Rational Bidding in eAuctions

October 3, 2013

Alan Holland

Auction technology providers have a duty of care to buyers and their bidders to ensure that Auctions do not encourage irrational bidding that could lead to contract failure. We discuss some design issues that need to be considered during suchThere's a famous result in Economics called the 'Revenue Equivalence Theorem' that states that the expected result across various types of single item auctions (English, Dutch, Japanese, Sealed-Bid etc) is the same when bidders are rational. But this result relies on bidders being rational and knowing when to walk away. In cases when bidders are irrational then hyper-competitive or spiteful bidding can produce seemingly attractive outcomes for the bid-taker but may be likely to fail.Encouraging Rational BehaviorWhilst the mechanisms available to dissuade irrational behavior cannot guarantee responsible bidding, certain provisions within the auction design can help encourage thoughtful and considered responses.      Round timing & extensions    It's important to strike a balance between speed of progress and rushing people into decisions. For that reason, we advise that ample time for bidding be offered but bidders can hit a button to signify they are finished when complete. If all bidders are finished, then progress can be made quicker but if someone needs more time then we wait.        Bidder Identities    On occasion, competing bidders have poor relations. To dissuade spiteful bidding, it is preferable to ensure that bidders identities are not revealed.        Weighting Cost and Non-Cost Objectives    Even across highly commoditized items there can be some differentiation in service levels such as lead-times, administrative efficiency etc. It may be desirable to consider offering some preferential advantage to higher scoring bidders so that they can ease their price competitiveness and not be forced into accepting uncomfortably tight margins that could lead to a deterioration in service levels.        English Vs Dutch Auctions Vs Sealed Bid    The timing element in Dutch Auctions can sometimes induce a panic bid and this is to be avoided because it often results in a contract failure. More time is allowed in English Auctions and yet more time again in Sealed Bid environments. Thus, risk managers would encourage avoidance of Dutch Auctions for items that are sensitive.        Package Bidding    By allowing bidders to be creative and communicate efficiencies across more specific packages (or Lots) in a Multi-Lot Auction, bidders may feel that they are playing to their strengths and allowed find a higher margin outcome that leads to increased efficiency for the buyer also.  Summary

Auction Technology providers have an onus to support responsible auction designs and there are some levers for doing so. But education is also an important aspect here. Game Theory and Mechanism Design tends not to be taught as part of strategic procurement courses, but this topic is at the heart of efficient trade, and that it is important to understand the strengths and weaknesses of the various approaches. More people need to understand why certain behaviors arise in certain competition formats and what can be done to find efficiencies but steer clear of irrational bidding behavior.

Dr. Alan Holland is the CEO and Founder of Keelvar

Image: Flickr StockMonkeys

Move Forward with the world’s fastest growing strategic sourcing platform and transform your sourcing process today.
Request demo