The reason we end up overspending is a result of one unavoidably irrational part of the bidding process – and that’s ourselves.
The allure and tension of an auction are familiar to most of us – let’s face it, we all like the idea of picking up a bargain. And on-line auction sites like eBay cater for this, allowing us to share in the over-excitement of auction bidding in the privacy of our homes. Yet somehow, despite our better judgement, we end up paying more than we know we should have done on that piece of furniture, equipment or clothing. What's going on?
One estimate states that about half of eBay auctions result in higher sale prices than the "buy it now" price. This is a paradox. If the people going into the auction really wanted the item so badly, why didn't they get it for less by paying the "buy it now" price?
This has nothing to do with the way the eBay bidding system works. In fact, unlike most auctions, the eBay auction process is actually perfectly designed to allow rational outcomes. By allowing you to set a private “maximum bid” in advance, eBay auctions are better for individual buyers than public auctions where everyone has to shout out their bid in public. No, the reason auctions – both on and offline – produce higher sale prices than any bidder originally imagined they would pay is because of one irreducibly irrational part of the bidding process: the bidders themselves.
Auctions push a number of our psychological buttons, and in fact the phenomenon of “auction fever” is well documented. They are social occasions, with lots of other people around, and this tends to increase your physiological arousal, an effect called social facilitation. As your adrenaline pumps, your heart beats faster, and your reactions quicken. This is ideal for something like sports, but makes cool rational decision making harder. The very rich often send delegates to auctions, and as well as avoiding the paparazzi I suspect this is also a strategy to combat the over-excitement induced by being physically present in the situation.
On top of this, auctions are time pressured, and – by definition – you're bidding on something you value highly. These factors create excitement whether you are in the room or not.
Another psychological bias that operates in auctions is the endowment effect, where we tend to over-value things we already possess. By encouraging us to connect the bid (our money) with the sale item, bidding on items lets us fantasise about owning them – stimulating a kind of endowment effect. This is why the auction catalogue (or the item picture and description on a website) is so important. This forms part of the psychological journey the seller wants you to go on to imagine owning this item in advance, so you'll place a higher value on it, and so pay more to make imagination reality.
Persuasion plays a huge part here, and the best book you can read on the psychology of the subject is Robert Cialdini's Influence. Cialdini is a Professor of Social Psychology at Arizona State University, and he lists six major ways you can make yourself persuasive. Auctions hit at least two of these six principles square on the nose.
First, auctions use the principle of scarcity, whereby we overvalue things that we think might run out. Auction items are scarce in that they are unique (only one person can have it), and scarce in time (after the bids are finished, you've lost your chance). Think how many shop sales successfully rely on scarcity heuristics such as "Last day of sale!", or "Only 2 left in stock!", and you'll get a feel for how powerful this persuasion principle can be.
The other principle used by auctions is that of “social proof”. We all tend to take the lead from other people; if everybody does something, or says something, most of us join in before we think about what we really should do. Auctions put you in intimate contact with other people who are all providing social proof that the sale item is important and valuable.
A final ingredient in the magic-spell cast by auctions was uncovered by researchers from Princeton. Their experiments asked volunteers to play on-line auctions with different rules. Some of these auctions had rules that encouraged over-bidding (like typical open auctions, which most of us are familiar with from movies), and some had rules that encouraged rational behaviour (like the eBay structure). With enough guidance from the auction rules, the bidders didn't end up paying much more than they originally thought was reasonable - but only if they thought they were bidding against a computer programme. As soon as the volunteers thought they were bidding against other live humans they found it impossible to bid rationally, whatever the auction rules.
This implies that the competitive element of auctions is crucial to provoking our irrational buying behaviour. Once we're involved in an auction we're not just paying to own the sale item, we're paying to beat other people who are bidding and prevent them from having it.
So it seems Gore Vidal had human nature, and the psychology of auctions, about right when he said: "It is not enough to succeed. Others must fail."