Behavioral Finance, Anchoring & eBay Auction Starting Prices

There is a great article today from Alex Goldfayn in McClatchy Tribune papers, like the Sun Herald in Mississippi:

The Sun Herald | 08/27/2006 | Starting price is key in eBay auctions

It quotes some recent research from the Kellog School of Management, including Associate Professor Adam Galinsky on the behavior of buyers in auctions.

Now, as someone who has been selling on eBay for over 8 years, and working for the company since early 2003, the conclusions of this study are fairly obvious. It turns out – yes, it’s true – that auctions that start with lower starting prices result in higher final sale prices.

Why is this interesting? Well, it turns out one of the staples of modern negotiation theory and behavior finance is the concept of anchoring. Anchoring, loosely defined, is the irrational human process where people will gravitate towards a number – any number – and use it as a sub-conscious basis for what they consider a fair price.

Example: it has been shown time & time again that the higher the original price quoted by a salesperson, the higher the final price that the buyer will end up paying for the exact same item.

Even more disturbing, experiments have shown that even quoting random numbers, like the last four digits of your social security number, can actually affect the answer the people give to seemingly unrelated questions, like estimating the number of doctors in New York.

What’s interesting about this research in relation to eBay is that you would expect, based on anchoring, that the higher the auction start price, the higher the final price of bidders.

However, what the Kellog research shows is that there are other, more important emotional factors in auctions. The low price lowers the “barrier to entry” for people, and then once they are involved, they continue to bid based on the “sunk cost” of their time spent already on the auction.

I personally believe a third factor comes into play with auctions, which is competitiveness based on a false sense of ownership. People find an item they like, and that message, “You are now the high bidder” is powerful. Getting the message that you have been “Outbid” is inflamatory – it signals a primal part of your brain that triggers fear and anger that someone has “stolen” your item away from you.

I think that there has been so little academic research on the largest and more varied global marketplace (eBay), so I love to see these papers that trickle out that begin to help scratch the surface of understanding how human beings interact with each other in marketplaces other than the stock and commodity markets.

Please, if you see other research like this, send me links or documents. I find this type of analysis incredibly interesting.

7 thoughts on “Behavioral Finance, Anchoring & eBay Auction Starting Prices

  1. I strongly agree with you and your idea. Actually when seeing that I was out of bid by someone, I would turn the auction with much more competitive senses. It is kind of irrational. As a person having MS degree from finance, I always wonder what psychological reasons are for irrationality in the online marketplace, eBay. The article you mentioned is very interesting too!

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  5. Adam, thank you for your insight into basic human behavior. The principles you refer to are often highlighted in popular items like the recent holiday furor ove the Tickleme Elmo TMX selling for thousands of dollars. I remember my first Christmas viewing over eBAy. I wanted to pick up a used DVD player. What beter place to get one than an auction right? Wrong. I say used players going for as much as 50% higher prices than if I were to purchase a brand new one at Circuit City. Since then I have seen it repeat itself over and over again. The market place will always offer an interesting model of human behavior both good and “interesting”.

  6. Hi Allen,

    Thank you for the kind words. While I do believe that some irrational behavior is involved with auctions & pricing, it’s dangerous to assume that this leads to higher prices than the incredibly expensive retail channel. Normally, eBay auctions have been shown to have prices that are significantly below retail.

    Sometimes, even though individuals may be irrational, the market itself can be surprisingly knowledgeable. For example, I remember in 2003, you could get more money for a used Tivo Series 1 on eBay than you could for a brand new Series 2! The reason why, however, was that hackers knew how to add networking and other services to the Tivo Series 1, and no one had yet “modified” the Series 2. In this case, while it might appear to an uninformed observer that the auction prices were irrational, they really reflected the fact that there was more to the products and their value than met the eye.

    In the end, to be an informed consumer, it’s always good to know what the retail price of an item is before shopping anywhere. Comparison shopping is key. Being an eBay employee, I tend to hit first, gauge the retail market, and the I go to eBay Express or eBay to buy the item, typically at a better price.

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