New Paper: Information Asymmetries in Pay-Per-Bid Auctions

I'm happy to announce a new paper that answers, among other questions, how I spent a huge chunk of my winter holiday break. The paper is by me, John Byers, and the graduate student we're co-advising, Giorgos Zervas, and is entitled Information Asymmetries in Pay-Per-Bid Auctions : How Swoopo Makes Bank (arxiv link, pdf). As you might guess from the title, the paper is about pay-per-bid auctions, the current popular example of which is Swoopo, which you might want to examine if only for cultural awareness. (Besides the Swoopo site, you can read a bit about Swoopo from major news sites here and here.) The trick in pay-per-bid auctions is the seller doesn't make the big money on the final item price, but on the bids themselves, which have a cost. The paper was a lot of work, but it was also a lot of fun both to work on and write; hopefully some of you will find it nearly as fun to read. The full version right now is about 40 pages; a shorter version will be submitted to EC 2010 next week. Our abstract provides a good opening description:

Innovative auction methods can be exploited to increase profits, with Shubik's famous "dollar auction" perhaps being the most widely known example. Recently, some mainstream e-commerce web sites have apparently achieved the same end on a much broader scale, by using "pay-per-bid" auctions to sell items, from video games to bars of gold. In these auctions, bidders incur a cost for placing each bid in addition to (or sometimes in lieu of) the winner's final purchase cost. Thus even when a winner's purchase cost is a small fraction of the item's intrinsic value, the auctioneer can still profit handsomely from the bid fees. Our work provides novel analyses for these auctions, based on both modeling and datasets derived from auctions at Swoopo.com, the leading pay-per-bid auction site. While previous modeling work predicts profit-free equilibria, we analyze the impact of information asymmetry broadly, as well as Swoopo features such as bidpacks and the Swoop it Now option specifically, to quantify the effects of imperfect information in these auctions. We find that even small asymmetries across players (cheaper bids, better estimates of other players' intent, different valuations of items, fully committed players willing to play "chicken") can increase the auction duration well beyond that predicted by previous work and thus skew the auctioneer's profit disproportionately. Finally, we discuss our findings in the context of a dataset of thousands of live auctions we observed on Swoopo, which enables us also to examine behavioral factors, such as the power of aggressive bidding. Ultimately, our findings show that even with fully rational players, if players overlook or are unaware any of these factors, the result is outsized profits for pay-per-bid auctioneers.

Here's a bit more description. As a starting point, there have been a few working papers that present essentially the same basic equilibrium analysis of Swoopo auctions. A problem is that the analysis results in zero profit for Swoopo, and it's easy to check that, instead, Swoopo appears to be raking in the bucks. The working papers offer some possible solutions, but they seemed (to us) fairly unconvincing.

Our starting point was looking at the assumptions of the model, which require remarkable symmetry: the players all know how many other players are in the auction, they all have the same value for the item, and they all have the same cost to make a bid. We argue that in practice none of these assumptions are viable, and in fact there are huge asymmetries (particularly asymmetries in information) that throw off the basic model. A fun example is that if some players pay less to bid than others, and the others don't know or realize that, the profit in a pay-per-bid auction grows. So auction sites can (potentially) make money by giving some people a cheaper price for bids! Analyzing these asymmetries, we find huge profit potential for pay-per-bid auctioneers that may explain Swoopo's profitability. We also consider the very interesting Swoop It Now feature, which lets users turn bids in a lost auction into a down payment for the auction item, and show how it can naturally lead to Swoopo auctions turning into games of chicken -- which also seems to benefit Swoopo's bottom line.