Sealed Bid Auctions

Loading...

From the course by University of Virginia

Cost and Economics in Pricing Strategy

179 ratings

University of Virginia

Cost and Economics in Pricing Strategy

179 ratings

Course 1 of 4 in the Specialization Pricing Strategy Optimization

How much should you charge for your products and services? Traditionally, businesses have answered this question based on the cost to produce or provide their goods and services. This course shows you the economic factors behind pricing based on cost and the pros and cons of a cost-based pricing approach. Led by Darden faculty and Boston Consulting Group global pricing experts, the course provides the practical and research-based models and methods you need to set prices that maximize your profits. By the end of this course, you’ll be able to: --Apply knowledge of basic economics to make better pricing decisions --Recognize opportunities for price discrimination—selling the same product at different prices to different buyers—and recommend strategies to maximize sales and profits --Calculate three types of price elasticities to determine the impact of price on demand --Analyze and apply different pricing models -Cost-plus pricing -Marginal cost-plus pricing -Peak-load pricing -Index-based pricing --Evaluate the impact of channel intermediaries and customer lifetime value on pricing

From the lesson

Pricing Fundamentals

Welcome to the first week of Cost and Economics in Pricing Strategy course! We'll begin our study of pricing by looking at some basic economic principles relevant to pricing, such as cost and cost variations and what that implies about the supply curve. Then we'll take a closer look at one pricing mechanism: auctions. You will never look at eBay the same!

Auctions as a Pricing Mechanism3:24

English Auctions3:21

Dutch Auctions3:21

Sealed Bid Auctions6:09

B2B Auctions7:36

Meet the Instructors

Jean Manuel Izaret
Senior Partner and Managing Director, Leader of BCG’s Global Pricing Practice
Thomas Kohler
Associate Director, Pricing
Marketing, Sales & Pricing Practice
Ronald T. Wilcox
NewMarket Corporation Professor of Business Administration & Senior Associate Dean for Degree Programs
Marketing

Now the first two auction types I talked about, English auctions and

Dutch auctions, are what are called open auctions.

Everyone just sits there and kind of submits their bid, and

then kind of look around them.

And maybe even make guesses about other people that might bid against them and

what they might bid, right?

That certainly happens in those kinds of auctions.

There are other types of auctions that are called sealed-bid auctions.

In those situations,

bidders submit their bid independently and they're not privy to the other bid values.

So you can imagine it, literally writing down how much you're bidding on something,

sealing it in an envelope, turning it into the auctioneer, and

then the auctioneer opens all the envelopes.

Now in the real world, of course, you may not have to put it in an envelope, but

that's kind of the way you want to think about it in your head.

So you really don't know what's going on.

You may not even know how many other bidders there are.

So there's a couple of different types of sealed-bid auctions.

A first-price sealed-bid auction, where the highest bidder wins, and

a second-price sealed-bid auction, where the highest bidder also wins but

doesn't pay the amount that they wrote down.

They pay the second highest bidder's bid.

Now recall from just a little while ago,

that's what I put you through when you did the auction pricing for the $20 bills.

I had you do a first-price sealed-bid auction for that $20 bill, and

I had you do a second-price sealed-bid auction for that $20 bill.

And I said, I generally make more money on the second-price sealed-bid auction.

So let's bore down into that a little bit and find out why that's the case,

and maybe when first-price may be better than second-price and vice versa.

So let's consider a simple example.

So we have four people, Bob, Raj, Sally, and Nora.

And the blue bar on the graph in front of you shows the actual value they have for

the item that they're biding on.

Now, of course, they're not telling you what their actual value is.

They may just know this in their head, right?

Now suppose they’re putting in a bid for a first-price sealed-bid auction.

They're not going to bid their full private valuation of the item.

They're going to bid a little bit less than that,

hoping they can get a deal on the item.

So the orange bar in front of you is kind of what they might put in as a bid.

So in this case, Nora bids the most, she has the highest valuation.

But she doesn't bid all the way up to her $4 valuation, and so

forth for each of these individuals.

Now what happens in the outcome?

Nora's going to win, but she's not going to pay $4.

She's going to pay something like $3.20 because her bid is the highest,

but there's a gap.

She gets sort of 80% surplus, $4 minus 3.20,

because she had an incentive to shave her bid down.

Now if we had the same private valuations but asked them to go through

a second-price seal-bid auction, everyone would bid their full private valuation.

I mean, why not?

You know you don't have to pay what you bid.

So you might as well bid your full private valuation in that situation.

Now, with these underlying preferences or

underlying valuations, Nora would still win.

She would bid $4, but she would pay what Sally bid, which is $3.

Now, if you notice, what happened here is that the first-price sealed-bid auction

actually yielded more money for the sellers than the second-price

sealed-bid auction, for this particular circumstance.

So, right, first-price beats second-price.

Now let's look at one other situation, okay,

that I think will illustrate the differences between the two auction types.

We have Bob, Raj, Sally, and Nora, again.

But this time, I've changed their private valuations.

So they range kind of in the $2 range, but

there's not much variance in their private valuations.

Look, before there was quite a bit of variance.

They range from $1 all the way up to $4.

In this case, it's much less than that, right, just in that $2 range..

If we put them through a first-price sealed-bid auction, what will they do?

Of course, they'll shave their bids down just a little bit.

And Nora will win and she'll get the item for

something like $2 and, let's say, 8 cents.

However, if we put them through a second-price sealed-bid auction,

what happens?

The left hand side is scaled a little bit differently, so don't let that fool you.

What'll happen is they'll bid their full private valuation.

Nora will win and pay Sally's valuation or bid.

In this case, Nora will win and pay $2.50.

Notice that in this particular example, the second-price sealed-bid auction

yielded more money for the sellers than the first-price sealed-bid auction.

Why was that the case?

Well, first-price works well when there's a lot of variance in the private

valuations.

And the reason that's the case is because if there's a lot of variance,

the difference between the value of the person who values it the most and

second most might be quite large.

So if you do a second-price sealed-bid auction, that first person,

the person that values it the most, is going to get it for

the second highest bidder's valuation.

That gap could be very large and you're giving away a lot of money.

However, if there's less variance in the underlying valuation,

that means Nora and Raj's valuations are very close to each other.

So even if the highest bidder gets it at the second highest bidder's bid,

the bids won't be very far apart, so you're giving up less money.

At the same time, you're incentivizing each of the bidders

not to shade their bid down, but to bid their full private valuation.

So that second-price sealed-bid auction generally does well in those

low variance situations.

And one of the low variance situations was that $20 bill, right?

In fact, the variance on the value of that is absolutely zero,

and that's why you make more money on a second-price sealed bid

auction when you're auctioning off that $20 bill.

Explore our Catalog

Join for free and get personalized recommendations, updates and offers.

Coursera provides universal access to the world’s best education, partnering with top universities and organizations to offer courses online.

© 2018 Coursera Inc. All rights reserved.

Download on the App Store

Get it on Google Play