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Internet auctions fairer for all

By Joshua Gans

Herald Sun, 14th August 2003, p.18

No one loves a good reality TV series more than me. What really attracts me is the strategy. When Survivor came out I regularly tortured my MBA students with exams based on voting strategies. Now we have The Block and my students are again in for a beating.

The Block is a simple concept: four couples have twelve weeks and a $40,000 budget (plus some extra for winning weekly contests) to renovate one of four apartments in the same Bondi block. On the 16^th and 17^th August the apartments will be auctioned off and each couple gets to keep the change from $595,000 with an extra $100,000 going to the couple whose apartment fetches the highest price.

What is attractive is the idea that the winner will be determined by a real set of auctions with real bidders (especially given recent changes to NSW real estate auction laws) who will pay real money, to live in Bondi. And it is auction theory that is the topic of this week’s class. Specifically, did the folks at Channel 9 get the rules of the game right? Is this a fair contest?

The apartments will be auctioned off in sequence with Amity & Phil first (Saturday 16^th at 10am) followed by Waz and Gav an hour later with Kylie & Paul at 10am the next day with Fiona & Adam finally at 11am.

Question to the class: All other things being equal, who is likely to win the game?

Answer: Amity & Phil. The reason is simple: it is well known that when nearly identical items are auctioned off in sequence, prices decline with each lot. This has been documented for wine but also in the large spectrum auctions. In one case (the FCC DBS auction), the 7^th lot sold for 13 times that of the 8^th lot. That was a half billion dollar differential! This means that Amity & Phil have the best chance while Fiona & Adam are in the worst position.

But it may not be quite as bad as all that. For one, Fiona & Adam have been able to secure at least $11,000 in extra play money than Amity & Phil. Moreover, other things are not necessarily equal, as different apartments have been decorated in different styles. But, regardless, I would rather be earlier than later in this contest.

Next question: what would have been a better (and perhaps fairer) way to do this?

Answer: to auction them all at the same time. Now it might be difficult to do this with everyone standing out front of The Block but using an internet-based auction this is quiet easy to do. Indeed, this is precisely what happened in auctions for spectrum. The Australian government used a simultaneous ascending bid auction to allow telcos to bid on several lots at the same time. No lot was closed until all bidding activity had stopped. What that meant was that bidders on the first lot did not have to fear being left without an option later on. Also, the seller did not have to worry that competition on later lots would be thin. In the end, similar lots sold for similar prices (with differences in the thousands not millions). Although the TV experience might be diminished.

A shrewd student might query this, “Isn’t all real estate auctioned one after another? Wouldn’t this just be a general problem in the industry?”

True and we have all seen the consequences. Should you bid a lot for a house today or wait for next week’s auction? Will you regret it if you do? A greater set of inefficiency is hard to imagine.

The problem is generic to the way we currently sell real estate. It is about time that someone took advantage of the internet and let auctions track over weeks (say for the entire period a house is on the market) rather than try to get everyone together for an hour at a time. The Block may be employing best practice for the industry but it is not best practice in auction design.

Joshua Gans is a Professor of Management (Information Economics) at the Melbourne Business School, University of Melbourne.