Online auction business model

We have all visited a site on the net that allows it's users to auction off their own items. Of the many auctions sites around, a few stand out:

eBay is the worl's largest online auction site. Like most auction companies, eBay does not actually sell goods that it owns itself. It merely facilitates the process of listing and displaying goods, bidding on items, and paying for them. It acts as a marketplace for individuals and businesses who use the site to auction off goods and services.
Trademe is the New Zealand equivilent of eBay, and was the most popular website in the country for 2005. Trade Me shares many features with other online auction websites, such as the American auction giant eBay. Some of these features include "Buy Now", "Auto bidding" and the Safe Trader escrow service. Members in New Zealand can become "Address Verified" by confirming their street-address, and the site may block unverified members from bidding. Significantly, despite its global reach, eBay has failed to make a sizeable penetration in the geographically isolated New Zealand market.

Several types of online auctions are possible. In an English auction the initial price starts low and is bid up by successive bidders. In a Dutch auction, multiple identical items are offered in one auction, with all winning bidders paying the same price -- the highest price at which all items will be sold (treasury bills, for example, are auctioned this way). Almost all online auctions use the English auction method.

Strengths of the business model

The strategic advantages of this business model include:

  1. No time constraints. Bids can be placed at any time (24/7). Items are listed for a number of days (usually between 1 and 10, at the discretion of the seller), giving purchasers time to search, decide, and bid. This convenience increases the number of bidders.
  2. No geographical constraints. Sellers and bidders can participate from anywhere that has internet access. This makes them more accessible and reduces the cost of "attending" an auction. This increases the number of listed items (ie.: number of sellers) and the number of bids for each item (ie.: number of bidders). The items do not need to be shipped to a central location, reducing costs, and reducing the seller's minimum acceptable price.
  3. Intensity of social interactions. The social interactions involved in the bidding process are very similar to gambling. The bidders wait in anticipation hoping they will "win" (eBay calls the successful bidder the "winner"). Much like gambling addiction, many bidders bid primarily to "play the game" rather than to obtain products or services. This creates a highly loyal customer segment for eBay.
  4. Large number of bidders. Because of the potential for a relatively low price, the broad scope of products and services available, the ease of access, and the social benefits of the auction process, there are a large numbers of bidders.
  5. Large number of sellers. Because of the large number of bidders, the potential for a relatively high price, reduced selling costs, and ease of access, there are a large number of sellers.
  6. Network economies. The large number of bidders will encourage more sellers, which, in turn, will encourage more bidders, which will encourage more sellers, etc., in a virtual spiral. The more the spiral operates, the larger the system becomes, and the more valuable the business model becomes for all participants.
  7. Captures consumers' surplus. Auctions are a form of first degree price discrimination. As such, they attempt to convert part of the consumers' surplus (defined as the area above the market price line but below the firm's demand curve) into producers' surplus. On-line auctions are efficient enough forms of price discrimination that they are able to do this.
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