When a prospective client asks several firms it is evaluating to present their qualifications one after another, it is usually referred to as a beauty contest or bakeoff. Often it might more accurately be called a dollar auction.
A dollar auction is a game concocted by game theorist and economist, Martin Shubik. Try it out, yourself. It requires an auctioneer (presumably you), six or more others who will perform better if plied with alcohol for a few hours first, and a dollar bill. Once everyone has downed two or three drinks, ask for quiet, hold the dollar bill high in the air where everyone can see it, and say the following:
“I am about to auction off this dollar bill too the highest bidder. For example, if the highest bidder offers me ten cents, she wins and makes a ninety cent profit. There is only one other rule: The second highest bidder also has to pay me the amount of his final bid. So, if the highest bid is ten cents and the second highest bid is nine cents, I get paid nineteen cents and the dollar goes to the highest bidder. Do I hear five cents, five cent for one slightly used dollar bill?. . .The woman with the red dress offers five. Now do I hear ten anybody, just ten cents for this dollar? Do I hear fifteen, fifteen . ..”
In most cases, the bidding quickly narrows to two people. When the bidding reaches a dollar, there is a pause. When the bidding reaches a $1.01, the bidders pause again, and then the bidding goes on up. Auctioneers have won substantial sums.
I was reminded of dollar auctions recently when two professionals, an engineer and a management consultant, both used the exact same words to describe how much a firm should invest in a highly competitive pursuit of a major project, culminating in a classic beauty contest interview. Both said, “You have to invest whatever it takes.”
This may be a necessary attitude to win, if the competition is not a dollar auction. If it is a dollar auction, thinking this way will lead to disaster: No one wins a dollar auction.
The first and most important rule of dealing with dollar auctions is not to get into one. Avoiding them requires recognizing them when asked to participate. Seductive enticements to participate can be a tip off. Architectural design competitions, where the clients offer a small stipend to competing firms to submit partial designs, are classic dollar auctions. Alan Chimacoff of ikon.5 architects reports a joke one hears among architects that goes as follows:
Two developers are talking about the architects they use. The first one complains about how expensive the bids are that he is getting for an office development he is planning. “Why not ask them to do it for free?” asks the second developer. “No one will want the project,” says the first. “Of course they will,” replies the second, “Just call it a design competition.”
Chimacoff describes how design competitions turn into dollar auctions as follows:
Competing firms are given a stipend of, say, $20,000, which equals one week of design cost to defray the cost of submitting partial designs to be used in selecting an architect. They are scheduled to present these partial designs in, say, six weeks. Every competing architect realizes that she has a better chance of winning with a more complete submission presented compellingly in drawings and a model, so they put in a second week at $20,000 and then a third and so on, until the full six weeks are used up. The cost to the architect is $120,000 for which she was paid only $20,000. If the total fee to the winner of the project is $1,000,000 dollars on which the firm makes a ten percent profit, that profit has been burned up before the project even starts.
Clients may not be aware of the unfairness of the competition they have structured. Rick Holmes, also of ikon.5, describes a competition for a project for a college classroom building his firm participated in and lost. Ikon.5 did the one week’s design work that the stipend covered and stopped. Other firms kept going, the winning one submitting a stunningly beautiful (and expensive) wood model of the new building. Committee members complained that Holmes’s firm had taken their money unfairly, because it hadn’t done work comparable to the competing firms.
Rules for Dealing with Dollar Auctions
More traditional competitions culminating in beauty contest presentations can also degenerate into dollar auctions, especially when work is scarce and firms are willing to spend more to win an assignment. From an economic perspective, when you have too little work to keep your professionals employed, a money-losing engagement that covers your variable costs and contributes to paying for your fixed costs may be worth taking. It allows you to maintain your staff and pay for at least a little of your overhead while you wait for an upturn. As long as the upturn comes soon enough and you are not so absorbed by the money-losing project that you can’t take on a profitable one when it comes along, taking the project will be good for the firm. One firm willing to take the project at a loss can create a dollar-auction bidding environment.
The second rule for dealing with a dollar auction is to scare off competitors immediately by a seemingly irrational willingness to win at any cost. So, for example, when the auctioneer asks for a first bid of ten cents to win a dollar, a bidder immediately offers $1.00 or even $1.01, the auction is likely to end immediately, to the disappointment of the auctioneer. Preemption of this type is harder in a beauty contest among professional firms. Should one architect who is asked submit a partial design for $20,000, get word out to his competitors that he has be authorized to spend over $100,000 to win the competition, other firms might decline to get involved.
A final way to deal with dollar auctions is to ignore the client’s budget once you get the work. In the architectural world, a few famous designers are noted for getting their clients to pay much more than budgeted for a new building. One museum addition I am familiar with purportedly came in ten times over budget. Either because the architect really convinced the board that the massive unexpected cost was worth it or because the board was too embarrassed to acknowledge how financially disastrous the project was, the board ended up accepting that the building be built as designed and raised the extra money. Some technology consulting firms also seem to take work at below their costs with the expectation of making it up later in change orders. I have ethical concerns about this approach, but it clearly works for some.
Do any of you readers have dollar auction stories?