25 July 2012
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The History of Penny Auctions

The concept was first introduced in 1971 by Martin Shubik, the Seymour Professor of Mathematical Institutional Economics at Yale University, under the name of dollar auction. The game is an illustration of a paradox in which the participants are constrained to make, in the end, an irrational decision based on a sequence of rational decisions; an irrational escalation of commitment.

Rules: Bidding starts at $0.01 and goes up in $0.01 increments. The winner then pays the auctioneer whatever the highest bid is to get the item. Typically, the auction will start with a few bidders hoping to make a profit and then ending up in a bidding war of attrition. In most cases the bid will reach $1 and then a problem will become evident for the $0.99 bidder, He can no longer make profit but right now the only rational option is to bid $1.01 which will result in a $0.01 loss compared to $0.99.

Martin’s auction game was transformed into a penny auction site in 2005 by Telebid and its lead developer Josh MacDonald who practically invented today’s penny auction business model which later became swoopo.com. It was very controversial in the beginning and also heavily criticized. This led to a business change model adopted by all reputable penny auction sites. They allowed bidders, who lost the auction, to get back all their bids that were used and put them towards purchasing the item. This change made it impossible of the bidder to lose money with penny auctions.

Swoopo was a bidding fee auction site where purchased credits were used to make bids. Prior to changing its name to Swoopo in 2008, the website was called Telebid. Swoopo was operated by Entertainment Shopping AG and based in Munich, Germany. In March 2011, Swoopo’s website became inaccessible, and a notice page claimed that Swoopo was experiencing “technical issues.” On March 26, 2011, Swoopo’s parent company filed for bankruptcy.
Entertainment Shopping AG was guided by a man named Frank Han who was the chief executive officer right up until they filed for bankruptcy.

Unfortunately for Swoopo.com they failed to file a legitimate patent for the business mode. The reason being, prior art had been published by Shubik in 1971 illustrating the dollar auction concept. Although they still filed and still hold a patent pending title this did not stop copycats from starting their own sites to compete with the entertainment shopping giant.

This competition began slowly, chopping away at the profits of Entertainment Shopping AG. In an article written in April of 2010 Frank Hans outline the struggles his company was facing. He also went on to state these facts:

Swoopo hosts 250-300 auctions per day, split between global and local.

The average final price of an auction is 71 percent off retail (of course Swoopo also makes money from the cost of bids).

In one third of auctions, the final price is more than 90 percent off retail.

The company loses money on 65 percent of auctions. “Our margins are nothing like Google’s, but better than Overstock,” said Han.

The U.S. is the company’s largest market by far after launching a year and a half ago (the company started in Germany and was previously called Telebid).

Swoopo has raised two rounds of funding, one led by Wellington Partners and one by August Capital. It has nearly 100 employees.

The problem with these statements was that they were factually untrue. What was really going on was that the company was under attack by numerous competitors that were taking away the monopoly that the company once enjoyed.

Another interesting factor was that Frank Han and a few other company executives, implemented a new feature in the auctions known as the “Buy it Now” option. This option single-handedly killed the penny auction model for this once thriving business. Where the company once enjoyed massive profits by retaining every bid which was placed in its auctions, it now was becoming a clearing house for items that were selling at retail value for which they could not secure wholesale cost.

In 2010 this also introduced a new type of bidder to the penny auction industry called “power bidders”.

A power bidder is a professional penny auction user. The introduction of the buy it now business model allowed these professional users to purchase thousands of bids at the penny auction website and proceed to aggressively bid on auctions. If they lost, they simply hit the buy now button and received the item for its retail value. This item would be shipped and resold once received. Therefore, the power bidder never lost an auction. In most cases the power bidder wins an auction for far less than the auction owner expected. With their own business model in mind, these types of bidders were able to successfully apply this to ongoing auctions and in most cases win auctions for next to nothing.

Due to the aggressive nature of the bidding practices of a power bidder, many of these users gained infamous reputations and were avoided by other bidders.

One can easily argue that the fall of Entertainment Shopping AG was not the competitors that were springing up around it but rather a fatal business decision of introducing the “Buy Now” option on every auction listed on the site.

Other factors that ultimately led to this website’s demise were chargebacks from users who did not win. These users viewed the website as a scam and ultimately complained to anybody who would listen, including their credit card company.

There are two views on penny auctions. Those that have won a penny auction think they are the greatest thing ever invented. Those that have lost a penny auction think they are evil and are some form of gambling.

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