he’s well informed about its quality. So why are these people revising their bids?

Maybe they’re just addicted to bidding. Maybe I am too. Last week, eBay listed a collectible knife with which I am entirely familiar. I bid $225, which exhausted my willingness to pay. But in the final five minutes, I raised my bid to $250, then $275, then $300, and finally won the auction, exhilarated by my victory.

Maybe eBay just makes me giddy. As a free market aficionado, I am intoxicated by the prospect of one-stop shopping for houses, cars, Beanie Babies, and underwear, all at prices that adjust instantly to the demands of consumers around the globe. Or maybe the behavior of eBayers can be explained only by subtler and more carefully tested theories that have not yet been devised. Given the mountain of data being generated by eBay, I suspect those theories will be the stuff of doctoral theses for a long time to come.