THE BLOG
04/07/2011 04:51 pm ET | Updated Jun 07, 2011

The Seduction of the Penny Auction

As a company focused on consumer advocacy, FindTheBest.com aims to expose the hidden or misleading practices of businesses that take advantage of the fact that their users don't have full knowledge or awareness of its practices. One such industry that has recently gained much attention is the Penny Auctions industry. This is the first in a series of articles on companies or industries that consumers should beware of.

Penny auctions are sites that charge participants a non-refundable fee for each one cent bid they place. When the auction clock runs out, the last participant to have placed a bid wins the item and also pays the final bid price -- which is usually significantly lower than the retail price of the item. The auction site then collects money from the fees all participants must pay per bid and from the final bid the "winner" must pay.

Bids typically cost between 50 cents and $1, unlike other auction sites like eBay that don't charge any bidding fees. Each bid increases the price of the product by 1 cent and also extends the bidding time -- typically between 15 seconds and 1 minute but sometimes up to 20 minutes -- to allow others to continue to bid and for the hosting sites to continue raking in nearly 100 percent profits on the bidding fees. Since each new bid extends the bidding clock, a bid that currently is set to close in 15 seconds can actually be extended by hours. While it is possible for one bidder to win a product for a fraction of the price it retails for -- which is the allure of the penny auction -- it is certain that 99 out of 100 bidders will waste time and money bidding for a product they will not end up winning.

Interestingly, many times the auctioneer doesn't actually have the product it is auctioning; instead they wait for the cash to come in before they actually go out and purchase the product. For example, the BidsTick site explains that the product will be ordered "within 6 to 8 weeks, from the time that payment is completed." In terms of tech products, the six to eight week waiting period could mean that the retail product price has already been significantly reduced by the time the penny auction site has shipped the order.

Sites like BidsTick also ensure that they remain in control of the bidding at all times. Under the site's FAQs -- which most participants are not likely to read -- it says: "Bidstick reserves the right to pause any of the auctions at anytime and for any reason. Tick timers pause so that we can lower them on auctions to surprise you and to keep things interesting." This ensures that users retain very little control over the outcome of their bidding while the host site retains complete control over the final outcome. With no oversight and little transparency, it is possible that these sites pause or reset the time to best serve their profit margins -- not simply to "keep things interesting."

Some of the sites, like BidFun and BidsTick, take it a step further, auctioning off not only products but packages of non-refundable bids. This process of bidding on bids -- and not on actual products -- is reminiscent of derivative trading, which is generally carried out by financial professionals who fully understand the complexities of such instruments. Similar to how people in the financial world trade derivatives, which are often times hedged or speculative bets on the performance of a stock or bond, penny auctions allow people to bid on bids.

While most of these sites do disclose the details of the auction rules, one can't help but relate some of these disclosures to the lengthy disclosures of many credit card companies, which users don't have the time -- and sometimes understanding -- to sift through. For example, when reading over the disclaimer section of BidsTick, it states that some of the goods up for auction might actually be substitute goods or services. "In no event shall BidsTick.com, or its contributors be liable for any direct, indirect, incidental, special, exemplary, or consequential damages (including, but not limited to, procurement of substitute goods or services; loss of use, data, or profits; or business interruption)...."

The Better Business Bureau is reportedly still tallying figures from last year, but a BBB spokeswoman told Smartmoney.com that just four local branches reported more than 1,500 complaints about penny auction sites; this number is greater than the total number of complaints reported nationally about internet auctions the year prior. According to the BBB, QuiBids had 197 closed complaints in the past 12 months.

Smartmoney.com reported that QuiBids recently auctioned off a Canon digital SLR camera for $194.16, which is reportedly at least $1,000 less than the retail price. But that final sale price represented 19,416 bids, at an average 60 cents per bid, racking up $11,650 in fee income for QuiBids.

Like gambling, the realization that you have lost time and money after being outbid, often causes an addictive and irrational drive to continue playing. The fact that some of the sites refund part or all of the fees participants pay as credits toward future auctions just perpetuates the vicious cycle. In addition, the creation of a sense of urgency -- as users see flashing tick times counting down--oftentimes causes brash and quick action instead of weighing costs and benefits to find the disproportionate relationship between the size of the potential reward and the cost of trying to obtain it.

Claire Rosenzweig, President and CEO of the BBB of Metropolitan New York, said: "BBB has received hundreds of complaints from consumers about penny auctions so far this year and we're encouraging online bargain hunters to do their research.... BBB has heard from people who lost thousands of dollars bidding on items and have nothing to show for it."

The BBB website also reported that they have received many complaints "about being automatically charged $150 just for signing up for what was supposed to be a free trial." Others claim that "some sites use phony bidders and 'bots' to drive up the prices on items."

Many people have expressed outrage by penny auctions and the way in which they lure in oftentimes unknowing participants with lofty dreams of winning a $2 iPad or a $5 flat screen TV. Some critics are calling for such sites to be shut down, or at least regulated, equating it to gambling without oversight. But supporters would argue that these sites are simply playing by the rules of free market capitalism, as their consumers are willingly playing a risky game which happens to result in juicy profits for the host company.