Online auction economics, and great ebay tips

Ulrike Malmendier, an economist at the University of California at Berkeley, tracked auctions of common items – things readily available online or in stores but offered on eBay at a discount.

Most economists assume these kinds of auctions are largely immune to the passions and unpredictabilities of ravenous bidders, she says. Simple bargain hunting, they hope, would bring out our inner homo economicus, someone who acts in their self-interest to get the best deal possible.

No such luck, she says.

Ms. Malmendier tracked 166 auctions offering "CashFlow 101," a personal-finance-themed board game. During the seven-month trial, the game's designer sold the box set on his website for $195.

Meanwhile, eBay sellers usually offered an opening price of about $45 and set a one-click, "buy it now" price of about $125. It looked like a great deal for buyers. They could pay less than retail to end the auction immediately or place bids in the hope of fetching an even lower price.

But this is where eBay users fell prey to what Malmendier and her coauthor, Stanford University economist Hanh Lee, call "bidder's curse." Apparently, some bidders grew so enthusiastic about winning the auction that they lost sight of the "buy it now" price, sometimes offering more than $185.

There's much more here, via Seth Godin. But enough with theory: how can the economists help you make some money?

If you are a seller:

1. Set low opening prices. Buyers favour whichever auction has the most bids, and starting with a low price is a great way to attract offers. A buyer has limited information on the quality of your item/service, and even if he can be bothered to read the description he will still worry he could be missing something. Observing lots of other bids allays those fears.

2. Don't use secret reserves. Buyers are afraid they may be wasting their time with your auction, and your item will attract fewer bids and end up selling for a lower price than it could have achieved.

3. Try to appear honest and dependable. If the buyer spots relatively large shipping costs or some other 'clever' trick, he will start worrying what else he may be missing - try to present your offer in a simple and straighforward manner. (the article has more on optimising shipping costs).

And if you are a buyer:

1. Don't bid until the last minute - early bids attract competition.

2. Don't fall in the 'many bids' trap: read the item description and seller information carefully and disregard demand by other buyers completely - they are unlikely to know more than you do. You are simply observing their preferences and biases, none of which carries information of relevance to you. Have a clear idea of how much you value an item before bidding, and don't succumb to 'bidder's heat' - you want to buy a product at a good price, not come first in a fools' race.

3. Dump Ebay and switch to Yahoo's online auctions (no longer available in the US, alas). Identical items auctioned on both sites sell on Yahoo for 30% less. The smaller Yahoo marketplace seems to lessen competition amongst buyers more than amongst sellers.

Should I buy myself a football team?

Following a reader's request, I've been meaning to post something on this for a while. But Austan Goolsbee at the NYT beat me to it (via Mark Thoma):

Answering why people buy teams turns out to be important to more than just sports fans. There is big money at stake.

After owners indulge their childhood fantasy of buying a team, they tend to switch to an adult perspective and start viewing the team as a business. And they typically conclude that it’s a bad business.

Should we really care that it’s a bad business? If a billionaire throws a lavish 60th birthday party, it costs a lot of money. But that doesn’t make it a bad business. It’s a party. It’s not supposed to make money.

Is a sports team really that different?

Owners’ complaints about losses leave out the basic fact that capital gains are profits, too. And when scores of grown men desperately want to buy sports teams, there tend to be big capital gains.

Take the Sonics. The team may have lost $60 million while Mr. Schultz owned it. But he bought it for $200 million in 2001 and sold it for $350 million five years later. So he ended up making something like $90 million (taxed at the favorable capital gains tax rate, no less) on top of the fame, prestige and free tickets he got while he was owner.

If the Cubs do, indeed, sell for $1 billion, Tribune will have earned an annual return of almost 15 percent since it bought the team for around $20 million in 1981. Given the company’s recent problems, it’s probably the best investment it ever made.

So owning a sports team gives budding billionaires local stardom and a big return — no wonder that they are lining up to buy these teams. The only question that remains, I suppose, is why the vanity value of teams keeps climbing. You might have thought that this value would be about the same whenever there’s a sale, so that the capital gain wouldn’t be such a big component. But because ever-richer guys are bidding against one another, there has been persistent inflation in team values.

Having a stake in most companies yields no utility to its owners by itself: what matters is the financial rewards the investor is looking forward to. That said, a sports team (much like a charity) can survive and prosper even if the financial returns on offer are consistently below those of 'normal' companies.

Goolsbee makes a good point, in that when you buy shares in a sports team what you get (and pay for) is more than just a stake in future company profits and expected capital gains. Buying a controlling interest earns you status, and even fans owning a few shares acquire the privilege of owning a piece of their favourite team.

So should you buy yourself shares in a sports team? As is the case with 'ethical' or 'islamic' funds, the question you should really be asking is whether you value owning these shares in itself as much as the marginal investor. If you believe markets are efficient and you are not a fan or status-seeking multibillionaire, the answer is simple: steer clear.

The WSJ's Laffer-out-loud curve

The Laffer Curve analysis indicates that these corporate tax increases are likely to raise little if any additional revenue [...]

That's what I call ha-ha-ha analysis, proudly printed in the Wall Street Journal (via Statistical Modeling).

And to think that some people worried Murdoch would push the Journal downhill.

Look at the future, the future is bright

[...] the greater a society’s future orientation, the higher its average GDP per capita and its levels of innovativeness, happiness, confidence, and (as the chart shows) competitiveness.

From the Harvard Business Review (free access), via MR.

I am not as sure as the authors about the direction the causality runs, however: rather than forward thinking leading to higher GDP per capita and all the other goodies mentioned, I suspect that worrying about the future is a luxury you can only afford once you are comfortable in the present.

Breaking up is good for your savings

Via the excellent Organizations and Markets:

SEOUL (AP) — A South Korean bank is offering to help heartbroken soldiers dumped by girlfriends while away on mandatory military service by providing special interest rates for stilted troops.

Soldiers who can show letters or e-mail proving their break-up to a bank clerk can receive a new deposit plan with better rates and waived service fees.

A friend challenges me to explain this using standard economic tools, i.e. without retorting to 'the world has gone mad' class of explanations.

I'll try to rise to the challenge. Of course, there is always the possibility the bank is making a mistake and will suffer as a result. That said, I can think of at least four ways in which offering lower interest rates to heartbroken conscripts may actually be good for profits:

1. Dumped soldiers may indeed represent better credit risks bacause they are less likely to splash out on expensive gifts to their girlfriends.

2. The 'good-will' and publicity effects compensate for the suboptimal pricing of credit risk by drawing more customers to the bank.

3. To the extent that shareholders' utility arguments include both a private income and a social welfare element, 'socially responsible' undertakings can lead to increased demand in the bank's shares, and the company enjoying a lower cost of capital.

4. Assuming switching banks is costly, consumers optimise their choice of bank intertemporally. Choosing this particular bank may thus be a form of insurance against being dumped in the future.

Am I half-convincing?

Addendum: A reader alerts me that I am actually talking about lower interest rates for loans, while the bank is offering higher rates for deposits (this post was initially titled 'Breaking up is good for your mortgage').

Let me try and rescue this. Explanations #2 and #3 still stand. #1 has to be adapted to say heart-broken soldiers are more reliable savers (e.g. they are less likely to make large, sudden withdrawals or take out unathorised overdrafts. #4 is only relevant to the extent the bank establishes a reputation for offering premium rates to those suffering misfortunes.

Updated analysis aside, I'm still a bit embarassed about my initial attempt to explain the 5th of the last 3 recessions. There's a lesson here: Alcohol and econ-blogging should not mix.

Goolsbee's nonsense take on Buffett

A couple of weeks ago the NYT ran an interesting piece by Austan Goolsbee on Warren Buffet's plan for picking a successor. (gated NYT version, non-gated version at Economist's View). I tend to agree with Goolsbee's main point that Buffett's plan for picking a successor is a bad one (that is the plan as described in the article - there is some disagreement as to whether Goolsbee got his facts right to start with). What doesn't make sense is this:

A number of years ago, in a moment of professional weakness, I bought exactly one share of Warren Buffett’s Berkshire Hathaway....

For a brief moment, I thought his track record might disprove the economist’s mantra that no one can beat the market in the long term so it’s better to just invest in index funds like one that matches the S.& P. 500.

The mantra comes from the rather compelling evidence that actively managed mutual funds cost too much and don’t always act in the shareholders’ interests. They churn stocks, for example — raising fees while also generating capital gains taxes for the investors. Their high fees sharply cut into investment returns in the long run. ...

Berkshire Hathaway seemed like a mutual fund but without the bad incentives. Mr. Buffett doesn’t care about churning stocks to get bigger fees. He doesn’t do things at the expense of his shareholders. He is the Oracle of Omaha, for Pete’s sake. If anyone can beat the market, it’s him.

Well, I still own that share, but it hasn’t worked out as well as I had hoped. My share has underperformed the S.& P. 500... My colleagues have mocked me incessantly, but I have remained a closet romantic, hoping that Mr. Buffett would renew his secret formula and prove my colleagues wrong.

I have no choice but to be blunt: that's complete and utter nonsense. Furthermore, it seems that Goolsbee is not motivated by a desire to mislead the readers - he genuinely doesn't get it. The fact that his share did not outperform the market is no indication of whether or not Berkshire Hathaway's portfolio consistently does so.

For the sake of argument, let's say that Warren Buffett's portfolio consistently beats the market by 300% each year, and that he also has a certificate from God stating he will keep doing so in eternity. Should you expect to beat the market yourself by buying Berkshire Hathaway stock? The answer is a resounding no. The moment Buffett gets his holy certificate, the stock of Berkshire Hathaway will jump so that BH offers the exact same risk-weighed return to new investors as companies not similarly favoured by the Almighty.

Goolsbee's investment would have beat the market only if Warren Buffet had got unexpectedly better at generating investment returns sometime after the renowned University of Chicago economics professor and Obama's lead economic advisor purchased his BH share. If on the other hand Buffett unexpectedly went from generating (or being expected to generate) a 300% return on investment a year to 200%, BH's price would fall - and Goolsbee's own investment would not have proven to be such a good one.

To cut a long story short: You buy shares in a company if you believe other investors underestimate its potential. A company's profitability per se is neither here nor there.

Advertisement: An extensive post on the widely misunderstood efficient market hypothesis (as well as a couple of on-request posts and one on 'virtual' worlds) has been in the making for a while now, and should be appearing here soon.

A new market is born

Coming to you soon, real soon. And it will mean that the computer I'll be writing this blog on two years from now will turn out to be much cheaper than its cost of production.

What is it that gets me so excited? Stories like this:

More than 250,000 PS3 owners have enrolled their console in the Folding@HoME project which uses it to study the shapes proteins assume.

And, even more, stories like this:

Sun Microsystems has launched a pay-as-you-go service which will allow customers requiring huge computing power to rent it by the hour.

Sun Grid costs users $1 for an hour's worth of processing and storage power on systems maintained by Sun.

So-called grid computing is the latest buzz phrase in a company which believes that computer capacity is as important a commodity as hardware and software. Sun likened grid computing to the development of electricity.

The company will have to persuade data centre managers to adopt a new model but it said it already had interest from customers in the oil, gas and financial services industries.

Today, most companies that rely on computing power face high costs associated with IT maintainance, building up excess processing capacity to deal with peak times (which may be few and far between) and storing all this power in what is expensive real estate.

For such a company, the ability to rent processing power on demand is an amazing boon. But despite Sun's rhetoric, the comparative advantage lies elsewhere: home computers.

Just realise that the average home machine operates only a few hours a day, and even fewer at full capacity. Home users already meet the fixed costs of maintainance and real estate. How long till some clever silicon valley entrepreneur adapts the (already available) software and develops a viable business model?

Murdoch makes an offer you can't refuse

Here's the story:

DOW Jones could face a flood of shareholder lawsuits if it rejects a buyout bid from News Corporation and its shares tumble, legal and governance experts said overnight.

Dow Jones, publisher of the Wall Street Journal, has said it is evaluating the $US5 billion ($6 billion) takeover bid from Murdoch's News Corp (nws.ASX:Quote,News), a proposal that triggered a nearly 55 percent jump in its stock price on Tuesday.

But a representative of the publisher's controlling shareholders, the Bancroft family, said they would oppose it.

If the board ultimately rejects the offer, and no comparable bids emerge, lawsuits almost surely will be filed accusing the directors for failing to look after investors' interests, said Thomas Dewey, a partner at law firm Dewey Pegno & Kramarsky.

55% jump in the share price upon publication of the offer? If I was a shareholder, I'd sue too.

Who said that the rise of litigation culture is a bad thing?