Auctions are quintessentially a variable pricing format, but recently the largest online auction sites have introduced a fixed-pricing element known as a buy-it-now option. This feature allows a bidder to immediately stop an ongoing auction and purchase the item at a fixed, posted price set by the seller. This feature is known as “Buy-it-Now”, “uBuy”, and “Buy-Now” at eBay, uBid, and Yahoo, respectively. For clarity we refer to all these services generically as buy-it-now. These buy-it-now features have become an important component of online auctions. eBay introduced its service in 2000. Subsequently it has been adopted by 45% of eBay’s U.S. auctions by the end of its first year (ZDNet, 2002). These buy-it-now auctions accounted for 28% of gross merchandise sales at eBay by the end of 2003 (eBay, 2003). Empirical work by Park and Bradlow (2005) also indicates that the buy-it-now feature is an important element in auction design.
Economists advocate the efficiency of auctions over fixed price markets when auction costs are low (Wang 1993). The principle being that auctions match products to customers with the highest valuation in the market. However, the buy-it-now feature effectively limits the maximum auction price which would seem to lower the profitability of auctions for sellers. This leads to several perplexing problems: why would sellers choose to adopt buy-it-now auctions, when should they be used, and how should an optimal buy-it-now price be set? To answer these questions we develop an analytical model of auctions. Our results show that the buy-it-now option can actually increase the expected profits from an auction if customer participation costs are substantial. As we show in this research, customer endogenous participation due to costs not only plays a crucial role in determining the outcome of buy-it-now auctions, but also has important pricing and profitability implications.
Our model considers a potential customer’s optimal bidding strategy, willingness to pay, probability of winning, and the costs of participating in an auction. We believe the participation and transaction costs borne by the consumer are critical in explaining consumer behavior concerning online auctions, and we consider costs that are born during the auction and those associated with completing the transaction. The customer’s participation during the bidding process include direct time costs, opportunity costs associated with waiting for the auction to close, transaction costs associated with bidding, and the customer’s cognitive effort expended in the bidding process. Our conjecture is that the cognitive effort expended by a customer in deciding whether to accept a buy-it-now offer is less taxing than a customer who must decide upon a bid. Additionally after the close of the auction the customer may incur additional transaction costs to complete the auction order, such as the time involved in paying for the order and may incur opportunity costs associated with waiting for delivery.
The importance of these participation costs is that they can lower the number of bidders, which in turn reduce the seller’s profit. The buy-it-now option reduces participation costs for buyers and attracts buyers who might otherwise bypass the auction. To illustrate this problem consider a customer bidding for an ideal gift for her friend’s birthday coming up in one week. The buy-it-now auction presents two options: to bid and wait for the auction to close in three days to find out if she will win, or to purchase at the posted price right away (provided her valuation is higher than the price). If she chooses to bid, then there is a chance that she may not win, in which case she has to start over and bid again or buy at another store. In this example the auction participation cost borne by the customer includes the opportunity cost associated with waiting, checking emails to see if she has been outbid, potentially having to pay an extra charge for quick shipping if she loses and must buy elsewhere, and the possibility of not having a gift on time for her friend’s birthday.
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When Auction Meets Fixed Price: A Theoretical and Empirical Examination of Buy-it-Now Auctions
