Beware the Winner’s Curse in Auctions

The winner’s curse—the tendency for the winning bidder to overpay for a commodity—is a common pitfall in auctions. Amazon’s H2Q competition illustrates this risk; we suggest ways to avoid it.

By on / Business Negotiations

winner's curse

In 2017, Amazon announced it was taking bids from cities interested in being the site of its second headquarters, known as HQ2. The online behemoth said it would be investing $5 billion in a campus and creating 50,000 well-paying jobs. Cities and regions across North America snapped to attention, and Amazon received 238 proposals.

Amazon asked applicants to include information about tax breaks and other corporate incentives in their proposal. The implication: Cities would have to pay up to win the prize. The auction created a real risk of the winner’s curse in negotiation, auction, and “negotiauction” scenarios—the common tendency for the winning bidder for an item of uncertain value to overpay.

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Discover step-by-step techniques for avoiding common business negotiation pitfalls when you download a copy of the FREE special report, Business Negotiation Strategies: How to Negotiate Better Business Deals, from the Program on Negotiation at Harvard Law School.


Was the Contest a Publicity Ploy?

Some cities competing for HQ2 believed that tax breaks would be a small price to pay for the jobs and revitalization that a huge Amazon headquarters could bring to their community:  “Whatever it takes,” Tulsa, Okla., mayor G.T. Bynum told the New York Times. But University of Minnesota economist Art Rolnick called Amazon’s requests “blackmail” and “corporate welfare.”

Amazon has had great success winning tax incentives. As of January 2022, the company received at least $41.8 billion in economic-development subsidies in the United States and at least $4.7 billion in other countries, according to a report by research center Good Jobs First and UNI Global Union.

In the end, Amazon announced it would split HQ2 between the two most obvious choices, the Washington, D.C., area and New York City. Many questioned whether Amazon had been negotiating in good faith—or simply held the competition to drum up publicity.

In exchange for a new Amazon campus in Queens, New York, Andrew Cuomo, then New York’s governor, promised Amazon $1.525 billion in incentives, as well as support for infrastructure upgrades, job-training programs, and other perks. The company also would have benefited from New York City tax credits worth nearly $1 billion over 12 years.

But Amazon walked away from the deal in February 2019 after other politicians, including New York representative Alexandria Ocasio-Cortez; unions; and progressive groups protested the agreement as wasteful corporate welfare. Amazon later launched a smaller expansion in Midtown Manhattan without the aid of new subsidies.

What Is the Winner’s Curse?

The bidding war that Amazon ignited raises a broader question: How extreme should your bid be in an auction for a hot commodity?

The winner’s curse phenomenon arises in auctions when the winning bidder of an item of uncertain value overpays. When an auction heats up, the fact that you are the winner suggests that others reached more realistic assessments than you did of the item’s true value.

The winner’s curse is not the same thing as “auction fever”—which refers to the tendency of bidders to irrationally escalate their bids in the heat of the moment, writes Harvard Law School and Harvard Business School professor Guhan Subramanian in his book Dealmaking: The New Strategy of Negotiauctions. Auction fever, a likely factor in the Amazon contest, is an emotional reaction to participating in a high-stakes bidding war. Those who catch auction fever risk overpaying because of a desire to win at any cost. Such winners often have regrets once the “auction high” wears off.

By contrast, the winner’s curse arises from the fact that the average of all bidders’ estimates of a commodity’s worth is likely to be close to the actual value of the commodity up for sale—which means that the bidder, by submitting an above-average price, probably overpaid.

Avoiding the Winner’s Curse

Not every auction winner is afflicted by the winner’s curse, writes Subramanian. Some bidders have knowledge or expertise that allows them to assess an item’s value better than other bidders. For instance, an experienced art dealer will have an “edge” over other bidders if they are the only art expert at a local estate sale.

How do you know if you have such expertise? Ask yourself, What do I know that no one else knows? recommends Subramanian. If the answer is nothing, then the winner’s curse is a very real risk.

Bidders who bring unique value to the contest also may be able to avoid the winner’s curse because their offer may be particularly attractive to the seller. Boston, for example, passed on offering tax incentives to Amazon because city leaders calculated that the city had an edge in other areas (though it didn’t end up winning).

To avoid becoming the next victim of the winner’s curse, ask yourself whether you’d be comfortable making the same bid if you knew that all other bidders valued the item less than you do, advises Subramanian. If you wouldn’t, shade your bid downward.

If you would still be comfortable making the bid, determine whether you have an edge that might make your bid more attractive to the seller than other bids. If you don’t have an edge, again, shade your bid downward; if you do, you should feel comfortable making the bid.

Do you have a winner’s curse example from your own business negotiations?

Business Negotiation Strategies

Claim your FREE copy: Business Negotiation Strategies: How to Negotiate Better Business Deals

Discover step-by-step techniques for avoiding common business negotiation pitfalls when you download a copy of the FREE special report, Business Negotiation Strategies: How to Negotiate Better Business Deals, from the Program on Negotiation at Harvard Law School.


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