An auction is a common way to sell something. At first glance, it’s simple to follow and implement. That, however, is deceptive. Auctions have evolved into highly sophisticated tools to sell a range of things. They span auction generated advertisements which appear each time a search engine such as Google is used, to the trillions raised for the government by RBI through bond auctions. This year’s Nobel awardees for economics, Robert Wilson and Paul Milgrom, have been recognised for their pioneering work in both auction theory and design. It’s richly deserved.
The success of an auction depends mainly on three things. The rules which govern the process, the bidders’ idea of the value of the auctioned item and the information asymmetry among bidders about the item. Wilson, beginning 1960s, and Milgrom in the 1980s, spelt out how these three aspects interact. What’s unusual is that the winners collaborated to build real world applications arising out of their theoretical work. The best known of their applications is the Simultaneous Multiple Round Auction (SMRA) method used in the US in 1990s for telecom auctions. SMRA has been used elsewhere, including in India.
A criticism levelled against auctions is that results can be suboptimal. It’s misplaced. The success of an auction depends crucially on the aim of the auction. For example, if a charity aims to raise the highest possible amount of money by auctioning memorabilia of a sports celebrity, there’s hardly anything that can go wrong with the design. On the other hand, if a government that wants to auction telecom spectrum has more than one goal, challenges will be plentiful. One of those challenges, in the Indian experience, is to protect potential revenue by preventing collusion among bidders.
In India, it’s been addressed by a floor price for bids. This method spawns another set of problems such as failed auctions because the floor price is too high. Another challenge is the winner’s curse, where the winning bid is based on an overestimate of value. Auction design remains work in progress because contexts and aims keep changing. Also, the very nature of what’s sold evolves with technological advancement. Search engine advertisements were inconceivable 50 years ago when Wilson was building the theoretical foundation. The award is a reminder of the work that has gone into the scaffolding supporting many modern markets.