Negotiation in the News: Will Amazon’s winner be cursed?

The bidding frenzy stirred up by amazon’s contest for its second headquarters raises the question of whether the winner will overpay for the prize.

By on / Business Negotiations

On September 7, 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 the campus, which was expected to create 50,000 well-paying jobs. Amazon’s wish list for its winning city or region included a metropolitan area of more than one million people, a “stable and business- friendly environment,” access to strong technical talent, and a community that thinks “big and creatively,” according to CNBC. Cities and regions across North America snapped to attention, and by the October 19 deadline, Amazon had received 238 proposals.

Even as Amazon soaked up weeks of publicity, some municipalities coupled their proposals with PR stunts. Tucson, Ariz., had a 21-foot-tall saguaro cactus delivered on a flatbed truck to Amazon’s Seattle headquarters, only to have it politely returned, the New York Times reports.

When an auction heats up, the fact that you are the winner suggests that others reached more realistic assessments of the item’s true value.

Ottawa touted Canada’s more liberal immigration policy relative to the United States, which it said would make it much easier for Amazon to fill engineering positions. And Dan Gilbert, a business leader in Detroit, established an “Amazon war room” where more than 40 people analyzed videos of Amazon CEO Jeff Bezos— and his likes and dislikes—to try to determine how to tailor the city’s pitch.

Welfare or benefits?

Some critics complained about Amazon’s request that applicants include information about tax breaks and other corporate incentives in their proposal. The implication: Cities would have to pay up to get the company’s attention. Indeed, in the past, Amazon has had success convincing cities to pony up with tax incentives. From 2005 to 2014, the company received at least $613 million in local government subsidies to build warehouses, according to an Institute for Local Self-Reliance study. Amazon could even end up with “a negative tax rate in the jurisdiction where it locates,” according to CNBC, in which “Amazon doesn’t pay the state. The state pays Amazon.”

Some cities believed that tax breaks would be a small price to pay for the jobs and revitalization that HQ2 might bring to a community. Tulsa, Okla., mayor G.T. Bynum told the Times that he “doesn’t worry at all” about paying too much in tax incentives. “Whatever it takes,” he said.

But Matthew Gardner, a senior fellow at the nonpartisan Institute on Taxation and Economic Policy, told the Times, “[Amazon] would like a package of tax incentives for something they were going to do anyway.” University of Minnesota economist Art Rolnick called Amazon’s requests “blackmail” and “corporate welfare,” but conceded that cities had little choice but to enter the race. “If you ask any mayor, they’ll say their first job is to bring good jobs to the city,” he said, and Amazon is promising a spectacular number of them.

Feverish competition

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

Regular participants in auctions are familiar with the winner’s curse phenomenon, or the common tendency for the winning bidder in an auction for an item of uncertain value to overpay. When an auction heats up, the fact that you are the winner suggests that others reached more realistic assessments of the item’s true value.

The winner’s curse is not the same thing as “auction fever”—the fact that bidders tend 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 (Norton, 2011). Auction fever, which likely has been a factor in the Amazon contest, is an emotional reaction to being in the thick of a high-stakes bidding war.

Those who catch auction fever risk overpaying due to a desire to win at any cost and claim the prize. Not surprisingly, such winners often end up having regrets once the “auction high” wears off and it sinks in what they paid.

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, is likely to have 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 the value of an item better than other bidders. For instance, an experienced art dealer will have an “edge” over other bidders if she’s 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. In the case of the Amazon bidding war, for example, Boston passed on offering tax incentives as part of its bid package because city leaders calculated that the city had an edge in other areas.

To avoid becoming the next victim of the winner’s curse, ask yourself whether you’d be comfortable making the bid you’re considering if you knew that all other bidders in the auction 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, shade your bid downward; if you do, you should feel comfortable making the bid.

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