Irrationality and Ebay July 19, 2007Posted by jeremyliew in auctions, ebay, Ecommerce, economics, irrational.
USA Today has a fascinating article today about how some economists are puzzled by irrational eBay buyers. (via Techmeme). The article summarizes research by a number of economists. One showed how buyers in an auction frenzy will bid an item up above “buy it now” prices – almost half the time!
Ms. Malmendier tracked 166 auctions offering CashFlow 101, a personal-finance-themed board game. During the seven-month trial, the game’s designer sold the box set on his website for $195.
Meanwhile, eBay sellers usually offered an opening price of about $45 and set a one-click, “buy it now” price of about $125. It looked like a great deal for buyers. They could pay less than retail to end the auction immediately or place bids in the hope of fetching an even lower price.
But this is where eBay users fell prey to what Malmendier and her coauthor, Stanford University economist Hanh Lee, call “bidder’s curse.” Apparently, some bidders grew so enthusiastic about winning the auction that they lost sight of the “buy it now” price, sometimes offering more than $185.
“We found that in 43% of the auctions the bidders ended up paying more than the ‘buy it now’ price,” Malmendier says.
Other researchers also found that buyers will often ignore shipping costs in their bidding.
Instead of observing auctions initiated by others, like Malmendier, Hossain posts his own controlled auctions. He offers identical items, but plays with the specifics of the sale. For example, he auctioned pairs of popular music CDs. One copy would start at $4 and include free shipping. The other would open at 1 cent but charge $3.99 for shipping. Either way, the initial cost was four bucks.
But bidders didn’t see it that way. On average, the low-cost, high-shipping auction attracted more bids, more bidders, and 25% more money.
The article summarizes other research findings as well and is a fascinating read.
Slate published a related article in May when it asked “Are Ebay auctions rational?“. Apparently standard auction theory predicts that having a secret reserve price will maximize value, but research on Ebay showed the opposite:
… Katkar and Reiley put the theory to the test by simply selling 50 matched pairs of collectible Pokemon cards, half with an open reserve price and half with a secret reserve price of the same level. Their conclusion, contrary to the theoretic argument, is that secret reserve prices are counterproductive. Far from stimulating interest, they seem to put bidders off, perhaps out of fear that a secret reserve is secret because it is far too high. Not wishing to waste their time, many of them just click “back” on their browsers and find somewhere else to bid.
I love this stuff.
Congratulations to Chamath and to Facebook July 10, 2007Posted by jeremyliew in facebook, VC, Venture Capital.
As the WSJ announced today, Chamath Palihapitiya is leaving Mayfield to join Facebook as VP of Product Marketing and Operations.
I used to work with Chamath at AOL; he was GM of AIM and ICQ while I was GM of Netscape. Chamath is brilliant; visionary, thoughtful, charismatic, charming and very, very smart. At AOL he was a tireless advocate for the user experience. It is no accident that at the age of 30 he has achieved so much.
While some who do not know him might question the hire, I have no doubt in my mind why Facebook would want Chamath on their team. He will add a great deal to the company, and Mark pursued him for some time.
On a selfish note, I am also somewhat glad that Chamath is out of the Venture Capital business. I think that had he stayed, he would have been one of the best investors of this generation. Entrepreneurs that I have met hold him in high regard.
Congratulations to Chamath and to Facebook.
I recently met a company that I really liked; an innovative online financial services product. It hit a lot of my criteria for investment; it had a working product, it paralleled existing offline behavior, and it had achieved some early success in gaining distribution. And it had done all this on just $1.5m of angel money.
However, although I really liked the company, I didn’t seriously pursue an investment. The reason is that the $1.5m was raised at a $30m valuation. The company was still very early stage, with very limited usage and an unproven revenue model. Any sort of investment that we we would have made would have been at a much lower valuation than $30m.
The company is still pursuing financing, but it is currently focusing its efforts on raising more angel money.
This made me think about the asymmetric risk that an entrepreneur faces when pricing a round.
An example of asymmetric risk is catching a plane. If you arrive early, you waste some time sitting in the airport. This is unfortunate, but it’s tolerable. If you arrive late, you miss the plane altogether. This can be expensive and very inconvenient.
The same situation exists when an entrepreneur determines at what valuation she can raise money. So if she raises at a valuation that is too low, she suffers more dilution than she needed to. This is not desirable, but the negative consequences are linear in that they are roughly in proportion to the degree that the valuation was cheap. [Disclaimer: As a venture capitalist, I benefit from investing at lower valuations.]
On the other hand, if she raises at a valuation that is too high, she runs the risk of a future “down round“, or even worse, being unable to raise more money at all. Valuation is always based on some combination of past performance and future potential. When valuations creep up and are based more on future potential than past performance, more pressure is put on the company to hit its potential and justify its valuation. If things don’t go to plan, when the company next needs to raise money it may not be able to justify its past valuation at all.
The American Bar association has a good article describing some of the likely consequences of a down round. In this case, the negative consequences are not linear, but look more like a cliff. A downround can be highly disruptive and cause significant damage not just to ownership stakes, but to overall company morale and the relationship between investors and founders
Marc Andreessen recently posted about fundraising for a startup and answered the question “So how much money should I raise?” as follows:
In general, as much as you can.
Without giving away control of your company, and without being insane.
Entrepreneurs who try to play it too aggressive and hold back on raising money when they can because they think they can raise it later occasionally do very well, but are gambling their whole company on that strategy in addition to all the normal startup risks.
Suppose you raise a lot of money and you do really well. You’ll be really happy and make a lot of money, even if you don’t make quite as much money as if you had rolled the dice and raised less money up front.
Suppose you don’t raise a lot of money when you can and it backfires. You lose your company, and you’ll be really, really sad.
His rationale is the same as the one for thinking about valuation – asymmetric risk.
Today’s startup funding environment is buoyant, much like it was in the late ’90s. It’s a good time to be an entrepreneur. However, entrepreneurs should also be careful not to repeat some of the mistakes of the ’90s. Inc magazine has a case study of one company that raised money at too high a valuation that is worth reading as a lesson in the dangers of asymmetric risk.