Internet fraud: shill bidding

Table of content Page 1
1. Introduction Page 2
2. Shill bidding Page 2
3. The English auction Page 3
4. Strategies and payoffs Page 3
5. The price of the product and the frequency of shill bidding Page 4
6. The profit of the seller Page 4
7. Conclusion Page 5
8. References Page 6

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1. Introduction
In today’s world, Internet auctions are becoming increasingly popular and are one of the most successful forms of electronic commerce (Bajari & Hortacsu, 2004). “Internet auctions already represent billions of dollars in transactions and have been growing at a rate of more than 10% per month (Lucking-Reiley, 2003)”. At an auction, a participant can buy and sell goods or services by making bids or taking bids. These selling transactions occur between businesses and consumers (B2C), between two businesses (B2B), between the government and businesses (G2B) and between the government and consumers (G2C). Although Internet auctions are becoming increasingly popular, because they offer many advantages to buyers and sellers, they also bare some negative consequences as snipping and shill bidding. Shill bidding is a strategy of the seller to raise the final price of his own offered items. The questions that arise are: how does shill bidding work and why is it used?
To investigate shill bidding, first this paper introduces the concept of shill bidding. Second it discusses the English auction, followed by the payoffs and strategies of the sellers and the buyers. Third, the frequency of shill bidding in relation with the price of the item is analysed. Finally, the paper examines the profit of the seller.
2. Shill bidding
Shill bidding is a strategy in which a seller is bidding on his own items to raise the final price. These high bids influence the value perception of the other participants which results in higher bids and thus a higher revenue for the seller. One way a seller can do this is by creating a fake account and bid on his own items. Another way a seller can do this is to collaborate with another seller and bid on each other’s items. If the seller's bid is the highest bid when the closing time has passed, the transaction will not occur and the seller will try to sell it at another time (Bharat, Mamata, Yuhui, 2003). Some auctions do not charge a fee hence, the seller does not lose or gain money from this transaction. Since these auctions occur on the internet, shill bidding happens more often because it is easier to conceal its identity. Because of this strategy, an honest bidder has to pay more than the true value of the item which is unfair. Therefore, it is forbidden and Internet auction websites are doing its best to prevent it. This strategy occurs most in English auctions because the strategy has the most effect in this type of auction.
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3. The English auction
There are four basic types of Internet auctions namely the English auction, the Dutch auction, the sealed-bid auction and the double auction. These auctions are divided in categories on ascending or descending bidding prices. Another way they are categorized is whether or not the bids of other participants are known. The most common auction is the English auction. The English auction is a completely transparent and ascending auction. A buyer is able to see the highest bid and can decide whether or not to raise it. If the buyer raises the bid, he is the current highest bidder. When the time limit -which was set in advance- has passed, the highest bidder has to buy the good or service. In addition, the auction closes when no higher bids are made within a time interval (Ockenfels, Reiley, Sadrieh, 2006). Often a seller sets a reserve price. The reserve price of the seller is the minimum price at which he is willing to sell the item. Since the English auction is an ascending auction, submitting an early bid, is always dominated by the strategy of submitting a bid just before the auction ends. This is the reason why shill bidding is most effective in an English auction because a shill bidder can force up the final selling price. When a buyer really desires the product, he has to raise the bid which is the goal of a shill bidding seller.
4. Strategies and payoffs
A seller who wants to raise his revenue by shill bidding can choose between two possible strategies (Nikitkov, Bay, 2010). The first strategy is called the bid encouragement strategy. This strategy shows the herding behaviour of human beings. When there is no bid on an item, people are not attracted to make a bid because they think that it is not valuable. If a seller bids on his own item, potential buyers may think that the item is desired and valuable and they start bidding. This results in more and higher bids from the participants. The second strategy is called the competitive bidding strategy. This strategy is used when a seller is noticing that a buyer is interested and that the buyer really desires to purchase the item. A seller can take advantage of this situation by bidding close to the end of the auction. At the end of the auction, the seller can force up the value to the reserve price of the buyer (Nikitkov, Bay, 2010). The reserve price of a buyer is the maximum price he is willing to pay. The seller’s payoff is the difference between the final price and the true value of the item. The seller can increase its payoff by using these strategies because he is forcing up the price and thereby it increases his revenue. 3
From the buyer’s perspective, the possible strategies are raising the current highest bid or stop bidding. The buyer only raises the bid until he has reached his reserve price.
Until this point the buyer has a dominant strategy which is raising the bid and when the buyer’s reservations price is reached, the buyer stops bidding. When a seller is using shill bidding, he reduces the payoff of the buyer since he is forcing up the price to the reserve price of the buyer. Shill bidding is a good example of strategic interactions. The strategy of the buyer depends on the strategy of the seller and the other way around.
5. The price of the product and the frequency of shill bidding.
Most sellers are attracted to shill bidding if they believe that the value bid by buyers is much lower than the true value of the item they sell. Since not all information is available to the buyer, it is hard for buyers to bid the true value. This makes it risky because a buyer does not want to pay more than the true value. Another reason why it is hard for the buyer to bid the true value is that they cannot feel, see, or touch the product since it is sold on the Internet. This is called asymmetric information which means that the buyers and sellers are not equally informed. When a product is expensive, people are even more uncertain about the market price and the risk is greater because there is more money involved. When a buyer buys a car of 6000 Euros which is defected after two weeks, it is more risky compared to when he buys a lamp of 50 Euros which breaks down after the same amount of time. Therefore, bidders tend to bid lower than its true valuation price which results in a lower final price. This is an incentive for the seller to shill bid because they do not want to sell the product below the market price (Nikitkov, Bay, 2010). In addition, buyers expect more discounts on more expensive products because they think in proportions and not in absolute numbers. Therefore they tend to bid lower on expensive items. For example when people are buying a car or a television (McDowell, Thom, Pastine, Frank, Bernank, 2012). They receive a 20 Euros discount on both products. In absolute numbers the amount of discount is the same. In relative numbers they receive 10 per cent discount on the television and 1 per cent on the car which they think is unfair. This makes them bid lower than the market price.
6. The profit of the seller
The main reason that sellers are using shill bidding is to enlarge its profit but the seller’s profit is only larger in the short run. If a seller is using shill bidding and it is one of the first times he

4 is selling items in Internet auctions, there is little chance that people can detect it. Shill bidding ensures that buyers pay more for a product but the costs and quantity of the items sold are the same for the seller as without using shill bidding. Since the profit function is defined by the quantity times the price minus the total costs, shill bidding yields in a higher profit. Nevertheless, in the long run, the sellers profit will decrease and maybe even become negative. Since buyers can see the past auctions of sellers, they can notice a shill bidder. For example when a bidder is frequently bidding at an auction of one particular seller or when a bidder has a few or no wins. Internet auctions are based on trust and when a little thing does not seem right, buyers stop bidding at the auction of this particular seller. Moreover, when it is detected once, it will give the seller a bad reputation which results in less buyers and lower bids. Buyers can also recognise the strategy of the seller by analysing the previous auctions and adjust its bidding strategy which will lower the price and therefore the profit. Therefore, in the end, a seller who is using shill bidding will be worse off because he will sell a lower quantity at a lower price.
7. Conclusion
Auctions were always very popular because of all the benefits but since they are on the Internet, they also offer a negative outcome namely shill bidding. Shill bidding is a strategy which is used by sellers to raise the price and therefore its revenue. Although it is unfair to the buyers because it pays more than the true value of the item, it still happens very often in the English Internet auction. Shill bidding is the most effective in this auction because the English auction is an ascending auction. A seller can choose between two strategies namely the bid encouragement strategy and the competitive bidding strategy. These two strategies yield in a higher payoff for the seller in the short run and thus a higher profit. A buyer has a dominant strategy which is raising the bid until it reaches his reserve price. This lowers the payoff of the buyer because the shill bidder is forcing up the price to the buyers reserve price. In addition, the paper concludes that shill bidding happens more often when products are more expensive. This happens because there is more money involved and therefore more risky. The main reason that sellers are using shill bidding is because they want to enlarge its revenue and thereby its profit. The paper shows that using shill bidding only results in a higher profit in short term but in long term a seller is worse off than without using this strategic bidding behaviour. 5
8. References
Bajari, P., Hortaçsu, A., (2004) Economic Insights from Internet Auctions, Journal of economic perspectives, Vol. 62(2), 457-486, Retrieved: http://faculty.washington.edu/bajari/published/insight.pdf
Bharat, B., Mamata, J., Yuhui, Z., (2003) "Understanding the Impact of Shill Bidding in Online English Auctions", Computer Science Technical Reports, Paper 1585, Retrieved: http://docs.lib.purdue.edu/cstech/1585
Lucking-Reiley, C., (2000) Auctions on the internet: What’s being auctioned, and how?, The journal of industrial economics, Vol. 68 (3), 227-252, Retrieved: http://www.econ2.jhu.edu/People/Harrington/375/l00.PDF
McDowell, M., Thom, R., Pastine, I., Frank, R., Bernank, B., (2012), Principles of economics, Berkshire, McGraw-Hill Education
Ockenfels, A., Reiley, D., Sadrieh, A., (2006), Online auctions, NBER working paper series, NBER Working Paper No. 12785, Retrieved: http://cid.bcrp.gob.pe/biblio/Papers/NBER/2006/Diciembre/w12785.pdf
Nikitkov, A.N., Bay, D., (2010), Online Auction Fraud: An Empirical Analysis of Shill-bidding Practice, Journal of Forensic & Investigative Accounting, Vol. 2(3), 191-228, Retrieved: http://www.bus.lsu.edu/accounting/faculty/lcrumbley/jfia/Articles/FullText/2010_v2n3sa7.pdf

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