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Open-Bid Auctions Offer the Best of Both Worlds

10/1/2007 --

Dual channels, in which identical items are sold online via auctions and posted price at the same time, can increase sellers¿ profits when designed correctly.

ANN ARBOR, Mich.—More business-to-consumer firms seek to boost their total revenues by selling the same or nearly identical products online using auctions (such as those offered on eBay) and fixed prices (posted on company Web sites) simultaneously.

However, a new study by Ross School of Business professors suggests that sellers must make strategic decisions about the design and operation of these parallel selling channels in order to realize the highest gains.

One concern is that by attracting more customers to auctions where goods often sell for less, a seller may reduce the number of deep-pocket buyers who are willing to purchase the same items at higher fixed prices. To increase revenue while controlling for cannibalization of posted price sales, the seller can strategically set the posted price, auction quantity and auction length. The researchers suggest that the choice of auction format also affects consumer buying behavior.

When the seller offers a "sealed-bid" auction, buyers face the "buy or bid" decision only once, upon their arrival to the Web site, and if they choose to bid, they have to wait until the conclusion of the auction to obtain the item. On the other hand, when the seller offers an "ascending open-bid" auction, in which buyers can observe the lowest bid needed to win at every moment, a consumer might face the "buy or bid" decision several times during the auction, with new information available for that buyer each time he or she needs to make this decision, and not only upon his or her arrival to the Web site.

"In a dual channel with a sealed-bid auction, the seller faces a tradeoff," says Hila Etzion, assistant professor of business information technology. "On the one hand, the seller does not want high-valuation consumers to participate in the auction because he wants them to buy at the fixed price. On the other hand, he wants them to drive up the auction price, so that low-valuation consumers are forced to pay more, and the auction generates more revenue."

Etzion and Moore find that using an open ascending-bid auction, combined with posted price, gives sellers the best of both worlds.

"The high-valuation bidders have more opportunities to leave the auction, so a greater number of them buy at the higher posted price," says Moore, associate professor of business information technology. "On the other hand, they also participate in the auction for a period of time, thus helping to push up the prices."

For their study, the researchers developed a simulation model to test the effect of changing controllable factors such as the auction quantity, auction length and the posted price on the seller's revenue. They also compared the performance of two different auction mechanisms (when offered parallel to a posted price) under changing market conditions, i.e., the arrival rate of consumers to the Web site and the sensitivity of buyers to delays in obtaining the desired product.

Their findings show that both dual-channel setups are more profitable than the single channel of only posted price, and that the dual/open regime often performs better than the dual/sealed regime. At their relative best designs, the dual/open generates on average 7.7 percent more revenue, while the dual/sealed returns 6.8 percent more revenue than the single channel with a posted price.

For markets with either a low customer arrival rate at the Web site or a low delay cost, the dual channel with an open-bid auction results in slightly higher average daily revenues. However, for markets with both a high customer arrival rate and a high delay cost, the dual channel with a sealed-bid auction generally gives better results.

"Our simulation shows that the dual/open regime performs close to optimal at the design that maximizes the expected revenue from the dual/sealed regime," Moore says. "This confirms that analytical models of dual channels with sealed-bid auction can be used to evaluate the performance of dual channels with open-bid auctions, and to determine an appropriate design for the latter.

"However, our simulation also demonstrates the large variability in auction results. This suggests managers should be cautious when employing dual channels, because it might take a very long time to observe the benefits."

Written by Claudia Capos

For more information, contact:
Bernie DeGroat
Phone: (734) 936-1015 or 647-1847