Dear Economist

Builders and the winner’s curse

Dear Economist,

I have bought a dilapidated house and hired some professional builders to renovate it. I thought I could ensure a good deal by soliciting a variety of quotes and estimates and choosing the lowest ones. But from the plumber to the decorators, every single tradesman has failed to stick to his estimate, renegotiated his quote, or simply walked away without finishing the job. Can you advise?

— S. M., Bristol

Dear S. M.,

Your strategy has been, in effect, to hold a series of what economists call “reverse auctions”. That is, rather than trying to sell for the highest price you are trying to buy for the lowest price. And it is to auction theory that you must turn for guidance.

Auction theorists have long recognised that when bidders have to estimate the value of a prize – whether the prize is a work of fine art, a licence to drill for oil, or the obligation to rewire your electrics – then an auction will systematically select the most optimistic estimate.

Even if most bidders make accurate or even cautious estimates, there will usually be some who get it wrong – and one of them will of course win the auction. Winners of auctions tend to be disappointed, a phenomenon known as the “winner’s curse”.

When you are selling, you may be rather pleased that one bidder makes a mistake and accidentally offers too much. After all, all you need is to ensure that you get paid. But in a reverse auction, it is hard to ensure that a disappointed winner will provide the promised service.

If the winning electrician discovers that he has bitten off more than he can chew, it will be difficult to hold him to his original quote. There is a long and dishonourable history of such renegotiations in the procurement business, so you are not alone.

You should certainly make sure that you get binding quotes in future, and to make sure they stick, withhold payment until the job is finished. But unless you are a skilled builder yourself, you may still find unpleasant surprises long after the event. My advice is to turn the winner’s curse to your advantage. Why not sell the finished house at an auction?

First published at ft.com.