This is the second in an occasional series on the economics of e-commerce. The first was about Priceline.com.
eBay is the popular Internet site that allows anyone with a credit card and a modem to begin bidding at auction. Just 5 years old, eBay is worth $13.8 billion—13 times more valuable than Sotheby's, the venerable auction house that has been around for 256 years. The truth, however, is that eBay's business model owes a lot more to low culture than high culture. From an economic perspective, the most interesting thing about eBay is that it has become the world's largest classified ads section. That might not be especially glamorous or cutting-edge, but with almost half a million new auctions each day and dozens of imitators, eBay has perhaps the best chance among the major e-commerce Web sites of changing the way Americans shop.
How eBay Works
eBay describes itself as a "person-to-person online trading community." In other words, eBay itself doesn't actually own any of the merchandise being offered on its Web site. Instead—like the classifieds section—eBay just provides a parley-ground for buyers and sellers. Sellers provide a couple of pictures and a short description of their item. Buyers may browse the site or search directly for the item they require. But, unlike the classifieds, the first person to answer the ad doesn't necessarily get the item. Instead, potential buyers have a week or so to place bids, and the item goes to the highest bidder (unless the final price is below a seller-specified minimum value, in which case there is no sale).
eBay has become popular among all sorts of sellers. Some are just ordinary folks trying to get rid of stuff from their attics. One funny guy, a mortician from Great North, Maine, has a an annual "couch sale," in which he sells off the odds and ends found underneath his sofa cushions. (This year, he found a human pacemaker, which sold for $16.61.) Other sellers are oddballs hawking such treats as exclusive rights to the domain name "kosherotica.com." Still others are charlatans and media whores offering such items as a human kidney, human soul, or a $135,805 counterfeit painting. But many sellers, perhaps most, are small businessmen who put medium-sized inventories of Persian rugs or antique armoires, for instance, up for auction. Why do these sellers prefer eBay to selling through a regular shop?
How Auctions Really Work
One theory is that the auction format is more advantageous for sellers. That may be true in some cases, but it's hardly a general rule. For instance, suppose an ordinary shopkeeper prices a Persian rug at $300 and sells it to the first guy who walks through the door who is willing to pay that price. Suppose also that the next two guys who walk through the door would have paid $350 and $400 respectively for that same rug.
It's true that an auction would yield the seller a higher price than pricing the rug at $300.
But our seller still wouldn't have gotten the very best price. In the scenario above, the auction would have settled on a price of $351—not $400. That's because, as soon as the bidding hit $350, the second buyer would drop out, and the third buyer (who values the rug at $400) would bid $351 and win the auction. In other words, the auction format only guarantees the seller the value that the second-highest bidder places on the good. If the shopkeeper had a good sense of the market, he could have just priced the rug at $399 and sold it to the guy who values it at $400.
In sum, there is no general rule about whether auctions fetch higher or lower sales prices. It all depends upon how certain the seller can be about market demand. The less certain he is, the more likely that he will benefit from an auction as compared with setting a fixed-price. This is why auctions have historically been popular when it comes to selling unique goods like fine art and real estate. This also might explain why eBay is so full of relatively rare used goods and collectibles, which, like fine art or real estate, are of uncertain value. But it also suggests that eBay is a bad way of selling things popular items like, say, computers—even used computers—where the market demand is pretty well known.