9781118041581

Bidder Strategies 677

It is also interesting to compare the Dutch auction and the sealed-bid auc-

tion. In the latter, buyers submit sealed price bids, and the highest bidder wins

the item at his or her bid price. The two auctions appear to be very different

in form, but as some simple reasoning can readily show, the two methods are

strategically identical for bidders. In each auction, a buyer must choose how

high to bid (or how low to let the price drop), trading off the probability and

profitability of winning. Holding a given reservation value and facing the same

set of rivals, any buyer should make the same bid in either auction. After all, a

Dutch bidder could just as well write down its bid-in price beforehand. If all bid-

ders did this, the Dutch auction could be run as a sealed-bid auction: Prices are

“opened” and the highest-price buyer obtains the item at its bid-in price. In

short, the Dutch and sealed-bid auctions are expected to induce identical bid-

ding behavior and, therefore, to generate identical expected sale prices.

Flower sales in Amsterdam occupy the pinnacle of the Dutch auction.

Auctions take place in a building roughly the size of 10 football fields. Each day

thousands of lots of flowers are brought for sale before hundreds of bidders occu-

pying steeply tiered seats in separate auction halls. To expedite sales, prices are

displayed on the hand of a computerized “clock.” The price descends with the

downward counterclockwise sweep of the clock hand, and buyers bid by pushing

a button that stops the hand and automatically records the sale price. Sales are

completed at the rate of 600 transactions an hour (one every six seconds).

Flowers for sale come not only from Holland but also by air from Europe, Israel,

Africa, and parts of Asia. Upon sale, the flowers are shipped to Canada, the

United States, and scores of other developed countries.

Sealed-Bid Auctions

Sealed competitive biddingis frequently used to sell unique items: certain

antiques, real estate, oil leases, or timber and mineral rights by the U.S. govern-

ment. Submitting a bid in a sealed-bid auction is a classic example of decision

making under uncertainty. Each bidder faces a fundamental trade-off between

the probability and profitability of winning. In raising its bid to purchase an item,

the company increases its chances of winning but lowers its profit from winning.

(Similarly, in a competitive procurement, a lower price increases a supplier’s

chance of being selected but reduces its potential profit.) Given this trade-off, it

is natural to ask, What bid will maximize the bidder’s expected profit?

STRATEGY AGAINST A BID DISTRIBUTION The key to formulating a profit-

maximizing bidding strategy is to anticipate the distribution of competing bids.

Obviously, to win the auction, the firm must beat the best competing bid. If the

firm could predict this bid perfectly, its most profitable bid would be the one

that wins by the smallest margin. But a perfect prediction clearly is impossible;

at best, the firm possesses a probability assessment of competing bids. Based on

this assessment, the firm determines its optimal (i.e., profit-maximizing) bid.

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