While most people are familiar with traditional auctions where bids are open and the winning bidder pays the full amount of his or her bid, there are times when that type of auction may not be in the best interest of the seller. For example, the seller may have multiple quantities of the same item to sell but may not be able to sell the entire quantity to only one buyer. In these cases, sellers using a traditional auction would lose money because everyone would pay a different amount for the same goods and most people would pay less than the highest bid. A better alternative is the second price auction, also known as the Vickrey auction.
Named for Walter Vickrey, a Nobel Prize winner in Economics, these auctions have a number of differences from traditional auctions. First, bidders are not allowed to see the other bids. All bids are sealed during the duration of the auction. Next, bidders not only place a bid but also specify their desired quantity of the item up for sell (if multiple quantities are available). For example, if a company is selling off ten of its old ink jet printers in order to recoup some of their investment and all of the printers are the same, bidders may choose to bid $50 each for 4 printers. This extra step is not included in traditional auctions where bidders are either bidding on the entire quantity or on a single item. Finally, the winning bidder(s) in a Vickrey auction pay the highest losing bid for the items. So if Bidder A bid $50 per printer, Bidder B bid $60 per printer, and Bidder C bid $75, then Bidder C would win the auction but would only have to pay $60 per printer since that is the highest losing bid.
While that may seem straightforward, the process gets a little more complicated when the additional quantities of the item are figured in. Because each bidder only has to purchase the number of printers he or she wanted that means there are usually multiple winners in second price auctions. The process works in the following way:
A seller offers 20 identical office chairs up for auction. Bidder A bids $25 per chair for 10 chairs. Bidder B bids $40 for 5 chairs. Bidder C bids $40 for 8 chairs. Bidder D bids $50 for 13 chairs. Because the bids are sealed, it is possible for multiple bidders to place the same bid. When the auction ends, Bidder D is the clear winner and he purchases 13 of the available chairs for $40 (the highest losing bid) each. Another 7 chairs are still available, so the next highest bidder is also a winner, but since both Bidders B and C placed the same bid, the one who was the earliest bidder is the winner. So Bidder B purchases 5 chairs for $40. Since 2 chairs are still left, they are offered to Bidder C, but he is not required to purchase them. One stipulation with these type of auctions is that if the quantity a bidder requests is no longer available, the bidder does not have to purchase a partial quantity. If Bidder C does not want the chairs, they would be offered to the next highest bidder for $40 also. This process would continue until all 20 chairs were purchased by bidders for $40 each.
For successful bidding in this type of auction, bidders must bid a somewhat higher amount than they would in a traditional auction. Because the highest bidders are going to win the desired quantities of the items, bidding low may actually backfire on participants because they may either not get any of the items or may only be offered a partial amount of their desired quantity. Another advantage of Vickrey auctions is that bidders are less likely to work together to keep prices low. Since the prices paid by bidders are determined by the competition, not by the bidder's own actions, it would not be in anyone's best interest to compare notes ahead of time.
When sellers have multiple quantities of an item or when they want a better chance of getting a good price on their item, the Vickrey or second price auction may be an ideal choice for them. Although the process behind these types of auctions may seem complicated, in online venues they are quite simple to conduct and to participate in. Sellers and buyers can definitely both benefit from second price auctions.