The cost of uncertainty in competitive bidding Professor Joel Huber Fuqua School of Business Electronic Commerce

Imaging the following bidding context: You and other suppliers are bidding for a job—low bid wins the job You are uncertain about your final costs and will only learn them after the job is completed Over time you have found that your estimate plus can be as much as 20% over or under the estimated costs Your opponents also draw from the same uniform distribution in getting their estimates

Suppose true cost + profit = $100k and both parties bid their estimates Your estimate Opponent’s estimate $80k $100k $120k $120k $80k YOU WIN CONTRACT OPPONENT WINS CONTRACT MAKE $ LOSE $

What is going on here? Winners curse  When your estimate is low you win contract but lose money on it  If people bid their estimates they will lose money 75% of the time This happens with oil drilling and airwave frequency auctions, fine art (Sotheby's) and branded products on eBay  Solution: Optimal bid is amount given +75% of bid half range: Estimate = $100k, Bid*=$115k

Lessons Raise margins for more risky jobs Don’t expect to win many contracts Don’t confuse winning a contract with a winning strategy Create a differential advantage by having more accurate estimates Work with clients to share risks If you are setting up an auction and you can minimize uncertainty among bidders…they will reward you with more favorable bids