The escalation of commitment, or, rational thought meets…people

In a recent New York Times article, Richard H. Thaler talked about dollar auctions.  In business schools and economics classes, a professor will offer to sell a dollar (or a twenty-dollar bill) to class members via an auction.  The catch is that when the auction ends, the winning bidder pays up and gets the money–but the second-highest bidder also has to pay up, even though he or she gets nothing.

Under that rule, with stubborn bidders, Thaler says, the total paid for $20 can exceed $50.

The original dollar auction as invented by Yale’s Martin Shubik (who described it in this 1971 article [PDF]).  Escalation of commitment is the concept under which, after people have begun bidding in such an auction, they’re increasingly reluctant to stop.

Thaler’s real topic is the website, an auction site practically printing money on the escalation-of-commitment principle.  Items go on auction at an opening price of one cent.  Some items have a minimum bid of one cent; I found others with a minimum of 12 cents.

There may be other minimums–but the price of each bid is 60 cents.  Got that?

duplo5609I watched one instructive auction for about three minutes as I started this post.  The item?  Lego Duplo set 5609, a construction play set.  As I’m writing, you can buy this on Amazon for $104.13 with free shipping.  Swoopo said the item was worth “up to $110,” which is reasonable.

Each time someone bid, the minimum increase was twelve cents — but each bidder had to pay Swoopo 60 cents per bid.

In the three minutes I watched carefully, there were at least 60 bids–probably more; I missed some as I was making hash marks.

The winner bid $41.76–but placed 56 bids, which added $33.60 to the price.  So the net net, as they say, was a price of $75.36 for the winner, a savings of about $29 off the Amazon price, or $34.64 off the value stated on Swoopo.

The point is that the winner wasn’t the only bidder.  A price of $41.76, at twelve cents per bid, means 348 bids.  At 60 cents apiece, that’s $208.80 in bid charges.  Add the $41.76 cost to the winner, and Swoopo took in $250.56 for a $110 toy.

That’s some margin.  Or, as Thaler puts it in his article, “the difference between Swoopo and Best Buy is that at Swoopo you end up paying for stuff in the other guy’s shopping cart.”

I don’t mean to criticize Swoopo (necessarily).  I do recall the magician Penn Gillette, who often performs in Las Vegas, responding to a question about whether he gambles while he’s there.

“No,” he said.  “I’m too good at math.”

4 thoughts on “The escalation of commitment, or, rational thought meets…people

  1. Julie, it’s a perplexing phenomenon. I can imagine those running these auctions (and it’s not just Swoopo) spreading their hands, palms up, a practiced look of innocence: Hey, we’re selling these Duplos (or this TV, or this ocean liner) at a real bargain. And nobody has to bid. At the same time, they’re counting on, possibly depending on, the addictive and irrational behavior that brings them $120 in revenue above a list price of $110.

    Thanks so much for the link to The Frontal Cortex. I hope others read it. I think one piece that Lehrer quotes is worth repeating:

    It turns out that [in an experiment] near-misses activate almost exactly the same dopamine circuits as actual wins – but here’s the punchline – they were subjectively experienced as the most unpleasant outcome, even worse than total misses.

    In other words, the dopamine system was firing like a rocket display but the experience was awful.

    Interestingly, although near-misses were experienced as aversive they increased the desire to play the game but only when the person had some perception of control, by choosing what the ‘lucky’ picture would be. Of course, like choosing ‘heads or tails’, it’s only an illusion of control because the outcome is random anyway.

  2. Hi Dave

    Great post. I don’t think we have Swoop but I do get loads of emails telling me they’ve ‘just sold a PlayStation for £11.62’ and even a hard-bitten rationalist (cough) like me wondered how this was possible and was tempted to have a look.

    As David Zetland points out in the short video above, though, it’s way bigger than a smart retailer price-gouging. The Dollar Auction is essentially how politics works.

    I think David Zetland shows a pretty good demonstration for good in the video above, Julie. Drawing attention to cognitive bias is important for learners. And this one’s a doozy demonstration-wise.

  3. That’s an interesting angle, Simon. I recall clearly the George W Bush administration, after a very narrow win, claiming a mandate and pulling more levers than Lyndon Johnson did after his landslide: a win is a win.

    The link that Julie provided was fascinating to me: near-wins far more painful than obvious losses.

    Without getting too heavy, I think this is reflected by an industry that calls itself gaming rather than gambling.

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