A critical review of online auction models

A critical review of online auction models

Subir Bandyopadhyay

ABSTRACT

Online auction has become an integral part of Internet shopping. It is one of the few models of e-commerce that has proven to be successful. However, many auction sites have failed because they were not able to create a unique business mode/that appealed to buyers and sellers. This paper explores the myriad of business models associated with online auctions, and classifies them as consumer-to-consumer (C2C), business-to-consumer (B2C), business-to-business (B2B), business-to-government (B2G), and government-to public (G2P). In addition, it identifies some of the key variables (such as user interactivity, product offerings, level of trust, rapid growth and adoption, networking, level of commitment, and payment options) that determine the success or failure of online auction models.

1. INTRODUCTION

The Internet has transformed business and business models. Some models have caught the imagination of consumers; others simply faded into oblivion. Online auction is one of those business models that have proven to be successful. In fact online auction was expected to account for 29% of all e-commerce in 2002 (Kaiser, 2003). The big auction powerhouse, eBay, had $2.17 billion in revenue for 2003 with net income of $441.8 million (www.ebay.com) and is one of the few Internet companies to post positive earnings. Hence, it is important to consider online auctions as a part of the Internet’s phenomenal economic growth.

However, this remarkable growth of online auctions overshadows a tale of many failures. In the last three years, many online auction sites have shut down or merged with other auction sites. Sites that have recently shut down include SandCrawler.com, FirstAuction.com, and Auctions.com. It is, therefore, clear that the online auction business is going through the “shake-out phase”. Consequently, we believe that it is critical for businesses to understand what it takes to be successful in the online auction arena. Only those companies that create a unique model and know what buyers and sellers are looking for in an online auction will be able to survive this critical phase.

In this paper, we first classify different types of auction models into five major categories: consumer-to-consumer (C2C), business-to-consumer (B2C), business-to-business (B2B), business-to-government (B2G), and government-to-public (G2P). Next we identify and discuss some of the key variables (i.e., user interactivity, product offerings, level of trust, rate of growth and adoption, networking, level of commitment, and payment options) that determine the success or failure of online auction models. Finally, we evaluate a popular online auction model with respect to these key variables.

2. CLASSIFYING ONLINE AUCTION MODELS

When considering online auctions, it is important to consider who is involved in the auction process as the buyer and as the seller. There are three main groups of buyers and sellers: individual consumers (C), businesses (B), and the government (G). We term buyers of government auctions as the general public (P), as the government does not distinguish between consumers and businesses when they are selling surplus goods. This would result in six business models, but because of economies of scale it is not likely that a consumer will sell to a business. Hence, we believe that online auctions can be classified into five main models based on who the buyer and seller are: C2C, B2C, B2B, B2G, and G2P.

3. RECENT AUCTION TRENDS

Many businesses, including the Disney Store and Hooked on Phonics, have realized that online auction is rapidly becoming a large sales channel. In addition, auctions can be a very cost effective way to “recycle” returned goods (Gentry, 2003). Recently Sears started selling returned merchandise on eBay and reported that it actually made more money listing the item on the auction site than it did by discounting the item in a local store (www.shareholder.com/ebay).

In the infancy stages of online auction sites, most sites were purely C2C or B2C. However, recent trends have indicated there is a dramatic rise in the B2B online auctions. According to an eBay press release it is estimated that “business buyers represent more than $1 billion in annualized gross sales. Hence, the online auction sites need to capitalize on this new model.

4. KEY VARIABLES FOR THE SUCCESS OF ONLINE AUCTIONS

There are many important variables that determine the ultimate success or failure of an online auction site. These include user interactivity, product offering, level of trust, rate of growth and adoption, networking, level of commitment, and payment options. We used a multi-pronged approach to determine the set of key variables. First, we asked 50 participants in a famous auction site to rate 10 key variables. Second, we reviewed the auction literature thoroughly to identify the key variables. Finally, we leveraged on our vast personal knowledge gained through participation in online auctions. Based on this elaborate process, we identified the six key variables mentioned earlier. Below we describe the six variables in details. Please see the table for a complete list of these variables and comparative evaluation of major auction sites

Traditional marketing has shown the importance of user interactivity. Customers who feel like more than just a number are more likely to become involved with the business and become frequent buyers. Interaction begins the moment the customer enters the parking lot and includes interaction with other customers and employees. Traditional marketing has been able to ensure high level of user interactivity mainly through face-to-face interaction with the customers. Because the online auction site does not include face-to-face interaction, other methods of interaction need to be utilized. For online auctions, user interactivity issue becomes relevant from the moment a customer decides to visit the online auction site. It includes the web address being simple to remember, the ease of using the site, the customer interface (design of the website), and interaction with other members and employees.

It is the first visit that is critical for potential members; therefore the website needs to make certain the site is easily navigable by novice users and needs to be accessible 24/7. After the user transitions out of the novice stage, the user starts to look for more advanced features. Therefore the website should tailor to both types of users by enabling an advanced search feature. Fortunately with the use of cookies, online auction sites can tailor the ways individual members view the site. This enables new visitors to receive a more basic, easy to understand website view while the advanced users see the more advanced view of the website.

High user interactivity can be aided by having emails available for buyers and sellers so that they feel like more than just another number. Another way to increase interactivity is through the use of community bulletin boards which offer participants the opportunity to create relationships with other members. In many cases, community boards assist the participants with problems. For example, if one auction seller posts a question, other sellers can answer the question. This would be beneficial to the participants and also the auction site, since a fellow community member will be answering a question and that translates into the auction site not needing one of their employees to take the time to answer the question. In addition, some companies use chat boards and bulletin boards to aid in designing “marketing mixes that meet users’ needs”. This means that if a company analyzes the discussions, they can create customized offerings based on what community members were discussing (Strauss, El-Ansary and Frost, 2003). But auction sites must be careful not to “intrude” on the discussion board. Participants will resent blatant marketing messages intruding on their space (Siegel, 2004).

One of the most popular ways to create user interactivity is the use of feedback. The auction site should encourage buyers and sellers to publicly post information about the transaction. This feedback allows other potential buyers to review the seller’s past transactions to see if they are honest and trustworthy. This key component will also aid in increasing the trust–another of the key variables we will discuss later.

As we have shown, user interactivity can be a very critical element of online auction sites. By enabling a customer to feel like more than just “another customer,” online auction sites encourage users to create relationships with others. By doing this, sites can create a unique niche and increase customer loyalty.

4.2 PRODUCT OFFERINGS

Customers like one stop shopping. This is exemplified by the increasing popularity of Wal-mart Supercenters in the brick-and-mortar world and eBay in the click-and-mortar world. Many people do not like to go to several stores to complete all of their purchases but rather they prefer to go to one store to purchase everything. Therefore, it is critical for online auctions to offer a wide breadth of products and services. A wide breadth of products ties into the diversification theory. A company should consider diversification if the firm has a core competency or needs to revive its business. By creating diversified product categories, the online auction site is not “putting all its eggs in one basket”. In addition, diversification can aid in creating a larger customer base with varied interests (Thompson and Strickland, 2001).

Some auction sites specialize in one particular product offering. For example, uBid specializes in electronic items and has yet to break even (Kaiser, 2003). An auction is better off when it offers many items rather than a few. Of the ten most popular sites reported by Bandyopadhyay, Lin and Zhong in their 2001 study, only four of the sites are still in business today and the majority of the remaining sites offer wide product offerings. Hence, we believe that an auction site should offer a wide array of products to ensure growth and profitability.

4.3 TRUST

As with all industries, trust also plays a dominant role in online auctions. Trust is one of the key stepping stones to creating brand loyalty (Bressler and Grantham, 2000). Due to the fact that members never see a physical store, it is critical that online auction sites foster trust from the beginning. Online members need to be assured that their personal information will be kept private and that they will receive the product purchased. There are various encryption techniques in use in the online marketplaces to protect customer’s information. Privacy issues are relevant to all online marketplaces, and therefore are not specific to online auction sites.

There is large concern over the security of transactions since there is a high level of fraud online. This second component of trust is posing a problem for online auction sites that many traditional brick and mortar businesses do not face. How can a site that never physically has control of the item being sold ensure that the buyer actually receives the product purchased? This poses a big problem to the online auction community, but the site can provide safeguards such as insurance. For example, PayPal which is eBay’s subsidiary that accepts online payments provides buyer/seller protection on items paid for with this service. At no additional charge, PayPal will refund the purchase amount for items that the seller cannot prove that they shipped. In addition, the use of feedback is “emerging as a promising approach for building trust and inducing cooperation in online trading environments (Dellarocas, 2003).”

4.4 RATE OF GROWTH & ADOPTION

An online auction site needs to be on the cutting edge of technology and should be structured to react quickly to market changes. Mintzberg’s classical theory of organizational forms is useful for this key variable which suggests the use of an adhocracy organization that allows quicker adoption of changes when faced with rapid changes in technology and market conditions. The adhocracy results in a flatter organization so changes do not have to go through multiple bureaucratic layers which would be time consuming and may cause the company to lose their competitive edge (Mintzberg, 1979).

In addition, an online auction site needs to actively seek new business opportunities to expand their market share. A large area of growth in the online auction business is taking place outside of the U.S. The auction site needs to pioneer these new markets and introduce these markets to their brand.

4.5 NETWORKING

For years, everyone has acknowledged the importance of networking in business and social climates. The traditional network effect theories apply to the auction key variable. According to Metcalf’s Law, the usefulness of a network equals the square of the number of users (www.mqt.smsu.edu). Hence it is critical for the online auction site to have a large network of users. In addition, network effects arise in industries where the size of the “network” of complementary products is a primary determinant of demand for an industry’s product (Hill and Jones, 2004). In the instance of online auctions, the network includes buyers, sellers, suppliers, delivery agents, and the auction site itself. Basically this industry is a big network that needs to encourage the groups to interact through such strategies as strategic alliances. For instance, eBay has strategic alliances with UPS and now even with the United States Postal Service. The alliances with the packaging companies allow the sellers to lower their shipping costs.

Besides creating alliances between strategic partners, online auction sites must create networks between their users. This can be accomplished through the bulletin boards as discussed previously. However, online auctions need to take this even further and help their members create networks between the sellers. Networks will help sellers feel like they are part of a company and have access to a variety of knowledge from their “co-workers.” Creating networks will facilitate the procurement process for sellers, enabling sellers to find more profitable ways to buy and sell their items, eBay has taken the first big step in this new area of online auctions and has created a “Group Center” where buyers and sellers from a specific geographic location can discuss their views on a bulletin board.

Consequently, the online auction site that is able to create a strong network will have a distinct competitive advantage. The networked auction site will be able to pass savings onto their buyers and sellers as a result of the strategic alliances and strong networks that it creates.

4.6 COMMITMENT OF BUYERS AND SELLERS

Most buyers and sellers prefer a high level of commitment when using online auctions. What is the use of spending your time bidding, only to have the seller decide not to sell the item you “won”? And of course, sellers would not like it if buyers did not follow through and pay for the item they successfully bid for. As a result, most online buyers and sellers prefer the sense of security that comes from strong commitment from the participants.

It is critical that the online auction site has a way to ensure that buyers actually receive the merchandise and that sellers actually receive payment. As a consequence, both buyers and sellers expect a high level of commitment from the other party. If, however, something goes wrong during the transaction, the auction site needs to have a backup plan.

4.7 PAYMENT OPTIONS

Buyers prefer to have a wide array of payment methods for online auctions. Some buyers may prefer the traditional method of mailing payments, while others prefer to pay instantly with an email payment program. We will discuss the online payment options in the next section. For simplicity, sellers prefer one payment method. However, most online auction sellers realize that buyers prefer to choose the payment method. Consequently, it is important for online auction sites to recognize the value of allowing buyers and sellers to agree on any payment option they wish.

There are a variety of ways to pay for an online auction. Popular payment methods include money orders, checks, debit cards, credit cards, and email payment options. The new payment methods that are made possible by the Internet options are quickly becoming some of the most popular payment choices for online auction consumers. On average out of 25 personal B2C auctions, approximately 22 consumers choose to pay via PayPal. eBay capitalizes on this by allowing buyers to pay instantly with PayPal after the auction is completed. All the buyer needs to do is click on the link on the auction page and type in their user name and password. Another popular payment option for online auctions is Western Union Auction Payments where the seller pays online and the seller receives a Western Union money order.

5. WHAT IT TAKES TO BE A SUCCESSFUL ONLINE AUCTION SITE

There is no question that online auctions have proven to be a highly successful new business model, but as we have shown not all online auctions are the same. Many people believe that everything comes down to money, but that may not be the case. If you compare auction listing fees and final value fees, the most successful website, eBay, has one of the highest fee structures around.

So what does it really take to be successful? We believe that it takes a unique business model that encompasses all the variations of online auctions and must possess all of the key variables mentioned previously: higher user interactivity, a wide variety of product offerings, high level of trust, rapid growth and adoption, networking among users, high commitment, and a wide variety of payment options.

It is no wonder that eBayso far has been the most successful online auction site because it offers a wide selection of products, group networking, high commitment, high user interactivity, and a wide variety of payment options, eBay also provides promotions to sellers to encourage them to list more and to upgrade the listings. For example, eBay offers free listing days after the holiday rush and penny gallery days where it is only a penny to display a picture on the search page. By using these clever marketing gimmicks, eBay not only maintains its current customer base but also encourages new users to try selling.

Furthermore, eBay has recognized the importance of rapid growth. The company has purchased many auction sites, especially international websites. In addition, eBay stays at the cutting edge of technology. For example, in January 2004, the New York Times published an article that showed how costly spelling errors can be in online auctions (Schemo, 2004). One month later, eBay started offering a spell checking program when sellers list their item.

6. CONCLUSION

There are mainly five types of auctions C2C, B2C, B2B, G2P, and B2G. It is our belief that currently consumers are much more likely to shop on the Internet than businesses. A business is taking a much bigger risk if they purchase from an auction since the value of the purchase is generally much more than a consumer purchase. It is our belief, however, that, as businesses try to trim expenses, they will turn to online auctions for commodity products. We predict that the number of businesses and government agencies that purchase through an online auction will increase and make B2B auctions one of the most profitable models.

Currently, the most popular online auction model is exhibited by eBay. Many companies have tried to copy their success but have failed, eBaymanages to be successful because their model has incorporated all of the key variables we discussed: high user interactivity, networking, broad product offering, high level of trust, rapid growth and adoption, high commitment, and large number of payment options. In order to succeed, new as well as existing auction sites, must pay due cognizance to the aforesaid key variables.

TABLE 1: COMPARISION OF KEY VARIABLES IN ONLINE AUCTION SITES

User Trust Growth/ Networking

Interactivity Adoption

eBay High Medium High Medium to

High

uBid Low Medium Low Low

Amazon Medium Medium to Medium to Low

High High

Product Commitment Payment

Offerings Options

eBay Wide Medium/High Wide

uBid Moderately High Moderately

wide wide

Amazon Wide High Wide

7. REFERENCES

Bressler, Stacey and Grantham, Charles, Communities of Commerce: Building Internet Business Communities to Accelerate Growth Minimize Risk and Increase Customer Loyalty, McGraw Hill, New York, 2000.

Dellarocas, Chysanthos, “Analyzing the economic efficiency of eBay-like online reputation reporting mechanisms,” Proceedings of the 3rd ACM Conference on Electronic Commerce, Tampa, FL, October 14-16, 2001.

Gentry, Connie, “Recycled returns”, Chain Store Age, Vol 72 January, 2003.

Kaiser, Rob, “Online auction site uBid returns to roots in technology,” The Chicago Tribune, 12 January, 2003.

Metcalfe’s Law. http://www.mgt.smsu.edu/mgt487/mgtissue/newstrat/ metcalfe.htm

Mintzberg, Henry, The Structurinq of Organizations. Prentice Hall, Englewood Cliffs, 1979.

Schemo, Diana, “In Online Auctions, Misspelling in Ads Often Spells Cash,” New York Times, 28 January, 2004.

Siegel, Carolyn, Internet Marketing: Foundations and Applications. Houghton Mifflin Co., New York, 2004.

Strauss, Judy, El-Ansary, Adel, and Frost, Raymond, e-Marketing. Prentice Hall, New Jersey, 2003.

Thompson, Arthur., and Strickland, A.J., Strategic Management: Concepts and Cases. McGraw-Hill Irwin, New York, 2004.

http://www.amazon.com

http://www.auctionpayments.com

http://www.eba.y.com

http://www.paypal.com

http://www.shareholder.com/ebay

http://www.ubid.com

Author Profiles:

Dr. Subir Bandyopadhyay is an Associate Professor of Marketing at Indiana University Northwest for the School of Business and Economics.

Julie Wolfe earned her M.B.A at Indiana University Northwest in 2004 and is currently a small business entrepreneur.

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