Why we do what we do on eBay

Economists mine the online auction site to find out why shoppers act irrationally.

In the 12 years since eBay's launch, the online auction house has established itself as a one-stop shop for all things rare, kitschy, and collectible. But recently, a small group of economists have mined the site for a different prize: clues on how people spend their money.

Behind the millions of online auctions lies a virtual mini-economy flush with raw data. Harvesting this information has fed a new branch of economics, one that has proved again and again that shoppers act in unexpected ways.

Auctions can be hard to predict. Various items, be they ancient coins or next-generation electronics, can inspire odd behavior in buyers.

Late last year, crowds waited for days outside retail stores to buy the new Play­Station 3 video-game system. Many of those in line then sold the $600 machines on eBay for thousands of dollars.

But when Apple's iPhone drew similar crowds last month, resale prices on eBay were rather flat.

This unpredictability makes research difficult. After all, how do you quantify fashion? Or translate passion into a line chart?

Hoping to squelch this X-factor, Ulrike Malmendier, an economist at the University of California at Berkeley, tracked auctions of common items – things readily available online or in stores but offered on eBay at a discount.

Most economists assume these kinds of auctions are largely immune to the passions and unpredictabilities of ravenous bidders, she says. Simple bargain hunting, they hope, would bring out our inner homo economicus, someone who acts in their self-interest to get the best deal possible.

No such luck, she says.

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 percent of the auctions the bidders ended up paying more than the 'buy it now' price," Malmendier says.

"This is really huge. It's far more than I could have expected."

Confused, the team tried a larger sample – this time observing thousands of iPod auctions. In that case, 45 to 50 percent of eBay auctions exceeded the "buy it now" price, she says. Expanding the pool again, they found that the quirk affects expensive and cheap items, men's cologne and women's perfume, and books by liberal Sen. Barack Obama and by conservative commentator Bill O'Reilly. The Romans had a term for this auction-house "curse," Malmendier says, "They called it calor licitantis – bidder's heat."

Before eBay, economists had few ways to test their theories about auctions. They could recruit and test volunteers, but that often meant subjects already knew they were being watched. Some experiments in the mid-1990s involved digital auctions on primitive Internet message boards. But the pool of potential bidders was too small back then to draw any broad economic conclusions, says Tanjim Hossain, an assistant professor at the Hong Kong University of Science and Technology.

Now, thanks to eBay, economists can watch and document this 2-­millennium-old idea play out.

"The wonderful thing about eBay is it lets us ... participate as a buyer or a seller – and whoever is on the other side is unaware," says Professor Hossain. "EBay has succeeded in becoming a true bazaar, bringing buyers and sellers from all walks of life."

This grand variety of personalities and preferences has created near real-market conditions, he says. Better still, the site catalogs everything. Easy access to the who, what, and when makes distilling the why much easier.

Bidders disconnect shipping, price

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 percent more money.

"There are a number of ways to explain this," says John Morgan, of UC Berkeley, who cowrote the study, "but my favorite is that people have two different budgets in their head: how much I'm willing to pay for the item, and how much I'm willing to pay for shipping."

If the shipping cost isn't too high, many buyers will start bidding and forget to calculate shipping into the final price.

Retailers have exploited this mental disconnect for decades. Online, some auctioneers have even tried to bury shipping costs deep in an item's description so that casual bidders will overlook the fee. (EBay recently made this questionable practice, known as "shrouding," much harder to pull off.)

Hossain and Mr. Morgan tinkered with the mechanism on Yahoo's Taiwanese auction website. The pair auctioned iPods with a mixture of starting prices, shipping fees, and shrouding techniques. They discovered that hiding extra fees amid all that fine print did not always result in a higher sales price. In fact, average revenue was 3 percent lower when an auction shrouded the shipping fees than those that did not. They found a similar result when comparing hidden-fee items sold before eBay's antishrouding redesign with items auctioned after the change.

There's no theory to explain this wrinkle, but Hossain takes comfort in the findings.

"This is a puzzling result and, in some sense, a happy result," he says. "It shows that making prices – and fees in other application, such as banks' charges [on a credit card application] – more transparent may actually be beneficial to sellers on average."

Best time to close an auction

Another study challenges commonly held beliefs on when to close an online auction. Many eBay-for-beginners books alert sellers that online bidding spikes as the workday ends on the East Coast and holds strong until the West Coast goes to bed. Guidebook wisdom suggests that smart sellers time their auctions to end during those rush hours.

"You would think it's a good idea, but it's in fact counterproductive," says Uri Simonsohn, a behavioral economist at the University of Pennsylvania. He compared the proportion of bids filed each hour to the proportion of auctions ending each hour. Yes, the number of bids jumps, but Mr. Simonsohn found that the share of auctions soared even higher.

"Sellers have outwitted themselves," Simonsohn concludes. "They think they are smart, but really they don't know that everyone else thinks they're smart, too."

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Advice for buyers and sellers on eBay

Tips for sellers
• Set low opening prices. When choosing between identical items, buyers seem to favor whichever auction has the most bids. The best way to grab early bids: Start with a cheap price. By the time a $1 DVD auction reaches $10, it will probably attract more newcomers than a DVD that started at $10.
• Don't use secret reserves. A study of online auctions with and without hidden minimum prices showed that many buyers steer clear of items with a secret opening price. It’s like that old shopping joke, "If you have to ask how much it costs, you can’t afford it."
• Stick with eBay. Research into various different auction websites revealed that eBay attracted almost 60 percent more bidders and 30 percent higher prices than identical items on Yahoo’s online auctions. Unable to keep up, Yahoo shut down its US auction site last month. But in countries where Yahoo is dominant, it enjoys similar results.
For buyers, it's about timing
Since eBay uses second-price auction rules – where the highest bidder has to pay only the second-highest bid plus an extra fee – the site's official guide suggests bidding your maximum offer right off the bat. Then you can relax. As others join in, your maximum bid remains hidden and the site automatically (and incrementally) outbids the next-highest offer. If someone outbids your maximum, that's OK. It’s clearly worth more to that person than it is to you.

But Ken Steiglitz, author of "Snipers, Shills and Sharks: eBay and Human Behavior," says that's "disconcertingly naive." An early offer attracts competition, he says. Studies show that the more bids an item gets, the more likely it is that other bids will follow. So even if no one else tops your maximum bid, the second-highest bid could rise significantly. Mr. Steiglitz's advice: "Bid late. The first few weeks of an auction mean nothing.... It's all about what happens in those last few seconds."

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