Auctions are not much different than most areas of business: strategy is critical for success. In the case of all types of auctions - second-price, Dutch, English, etc. -- both bidders and sellers need to have a firm concept of their strategy if they hope to have the auction go in their favor. Sellers want to select a strategy that will allow them to get the maximum price for their item while bidders want to select a strategy that will allow them to be the winner but at a price that is under their perceived value of the product. Even though it may not seem like it, both bidders and sellers can simultaneously apply their strategies successfully.
Understanding and determining appropriate strategies for bidders and sellers for all of the auction types has been the work of economists for many years. In fact, economists use something called game theory to help them understand these concepts. Game theory is an area of mathematics that looks at interactions between independent and intelligent agents as they make choices that affect the outcome of their interactions. Using game theory, economists were able to determine some primary strategies for bidders and sellers to use for online and brick and mortar auctions.
In order to understand these strategies, one must first understand the idea of valuation when it comes to auctions. Generally, two types of bidders participate in auctions. One type of bidder wants to win the item for the bidder’s own use. In these cases, the person sets a specific private valuation on the item, which means essentially how much winning the item is worth to them. The second type of bidder wants to purchase the items in order to resell them and to earn a profit. These types of bidders have an estimated common value for the item. The common value is basically how much the average person would think the item is worth. Even bidders who have a private value for an item can be influenced by common value, particularly external standards of value. For example, if a seller is auction off a diamond ring, the bidder may have a specific private value on that ring but if that bidder sees an appraisal of how much the ring is worth that information may cause his concept of the ring's value either to increase or decrease.
As the example above indicates, sellers can often benefit from revealing more information to bidders. The more that is known about an item, the higher the common value generally goes. Additionally, the consensus among most auction bidders is that any information that is not revealed is being deliberately concealed because it will have a negative impact on the auction results. Sellers must also be strategic about the type of auction they select. Private values alone do not affect the amount a bidder is willing to pay for an item, so for those bidders there is no difference between the types of auctions. When common value is figured into the formula, however, English auctions generally bring in the highest revenues according to economists because of the competition. Of course, auction strategy is not that simple for the seller who must also factor in whether the bidders will be risk averse or risk neutral.
For bidders, other strategies must be taken into consideration. Regardless of the type of auction they are participating in, bidders must determine their maximum value for the item. If they do not, then they are guaranteed to fall victim to the Winner's Curse, which occurs when a buyer pays more for an item than what it is worth. Once they know that maximum value, they must bid slowly and cautiously. Beginning with a high bid does not ensure success, but it does ensure that the price for the item will be driven up even further and may quickly become unaffordable for the initial bidder. The reason for this behavior is that high bids give other bidders the impression that the common value for the object is possibly more than they might have imagined. As a result, they are willing to spend more. Slow increases in the bidding keep the prices lower. Then, when the bidder reaches his highest value, he should stop bidding.
Regardless of their role in the auction, all participants must understand the rules of the specific auction or their strategies simply won't work.