Penny Auctions have gained a lot of momentum as a form of online entertainment. Does the vary name of this legal form of gambling have a potential to damage the real auction industry? The auction method of marketing means selling to the highest bidder. The penny auction method of marketing has players purchase bids with the hope of winning a prize. Penny auctions take advantage of the thrill of winning and the positive connotation from the word “auction” that has been built up over generation of ethical auctioneers.


Q: Are Penny Auctions Illegal Gambling or Legit Auction?

A: Neither. Penny Auctions are gambling sites, but they are not illegal. They have little to do with actual auctions they merely represent a lottery masked as an auction to pass regulatory scrutiny.

Q: What is a Penny Auction?
A: The best way to understand a Penny Auction is to think if it as a “penny game”. Forget the entire concept of an auction for a moment and think of it as a game with these rules.

Penny Game Rules
There is a prize with a value of $1,000
The winner has to pay $50 to claim the prize
Anyone can be a player
To compete for the prize players take turns drawing cards
There is no limit to the number of cards that can be drawn
Each time the player draws a card they must pay $0.60
Each time a card is drawn the winner must pay an additional $0.01 to redeem the prize
Players do not know if and when another player will draw a card
The winner is the last person to draw a card after no additional cards have been drawn for 1 minute

Players try to be the last player to draw a card, thus winning the prize. Since the value of the prize is high relative to the price to draw a card, naturally people will be interested in playing. This is the draw of spending a little to get a lot. Games often have many individual players drawing cards. It is just like a lottery or a raffle. There is a low cost to play and a large reward for the winner. Like a raffle or lottery the total amount charged in selling cards exceeds the value of the prize. Ultimately it is just chance the player will draw the last card.

In the penny game redemption amount necessary to claim the prize gets higher with each card drawn. Over time the increase in the redemption amount reduces the potential reward causing players to stop drawing cards as the risk no longer justifies the reward. As players drop out it becomes more likely there will be a winner. This small but important addition also prevents this game from being a pure game of chance.

If this simple game was available online with players spending real money to draw cards to win real money it would quickly be shut down as gambling. The purveyors of Penny Auction sites have cleverly masked this game by wrapping it around an auction theme. But make no mistake these are not auctions. Real auctions operate with different rules.

Real Auction Rules
There is an item worth $1,000
Anyone can register to bid for this item
The auctioneer suggests progressively higher prices (bids) as people show interest
The bid continues to go up until there is only one bidder willing to pay the suggested price
The final bidder must pay the suggested price for the item
All other bidders do not have to pay anything but would have been obligated had their bid been the final offer

Key differences between the Penny Game and a Real Auction:
In a real auction the winner is the person willing to pay the most of that item. Only the high bidder has to pay. The auction is over when no other bidder will increase the amount bid.

In the penny game the final redemption price has little to do with the value of the item. There are other bidders who are willing to pay more for that item then the winning bidder paid. Each bidder has to pay every time they draw regardless of actually winning the item.


Penny Auctions:
Penny Auctions are the same as the penny game we were just talking about. Here is a breakdown of how a penny auction works.
Q: What is a penny Auction?
A: Unlike a traditional auction where only the high bidder has to pay, every player in a Penny Auction pays each time they bid on an item. In a Penny Auction there is a set ending time but each time there is a bid addition time is added. The person who places the last bid before time expires is declared the winner. Bidders have no way of knowing when time will expire since more time is added with each new bid. In order to remain the player with the highest bid, they have to keep bidding and paying each time they are out bid. The purveyor of the penny auction charges the final selling price to the winning bidder and collects a fee for every bid placed.
Q: Why “players” and not bidders?
A: I use the term player not bidder because Penny Auctions are a game. Unlike a traditional auction where only the high bidder has to pay, every player in a Penny Auction pays each time they bid on an item. Bidders are competitively increasing the amount they will pay for an item. Players are just buying another chance at winning.

Q: What are Typical Increments at Penny Auctions?
A: Increments at a Penny Auction are nothing like a real auction. Generally the starting bid is only one penny and each additional bid is only one penny, hence the name “penny auction.” Therefore after 100 bids have been placed the next required bid is only $1.01. The penny auction purveyor gets paid with every new bid so he wants to keep the price as low as possible to encourage more participation. In a real auction the increments are used to determine who is willing to pay the highest price. Since the only person to pay is the high bidder the auctioneer uses large increments to move the price up quickly.

Q: Are There Hidden Charges in a Penny Auction?
A: The charges may not be exactly hidden, but the majority of the money made from penny auction sites is by charging to place bids, not charging for the merchandise. In fact most merchandise sells well below retail value, which is how they attract more bidders. Just like a raffle, buying bids relatively cheap you have the potential to win a large item with a small investment.

Q: Why do Penny Auctions Sell Items Well Below their Retail Price?
A: Penny Auctions appear to sell items for a fraction of the retail value. It is not uncommon for new items to sell for 85-95% off of retail. However, since the websites typically charge per bid in addition to the final selling price they often make more money than retail price even when they sell at such steep discounts.

Q: What’s the Math Behind Penny Auctions?
A: If you have a television with a retail value of $500 that sells for $25 it is sold for $95% discount from retail price. This attracts a lot of people looking for a real deal. $25 appears to be a phenomenal purchase price for a buyer, but it does not take into account the cost behind all of the bids required to win it. To sell for $25 there first needed to be 2,500 individual bids placed on that item. At $0.60 per bid those 2,500 bids amount to $1,500 (2,500 x $0.60). So the purveyor actually collected three times the retail price and still sold the item for $25. In fact they achieved full retail price when the bidding reached $8.33 ($0.60 per bid x 833 bids = $500).

Q: What’s the Downside for Players in Penny Auctions?
A: The purveyor of the penny auction is selling items above retail cost. This is a great business model but unless gambling/chance is involved, there is no reason a collective community would pay more than the retail value for an item. The problem is that most of those fees collected from bids are not from the winning player. They are from other players who will wind up bidding on an item but winning nothing. If there were five players bidding on the $500 TV that sold for $25, each person would have to pay $300 in total bids ($0.60 each bid x 300 total bids); however, even after this investment only one of the five players will win the TV. The other four players end up with nothing and they’re out a significant amount of money. The winner ends up paying $325 for a $500 TV. Not nearly as good as the $25 final selling price suggests. If there were only two players each bidder would pay $750 to cover the bids necessary to get to $25. Now the winner paid $775 to win a $500 TV. Note: Some penny auction sites offer discounts based on the number of bids placed even if you are not the winner. This is another tactic to avoid being branded as a gambling site and to offer a rarely accepted consolation prize for the losers.

Q: What’s the Rub?
A: In a penny auction the selling prices are so low relative to the retail price there is no pressure for the players to stop bidding. The penny auction website keeps collecting fees as users place their bids. This is why I compare penny auctions to playing the lottery, there really is no difference-one person will win, several will essentially pay to lose. The increment and final selling price do not matter relative to the price paid for all the bids required to win an item. The idea of a player being lucky enough to win an item after only bidding several times is the luck of the draw and further evidence that these are a game of chance.
At a traditional auction the high bidder is the person willing to pay the most for that item. The auctioneer keeps calling higher princes until there is only one person willing to pay the final (and highest) price. This person is the winner. The unsuccessful bidders do not have to pay anything for the pleasure of bidding; would you want to keep bidding at an auction if you had to pay for each bid? Becoming a winner at a penny auction is just a matter of chance or persistence. Chance if you are lucky for the bidding to end on your last bid, persistence if you place too many bids and pay more than retail when the cost of your bids are added in.
The final price will have nothing to do with retail value. It will represent a moment in time when no one else was interested in bidding for that item. If guaranteed the win with one more bid most Penny Auction players would bid again without hesitation. After all they are spending $0.61 cents to win an item worth many times more than the final selling price. The final price represents a great deal for the winner, if they didn’t have to pay for too many bids to get it. But for all the losers (every other bidder who paid to bid but did not win the item) it represents money down the drain. They paid for each bid and wound up with nothing. Becoming the high bidder means you won the lottery, one that you likely entered repeatedly and paid for with each entry.
Penny Auctions have nothing to do with actual auctions other than a clever guise to hide from what would otherwise be a clearly illegal gambling enterprise. Instead of a $500 TV assume it was $500 cash. Now it is a lottery. You just don’t know how many tickets they will sell, and therefore what your odds of winning $500 truly are.

Q: Boil It Down, What’s the Reality Behind Penny Auctions?
A: The penny auction model is terrible for consumers even when legitimately conducted. It should be used for entertainment only, yet they are advertised as a great place to buy items at large discounts. It is not logical to pay money to bid on an item you may not win, and moreover you don’t know what your chances of winning are. Also, many penny auction sites cheat. They use shill players to add bids to keep the paying players bidding longer. This is both computer controlled and done by actual people who are using free bids. The American Association of Retired Persons (AARP) has issued a warning to their members about Penny Auctions. Many other blogs before me have suggested that Penny Auctions are gaming not actual e-commerce.

Q: What are the Implications of Penny Auctions on Me, the Auctioneer?
A: Penny auctions represent a real threat to the credibility of the auction industry as a whole. The auction method of marketing means selling to the highest bidder; all are welcome to bid, no one needs to pay to join in the bidding. The penny auction method of marketing preys on the hope of getting a deal that is too good to be true. They take advantage of the positive connotation from the word “auction” that has been built up over generations by ethical auctioneers.