Using Vickrey auctions as a price discovery mechanism

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I recom­mend “Pric­ing niche prod­ucts: Why sell a me­chan­i­cal key­board kit for $1,668?” for pro­vid­ing a prac­ti­cal case study in price dy­nam­ics that helped with my eco­nomic in­tu­itions.

The au­thor’s friend had cre­ated a new cus­tom key­board kit. Their friend’s pre­vi­ous kit had sold out in min­utes, so clearly some­thing was amiss with their “es­ti­mate costs and pre­miums and then set a price” ap­proach:

I’m not a fan of this in­side-out ap­proach, for sev­eral rea­sons:

  • fac­tors like “brand pre­mium” are in­her­ently sub­jec­tive — the temp­ta­tion to com­pare to oth­ers limits po­ten­tial up­side and differentiation

  • pick­ing a (new, higher) price may have rep­u­ta­tional down­sides (be­cause o_f course_ your cus­tomers spend all day in me­chan­i­cal key­board chat rooms and may gripe about you “sel­l­ing out the com­mu­nity”)

  • you will sec­ond guess your­self re­gard­less of the out­come; ei­ther you sell out again (goto 0) or you sell too few and then must live with the shame of hav­ing $20k worth of un­sold key­board in your garage

The most com­pel­ling ar­gu­ment against sim­ply pick­ing a price, though, is that it limits how much you can learn about your mar­ket.

In­stead, they run a Vick­rey auc­tion (or “sec­ond-price sealed-bid auc­tion”) and find that the de­mand curve sup­ports 3x the list price they would have cho­sen:

I can’t over­state the benefits of know­ing the de­mand curve.

In my friend’s case, the auc­tion let them sell far above their ini­tial price and re­vealed that the mar­ket was deep enough to jus­tify a larger pro­duc­tion run.

(I dis­cov­ered this post via The Pre­pared, a newslet­ter that I’d strongly recom­mend.)