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How Do Penny Auctions Work?

How Do Penny Auctions Work?

That brand new iPad, going once.. Going twice.. And sold! The item goes to userxyz123 for $20! That's pretty much what would happen if penny auctions had a live auctioneer. But they don't, and you'll never know who exactly won the bid. Welcome to the world of penny auctions!
Arun Prabhu
Starting off, I hope you know how real life auctions work. Well, penny auctions work the same way, with some 'changes'. Now, the auction sites will call these changes as a new form of retail purchasing. Most people will tell you it's gambling. Even worse, it's gambling without a legitimate and trusted overseer or regulator. What the sites do behind the scenes may remain undisclosed to its users, giving the penny auction sites the upper hand. In essence, a penny auction site doesn't work like a regular online bidding site like eBay. You know what they say about "If it's too good to be true..."

Penny Auctions - As The Bidder and The Site

The Concept of Penny Auctions
To know whether to stay away from penny auction sites or not, you will first need to know two things; how a penny auction really works and how can the sites provide these items at such impossible prices.

The working of a penny auction can be simple enough from the surface. First, you create an account on their site. You will have to give them some financial details before you can start bidding. Once done, you will move to their bidding pages, which is generally their home page. Seeing something you want, you'll click on "Bid" to place your bid. Each item has its own timer. When the time runs out, the highest bidder wins.

That's pretty much what the rulebook will say. But what's really happening is that every time you place a bid, you spend some money to buy that bid, almost like buying the right to place that bid. This money depends on the site you use; from 1 cent to 60 cents, whatever the site chooses. So you're losing money every time you place a bid. So, in the end, you'd be spending for the item if you won it, and the money you spent on bidding and shipping the item too! Still, the total price you pay won't come close to the real price of the item. Some sites may refund the lost bids back to you in case you don't win the item, but not every site will do that.

This brings us to the thought that if the site gives away so many goods at so low prices, how can they afford to stay afloat? To answer the question, you'll have to understand the sheer number of people bidding on an item, the total money each one spends bidding for that item and the final price the winner spends on the item. An important fact here is there's always only one winner for one item, regardless of the number of bidders. It's a classic gambling concept; at the end of every round, nobody is told about the number of people that lost their money. They will always tell you how much the last product they auctioned was sold for. Again, you'd be right to doubt whether they're telling the truth and the item really did go for that price (like an iPod going for $1.01).

Let's do a little math. Take an electronic item like a TV. Its retail price would be, for the sake of calculating convenience, be $2000 and let your bids be at 25 cents per bid. If the winning bid was for $100, that means there have been 10,000 bids on the TV, since each bid increases the price of the item by 1 cent. Regardless of who wins, the site just got 10,000 bids on the item, which means they earned 10,000 x 0.25 = $2,500. All in all, they got $2,500 on bids and $100 from the winner, which basically means they sold a $2,000 TV for $2,600. Now you know how penny auction sites make money. The thing is, if there were 50 people bidding on that TV, each bidding 200 times, it means they each spent $50 trying to but that TV, with only one of them winning it. So 49 people get nothing even if they spent $50 each. Now this is just a rounded up calculation. There are some other factors that haven't been taken into consideration, like the competition between multiple bidders and the bids placed at the end of the timer. What I'm trying to say is, the more you bid, the more you know others are bidding too, which keeps lowering your chances to win, making you lose a lot more money than you previously thought.

Then there's the idea of a "Bid Pack", which is a pack of bids that you can either buy flat out, or can bid for in the sites auctions. If you're a beginner, you'll be spending more on each bid than someone who bought a whole pack of bids.

Biddings at the End of the Timer
So you've been eying that ultra-cool gizmo that you always wanted and it starts for a cool $1 auction. The total auction timer would be, let's say 3 hours. There are many types of bidders, each coming in at different times and each pulling out for different reasons. The first type would be the ones who start bidding as soon as the auction starts. There won't be many of these, unless the auctioned item is really, really sought after. As the timer ticks, more bidders will join in the auction, bidding more and more, increasing the item price by 1 cent each time they bid, losing 25 cents every time (both numbers vary with the sites). Towards the end of the auction, around the final 30 seconds, there will be the most bidders the item will have. The timer will be extended every time someone bids. Each item has its own specific time extension. If an item has a 20 second timer extension, every time someone bids towards the end, the timer extends by 20 seconds. This, is where the site really makes all its money and where all the serious bidders come into play. The game gets intensely competitive here. If there were only 2 people lazily bidding at the start of the auction, there may be 20 different users trying to outbid each other at the final seconds. Unlike eBay, where the final auction time is fixed, the timer at the penny auction site will keep increasing till the final second where no one bids again. Now you're beginning to get the kind of thing a penny auction site can become.

This is why I call it gambling, you're placing bets per click, spending some money on each click, trying to get the prize, as its price keeps increasing. And there's no telling when people are going to quit. The psychology works the same as in a Vegas casino. People will keep outbidding each other, either to just prove a point, to scare off any future competition, or to make sure the money spent on bids won't go to waste. In some cases, this may even take the price beyond the original retail price! Now you will see the desperate need to control the process and to have an external regulator.

Bidding Bots and Possible Frauds
This is a nasty idea that the penny auctions can use. Since you don't know who you're bidding against on an item, you won't even know if that bidder is even a real person. Sites can use a program to keep bidding against you to get the item prices up and making you lose more and more money. This ensures the sites earn at least the margin price of the item, most times earning even more. If you win, the site walks away with a lot more of your money (along with a horde of other bidders'), if the bot wins (it actually never does) the site retains the item and auctions it off some other time.

The other thing the sites may do is the misuse of your financial information. And this is happening. You may be applying for a small bid pack of $10, when the site may actually take you for a ride and slap you with a $170 bid pack. The sites use the legal loopholes very smoothly to just nick the money out of your accounts. Know that such practices of being unknowingly charged for things you didn't really want is illegal and you can get help from the law and your bank to cancel your credit card and fight the site.

I'll end the article, repeating the two things I told you before; if it's too good to be true, it usually isn't; they always tell you about the one person who won, hiding the thousands that lost so much trying to win. If you intend to start bidding at penny auctions, I warn you to do it in moderation and to do it smartly. Do not fall for any ploys that the sites may pull. Personally, I don't think I'll ever get into penny auctions unless they are restricted with hard-bound Internet gambling laws, maybe not even then. If it works like gambling, then it probably is, which means you will end up losing money and even be addicted to it.