There are many business negotiation examples involving auctions. Suppose you’ve weighed the pros and cons of selling an asset via auction or negotiation and decided an auction is the best choice. What kind of auction should it be?
That depends in part on the type of asset you have.
A common-value asset is one that all bidders should ultimately value the same, though their current estimates will differ. An oil lease is a classic example: all bidders are trying to guess how much net revenue the lease will produce.
In contrast, bidders’ estimates of the worth of a private-value asset can be quite different.
An old family photograph—worthless to many, priceless to a few—is a good example.
Most assets have both common-value and private-value elements.
For example, art dealers at an auction for a Monet painting would have a strong common-value element; they are all trying to guess how much the painting will fetch on resale. Meanwhile, a wealthy art collector might covet the painting for her living room; in this case, though the resale value is relevant (no one likes to overpay), it is not the primary consideration.
Business Negotiation and Auction Design: Open-Bid and Sealed-Bid Auctions
How should you design your auction? In a sealed-bid auction, typified by the procurement auction, bidders do not know who else is bidding or even how many bidders there are. In an open-bid auction, similar to those held at Sotheby’s or Christie’s, bidders are well aware of who else is bidding, though the waters get muddied when bidders use surrogates to preserve their anonymity.
When an asset has a strong common-value element, an open-bid auction is often more attractive for the seller. Bidders can learn a lot from others’ willingness to bid. If an oil wildcatter who owns an adjacent lease makes a high opening bid for a plot of land, other companies that might not be as well informed will feel comfortable bidding higher.
Of course, if the wildcatter expected others to get a free ride on his expertise, he might not participate in the auction. Why waste time figuring out the lease’s value, only to be outbid?
A sealed-bid auction would secure his participation, but at a cost. Sealed-bid auctions attract the experts but discourage those who are not as well informed, whereas open-bid auctions attract the less knowledgeable but drive away the experts. The right choice balances these competing factors.
Sometimes an auctioneer can dispose of this tradeoff. Auction houses such as Sotheby’s and Christie’s employ experts who assess the condition, legitimacy, and value of each item and share this information with all potential bidders.
Thus, a bidder whose wealth far exceeds her knowledge can bid comfortably on a diamond necklace, knowing what the auction house thinks it is worth. When auctioning off a common-value asset, particularly when bidders are not equally informed, the seller should provide detailed information about its worth.
Do you have any other auction related business negotiation examples? Share them with us in the comments.
Adapted from “On the Block: Choose the Best Type of Auction,” by Guhan Subramanian (professor, Harvard Law School and Harvard Business School) and Richard Zeckhauser (professor, Harvard Kennedy School), first published in the Negotiation newsletter, December 2004.
Originally published June 2011.