Thursday, June 23, 2011

Auction Lessons from Storage Wars

After yesterday's post about American Pickers, I couldn't resist taking a look at another reality show, Storage Wars.  Where American Pickers is about negotiation, Storage Wars is about a very unusual type of auction.  Just as American Pickers has a lot to teach us about negotiation, a look at why the Storage War auction works offers some useful insights to anyone thinking of holding or entering an auction.

A lot of people store extra belongings in rented storage spaces.  If they don't pay their monthly fees the storage company is eventually allowed to take possession of the goods.  They naturally want to sell the goods for as much as possible but they also want to sell quickly so they can rent out the units again.

The value of what's in the units can vary tremendously.  One unit might have nothing but clothing and some old furniture while another could hold a valuable collection (in the handful of episodes my wife and I have watched we've seen coins, baseball cards, tens of thousands of dollars worth of newspapers reporting the death of Elvis and one buyer reflecting on the time he bought a comic book collection worth hundreds of thousands of dollars).  Thus, a given unit could be worth anything from "less than it costs to haul it out and look through it" to six figures.

As a buyer of an item that could be worth almost anything from $0 to $100,000+ you'd naturally want to be able to invest some time in figuring out what the actual value was.  And surely as the seller you'd want to give buyer's this opportunity so that when you have a unit worth $100,000 it doesn't go for a few hundred bucks.

But no.  The rules of Storage War auctions are that potential bidders get just five minutes to look at a unit and they must do so from outside the unit.  No boxes are opened, no clues are given -- the only opportunity the buyer's have to learn about the unit is a brief look from outside.

Moreover, this isn't a whacky auction created for TV drama.  It's the way these auctions were done long before someone decided to film a subset of bidders and create a reality TV show.  Is the industry in the hands of an insane person or is their logic to this counter-intuitive system?

The most obvious advantage of the Storage Wars auction system is that it's fast.  Five minutes to look, about the same to bid, the winner puts a lock on the door and it's off to the next unit.  This lets the storage company auction off all delinquent units in a single day, reducing not only their costs but the time commitment of the buyers.

That's not enough, though.  As the show highlights, these companies regularly sell units for a tiny fraction of what they're worth.  So why not spend the extra money and give the buyers time to come through the units?

When you're setting the rules for an auction (or any kind of deal where you're the process setter), it's important to think dynamically from the perspective of the process takers.  Let's think forward to what an auction might look like with better information and then consider how a rational buyer might react.

Better information seems great from a buyer's perspective...but not if everyone has access to it.  In one episode, a nearly-empty unit held a vintage mannequin with a phone built into it.  To me, and to most of the bidders, it wasn't anything special but one person knew it was valuable.  He bought the unit for $250 and sold the mannequin to a dealer for $2,000.  If there was plenty of time, the other bidders could have taken a picture and emailed it to an appraiser.

An auction with full information thus offers a much lower opportunity for profit for expert buyers, who are the ones that will reliably come out to bid on units.  The restriction on information is actually a benefit to core buyers and helps to maintain a strong base of buyers.  What seems like a cost-saving tool for the seller is actually a conscious transfer of some value to buyers to maximize the likelihood that the auctions will be successful.

Having a strong base of buyers is critical to the sellers due to the nature of auctions.  In a negotiation the price pressure comes from the opposite side of the table -- i.e. the buyer tries to push the seller's price down and the seller pushes the buyer's price up.  In an auction the pressure on buyers comes from the same side of the table -- if it's worth $250 to you and $240 to me, my desire to push it will force you to pay $240 for it.

If you have a small number of bidders (and what counts as small depends on the circumstances), you lose that pressure and suddenly prices can be quite low.  At best you'll have sales where only one player puts a high value on an item; at worst you'll see collusion (explicit or implicit) between the buyers.  A "busted" auction can be disastrous.

A few lessons to take away for anyone thinking of holding an auction or an auction-like sale:

  1. Think about your process choice from the perspective of would-be buyers.  There are a lot of choices with auction structure, but don't just think about how a given structure suits your needs.  Is it sufficiently attractive to the bidders you most want?
  2. Have you got the right bidders?  Thinking back to the mannequin example, the sellers lost several hundred dollars in value because only one bidder knew what it was worth.  That's going to be unavoidable in a storage unit auction, but the success of an auction depends on having bidders who place a high valuation on what's being sold.
There's also good lessons for anyone thinking about participating in an auction: ask yourself, "What is my edge?"  The successful bidders in Storage Wars have two important advantages over a random person.  First, each has considerable experience -- meaning they can more accurately estimate the value of a unit.  Second, each has established sales channels for what they get.  Two run thrift stores (and buy specifically for what they can sell in their stores) and the other two have networks of collectors they work with.  This means they can price units more accurately and that a given unit will be more valuable to them than to an average bidder.  If you don't have an edge, you're set to lose money.

(In this post I've assumed that auctions are one seller (the process giver) and multiple buyers (the process takers).  In practice, some auctions involve multiple sellers (e.g. if a procurement department holds an auction to supply a company with a good or service) and many deals are neither pure negotiation nor pure auction but rather negotiauctions (to borrow a phrase from one of my professors).  We'll talk more about those in coming days.)

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