Friday, 21 February 2020

Second-Price Sealed-Bid Auctions

Auctions are important to the art world. It is where prices are paid that make headlines and it is more generally believed that auctions are where the genuine market value of artworks is measured. Economist John McMillan even only discusses art in relation to auctions in his fundamental work on markets; Reinventing the Bazaar.

Of course, what most people are envisioning by an art auction is something along the lines of what is offered by Christie's or Sotheby's, where works in high-demand are sold to an audience that is usually expecting, prepared and able to pay relatively high prices.
These auction houses employ open auctions to sell their goods, where bidders go on topping another's bid until only one party wants to continue. The transparency of these open auctions works well for them for a number of reasons. For one, it clearly establishes a kind of common value for the artworks on offer, as well as demonstrably show the value of the auction houses themselves in facilitating the sale. At the same time, many people buying things at up-scale auction houses are either looking to get a bargain or conversely want to show, at least implicitly, that they can flex their financial muscles more than their peers. An open auction provides a great deal of information about the interests of others, so the needs of both ends of the public are well represented. Due to the scale and renown of the auction houses, there also tends to be a large number of interested parties present. This drives prices up as each of them will have some fear of losing out on the work they covet the most as well as ensure that another work can take its place in the event that a person's favourite work couldn't be acquired.

The open auction is also the format used by eBay and is consequently copied by many other online auctions that try to emulate their success. Generally speaking this works well, although it must be said that the longer and asynchronous time span of the auction makes its mechanics somewhat elusive to inexperienced bidders. It is often seen that for there are no bids on an item for the first few days of the auction, only for the bidding to get frantic in the last thirty minutes before arriving at a price at or even above market value. It could be argued that the function of the first few days was merely to attract potential bidders, like viewing days tend to do for more traditional auction houses.

In the last decade or so there have been a number of companies that are attempting to fill a market for online auctions specifically focused on artworks that are unable to attract the large audiences and prices associated with the upscale auction houses. These kind of artworks were traditionally sold at more regionally oriented auction houses, where information tended to be somewhat scarce and the idea of the undiscovered gem could well become a reality.
With websites such as Kunstveiling.nl and Catawiki, these kind of works are now given a national or even worldwide platform and in my experience these kind of websites are not quite optimised for the kind of products they are offering.

Both of these websites use the open auction format that the larger auction houses as well as most online auction websites use. At first glance this seems a good choice, as there must be a reason that most of your direct competitors opt to use a certain format.
However, if one takes a closer look at the actual results of these auctions a different picture emerges.
Many of the works on offer are sold at a relatively low price or not sold at all. A major cause for this is the lack of competition between buyers on these websites. Many items are sold with only one bid, which in an open auction gives a skewed view of the item's actual worth, as in an open auction the price the winning bidder pays is always the price the second highest bidder valued the item at. If only one person bids on an item, this price is ostensibly zero. As a result of this, a number of frequent sellers on these websites only post items with a reserve price that is set at what they perceive the value of the works to be and simply wait until one bidder is willing to pay that price. Which is a reasonably effective business strategy, but has little to do with selling works at auction.
Catawiki on their part tries to mitigate the problem by having a '€ 75 minimum value' on items that are offered up for sale, but it's clear that this figure is arbitrary in this kind of market. A potential buyer might be willing to pay € 75 or even more for a given item, but if there are no other bidders, then they will never have to pay this price. The result of this is that their marketplace has become flooded with arguably worthless 'licensed' reproductions from artists like Picasso and Dali. Since demand is high and the minimum value of € 75 is 'guaranteed', these kind of items fetch unreasonably high prices while original work by lesser-known artists often fails to reach a reasonable reserve price, once again due to a lack of competition between bidders.

The current practice of the smaller online auction houses is thus problematic in reflecting a realistic value for the artworks by the lesser known artists they offer. They employ open auctions likely because this type of auction is the most familiar to the general public and even then their workings are sometimes still able to confuse said public. The open auction format is therefore chosen as a default, rather than a deliberate choice that would best serve their market.
I nevertheless believe that these websites could do much better in achieving an accurate reflection of what buyers are willing to pay for the artworks on sale.
As the problem is a lack of interested parties that can bid against each other to reach an optimal selling price, perhaps a different auction format offers a better solution. The open auction might be the most common way to handle an auction, but it isn't the only option.
Indeed, a first-price sealed-bid auction, also known as a blind auction, seems to come closer to what a situation like this requires. In a first-price sealed-bid auction, or FPSBA for short, bidders only bid once on an item and the height of their bid is not announced to the other bidders. At the end of the auction the highest bidder wins the auction and the item is sold for the price of this highest bid. This kind of auction leads bidders to bid more truthfully to what they perceive the value of an item to be, although there is still a genuine concern for overvaluation that often leads bidders to be somewhat cautious in their bids. Say an item is offered up and there are nine people interested who all make bids between € 50 and € 100. If a tenth bidder then mistakenly values the item to be worth € 10.000, he will win the auction, but will have to pay a price that is exorbitantly higher than the common value of the item. Therefore buyers often bid not what they themselves believe the value to be, but what they believe others are willing to pay.

The solution to this is the second-price sealed-bid auction. The procedure of a SPSBA is the same as a FPSBA, except that the winning bidder doesn't pay the price of his own bid, but the price of the second-highest bidder, thereby ensuring that the value of the work is genuine. As the valuation of other parties is almost completely taken out of the equation, a SPSBA is one of the only auction formats where bidding truthfully is the dominant strategy. It is thus always in a person's best interest to bid exactly what they would be willing to pay for the item.
This certainly seems like a better solution for the likes of Kunstveiling.nl as any person would bid what they value the item at. It also suits the practical format of the internet auction, as any person can make their bid at any time during the auction. It could also be set up in such a way that an auction lasts for a set amount of time, say two weeks, or until there are two bidders for the item, ensuring that every item that gets sold for a price that a truthful market is willing to pay, even if that market only consists of two people.
The second-price sealed-bid auction is nevertheless an uncommon type of auction, although it has been prominently used in auctions of stamps since the late 19th century. As this is another market that is related to singular items that are in limited demand,  the enduring power it has had there shows a possibility to be successful in the online secondary art market as well.