Wednesday, April 14, 2010

How much would you bid for a $10 bill?




I have taught many negotiation classes over the years, and I continue to do so at my hospital. The attendees include students, doctors, and administrative people. It is a very interactive session, with several simulation exercises used to demonstrate some of the principles of the field.

I often present one game that is an auction. I offer to sell a $10 bill to the highest bidder. Here are the rules: Bids start at $1 and must go up in $1 increments. The winning bidder wins the $10 bill and pays me the amount of his/her bid. The second place bidder wins nothing but must also pay me the amount of his/her bid.

What do you think happens? Well, usually there are two bidders who have trouble stopping. The person in second place offers a new bid in the hope of being the higher bidder and getting the $10. Then, the other person, not wanting to pay money for no return, feels the same way. I think the highest price I have received over the years for the $10 was $24 (and $23), which netted me $37.

This game is illustrative of what happens during wars and lawsuits and other fruitless types of negotiations, where the parties lose track of their underlying interests and the value of the matter in question.

We only reached $14 (and $13) this week. Later, the "winner," one of our fine neurologists (and one of my soccer buddies), sent me this note:

Paul,

As a scientist, after the class yesterday, I immediately searched for explanations of what happened during the “Ten Dollar Auction” game. I had a particular interest in my behavior and the others’ reactions. I made significant revelations. The paradox of irrational decisions on rational choices worked perfectly.


I have found the following very interesting aspects and facts:

  1. In the overwhelming majority of games, both the highest and second highest bidders will pay in excess of the amount the group is auctioning.
  1. There are four major components of the players’ behavior:
  • prospect of winning for a small upfront investment
  • trapped near the $10 level by not wanting to lose the bid
  • remaining consistent with the earlier commitment to avoid being judged foolish to enter the bidding war
  • ego, competition, rivalry
  1. Yesterday I think the limbic emotional part of my brain overruled my higher level cortical thinking driven by my academic high ego and soccer player-coach competitiveness.

The general lesson I learned from this game and from my search is the following:

  1. Ego and competitiveness in a competitive and adversarial environment leads to irrational escalation of commitment, which beyond the “Ten Dollar Auction Game” lessons has very important implications for organizational behavior.
  1. According to Gregory P. Smith, international business consultant, this auction game is very effective for demonstrating the benefits of internal competition and the possible downsides of an adversarial environment.
  1. While internal competition can generate enthusiasm and energy, cooperation can prevent the irrational escalation of commitments (bidding war). Maybe this is why high ego academic professors can not and should not run academic medical centers?

It was fun to learn so much.

Thank you.

12 comments:

e-Patient Dave said...

Wow.

Wouldn't I like to see some papers by or about the people who intentionally create this situation, to derive maximum value when selling something. Create craziness, for profit.

I imagine aspects of this are at play when people will line up overnight for an iPad or Sox tickets: the prospect of setting out to get one and perhaps failing can induce extreme behavior.

(Except, of course, for Sox tickets, in which there's no such thing as extreme behavior.)

Leonard Kish said...

Are you saying markets are not always rational? That they depend on the rules of engagement and the irrational emotions of the investors/players?

Sounds like heresy.

Paul Levy said...

Impossible! Market run-ups in the value of WorldCom, Enron, secondary market in subprime mortgages, and credit default swaps never happened. :)

nasov said...

Have you ever had a class in which nobody bids?

Paul Levy said...

Never.

Paul Levy said...

From Facebook:

David Joseph: I've used that exercise many times as well, beginning in 9.70 at MIT (social psych), although I have always used a $1 bill instead of a $10 bill... and amazingly, I have gotten up as high as $200 in one case (when it became a fight between two huge egos), but bids in the $40 range are routine!

Dick Williams said...

A new CEO at a consultancy I worked for tried this on us, only for $20.

One person stood on his chair and bid $1. I bid $2 and said if everyone stops bidding I'll take the $20, keep $2, pay off the $1 bidder, and buy donuts for everyone with the rest.

Everyone looked at me like I was nuts, someone bid again, and it went up to $21 before people stopped bidding.

The guy standing on a chair, who had the $20 bid, said "Hey, I'm the highest bidder."

Everyone looked at him like he was nuts...

rickweber said...

The moral of the story is that bidding for a fixed prize (e.g. $10, a government contract, etc.) in a case where your bid is sunk (e.g. bid in an all-pay auction, or taking a senator out to lunch, or filling out paperwork) can lead to inefficient amounts of resources spent to win the prize.

In the author's example, if I have already bid $9 and someone bids $10, I have a choice between losing $9 or paying $11, getting the $10 and only losing $1. Likewise, if I have already paid my lawyer lots of money but I face the prospect of losing, I can possibly incur a smaller loss by paying my lawyer to keep fighting till the other side gives up.

Adam Dynes said...

It would be a mistake to portray this bidding game only as a critique of capitalism. In political science and economics, this bidding game is used by public choice theorists to highlight some of the pathologies of idealized government institutions that arise from phenomena like rent-seeking.

Paul Levy said...

Right, Adam. This is not about capitalism.

Andrew Schutzbank said...

Great to be there, and thank you Paul for making Bruce and I famous! You have inspired me to start writing on my own: Schutzblog

olaoluwatomi said...

They bid because they have the money to do so, I would not part with a dollar to buy a $10 bill unless it was linked with some higher purpose e.g. a charity!