What Is an Auction?

An auction is a sales event wherein potential buyers place competitive bids on assets or services either in an open or closed format. Auctions are popular because buyers and sellers believe they will get a good deal buying or selling assets.

How Auctions Work

In an open format, all bidders are aware of the bids submitted. In a closed format, bidders are not aware of other bids. Auctions can be live, or they can be conducted on an online platform. The asset or service in question is sold to the party that places the highest bid in an open auction and usually to the highest bidder in a closed auction.

Example of Auctions

In an open auction, parties come together at a physical venue or online exchange to bid on assets. An interested party is aware of the competing bid amounts and continues to raise their bid until they are either declared the winner of the auction (i.e., they submitted the last highest bid within the auction time limit) or until they decide to drop out of the bidding.

Examples of auctions include livestock markets where farmers buy and sell animals, car auctions, or an auction room at Sotheby's or Christie's where collectors bid on works of art. Leading online marketplace eBay is a host of online auctions.

Price is not always the deciding factor when assets are sold by auction; a company that is for sale might choose a buyer who will provide the best terms for its employees.

In many business transactions, including the sale of company assets or an entire company, auctions are conducted in a closed format whereby interested parties submit sealed bids to the seller. These bid amounts are only known by the seller. The seller may choose to hold just one round of bidding, or the seller may select two or more bidders for an additional auction round.

In a situation wherein a division of a company or the whole company is up for sale, price is not the only consideration. The seller, for example, may want to preserve as many jobs as possible for its employees. If a bidder does not submit the highest price but can offer the best terms for continuity for employees, the seller may select that bidder.

Fast Fact

According to Statista, eBay, the popular online auction and sales platform, consistently ranks as one of the largest U.S. online companies based on market cap. Notably, eBay's market cap was almost $40 billion as of June 2018.

Traditional Auctions Versus Dutch Auctions

A variant of the traditional auction is a dutch auction. Google (since renamed as Alphabet Inc.) used this process when it issued its initial public offering (IPO) in 2004. In this form of auction, prospective buyers submit bids including the number of shares desired and the amount they are willing to pay for those shares.

In the case of Google, after the auction, the underwriters sorted through the bids to determine the minimum bid they would accept from buyers. The IPO was priced at $85 per share.

Key Takeaways

  • An auction is a sale in which buyers compete for an asset by placing bids.
  • Auctions are conducted both live and online.
  • In a closed auction, for example, the sale of a company, bidders are not aware of competing bids.
  • In an open auction, such as a livestock auction, bidders are aware of the other bids.

A Dutch auction also refers to a type of auction whereby the price on an item is lowered until there is a bid. The first bid made is the winning bid and results in a sale, assuming that the price is above the reserve price. This is in contrast to typical options, where the price rises as bidders compete. Dutch auctions are rare in the pricing of IPOs.