Since You Asked

Mile-high bid to step up to a better class

Auctions seem a fine way of assessing willingness to pay, writes Tim Harford

‘For those seeking a way out of the economy cabin, a number of airlines, including Virgin Atlantic, Etihad, Austrian Airlines and Tap Portugal offer a facility whereby you tell them what you are prepared to pay to get upgraded.’
Financial Times, May 15

Am I supposed to be impressed? Isn’t the normal method of being upgraded to pay for it?

I think the distinction here is that traditionally, the customer – or the customer’s employer or client – pays the sticker price to fly business class or first class. This new scheme invites the customer to suggest the price. The airline will sit on that bid for a while, see whether better offers come in and, depending on how busy the front of the aeroplane is, will accept or reject the offer.

I see – that is a change.

Yes, but not a big change. A well-designed auction flushes out information about what people might be willing to pay, and charges accordingly. In some markets that is a very useful innovation, but there’s a reason why Tesco doesn’t run auctions when you pop in to buy milk.

It’s too much hassle, of course.

Partly that – although it is possible to run auctions incredibly quickly and cheaply in some circumstances. Every time you type in a search term on Google, the company runs a quick auction to decide which adverts to display. But Tesco doesn’t need to bother trying to figure out how to run auctions because it already has a fantastic amount of information about willingness to pay in general. It may also have information about your own shopping habits through which it can offer selective discounts.

And the same must be true for airlines.

Yes. Airlines are always tweaking the prices of their seats on each particular flight as the departure date looms and the plane starts to look full or empty. The auction may generate a bit of extra information, and therefore a bit of extra cash, but it seems marginal. My theory is that airlines want to differentiate between people who insist on flying business class and people who are willing to take a chance that they will not. A good way to offer different prices to these people is to sell some seats upfront and others in a more opaque auction.

Still, you’re making auctions sound rather passé.

This idea seems passé, but auctions certainly aren’t. The Bank of England uses auctions to determine how to inject liquidity into the banking system, for instance. This is a challenge because the problem is multidimensional: the BoE could offer loans backed by all sorts of different collateral, but would rather lend against safe collateral than riskier stuff. The potential interest rates at which the loans might be made depend on how desperate the system as a whole is for liquidity, but the spread between loans on safe collateral and loans on dodgy collateral should also vary depending on demand. Paul Klemperer, an economist at Oxford university, calls this general problem a “product mix auction” and has figured out a way to make the process run instantaneously, rather than dragging out for weeks as government auctions of yesteryear used to do.

It’s a long way from Sotheby’s, though. Or for that matter, a long way from eBay.

Both Sotheby’s and eBay accept proxy bids that come into play only when needed, and that is the key to Prof Klemperer’s scheme. And Sotheby’s could use a product mix auction to sell off a wine cellar, full of cases of similar but not identical wines. But you are right: auctions are becoming automated and a lot of auctions take place without us puny humans knowing. Your electricity supplier may soon be installing a computer that will vary the price of electricity by the second, and if prices are high some of your appliances will drop out of the bidding: the lights will dim, the fridge will allow the temperature to rise a little, the immersion heater will wait for a more propitious moment. An auction is a natural way for the computers to determine who gets priority.

I, for one, welcome our new silicon masters. Anything else?

You can already auction off your time to the highest bidder through Amazon’s “Mechanical Turk”, an online marketplace for small tasks requiring a bit of human judgment. It’s possible that sort of thing might become more widespread. On which point, I’ll have to leave you. This conversation was pleasant enough but I’ve just received a better offer.

Also published at ft.com.

18th of May, 2013Since You Asked • Comments off