The Winner's Curse
A quick word first
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We have a winner . . . sort of
The Jazz of Negotiation sealed-bid auction for a jar full of coins closed Sunday at midnight. Its aim was to collect data illustrating parallels between negotiation strategy and auction tactics. My thanks to Jazz readers who submitted bids, especially those who spelled out how they analyzed the exercise. (I’ve quoted several of them here.)
No worries if you didn’t have a chance to take part. The task was figuring out how much to bid given that you don’t have a clear idea of the jar’s value. It was as simple—and complex—as that.
The bids were all over the map. (No surprise for me, as that’s always the case when I do this exercise in class.) The median was $25.75, with a wide distribution on both sides of that number. The lowest two bids where $5.00 and $5.37. There was a long tail on the other side with bids in the $40’s, $50’s, and $60’s. Ultimately, the top bid was (drumroll, please), $101.36.
That gets us to the “winner’s curse.” The value of the coins was (another drumroll) $21.62. The top bidder could have been obliged to cough up almost five times what the coins were worth.1
Winning in an auction requires that you pay more than anyone else in the room thinks the item is worth. In other kinds of auctions, the winner may be the person with the deepest pockets. But here, where the prize was money, there was no economic incentive to pay more than the estimated value of what was in the jar.
Also, everyone was on the same footing, looking at the same photo and knowing the jar’s dimensions. Some people just guessed. Others, however, did some research to narrow the uncertainty. For example, Daniel Rosan, commented:
You know the internet can help you find anything. (See Lifehacker.) I assumed an equal distribution of pennies, dimes, nickels, and quarters; assumed no larger coins (as those are rare), and got an answer of $30. I then discounted that to account for some risk. I think most people won't go through the effort to do this exercise so a discount may still allow me to win (and if I don't win, I don't care that much).
Daniel’s risk adjustment brought his bid down to $22. As it happened, that still left him on the high side by $1.38, but he was far less exposed than those who bid several times that figure.
Other factors can come into play in bidding. Special knowledge, for example. If you’re at an auction and spot an unsigned Picasso that others don’t recognize, go for it. The same for an object that has sentimental value special to you. I didn’t expect that here, but was amused and flattered by a comment by Jillian Hirasawa who bid $40. She said, “Estimate jar worth about $15 but getting a note from Prof. Wheeler is worth the extra $25.” (I responded with a thank you note. No charge, of course.)
It comes down to this. Bidding is a matter of balancing risk and reward.
The higher you bid in auctions like this, the greater your chances of having the winning bid.
The higher you go, however, the greater the chance of overbidding.
Aggressive bidding usually pays off only if you have knowledge that other people lack.
Successful bidders at auctions can feel first a wave of exhilaration at besting their competition. But that can morph into worry that they’ve overpaid. Likewise in negotiation, both buyers and sellers can feel satisfaction at closing a deal yet have lingering discomfort that they might have done better. The fact is, that’s always hard to know.
Flipping an auction into a negotiation
One of the bidders, Nicole Watkins Campbell, nicely summed up this exercise:
“The principles for this and house-buying are similar: you don't know the real worth of your potential purchase (what house doesn't have hidden trouble or treasure?), and you don't know what others will offer.”
Uncertainty is inherent in negotiations and auctions alike. If you’re the least informed buyer in either setting, you’ve set yourself up to overpay. Real-time learning is a must.
Controlling the process, to the extent you can, is also important in both settings. On that point, a special shout out to Abhishek Gupta, writing from Singapore with an apparent bid of $60. He turned the tables on me with clever twists.
Mr. Wheeler, I know this does not have $60 in there, but the cost and added complexity of sending this to Singapore (where I live) is going to be huge for you. Not to mention the challenges with having to explain why you are mailing currency overseas (not allowed by the law). I have a middle ground for you. If I do end up being the highest bidder, you can announce me as the winner and let me pay equal to the 2nd highest bidder minus what is in the jar. You get to keep the jar and save yourself a trip to the post office! I get bragging rights for an amount smaller than $20 - worth it for both of us!
Did you spot the four things he did brilliantly?
First, he put in a high number hoping secure first place. But second, he pulled that back, saying he’d actually pay the amount that the second highest bidder offered, which might have been lower than his $60. (That second bid would no better and no worse than what I could do with anyone else.) And third—for his closer—he proposed a middle ground that would serve well our respective interests.
Finally fourth, here’s the kicker: He got his bragging rights without having to spend a penny. Well done, Abhishek!
Housekeeping
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I exorcised the top bidder’s curse by sending him the following note:
Hi,
Congratulations for winning the auction for the coin jar! Condolences, as well, since the value of coins is significantly lower than your bid of $101.36 . No need to wire me money, though. If—and only if—you’d like, you can make a contribution to a local charity in honor of my great-grandfather, who emigrated from your country and settled here in 1863. I was named after him and live three miles from the house that he built.
Warm regards, Mike