Price auctions vs. Beauty Contests

One critical distinction is between auctions on the one hand and Beauty Contests, also known as comparative tenders, on the other. Auctions are allocation mechanisms in which a pre-defined algorithm can establish which firm will offer the best bid. In a Beauty Contest, the auctioneer sets a number of criteria that will be used to evaluate the different bids (Binmore

& Klemperer, 2002).

A Beauty Contest can be either weighted or unweighted. An unweighted contest would imply that the firms are unaware of how the bids were to be evaluated. In a weighted contest, however, the participating firms know in advance what criteria they are to be assessed on, and what the various weights would be on the different criteria. Nevertheless, a Beauty Contests would always involve some ambiguousness. Even though maximum scores on criteria are known, it is hard to assess how to score bidders (objectively) on a given criterion (Janssen, 2004).

Inherently, Beauty Contests are used because auctioneers want to allow some autonomy in assessing the bids; otherwise, a price auction would be more accurate. Put differently, Beauty

Contests embrace, to some extent, the flexibility that follows subjectivity. Therefore, the key difference between auctions and Beauty Contests is that the latter always encompasses an element that cannot definitely be quantified (Dykstra & Windt, 2004).

In literature, auctions usually come out as the preferred allocation mechanism to Beauty Contests. Binmore and Klemperer (2002) compared auctions with Beauty Contests, and found that auctions outperformed Beauty Contests on a number of aspects. Auctions, when properly designed, were more likely to allocate resources to the firm that could use the object most valuably. They argued that a price auction would urge managers to put their “money where their mouths are” (p. 76) when placing the bids. This would be more reliable than if auctioneers, e.g. government bureaucrats, would be responsible for assessing the merits of the bids.

Designing a Beauty Contest would also be more time-consuming and less transparent than an auction. Transparency requires objective evaluating criteria, which by definition is impossible in Beauty Contests. The issue is that it is difficult to quantify, accurately, qualitative aspects and give appropriate weighting to these. A lack of objective assessment criteria and weighting makes it unviable to construct objective comparisons of various bids. That particular shortcoming can lead to (perceived) favouritism and corruption. Binmore and Klemperer (2002) indicate that whereas the Spanish and Swedish 3G spectrum Beauty Contests resulted in lawsuits and substantial and lasting political debate, losing bidders in the UK complimented the government on its auction process. The transparency issue is made more complex by the fact that perceived favouritism and corruption are enough to discourage possible entrants, even if the process is in reality fair.

Cartelier (2003) argue that the challenge of Beauty Contests has less to do with the evaluation and comparison of the bids itself as the fact that the assessment process opens for information manipulation. Because Beauty Contests lack a fully objective algorithm to assess the bids, the complexity of the assessment process can be exploited to benefit the bidding firm. Although it is questionable whether it is right to claim that the evaluation and comparison offers little trouble in a Beauty Contest, the argument still addresses a critical issue. That is, Beauty Contests are vulnerable to manipulation by the firm, with or without corruption and favouritism on the auctioneer side.

Furthermore, as long as the objective is to raise government income, Beauty Contests will fall short of auctions in stimulating price competition and ensuring that the highest bidder wins (Binmore & Klemperer, 2002).

That is not to say that prices cannot still be one criterion in a Beauty Contest. One advantages of including price, as one criteria in Beauty Contests, is the information it reveals: it would be an indication of how much money the auctioneer would be willing to give up, in the event that the object is not awarded to the bidder with the highest price offer (Janssen, 2004).

To ensure efficiency, a price auction needs to be designed in a way that all potential parties are offered equal information and a fair playing field. In other words, the differences in the bids should only be caused by differences in the valuation of the objects – nothing else. In a pure common value auction, this would imply that if designed correctly, all parties bid the same, correct, value for the object. This is nevertheless difficult to achieve. A key challenge is that there will be a difference in information between the incumbent and new entrants. This creates arguably unfair advantages to the incumbent (Janssen, 2004). To battle this, information needs to be made available to potential bidders. However, it is questionable how cooperative the incumbent would be to supply the regulators with crucial information when it is in the incumbent’s best interest to keep competitors uninformed.

If the auctioneer wishes to encourage qualitative aspects that are not easily identified and quantified to fit a pre-determined algorithm, then a price auction risk falling short of a Beauty Contest. An auction does not credit any initiatives that are not quantified and included in the algorithm, unless the initiatives also affect aspects that are part of the algorithm, e.g. the overall price offering or subsidy requirement (Janssen, 2004).

Auctions also introduce the risk of the winner’s curse, which is discussed in more detail in the following section. The winner’s curse explains why winning bids may be based upon judgmental failures and overly optimistic forecasts about revenues and costs (Alexandersson

& Hultén, 2006A).

Whether a Beauty Contest or an auction is chosen, consumer interest is in neither of the cases directly represented. In either case, the process can be designed to include consumer interests.

The auctioneer can decide to design the process so that firms bid in terms of the price they set in the market. This can be included when the concession concerns operations in well-established markets, where services and technology progress rather slowly (Janssen, 2004).