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Irrationality and Ebay July 19, 2007

Posted by jeremyliew in auctions, ebay, Ecommerce, economics, irrational.
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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.

Comments»

1. hunter - July 19, 2007

eBay is a boon for interesting studies. I love the economic value of high reputation:
http://www.si.umich.edu/~presnick/papers/postcards/PostcardsFinalPrePub.pdf

established identity yield 8.1% increase in price. Hence reseller arbitrage.

2. Adam Nash - July 19, 2007

Here is another blog post on the fascinating economics of eBay transactions, particularly around shipping costs and feedback. It comes out of Germany.

I quote the article and analyze the results here on my blog.

Adam

3. Adam Nash - July 20, 2007

As brief follow-up, there are some extremely logical explanations for all of the issues raised above. When you look more deeply into the eBay experience, some of the behaviors can be explained.

Examples:
– Why do people bid to heights above the Buy It Now price? Because eBay has the BIN price disappear as soon as the first bid is placed. Most of the bidders join the auction after the BIN price has already disappeared, so they don’t have that data. At the same time, many bidders place that first bid (usually at $0.99) because it is so low. Ironically, those early bidders rarely stick around for the full auction – they are off to try and get another cheap deal. But their work is done – the BIN is gone, and now the auction looks like it has real activity as bidders tend to serve as a validation of the auction, drawing in other bidders. People get hooked on the low price, get involved in the auction, and then those “Outbid” notices do their work, and people bid up the price.

– Why do reserve prices hurt eBay auctions? The economists are modeling only one auction at a time. When you have a large number of competing auctions, the reserve price sends a message to the buyer that even if they spend the time to commit to a bid, they still may not win because of the reserve price. As a buyer, you’d much rather spend your time and bidding on an auction without a reserve price than one with a reserve price. The auctions, in effect, are competing with each other.

Obviously, all of the above are simplified answers, but hopefully they help illustrate how deep and interesting the behavioral economics around eBay really are.

Adam

4. patricia - July 23, 2007

What a great post. Very insightful. I’ve found some interesting things in a big auction I had held recently. Nothing scientific, but it’s a very interesting arena to watch user patterns and responses.

5. Bob Parsley - July 23, 2007

I recently did a “test” with my first E-bay item offered for sale, a boat. It confirmed some of what Adam mentioned. I used a hidden reserve price, and noticed that only a few users were “watching” my auction. I then revealed the reserve price (by adding it to the description), and within hours, the number of users who were monitoring the auction skyrocketed. Even more amazing was that after seven days, the selling price was within than 5% of the BIN price.

I think that for many buyers, E-bay’s complexity interferes with what we typically thing of as rational market behavior. You can only be rational if you know how to use it to its fullest extent.

Regardless, I find it to be one of the most fascinating things on the internet.

6. Ryan Praskievicz - August 8, 2007

I graduated from Colby College this past May and I did an empirical study that examined the determinats of final bid price on eBay. I looked at 500 completed auctions for new 30 GB IPods. My paper focused on the affect of shipping price on final bid price, the affect of seller reputation on final bid price, and the affect of buy-it-now on price.

Below is the conclusion from the paper.
If you’d like to read it go to: http://www.geocities.com/ryanprask/ebay_price_determinants.pdf

Any and all suggestions are welcome.

VII. Conclusions
In conclusions the factors having the most direct effect on final bid price are shipping price, the seller reputation measured in terms of being a power seller, and the use of buy-it-now. If sellers meet the criteria for being power seller they should sign up with eBay immediately because they will increase their revenue. In the case of the IPods, they will increase their revenue per IPod by $7.71 holding all else constant. As a seller you also should charge a high fixed shipping price because buyers do not consider a $1 increase in the shipping price as a $1 increase in the total cost of the auction. Bidders consider shipping an add-on price, much like a tip at a restaurant. Specifically, a $1 increase in the shipping price leads to a $0.80 decrease in the final bid price, ceteris paribus. Power sellers should increase their shipping price by even more to increase revenues as a $1 increase in their shipping prices leads to a $0.71 decrease in the final bid price of the auction. Offering buy-it-now is the final piece in the puzzle for a seller trying to maximize their profits selling new 30GB IPods. The seller should look at other buy-it-now prices and in this case the seller should consider the mean buy-it-now price of $222.43 and set their buy-it-now at or close to this price. By setting this price impatient buyers who are willing to pay a premium to get the item faster will buy. To the degree the seller is risk-averse they should decrease the buy-it-now price relative to the mean. In this way the seller is placing a premium on minimizing the volatility in final bid prices. These conclusions add to the literature currently available and for the most part are in line with results from previous studies. An application of this model to another data set may be instructive in the future and a test of these findings may further solidify the results as support for eBay auction theory.

Ryan Praskievicz - January 14, 2010

For a copy of the Determinants of the Final Bid Price in eBay Auctions go to: http://www.scribd.com/doc/25164346/Ebay-Price-Determinants


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