A seller can have bidders submit sealed bids, and then sell the single-item to the highest bidder.
For example, 3 bidders place sealed bids of $1,000, $1,250 and $1,500. The seller sees the $1,500 is the highest bid, and that’s the sale price for the single-item.
Or, a seller may use another method, which many believe results in a higher sale price.
William Vickrey, a professor of economics and Nobel Laureate proposed the “Vickrey Auction” which would accept sealed bids in a similar fashion to any other sealed bid auction, but award the highest bidder the single-item for the amount of the second-highest (highest non-winning) bid.
For example, a seller can have bidders submit sealed bids, and then sell the single-item to the highest bidder for the second-highest bid amount. Prevailing theory is that because of this, the bidders will bid more, knowing that they will only pay at — or less — than their bid.
The Vickrey auction is based upon what bidders believe they know about the other bidders.
Our $1,500 bidder from the previous auction actually thought the single-item was worth $2,000. In fact, he was willing to pay as much as $2,000, but thought the other bidders would not bid over $1,500.
In a Vickrey auction, the prior $1,500 bidder bids more, thinking that he has to be the winning bidder to secure the single-item. And, he bids $2,000 knowing that if he is the winning bidder, he only pays what the second-highest bidder bids.
Given our prior auction, if the second-highest bidder still only bids $1,250, then our $2,000 Vickrey bidder secures the single-item for $1,250. However, it’s likely the $1,250 bidder bids more also, given that if he is the highest bidder, he only pays the second-highest bid amount.
Vickrey and others who have attempted to further explain the Vickrey auction say that in a standard sealed bid auction, bidders “shade” their bids knowing they only have to outbid all others, but they will pay that amount that they bid.
It seems the Vickrey auction builds in the “shade” so the bidders don’t have to, and can bid more.
For example, if our $1,500 standard bid bidder thinks the second-highest bidder will only bid $800, it is in his interest to shade his bid downward — as a bid of $825 would be a winning bid if his assumptions are correct.
However, in a Vickrey auction, even if this same bidder believes the second-highest bid will be only $800, he can bid higher, knowing that he will only pay the $800 if he’s the winning bidder. But, by bidding higher, he can also win the item even if the second-highest bidder bids more, so long as that second-highest remains the second-highest.
Auctioneers in the United States are most familiar with English incremental increasing auctions, where the high bidder wins and pays just one bid more than the second highest bidder. As many have noted, this type of auction becomes increasingly equivalent to a Vickrey auction as prices rise.
A home is selling at auction which Richard believes is worth $100,000. He only has to pay one more bid than the second-highest bidder believes they want to pay. So, if another bidder bids $82,000 and Richard bids the winning bid at $83,000, then Richard get the house as if he submitted a $100,000 sealed bid for the second-highest bid received of $82,000 + 1,000 (+1.2%) = $83,000.
For sealed bid single-item auctions, the Vickrey auction allows the auction to be most similar to what most auctioneers do every day — sell to the highest bidder for (just a bit more than) what the second highest bidder has offered; however, without the pressure and urgency which open competitive bidding provides.
Mike Brandly, Auctioneer, CAI, AARE has been an auctioneer and certified appraiser for over 30 years. His company’s auctions are located at: Mike Brandly, Auctioneer, Keller Williams Greater Columbus Auctions and Goodwill Columbus Car Auction and. His Facebook page is: www.facebook.com/mbauctioneer. He serves as Adjunct Faculty at Columbus State Community College and is Executive Director of The Ohio Auction School.