We’ve recently worked together with a potential client on business analysis of so called “penny auction” website and would like to share in this blog post information on how such sites and certain issues of concern.

For the ones who are not familiar with the term “penny auction”, let’s first try to understand what this concept is all about. For this, let’s have a some quotes from an article published in The Guardian UK published some three years back:

“Unlike eBay, where bids are free and you only pay the price at which you win an item, participants in a penny auction must pay to place each bid as well as the final price of an item should they win it. Of course, there can be only one winner so everyone else is left out of pocket.”

Such sites, are mostly popular in UK and probably the best known is madbit.com, which works like this:
“To place a bid you need to buy credits sold in blocks typically costing £9.99 for 80 or £374.99 for 3,750, meaning individual credits cost 10p-12.5p. You need up to six credits to make a single bid. This means that bidding on some items can cost as much as 75p each time. Each bid raises the auction price of an item by 1p and at the same time extends the closing time of the auction by up to 60 seconds. At some sites, as long as people keep bidding the auction never ends. If you win, how much you eventually pay depends on how many credits it took to place each bid, how many times you bid, and the eventual sale price.”

The article also includes a profitability analysis:
“We took a detailed look at the bidding history for Madbid’s recent LG TV auction, which required four credits per bid. We found that 79 people placed bids in total and the winner spent £217.60 on bids to win the TV – at great cost to rival bidders. Thirty nine of them bid once and so lost only 40p (assuming they bought credits at the cheapest rate of 10p per credit); 10 people lost 80p after making two bids; while 19 people wasted between £1.20 and £4.80.

Nine people spent between £5 and £30, but the failed bidder who lost the most cash was minga60, who wasted £211.60 by placing 529 bids.

Madbid can make a lot more than the sale price on each item. On the LG TV, Madbid could have raked in as much as £612, assuming all bidders spent 10p to buy each credit. That’s £162 more than the recommended retail price of £450.

Similarly, we have calculated that by attracting 252,907 bids Madbid could have made £151,744.20 on an Audi A3 Sportback that had an RRP of £18,790 – 600% more than the cost of the car.

But it often loses money too. A pair of hair tongs worth £40 recently sold for 25p, making Madbid as little as £10 from the 25 bids it attracted. A men’s Fila watch worth £139 attracted only 23 bids, worth as little as £9.20 to the website.”

Well, all above are about how such a site can work. However, during our study, we decided that there are at least two more issues of concern in regards to penny auction business:

• Is it a form of gambling?

While the UK’s Gambling Commission has refused to acknowledge penny auction sites are gambling operations, the article includes and expert opinion from Dr. Mark Griffiths, professor of gambling studies at Nottingham Trent University: “Winning a penny auction is essentially chance-determined and does not depend on any discernible skill – a person can bid again and again with no certainty that they will ever win the product. If there is no real skill in participating and it is essentially a chance activity, how is this not a form of gambling? The vast majority of people who bid on penny auction websites do not get anything for their money, except the hope of winning.”

Well, if we consider that one either loses or wins something as a result of his/her actions, this shall be called gambling. In example, in eBay or in other regular auction sites, you actually don’t loose money if your bid is not a winning one, unlike in penny auction sites in which you money spent on credits for placing the bids is lost even if you don’t win the auction.

• Can the process be manipulated?

Interestingly enough, the first concern that came into our mind was not covered in the article and we could not come across with it elsewhere. There may be regulations in UK about which we are not aware of, that control and monitor operations of such websites. Nevertheless, if this is not the case or if this business is run where such regulations do not exist, think about the following: Wouldn’t it be so easy to take the price up to desired levels by automated price increments by the owners of the website? After all they do not pay for the credits themselves! And even if the price of an item gets to high leaving no real buyer, the website can still keep the product (as the winning bid is made by its artificial user) and make the profit from other real users that spent money for the credits in that particular auction.