Imagine you are in the midst of purchasing a new house. There’s no auction but the agent asks for offers. You put your offer in but the agent comes back and tells you there’s a higher offer. You really want the house so you increase the offer. There’s another counter offer and you put in yet another offer. It’s a bit above what you wanted to pay but you really want the house. The agents very quickly come back and accept your offer. Chances are, you will walk away from the negotiation feeling a little dissatisfied even if you’re happy to buy the house.
This is the phenomenon know as the Winner’s Curse. Often, when multiple people or businesses are vying for the same thing, the winner of the auction is revealed to have been overly optimistic about the value of the item and is a victim of the “winner’s curse,” Typically this is described as paying more than the asset is actually worth.
While I have used the example of buying a house, the can often be seen in competitive tender situations as well. I the desire to win the tender, tenderers can reduce the price to a point where they win the work but make so little margin that it isn’t really worth the effort.
In these competitive situations, there a few things you can consider in advance to minimise your risk of suffering from the curse.
Know your interests
Not all assets are valued purely for their economic value. Take for example, a house which is valued at $1 million by an independent valuer. A buyer purchasing solely for an investment will be basing value on rental yields and capital growth. The $1 million may make sense. But, for a buyer who has an emotional connection to the house – perhaps it was built by an ancestor and they want it back in the family – a higher price may still represent good value. Or, for someone who desperately wants to have a house on top of a hill with a view, this view may justify a price above what other’s consider rational.
By being clear about your interests in advance of the bidding process, you can be clear why the value to you may be justifiably higher than others are willing to pay.
Understand your knowledge
You may be in a position where you are in a privileged position to understand more about the real value of the asset. Others may be basing their value on different knowledge. Take for example an auction of estate jewellery. Many may be bidding based only on the current value of gold and the precious stones and the resale value. If you have specialist knowledge and understand that this piece has a historical significance based on it’s history, then it is natural you will pay more than others are willing to pay.
Prepare for the win
By it’s nature, an auction winner has paid more than anyone else thinks the item is worth (or can afford). Reminding yourself of that in advance and sticking to the limits you have set yourself can assist in avoiding the Winner’s Curse.
Have you had an experience of the Winner’s Curse? What did you learn from it?
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