With the advent of the IPL, not only did cricket viewing and marketing as we know it change dramatically, it also introduced us back to a rather fascinating economic phenomena – auctions.

This year, Robert Wilson and Paul Milgrom won the Nobel Prize in Economics for their work in the arena of this very phenomena.

Auctions Are Everywhere

Any situation where there is some form of competitive bidding – explicitly or implicitly – is actually an auction. When two rival football clubs are chasing the same player as the transfer window closes and sending in their offers by phone to the agent, it is a kind of an auction. When you put in a bid for an item on eBay, it’s the same situation. Film studios chasing the film rights of a particular book, rival product companies trying to sign a brand ambassador, companies bidding for buying up telecommunications spectrum, companies bidding for taking over a firm – all of these are auctions. There are many commodities – from diamonds to tea to roses to rights of an oil field to shares of a company in an IPO – which are sold via auctions. The form and modalities differ but the essence is the same – the seller is trying to extract a reasonable price.

You could have the familiar (because you have seen it at art auctions and the like) English Auction - where bidders put in explicit (open) bids and the price rises until there is only one buyer left. There is the ‘Dutch Auction’ – the opposite of the English version where price is bid down instead of up till a buyer is found. There can be other variants as well.

The Economics of Auctions: All About That Value

Studies of auctions by economists have given us two paradigms as to how bidders (buyers) arrive at a value for something (that Van Gogh painting, or Sachin Tendulkar’s bat or a fresh batch of coffee beans) – the private value paradigm and the common value paradigm. In the private value scenario we assume that every bidder knows the value of the object to himself but not to others at time of bidding and even if he did know of other bidders’ values, it would not affect how much the object is worth to the given bidder. Such an assumption works for items that are relatively unique – a specific painting for example, or a piece of memorabilia (remember how Vijay Mallaya got Gandhiji’s glasses back – he claimed that it was important to bring them back to India so that was the driver behind how much value he’d attach to it regardless of what the other – generally foreign – bidders thought).

However it is unlikely that someone would be that obsessed with let’s say the rights to drilling an oil field or a batch of fresh Darjeeling Tea or Google shares. There would be a sense of general agreement (if not precise) about how much they are worth – a common value. In the common value paradigm, the value is the same for all bidders but each bidder has their own imprecise estimate of the value of the object (that depends on how much information they have).

Auctions In Action

How does the combination of these paradigms play out in the real world where everything has some private value and some common value? Let’s roll the clock a little bit and visit my favourite auction story, from the 2009 IPL auction. The second IPL auction had the usual share of big buys and big bucks but the one story that was as dramatic as some of the roles in Bollywood the actor owners of the teams involved in that incident have played, was the buying of Bangladesh's Mashrafe Mortaza by the Kolkata Knight Riders. Mortaza, a modest allrounder had a base price of $50,000 (IPL assigns a ‘base price’ or bid to each player which can be thought of as the ‘common value’ here) but he was sold in 2009 for a startling $600,000 as a bidding war erupted between Kings XI Punjab (Owner: Preity Zinta) and the Kolkata Knight Riders (Owner: Shah Rukh Khan).

So, why were KXIP and KKR willing to pay such an extravagant amount for Mortaza, as compared to the other six franchises who hardly bid anything above the Bangladeshi’s reserve price? It all boils down to ‘private value’. (Just an aside: The highest bids of KKR and KXIP were tied and then they used a sealed bid tie breaker – where each team submitted an extra amount written on a piece of paper inside an envelope – and KKR won.) In an interview to ‘Mid Day’, John Buchanan the then coach of KKR (who was on the phone with Shah Rukh Khan, who wasn’t present at the auction venue) explained how the bidding went. He said ‘we targeted Mortaza because he is a opening strike bowler and he can hit the ball hard around the park. Umar Gul has been ruled out (there was a ban on Pakistan players that season) and we needed someone to fill his shoes, so Mortaza presents the on-field package to us. He presents the off-field package as well. He is from Bangladesh and KKR have a close link to Bangladesh. So there is a bigger picture (in his signing) too.”

Buchanan’s use of the words on-field and off-field package are interesting. The on-field package represents the common value element – KXIP were also probably looking for a good allrounder or an opening strike bowler. But the Bangladesh link was unique to KKR – the off field package in Buchanan’s words – and that would be what we call ‘private value’. That would probably explain why Shah Rukh was keen to sign him and as per Buchanan ‘ensured that we stay in the bidding till we secured him (Mortaza)”.

But that’s not quite the whole story. In the same interview, Buchanan also says “Frankly, we paid more. Both franchises were keen to have him and the price shot up in the competition.” Buchanan is highlighting an issue called the ‘Winners Curse’.

An Own Goal?

Another such case has been the purchase of Brazilian superstar Neymar. Paris Saint Germain (PSG) sent shock waves across the footballing finance world in 2017 meeting a €222 million buyout clause for the then Barcelona player. The Neymar deal effectively doubled the previous world record fee United had paid for Pogba. The world record fee had increased only by around 10% from 2009 to 2016, but in 2017 PSG shattered it by a factor of 2X, a 200% jump. So, has the footballing world gone mad? Does PSG or its ownership not understand basic economics? Does Neymar have secret information on location of vibranium mines? Or did PSG fall in the winner’s curse trap?

Such a move, which may have been not entirely economically rational is a result of the poor ways in which auctions are often designed and that is something Milgrom and Wilson have pointed out in other contexts in their work. Incidentally, back in 2017, Jose Mourinho (then the Manchester United manager) made a good observation of how such things can make the market inefficient, or even fail. “I don’t think the problem is paying crazy [money] for Neymar. The problem is with the other group of players [below them]… That is the dangerous area because [other clubs] accept the numbers [and] by paying too much some clubs create a very strange and out-of-control market.” Economists do not like it when markets fail. Because the forces of demand, supply and rationality are supposed to create the best outcomes for almost everyone. Unfortunately, they do, and when that happens, the market design has to be relooked at and tinkered with. In short, that’s what the two laureates have done to earn the Nobel prize.

So, what have the Nobel Laureates done in terms of work? Their focus was to reduce the likelihood of this winner’s curse and figure out how best the price can be discovered for an item so that the seller, the buyer and all other stakeholders have a net positive outcome. They even demonstrated it through their design of simultaneous auctions of mobile telephony spectrum to telecom companies in the United States.

Auctions are a terrific example of extracting fair values and prices from buyers which is what economists would call an ‘efficient’ result. But human emotion, asymmetry of information and plain craziness can easily corrupt the mechanism. After all, in the 2009 season, Mortaza played only one game, and in that one game he conceded 27 runs in the last over of the match to a certain Rohit Sharma (then playing for the Deccan Chargers) that turned out to be pivotal in their title charge.