Entrepreneurs have discovered a business model that actually counts a weak economy among its advantages: the online penny auction. Promising discounts up to 95% off retail prices of big-ticket items like iPads and televisions, these sites are a magnet for hopeful consumers battered by hard economic times.
But in reality, penny auctions are not delivering the savings their penny-pinching customers expect. Although each bid increases an item’s price by only one cent, it costs potential buyers 50 cents to a dollar to a cast a bid in the first place. Unlike traditional auction sites, which serve as venues for buyers to connect with third-party sellers, penny auction sites own the merchandise and sell it directly to the buyer.
In each auction, profits come from two sources: the selling price of the good and, more significantly, those high bidding fees. Penny auctioneers can afford to sell a $500 television for $20, because the revenue from such an auction, assuming the price of each one-penny bid is 50 cents, is $1020 ($20 from the selling price, and $1000 from 2000 bids). In other words, the auctioneer makes a profit of $520 on the transaction.
Suppose the winner had to bid 100 times on the auction — he ultimately paid $70 ($20 for the selling price and $50 in bidding fees) for a $500 television, over 80% off retail. Sure, this is an incredible deal, but winning a penny auction is a rare and uncertain event. It’s more likely that buyers pour more money into auctions they lose.
Does that concept sound familiar? The Federal Trade Commission thinks so. The required buy-in and unfavorable chances of winning have led the FTC to deem penny auctions, which are all the rage in the UK and growing in popularity in the U.S., more like gambling than auctions.
So, how do penny auction sites hook consumers? Here are seven sly (and totally legal) tricks in the penny auctioneer’s portfolio.
1. Display items that have already been sold along with their selling price. Whether this makes customers envious, reassures them that good deals are possible, or spurs them to action with the urgency of scarcity, it’s an effective strategy for luring shoppers into the penny auction.
2. Sell bids in packs rather than individually, upfront. Converting money into bid credits at the outset creates psychological distance between the bids and what they actually cost, encouraging risk-taking and making it difficult to keep track of spending money. Plus, if shoppers buy packs of bids upfront, they are less affected by loss aversion than if they purchase the bids one by one.
3. Do not refund unused bids. Having already paid for the bids, a customer will find it difficult to withdraw without using all of them. On the other hand, a bidder who finishes his pack in the middle of an auction may buy another pack to finish the auction – and the cycle continues.
4. Offer losing bidders the option to buy the item at retail, less the money they already paid in losing bids. The price-sensitive consumers that penny auctions attract may not be able to afford purchasing the item at retail. Besides, if a losing bidder does purchase the item, the penny auctioneer breaks even. With nothing to lose on any given transaction, why not make customers feel like they can trust you?
5. Auction off high-ticket items that will generate buzz. The key to running a profitable penny auction is maximizing the number of bids on each item. Bidders can’t resist the prospect of large gains from a high-ticket auction.
6. Increase the time remaining in the auction with each bid. Rather than discouraging bidders, allowing them to get close to winning without winning strengthens their desire for the item. It keeps the auction running longer and intensifies the competition, which means more bidding fees for the auctioneer.
7. Turn the timer red in the last few seconds. If you ask a bull, an artist, or a psychology Ph.D., they’ll all tell you the same thing: red grabs attention and excites. A red-colored countdown is the cherry on top that keeps shoppers addicted to bidding, unable to let the clock run out.