Basic Pricing Mechanisms: Auctions
by Rasmi K R
Heard of auctions? Well, it's a market where buyers and sellers enter competitive bids simultaneously. The price at which a stock trades represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to accept. Now you can think of many situations in real life where you have come across an auction, can't you? Livestock market where farmers buy and sell animals is one such example.
If you are a buyer entering an auction, is it always wise to go with the maximum price? Or if you are a seller, would you get satisfied with any bid that a buyer offers? So depending on the type of auctions you are in, you may have to take different pricing strategies. Now it's time to dive deeper into different mechanisms of auction.
Types of auctions
1. English Auctions
2. Dutch Auctions
3. Sealed Bid Auctions
4. B2B Auctions
In English auctions, prices start low and bidders bid them higher up. Usually bidding starts at some price the auction house has already set. And there's often also a reserve price. So if the price doesn't go up beyond a certain amount then the seller reserves the right not to sell it to that individual and to keep the item for himself.
For sellers the advantage is that buyers can become emotionally caught up in the moment and make really high bids. It happens in a situation where people really want the item, so they bid for a higher price.
For buyers, there is the advantage that the winner doesn't pay their full private valuation. Think about this for just a second. The winning bidder doesn't bid all the way up to the maximum amount they're willing to pay. They just bid to beat the second highest bidder's bid.
In Dutch auctions, the prices start high and then come down. For example, the auctioneer starts at $2,000 for an object. The bidders watch the price decline until it reaches a price that one of the bidders accepts.
This bidding is private to the bidder. Everyone submits their own bid. One may not even know how many bidders are participating in the auction. There are two variations for this model: First-price sealed auction and Second-price sealed auction. In first-price sealed-bid auction the highest bidder wins and in the second-price sealed-bid auction, the highest bidder wins but need not have to pay the amount which they wrote down rather they should pay the second-highest bidder's bid.
B2B Reverse Auctions
In a reverse auction, sellers compete with one another to win the business of the buyer. Unlike a traditional auction where buyers are competing to purchase goods and prices go up, in reverse auctions, prices tend to decrease as sellers aim to win over their buyer with the best price they can offer.