Monday, April 11, 2011

harnessing irrational behavior for monetary gain: eBay

Question: How can a company like eBay increase prices and attract MORE buyers?

I am an established seller on eBay, and I recently got an email from the company talking about how they've implemented new fee policies. Before, eBay used to charge just to post an auction-style listing, as well as a percentage fee based on the ending price of an auction. Now, they're eliminating listing charges to entice more sellers to sell more items on eBay.

People are lured in by lower costs. Basic economics, right?

Well, here's the catch. eBay is eliminating insertion fees, but jacking up final value fees, which is a percentage of the price an item sells for. Since listing fees run $0.25-$2.00, depending on how expensive the starting price is, sellers are only saving money if their items don't sell.

For me, I normally start listing items in the $9.99-24.99 range, which cost $0.50 per item. This means that for every 10 items I list under the new policies, I save about $5. However, the final value fees increase from 9% to 10%, and the fee amount will be calculated with shipping costs included in the final price. If my auctions ended at an average price of $40 and shipping costs me $5, it actually costs me $9 more to sell on eBay with the new fee policy ($36 would be my final value fees under the old policies, and $45 would be my new final value fees). And that's not even counting PayPal's transaction fees, either. (Not surprisingly, PayPal is owned by eBay.)

So let's take a closer look at the psychology behind eBay's strategy. By simply understanding that people are risk averse, they are essentially eliminating all the risk associated with paying a small premium to list items on eBay. eBay is enticing first-time sellers to try out their services.

It feels cheaper. It feels less like a gamble.

Now, eBay has to make up for that lost profit from forgone listing fees somehow. So they decide to increase their final value fees (which they've been doing steadily since I've joined eBay), and start calculating them based on the ending price plus shipping costs. In essence, they are actually charging more for their services, which, if you've taken any basic economics course, you know would cause buyers (which, in this case are actually the eBay sellers who are consuming eBay's online market services) to stop using eBay. But instead, eBay is appealing to people's risk aversion by making them indifferent to selling.

And that's how they're raising prices and attracting new buyers.

Irrational? Yes. Genius? Yes.

Irrational behavior is profitable.

1 comment:

  1. I saw your guest blog on my Budgets Are Sexy and after reading through some of your posts here I just want to say keep doing what you're doing. I think you're way ahead of me when I was getting my degree...and probably now!