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Mini-Cases Mini-Cases Auction Vignettes

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Page 1: Auctions II

Mini-CasesMini-Cases

Auction Vignettes

Page 2: Auctions II

Two Auctions

Clinton memoirs 8 publishers chose to

bid Open bidding Royalty and fixed fee Chose highest and

with fixed fee $8 million

Rodriguez Blind auction Uncertainty about

bidders $252m deal

Page 3: Auctions II

Questions

How are the “assets” in the auction similar or different? What are the common and private value elements?

What do these differences mean for the seller and buyer?

How would you compensate the agents? Is there evidence on overpaying?

Page 4: Auctions II

On-Line Auction Sites

On eBay.com, peculiar bidding practices have been noticed. In particular,– Many bidders submit multiple bids in the course of the auction (i.e.,

they submit and later raise the maximum price they authorize for proxy bidding on their behalf); and

– a non-negligible fraction of bids are submitted in the closing seconds of the auction (a practice called “sniping”).

For example, in a sample of over 1000 completed e-Bay auctions (May – June 1999), 28% had 0 bidders, 16% had exactly 1 bidder, and of the remaining 585 auctions, 74% showed multiple bidding and 18% had bids in the last sixty seconds. There is variation in the degree of last minute bidding with the highest percentage (56%) in “Antiques: Ancient Worlds” while the lowest (0%) was in “Collectibles: Weird Stuff.”

Page 5: Auctions II

Questions

Would a seller prefer a fixed deadline (eBay) or a flexible deadline (amazon)?

What kind of seller would post a buy it now price?

Does ‘proxy bid’ system cause shaded bids?

Why does ‘sniping’ occur?

Page 6: Auctions II

Petrol Ofisi

Privatisation of gas station chain in Turkey (50% market share)

$10,000 for tender documents $20m in collateral 22 applications but 4 bidders English auction

Page 7: Auctions II

Questions

What are the benefits of an entry fee? What is the role of the indicative round?

How should a bidder bid? Common vs private value?

Page 8: Auctions II

Warner-Lambert/AHP/Pfizer

W-L and AHP wanted to merge– Agreed to a ‘break-up fee’

Pfizer wanted to take over W-L but was prevented by a prior agreement

Pfizer argued that rejection of their bid was not in the interests of W-L shareholders

Page 9: Auctions II

Questions

Will break up fees prevent the highest value use?

Should it have used an open auction? How about for M&A in general?

Page 10: Auctions II

Case AnalysisCase Analysis

Google

Page 11: Auctions II

Internet Advertising

Ad revenue from auctions– Google (2004): $3b– Yahoo (2004): $1.7b

Early (pre-1997!) models– Sold per-impression– Flat fees to show ads a fixed number of times– Slow entry, large customer spend

Page 12: Auctions II

Overture (then GoTo and now Yahoo!)

Generalised First-Price Auctions (1997)– Advertiser submitted a per click bid– They paid this every time the ad was clicked. Sold one click at a time

(rather than 1000 blocks)– Highest bids were most prominent– Ease of use, more entry

Example– 2 slots on a page and 3 bidders– 1st slot gets 200 clicks (per hour), 2nd 100 clicks– Bidder values per click of $10, $4 and $2– If B2 bids $2.01 is gets a slot and so B1 need not bid more than $2.02 to

get 1st slot. But in this case, B2 will find it worthwhile to increase their bid to $2.03, etc.

– No pure strategy equilibrium.

Page 13: Auctions II

Google’s Rules

Each bidder can specify a rich rule for determining how to bid as a function of the search terms and the site from which the search originates.

– Google sets a reserve or minimum price for each search term. Google estimates the “click-through rate” that each bidder would

have if it were listed in the first spot. Google ranks the bids according to the product of the clickthrough-

rate and the bid; it assigns ad spots in that order. Google is paid only if a bidder’s link is clicked. In that case, it

receives the smallest price the bidder could have bid to get its ranking.

Generalised second price auction Yahoo switched to this.

Page 14: Auctions II

Example (no CTR adjustment)

If 3 bidders, act truthfully, bid $10, $4 and $2.

Payments will be $4 and $2 so their total payments are $800 and $200 respectively.

No incentive to change their bids so it is an equilibrium.

Page 15: Auctions II

Example (with CTR)

(from Paul Milgrom) I bid $1 and have an estimated click-through rate of .50.

You have bid $2 and have an estimated click through rate of .2.

The reserve price is 0.1. My score is .5; yours is .4, so my ad ranks first.

– I could have won with a bid as low as .81, so that is what I pay if my link is clicked.

– You could have had your spot for as low as .1, so that is what you pay if your link is clicked.

Page 16: Auctions II

Questions

What are the key properties of this mechanism? Why is Google paid only for clicks?

– By comparison, television ads are priced according to “impressions” (how many times they are seen).

– By comparison, consignment stores are paid according to sales. Incentives

– Under what assumptions does Google’s pricing scheme lead to a dominant strategy of bidding “honestly”?

– Under what assumptions is the auction outcome efficient?– Under what assumptions is the auction revenue-maximising?– Are these assumptions realistic?

Page 17: Auctions II

Dynamics

Page 18: Auctions II

Botnets strangle Google Adwords(by John Leyden at The Register) Security researchers have discovered a way to shut down or seriously impair a Google Adwords advertising campaign by artificially inflating the number of times an ad is displayed. By running searches against particular keywords from compromised hosts, attackers can cause click-through percentage rates to fall through the floor.This, in turn, causes Google Adwords to automatically disable the affected campaign keywords and prevent ads from being displayed. By disabling campaign keywords using the technique, cybercrimals could give their preferred parties higher ad positions at reduced costs, according to click fraud prevention specialists Clickrisk."By disabling targeted keywords across many advertisers' campaigns simultaneously by artificially inflating the number of times an ad is displayed an attacker can secure a higher ad position," explains Clickrisk.com chief exec Adam Sculthorpe. The attack - dubbed keyword hijacking - is difficult to prevent because it takes advantage of a design feature of Google Adwords rather than a flaw, he added. Clickrisk came across the attack in investigating why the click through rates of one of its clients - which had been running at a steady rate - dropped to zero for no apparent reason. Subsequent monitoring and forensic testing revealed that a botnet made up of open proxies in China was responsible for the attack.High—cost-per-click (CPC) advertisers in niche markets are particular vulnerable to the keyword hijacking attack. "Once keywords are disabled they can't be re-enabled and attacks can go undetected for some time," Sculthorpe told El Reg. When keywords are disabled an advertiser must erase all campaigns featuring the affected keywords and create a new campaign as a workaround.Although the true scope of the problem remains unclear, Clickrisk security analysts believe the keyword hijacking attack may be widely exploited. Clickrisk advises users to monitor click-through rates and traffic levels, log into Google Adwords campaign frequently and check that keywords are not disabled.The incidence of click fraud risk exposure in general is on the rise. According to Clickrisk’s chief risk officer, Jack Bensimon, "our clients have experienced substantial losses ranging from 20 – 65 per cent of their total click costs." Bensimon believes that "managing business risk is a critical component of online advertising" and further recommends that "online marketers should be vigilant and regularly monitor keywords". ®

Page 19: Auctions II

Towards a Better Design

If the assumptions are unrealistic,– how might a bidder exploit the differences?– how might a competitor create a better design?

What constraints, if any, would you expect to be imposed on your design…– by competition from other search engines?– by legal considerations?

How might Google accommodate market power of advertisers?– Quantity discounts?

Page 20: Auctions II

VCG Auctions

Vickery-Clarke-Groves Auction – With one slot, identical to GSP auction– VCG charges bidder i the externality they impose on

others (their decrease in value of clicks because of i’s presence).

Example:– B2 still pays $200. B1 now pays $600 (rather than

$800) = $200 (externality on B3, pushed out) + $400 (externality on B2, pushed to second)

– VCG has lower revenues when bidders tell truth– But under GSP bidders may not tell truth.

Page 21: Auctions II

Sample Assumptions

Bidders value clicks– Without regard to the source of the click– Without regard to the position of the ad

The auction is honest and trusted– Click through rates are genuine– No shill bidders, false clicks, manipulated prices

Private values (no adverse selection) Searcher behavior

– Searcher clicks only on the first listing– Searcher clicks on the first relevant listing– Searcher inspects the top two listings equally

Page 22: Auctions II

Additional Additional ApplicationsApplications

Page 23: Auctions II

Uses of Novel Auctions Simultaneous design adopted for spectrum auctions

in Australia, Canada, Germany, Guatemala, Mexico, US

Variant with price-hour-quantity bids and a new activity rule adopted for day-ahead electric power in California– Variant proposed for “standard offer” electrical service

auctions Procurement auction with “endogenous market

structure” proposed by GTE for universal telephone service in the US.

Page 24: Auctions II

Wholesale Electricity Markets

Page 25: Auctions II

Resistance to Change

Cannot use decentralised allocation mechanisms

Market theory: supply does not equal demand. Particularly costly in electricity.

But does this really mean you can’t use a market-based process of decision-making?

Page 26: Auctions II

The Balance Requirement

Technical requirement that supply onto transmission exceed demand

Why is this an economic problem?• Losses from mismatches• Comparing apples and ambulances• Comparing ambulances and tow trucks

Page 27: Auctions II

Characteristics of Electricity

Nonstorability Lack of substitutes Difficulty in using price signals Localised effects

Page 28: Auctions II

Achieving Balance

Informational inputs• Demand forecasts• Costs and generating plant availability• Transmission loss information• Weather forecasts?

Network operator forms dispatch schedule• Determines reserve capacity requirement

Page 29: Auctions II

Economic rewards

Who provides the information? What are their incentives to report

accurately? What are their incentives to behave

efficiently?

Page 30: Auctions II

Vertical Integration

Internal arrangements to gather relevant information

Internal accounting arrangements link costs to individual performance -- no necessary economic conflict in cost apportionment

Not readily amenable to competition

Page 31: Auctions II

Contractual Arrangements

Network operator requires information from participants– Procedures for re-balancing– Procedures for handling constraints

Generators and retailers agree separately to how costs are apportioned using long and medium-term contracts

Page 32: Auctions II

Electricity Pools

Simply another form of contractual arrangement

Fixed rules• like contractual arrangements• unlike vertical integration

Lots of cost information• unlike contractual arrangements• like vertical integration

Page 33: Auctions II

Pools vs. Vertical Integration

Information problems under vertical integration• Incentives to minimise costs• Incentives to negotiate toughly on input

supply contracts

Fiscal constraints• Difficulties in financing new investments

Page 34: Auctions II

Pools vs. Contracts

Information provided to operator• richer amount under pools• only quantity information with contracts

Pool can be augmented by contractual arrangements• no compulsion to supply information• can make long-term financial arrangements if

so choose -- to minimise risk

Page 35: Auctions II

Pool Bidding Each generator bids in supply schedule

– How much it will supply at each price ISO uses bids to form industry supply schedule to meet

demand– Minimise costs treating bids as cost– Generates dispatch schedule– Takes into account inter-regional transmission constraints

System marginal price is the bid of the last unit dispatched– All dispatched units get this price

This is done every 5 minutes

Page 36: Auctions II

Simple Pool Model

Margina lCos t

Gene ra tor A Genera tor B

a t q = 1 2 3

a t q = 2 3 6

a t q = 3 7 8

Page 37: Auctions II

Truthful Cost Revelation

Suppose demand is q = 3 Optimal dispatch: A = 2, B = 1 Marginal cost bidding: A = 2, B = 1

– Payments to each of $3 per unit.– Achieves allocative and productive efficiency.

Page 38: Auctions II

Equilibrium Behaviour

Suppose demand = 2 units– MC Bidding: either A = 2 or (A = 1, B = 1)

Price equals $3 A earns $1 and B earns $0

– Can either do better? If A raises bid on second unit to 4, means only

dispatched for one unit. If B raises bid, then is not dispatched at all Neither can do better -- an equilibrium!

Page 39: Auctions II

Market Power

Suppose (again) that demand = 3 units– MC Bidding:

A earned $1 and B earned $0

– Can either generator do better? If A bids second unit at $4, then earns $2 extra. MC bidding not an equilibrium

– New equilibrium A bids (2, 5.9); B bids (3, 6) Resulting price equals $5.9

Page 40: Auctions II

Value of Contracting

In economics, consider value of contracting by comparing it to the appropriate counterfactual ...1.Pool price exposure: if do not contract with

that generator, what pool price will you face?

2.Generator exit: if pool prices insufficient to cover fixed generation costs, generator may exit without contract.

Page 41: Auctions II

Pool Price Exposure

If you do not contract with the generator what will pool prices be?– Pool market equilibria: at the contract time, how many

generating companies can bring pool price to VoLL by not bidding in capacity?

• If none, pool prices will equal system marginal cost

• If one or more, pool prices may go to VoLL

– If generator can bring pool to VoLL, want to contract with that generator.

Page 42: Auctions II

Maximum Contract Price

You should pay a generator no more than it brings to ‘value’ in the market.

This requires calculating the reduction in ‘value’ that occurs if generator is not in the market.

Page 43: Auctions II

Graphically

Quantity

$

VoLL Industry Supply

Demand

Page 44: Auctions II

Added Value

Quantity

$

VoLL Industry Supply

Demand

Gen’s Added Value

Page 45: Auctions II

Added Value

The added value of a generating company is the maximum amount of profits it can expect to earn from either contracting or the pool market.

Here a retailer may contract with the generator for VoLL price on all of its capacity. This may prevent it paying a VoLL price to other generators.

Page 46: Auctions II

An Example

Two generators A and B

A B

Capacity 20 10

Marginal Cost $2 $5

VoLL = $100

Page 47: Auctions II

Added Value (Demand = 10)

Quantity

$

5

2

A’s AV = $30

B’s AV = $0

10 20

100

Page 48: Auctions II

Added Value (Demand = 15)

Quantity

$

5

2

A’s AV = $520

B’s AV = $0

10 20

100

Page 49: Auctions II

Added Value (Demand = 25)

Quantity

$

5

2

A’s AV = $1485

B’s AV = $475

10 20

100

Page 50: Auctions II

Exit Option

Sometimes, a generator may not have sufficient value added to keep operating.

Nonetheless, it may bring sufficient value to retailers even if it does not bring sufficient value to the market.

A generator has some value if it reduces the added value of other generators.

Page 51: Auctions II

Entry Value (Demand = 15)

Quantity

$

5

2

A’s AV = $520

B’s EV = $950

10 20

100

Page 52: Auctions II

Additional Considerations

Demand uncertainty Impact of outages Financial analysis: determining option

values in an electricity market

Page 53: Auctions II

Rail AuctionsRail Auctions

Page 54: Auctions II

Rail Reform

Sweden: wanted to use a decentralised rail use allocation processes.

Consultants objected (Coopers & Lybrand)– “These train paths cannot be treated as independent units, since

they are not interchangeable, and depend on the specification of all other paths in the integrated timetable. There is therefore no common unit of capacity on a mixed-use railway which can be allocated to owners, prices and traded among a number of buyers and sellers.

– However, a simple free auction cannot be used for railway capacity since there are no independent units of capacity to bid for. The viability of every bid to operate a train service depends on the specification of every other train service which has been bid for.”

Page 55: Auctions II

Proposed Times

SYD

MEL

CBR

timeG

C D

A B E F H

Page 56: Auctions II

Feasible Schedules

SYD

MEL

CBR

timeG

C D

A B E F H

Page 57: Auctions II

Feasible Schedules

SYD

MEL

CBR

timeG

C D

A B E F H

Page 58: Auctions II

Which schedule should be chosen?

Can work out what is feasible? But what is most efficient?

Answer: use simultaneous ascending/combinatorial auction. – Bid for each particular route– Bid for route combinations– Choose schedule among these that maximises

revenue