How much would you pay to win a dollar?
“The Dollar Auction game: a paradox in non-cooperative behavior and escalation” was published by economist Martin Shubik in the March, 1971 issue of the Journal of Conflict Resolution (I know, I know — you've got a copy laying around somewhere).
Here's how it works: An auctioneer says, “I'm going to give a dollar to the highest bidder, just like a regular auction. The only difference is that both the highest bidder AND the second highest have to pay the auctioneer the value of their bid.”
Mr. Smith offers an initial bid of a nickel because who wouldn't want to get a dollar for five cents? According to the rules of the dollar auction, if no one else bids, Mr. Smith will get a dollar for a nickel.
But Ms. Jones bids a dime because, as she sees it, “I can get a dollar for ten cents. That's a good deal. I'll have to pay a dime and Mr. Smith will have to pay a nickel. But I'll get a dollar for my dime and he'll get nothing for his nickel.”
(For simplicity let's limit the explanation to just Mr. Smith and Ms. Jones even though the argument doesn't change if more people participate.)
Mr. Smith is now in a tricky spot: If he remains quiet, he loses a nickel. Ms. Jones will get the dollar, paying only a dime and he will get nothing for his nickel. Any rational person would bid 15 cents. Mr. Smith will still get 85 cents profit. So he bids 15 cents.
But Ms. Jones now bids 20 cents because if she doesn't bid again she will lose her dime. By bidding 20 cents, she will earn 80 cents.
But of course, Mr. Smith bids again. He has to. Otherwise he'll lose the amount of his previous bids. Similarly, Ms. Jones has to keep bidding.
Soon the bids approach a dollar. Ms. Jones has bid 95 cents so Mr. Smith bids a dollar. That's right. He bids a dollar to win a dollar because if he doesn't bid, he loses 90 cents.
So what will Ms. Jones do? She will do what any rational person would do. She can't lose her 95 cents and get nothing in return. She must keep bidding. She must bid $1.05 even though she has to bid more than a dollar to win a dollar.
Mr. Smith has to bid more than $1.05. Otherwise he'll lose his dollar and get nothing in return. He bids $1.10. Surely any reasonable person would agree it's better to pay $1.10 for a dollar than to lose $1.00 and get nothing. Losing a dime isn't as bad as losing a dollar.
Except of course that now Ms. Jones has to bid $1.15 by the same reasoning. She bids $1.15 to win the dollar.
Both Mr. Smith and Ms. Jones must now continue to bid amounts well in excess of the dollar. And there is no point at which it makes sense to stop bidding. When Mr. Smith bids $4.00 to preserve his $3.90, Ms. Jones will bid $4.15 so she doesn't have to pay $4.05 and get nothing.
The conclusion of Shubik's study? That the only way to win is to not play the game in the first place. Because once the escalation and non-cooperation starts, nobody but the auctioneer walks away with any money.
If the only way to win is not to play applies to some business activities as well as Shubik's study, then it creates a perfect context for sales strategies such as being the low priced leader or trying to outspend your competition.
When we created our recent campaign for Colombian Emeralds International (CEI), we used Shubik's theory. CEI operates more than 70 jewelry stores in the Caribbean that cater mostly to cruise passengers. And CEI competes with other chains that sell similar products but have bigger names and bigger marketing budgets. Where CEI excels is in their superior collection of emeralds and colored stones and their localized, personalized service.
So instead of going up against the big boys dollar for dollar, we avoided non-cooperative behavior and escalation by forging a new path for CEI. With our client's cooperation, we created a handsome South American adventurer/spokesman — Diego Galante — and crafted compelling tales of Diego gathering unique jewelry and gemstones from Colombia and around the world. Then we created a different in-store sales experience where our customers were not just buying brightly colored baubles but instead were buying the romance and glamour of exotic experiences.
Using in-room TVs on the cruise ships and social media sites such as Facebook, we promoted Diego as a unique asset that our competition couldn't match. And by building relationships between our customers and our spokesman, we were able to sell stories and experiences that gave our customers an enormous added value with their jewelry purchase. That is, when our customers got home, they didn't just have a beautiful piece of jewelry to memorialize their trip but they also could tell a story of romance and adventure to everyone they saw — creating interest, aspiration, and potential new customers.
Thanks to Diego, CEI's been filling their stores and breaking their sales records. And because he's provided them with a correct, consistent, and compelling brand vehicle, Diego's character makes it easier for us to keep moving CEI's brand towards increased awareness, sales, and profits.
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