BEST FORMAT OF AUCTION FOR ROUGH DIAMONDS

If somebody listens to the word AUCTION, the first thought appears to a mind is a scene from a Hollywood movie or a picture of Christie’s Sales of high-end jewelry, a beautiful and sensual woman cry-out millions of dollars of her ex-husband’s money at auction. 

Fundamentally, auctions are market fixtures with well-defined rules that determine how the winner is selected and what the payments are, depending on the bids. For that reason, auctions are typically modeled and analyzed as bidding games of imbalanced information. Auction design is a careful balance of encouraging bidders to reveal valuations, discouraging cheating or collusion, and maximizing revenues.

There are several formats of auctions for different types of products. The most commonly used methods for negotiating the business of rough diamonds are Dynamic and Static auctions, also known as Open-Bid Auction & Sealed-Bid Tenders. 

Dynamic Auctions: It is an open-bid auction where bidding is public, and every bidder has full knowledge of the value of all the other bids.

Static Auctions: It is a sealed-bid tender where bidders place bids ‘secretly’ and are unaware of what others have bid in the auction. Thus bidders do not engage in competition with other bidders. 

HOW SHOULD WE CREATE AN AUCTION?

The format of the auction depends on the behavioral regularities, which exhibit observations, how most of the other buyers are thinking of the product? It is hard to understand what are the operators of price differences between auction formats for choosing an appropriate design. 

To create an excellent auction that produces successful results, the auctioneer must understand the conditions of the value of the product he or she offers. Commonly, there are two types of environments of the value of the product, which requires proper analysis before designing an auction:

1. Common-Value Product Environment: When the buyer's valuation depends on other valuations. The best example to explain this situation is to assume that there are five same jars filled with coins at auction. All five jars are of the same value, but each buyer has a different belief about how full they are with the coins.
2. Private-Value Product Environment: When the buyer’s valuation does not depend on other valuation. The best example to describe this situation is the auction / tender of Memorabilia items like old jerseys and a cricket bat of a legendary player. 

WHAT IS THE BEST DESIGN OF AUCTION FOR ROUGH DIAMONDS?

Rough Diamonds are valuable and precious raw materials to produce polished diamonds. The element of surprise and difference in value creates a large disparity between the buyers of the rough diamonds. 

The buyers of rough diamonds are regularly intent to procure rough diamonds due to a large gap between the supply and the demand. They usually keep their supply chain channel ‘secret’ and hold price valuations private.  

Taking into consideration the facts about the behavior of rough diamond buyers and their buying strategy, we compare both Dynamic & Static formats for the sales of rough diamonds through auctions:

Dynamic Auctions / Open-Bid Auctions:

Many rough diamond auctioneers organize Open-Bid (descending clock) Auctions. They think that this is the best way to increase profitability. However, I find this format of auction not suitable for selling Privately Valued Rough Diamonds due to the following reasons:

• A Dynamic / Open-Bid Auction permits bidders to observe other bids, which results in the revelation of more information. As rough diamond falls in the private-value product category, it affects the price valuation of a buyer by adopting other bidders’ strategies during the auction process. 
• There are more chances of implicit collusion in Dynamic / Open-Bid auctions without any formal arrangement, which could end up as a monopolized auction. 
• Dynamic / Open-Bid auctions consist of several rounds and sometimes last for three to four days. It raises the administrative and communication expenses of the event.  
• Dynamic / Open-Bid takes more time in closing the event resulting delay in the delivery of the goods to the winner’s destination. For example, if ABC manufacturer of polished diamonds has an urgent requirement of the parcel to run their operations, the shipment would take a week or more, which causes factory overheads. 
• The less knowledgeable bidders are more attracted to the Dynamic / Open-Bid auctions by following other bidders’ willingness to bid and a high leakage of information. 
• It is hard to believe that the auctioneer of the Dynamic / Open-Bid auction format is playing by the rules. There is a possibility of submitting Fake Bids below the reserve price of the rough diamonds and pushes the Real Bidder to meet or pass the reserve price. 

Static Auction / Sealed-Bid Tenders:

• Static / Sealed-Bid Tenders attract experts and discourage novice buyers. 
• Static / Sealed-Bid Tenders require less time to evaluate the final results. A faster process proceeds in swifter shipments to the winning manufacturer. 
• There is more chance for the traders to join in Static / Sealed-Bid tenders and resale the product in the secondary market. 
• The manufacturers with ready market orders of polished diamonds would prefer to bid in Static / Sealed-Bid tenders and make higher bids to procure the rough and avoid the risk of failing the business. 
• Less complexity and straight forward Static Tender system makes it more prudent for the buyers to trust the auctioneer. 

CONCLUSION:

So far, I conclude that auctions with open price discovery and comparative valuation going on between participants of the live auction / online auction is not appropriate for a product that has no agreement on the price evaluation. Whereas, the sealed-bid tender capitalizes on the lack of disclosure is a successful approach to sell rough diamonds at auction. 

Though, there is a higher possibility of the event of the ‘Winner’s Curse’ in a Sealed-Bid Tender, which I encounter almost every day at my work. 

We will discuss in the next article how to avoid the occurrence of the winner’s curse by proposing a New Auction Design, a combination of both Open-Bid Auction & Sealed Bid Tender formats. 

The views expressed here are solely those of the author in his private capacity. No one should act upon any opinion or information without consulting a professional qualified adviser.