28 Feb 2005  Research & Ideas

How to Harness Auction Fever

HBS assistant professor Deepak Malhotra talks about the phenomena of "auction fever" in which bidders are driven to win at irrational costs.

 

Want to create a high-profit auction? One strategy is to create "auction fever" around your sale by generating lots of hype, having strict rather than flexible deadlines at the end of auctions, and making sure winners and losers are visible to participants, says Harvard Business School professor Deepak Malhotra. "These might all increase the likelihood of overbidding due to auction fever."

This research comes from a recently published paper, coauthored with Gillian Ku, "Towards a Competitive Arousal Model of Decision Making: A Study of Auction Fever in Live and Internet Auctions" currently in press in the journal Organizational Behavior and Human Decision Processes.

Malhotra says the research carries lessons for business people who bid on everything from services to new employees. "Individuals (managers, executives, and so on) should be wary of the consequences of competitive arousal and of wanting to win at any cost." In this interview, Malhotra provides tips for doing just that.

Manda Salls: Your paper opens with the unexpected money raised—over $3 million—in a "Cows on Parade" auction of "art cows." Can you tell us a little about why this sale surprised the auction community?

Deepak Malhotra: Auctioneers are often able to predict selling prices pretty accurately. In this particular auction, actual prices were approximately seven times initial estimates. Furthermore, the cost of producing the items was well known.

On the other hand, the items were unique in that such an auction had not taken place in the past. This was about to change: The striking results of the Cows on Parade led to a number of copy-cat auctions around the country.

Q: Briefly explain the difference between winner's curse, escalation of commitment, and what you call "auction fever." How are these phenomena related?

A: The phenomena are related in that they lead to a similar outcome: overbidding in auctions. That is, any of these might lead to an auction participant bidding higher than the value of the item up for bid.

The phenomena differ in that each proposes a different underlying mechanism:

  1. The winner's curse is an information story. When bidders lack perfect information regarding the true value of an item, they must act on whatever "noisy signal" they have regarding the true value. The highest bidder wins, but because the average bid is probably the best estimate of actual value, the winner will likely have overpaid.
  2. The escalation of commitment is a self-justification story. Even if bidders have perfect information regarding the value of an item to them, if they have invested a lot of time, effort, or money in trying to acquire the item, they may continue to bid past their initially set limit. To quit before "winning" makes it difficult to self-justify initial investments in pursuit of the item.
  3. Competitive arousal—or the mechanism underlying "auction fever"—is an emotion story. A number of factors can lead to emotional arousal in the context of an auction (or any other competitive situation). When this happens, bidders may want not only to purchase the item, but also to beat the competition. In other words, competitive arousal can lead to a "win at any cost" mentality. There are a number of factors that might increase arousal in an auction. For example:
    • Rivalry (when it's down to just you and one other party).
    • Social facilitation (when others are watching).
    • Time pressure.
    • Hype (when the auction has received a lot of press or attention).

Q: Do people who frequently go to auctions experience a lessening of these effects? Are there certain types of people who are more susceptible to getting caught up in the moment?

A: We found no difference in the degree of overbidding between those who participate in auctions often and those who might be considered novices. We can only speculate with regards to the types of people who might be most susceptible to the effects of competitive arousal.

For example, those who are highly emotional, highly competitive, or highly impulsive might be more susceptible. Also, those who are apt to take things personally (e.g., those who might take a competitor's bid to be a personal attack), and those who are highly sensitive to what others think of them, might fall prey to the effects of competitive arousal. Finally, those who are well-prepared and have a game plan when they enter an auction may be able to avoid auction fever.

Q: What would you say to a business that wanted to harness auction fever? In other words, what can someone running an auction do if they want to maximize the money raised at an auction?

A: Our study suggests that increasing the hype around the auctions, having strict rather than flexible deadlines at the end of auctions, and creating an audience for the auction to make winners and losers visible, might all increase the likelihood of overbidding due to auction fever.

Individuals should be wary of the consequences of competitive arousal and of wanting to win at any cost.

In addition, anything that might make rivalry salient (e.g., the auctioneer using language that suggests to the final two bidders that this is about "winning" and not "being beaten") might also increase competitive arousal.

Q: What differences did you find between live and Internet auctions?

A: We found that the propensity to overbid was not different between these two auction formats, but that when bidders overbid, they do so by larger amounts in live auctions. This suggests that social facilitation (i.e., the presence of an audience) might be at work.

Q: This research touches on sunk cost and some related business theories. What are the implications for decision making in other business contexts?

A: The obvious implications are with regards to the many types of auctions in which businesses participate. For example, companies bid for consulting projects, firms bid for acquisition targets, and organizations of all types bid for employees—executives, highly skilled salespersons, and so on.

More generally, the research may be relevant to any competitive decision-making context. For example, businesses that compete in a particular industry or region may find that they are motivated not only by the desire to make a profit and to sustain viability and profitability, but also by the desire to beat their rival. Indeed, the language with which competitors are often described or referred to internally suggests that they are seen not simply as competitors, but as enemies.

In all of these contexts, individuals (managers, executives, and so on) should be wary of the consequences of competitive arousal and of wanting to "win at any cost." Furthermore, managers and executives might try and diminish the likelihood of such consequences by making decisions when there is less time pressure, in which the decisions are not highly visible to evaluative others, and more generally, when the real costs and benefits of "winning" have been carefully considered.

Q: What other research are you working on?

A: Much of my research is on issues related to trust and trust development. In particular, I study barriers to trust development, and how individuals and organizations might overcome these barriers. For example, I study the pernicious effects of contracts and of real options on trust development. I am also working on a framework that might help organizations diagnose and solve the various types of trust problems that they face internally and externally.

I also study issues related to international and ethno-political conflict (e.g., the effects of terrorism on the prospects of negotiation, the determinants of support among the masses for negotiated peace agreements, and so on).

[ Read the paper ] (Harvard users only)
Ku, Gillian, Deepak Malhotra, and J. Keith Murnighan. "Towards a Competitive Arousal Model of Decision Making: A Study of Auction Fever in Live and Internet Auctions." Organizational Behavior and Human Decision Processes.