eBay or the Highway

articles
July 7 2000 3:00 AM

eBay or the Highway

Its size is its selling point—and its curse. 

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Finally, there's another reason why auctions might be bad for both sellers and buyers. It's a phenomenon that economists call the "winner's curse." Briefly, the idea is that when bidders are competing for something of uncertain value (like a Persian rug as seen through a fuzzy picture on the Web), some will overestimate its actual value and some will underestimate it. Since the item goes to the highest bidder, it's likely that the auction "winner" will be one of the people who overestimated. In theory, therefore, it is also likely that he or she will be disappointed with the actual rug—the winner is ultimately a loser. This may provide a short-term benefit for sellers, who get higher prices. But in the long run, buyers who are consistently disappointed will stop using auctions. (Click here for a more complete explanation of the "winner's curse.") eBay has a community rating system that allows past buyers to rate the quality of goods sold by frequent sellers. This is intended to stymie bait-and-switch artists. But the New York Times has recently published a series of articles alleging that the community rating system is easily manipulated.

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There is, however, at least one good reason why buyers might be partial toward eBay's auction format—it's a lot more exciting than the mall. Economists have always been puzzled by the popularity of activities—like gambling—in which the odds are obviously stacked against consumers. The Nobel-prize-winning economist Milton Friedman has offered the startling explanation that gamblers gamble because they enjoy it. (Click here to read one economist's account of his eBay obsession.)

Ebay's Real Advantage

The biggest factor in eBay's success, however, is probably that it offers low overhead. That is, an auction Web site is just about the cheapest way to bring buyers and sellers together. This has nothing to do with the fact that it's an auction site and everything to do with the fact the Web allows 10 million registered users to peruse 4 million offerings at negligible cost.

One might assume that this cost-savings would be passed along to consumers—making eBay a far better way to shop. Right now, this may well be true. eBay sellers pay only a small fee (between 25 cents and $2) to list their items and a small commission if the items sell ($1.87 on a $50 sale, for instance, and $13.13 on a $500 sale). For each individual seller, of course, these fees are probably less than the cost of renting a shop or printing flyers. For eBay, however, these fees added up to $267 million in net sales last year. Buyers pay nothing to use the site, and they too presumably benefit from the sellers' savings through lower prices.

Sadly, economic logic suggests that this may not last. eBay's size and popularity make it a perfect example of what economists call a "network effect." That is, the value of the Web site to each individual buyer and seller increases as more people use the Web site. That's because buyers are more likely to find what they want as the number of sellers increases. And sellers are more likely to find a high bidder as the number of buyers increases. And so on.

But "network effects" also give sites like eBay a type of monopoly power—which will only increase as the site becomes more popular. That is, it is very hard for a competing site to displace the original. This of course describes any Web business—take Amazon.com, which has gotten a lot of mileage out of being first. But it's doubly true for a site like eBay, since eBay benefits not just from brand recognition but also from its very size. Only eBay can promise sellers 10 million registered buyers. (And it can retain those 10 million buyers, because it attracts the best sellers.) To take one example, Yahoo! offers an almost identical service for free—yet sellers still choose eBay. So eBay's monopoly power would, in theory, allow it to raise sellers' fees to the point where much of the Web's cost-savings are erased.

 Lawrence Summers, the current treasury secretary and a former economics professor, recently gave a speech called "The New Wealth of Nations" in which he argued that "network effects" and monopolies are going to be "the central driving thrust of the New Economy." Summers got a lot of attention because he also seemed to suggest that this is not such a bad thing. His argument is more or less that monopolies may represent the price that we have to pay for the benefits of the New Economy. Certainly, no one is forcing people to use eBay—if they do use it, it must mean that eBay is better than the alternatives. And it's certainly a good thing if buyers and sellers are allowed to make mutually beneficial exchanges that they wouldn't make otherwise. But it's a little disheartening to realize that eBay's success may eventually mean more to its stockholders than its customers. 

Bruce Gottlieb is a former Slate staff writer and chief counsel at the Federal Communications Commission; he is currently general counsel at the Atlantic Media Company.

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