In “Deal Maker: Lessons From the Blind Master Negotiator” (Authourhouse.com) the authors present five different approaches to negotiation.
All these methods, however, have the potential to end up in court or before an arbitrator or mediator. “A stitch in time saves nine,” goes the proverb; which is to say that prevention is better than cure. Mediation and arbitration are costly. They present the most palatable choices from a set of unpleasant options. The science of business largely being the elimination of waste and inefficiency, would it not be better to prevent the need for dispute resolution by employing a better market mechanism to determine price and consummate a sale? Auctions are a way to do this.
The term auction is derived from its ancient root “auctio”, which means increase. Auctions are time-honored traditions by which cultures find a fast and efficient method for determining fair market value. An auction is the purest of markets. A seller wishes to obtain as much money as possible. A buyer wants to pay as little as necessary. The auction method, when it succeeds in attracting interested, qualified bidders into competition, ensures that resources accrue to those who value them most highly (a given buyer) and it ensures that a seller will receive the collective assessment of the auctioned item’s value (the marketplace’s opinion as expressed in price or the winning bid). Auctions work because they bring the largest number of suitors into competition for a given prize. Competition being the mechanism by which the marketplace derives the best price and the most efficient allocation of resources, price is maximized.
Maximizing price is desirable from the seller’s point of view, but it is not the goal of a sale. Maximizing net profit is the true goal of the seller. A seller that intelligently constructs auction conditions can maximize net profit by precluding conditions that would lead to buyer’s remorse and/or lawsuit. After all, the seller sets the rules and the type of auction to be used. Just as auctions are useful for reaching maximum price when selling a commodity of undetermined quality or value, so, too, do they help achieve maximum utility when constructed in a way that means that no one is going to end up in court or in mediation chambers.
“Wait a minute,” we hear you say. “Don’t I, the arbitrator (or mediator), put myself out of a job when I recommend a person go the auction route?”
The answer is no.
Auctions still have need of a third party: the auctioneer. An auction is unusual in that, unlike other methods of selling, generally the auctioneer doesn’t own the goods being sold, but acts as an agent for someone who does. The coin of the realm will pass through the hands of the third-party arbitrator or mediator (now termed auctioneer), just as it does when considering a conventional sale after things have gone badly. It is just that in the case of the auction the third-party is engaged beforehand, not afterwards. What’s more, instead of getting in on just the percentage of deals that go badly, the auctioneer can have a hand in all the deals brought to market using this method. All the deals, pre-acrimony; not just the percentage of deals full of pent rage after they’ve soured. Doesn’t this sound more pleasing to the auctioneer/arbitrator/mediator?
What duty does the auctioneer have in order the he or she justify compensation? In a price negotiation, each bid and counter-bid is considered separately, but in an auction the competing bids are offered almost simultaneously. (In order that price is maximized on the seller’s time-table, an auction can be held over a period of time to enlarge the window of opportunity by which to attract a buyer. In real estate this is known as the time interval auction.) The auctioneer’s fiduciary duty, besides promoting the auction in order to assure as many bidders are present as possible, is to see to it that all the bids are qualified and treated fairly. The auctioneer may also render value to the client by ensuring that, in the event of the “winner curse”, there is no recourse to lawsuit. (In the winner’s curse, winners are faced with the sudden realization that their valuation of an object is higher than that of anyone else. Eliminating the need for legal recourse, and the option of it, through a well-constructed auction is a savings of time and money. Hence, a stitch in time.)
Now then, how to build an auction so that it efficiently finds the highest bidder while avoiding disputes? Follows below a discussion of a variety of commonly used auctions, as well as list of other, lesser known variants:
The English auction is the format most familiar to Americans. It is sometimes also known as the open-outcry auction or the ascending-price auction. In it, the auctioneer begins with the lowest acceptable price (the reserve price) and proceeds to solicit successively higher bids from the customers until no one will increase the bid. When the auctioneer receives no more bids, the item is ‘knocked down’ (sold) to the highest bidder. The drawback to the English auction is that often a successful bidder acquires an object for considerably less than his maximum valuation simply because he need only increase each bid by a small increment. In other words, the seller does not necessarily receive maximum value. Here, again, is an opportunity for the neutral third-party to provide value to the client by moving the price up rapidly enough to incite passion and high enough to maximize price.
The Dutch Auction
The Dutch auction uses descending bidding, rather than ascending bidding. (A special note about Dutch auctions: the financial world has chosen to refer to another type of auction as the Dutch auction. In the financial world, the auction known as “Dutch” is what is referred to in the academic world as a uniform, second-price auction.) Another primary characteristic of the Dutch auction is that of bids being sealed (not open-outcry like the English or Dutch varieties) and thus hidden from other bidders.
First-Price, Sealed Bid*
In a first-price, sealed bid auction the winning bidder pays exactly the amount he bid; as opposed to the second-price auction which we will examine shortly. Bid preparation is especially important to the first-price, sealed bid auction. Here, again, is a way for the auctioneer to provide value. (*The financial community refers to this type of auction as an English auction, except in Great Britain where it is known as the American auction!)
The uniform second-price auction is commonly called the Vickrey auction, named after William Vickrey, winner of the 1996 Nobel Prize in Economic Sciences. In the second-price auction, the item for sale is awarded to the highest bidder at the price equal to the second-highest bid. In other words, the winning bidder pays less than their highest bid. To make sure this is clear, test yourself:
Who is the winner in this second-price auction?
What did the winner pay? (Answer at bottom.)
When auctioning multiple units in a second-price auction, all winning bidders pay for the items at the same price as the highest “losing” price –that is, the winning bid (a.k.a. the second-highest bid submitted).
In a double-auction sellers and buyers submit bids and bids are ranked highest to lowest. A commodity is exchanged by matching selling offers (starting with lowest price and moving up) with demand bids (starting with highest price and moving down).
Other Auctions for Study
In any of the forms of auctions discussed in this article, the seller is well served to consider the form of auction he or she wishes to employ. This decision should take into account the type of item being sold, and the best method and rules to will eliminate the winner’s curse if they wish to sell items at auction on future occasions. (After all, bidders who purchase at auction and feel that they have somehow paid too much unfairly are likely to spread the word and decrease the supply of future bidder.) The correct choice can be made with the help of the professional auctioneer.
The literature abounds with cogent treatments on bargaining styles, negotiation styles, bargaining types and negotiation types. In “Deal Maker: Lessons From the Blind Master Negotiator” we posit the benefits are substantial for the bargainer and the negotiator who consider the approach they should take to the bargaining session and the negotiating session well in advance of the actual sessions. The same principle applies to auctions.
(Second-Price Auction Answer: C is the winning bidder and pays $15.)