The successful bids for various properties in the Indian Premier League (IPL) have involved jaw- dropping numbers. The broadcasting rights sold for $918 million (Rs3,690 crore), the right to own the eight teams for $723 million, sponsorship for $500 million and, this week, the players for $42 million.
It is interesting to understand the auction process used for the various bids.
Auctions are particularly useful when it is difficult to ascertain the value and standardize products/services such as labour, artefacts, etc. Various auction strategies have been successfully used for privatizing companies, selling telecom licences, developing stock exchanges—and now building a private cricket league. Economists have contributed actively to the development in various auction types and have been recognized for their effort (James Mirrlees and William Vickrey, Nobel Prize in 1996; Susan Athey, Clark Medal in 2007).
Auctions can be broadly classified into four categories: English, Dutch, sealed bid first price (SBFP) and sealed bid second price (SBSP).
Here’s how they work. In an English auction, the participants bid openly against one another, with each bid being higher than the previous bid. A Dutch auction works the other way around: the auctioneer begins with a high asking price, which he lowers till some participant is willing to accept the auctioneer’s price. In an SBFP, the bid is submitted in a sealed envelope and no bidder knows the others’?bid.?The SBSP is identical to the SBFP, except the winning bidder pays the second highest bid. There is also further classification based on who starts the bidding—buyer (forward auction) or seller (reverse auction).
Now with the theory in place, let us see how auctions were used in IPL. Though the auction process for broadcasting, teams and sponsorship isn’t clear, we can draw some inferences from the substantial media coverage.
It seems an SBFP auction was used for team bids. Each bidder submitted a bid indicating its best price—and the team went to the highest bidder. And in case one bidder got more than one team, it had to indicate its preference and drop the rest for others.
Bidding alone is not enough. The authorities also have to ensure that bids are not excessive. SBSPs—second price bids—were developed as people got trapped in a bidding war, leading to what is called?the winners’?curse?(where a bidder wins, but the bid is so high that it is actually a curse).
In IPL, the authorities could have used SBSPs to minimize the winner’s curse and lower the stakes. The economics of IPL will be understood better once the actual event happens. Till then, it is better to keep a low profile. And it is not as if the cricketing world has not had bad experiences before. World Cup 2007 is a classic example: built around huge hype but a disaster, not just for the International Cricket Council, but also West Indies economies.
Auction strategy has not been used properly for players either. It seems that an English auction was used—keeping a reserved price for each player, asking the respective teams to increase their bids and awarding the player to the highest bidder. This has led to two things. One, the stakes have increased (as the teams have to bid higher than the reserve price to get the best players). Two, it led to some great players getting much lower value than relatively newer players. It’s odd, for example, that Ricky Ponting has got a lower value than Ishan Sharma.
It is understandable that the teams looked at future potential, but then what is the purpose of inviting the best players who may not be young (some have even come out of retirement)?
A better strategy could have been to use a Dutch auction, by lowering the prices of each player from the reserve price. The reserve price for best players could have been kept higher and this could have minimized the problems, higher prices and adverse selection.
So, from the available evidence, it looks like the Board for Control of Cricket in India and players (who have got much higher than their reserved price) are the winners. The ball is now in the bidders’ court. They have to ensure the players deliver, people come to the stadiums to watch, buy their memorabilia, etc. As of now, IPL is much like a hyped IPO (initial?public?offering)?for?a?greenfield project which manages to rake in huge revenues on the basis of future cash flows in the event.
IPL should be a success. But the authorities could have made it more successful by going a little slow and letting the event gain momentum with time. Again, we can draw some references from economics. There are two approaches to getting an economic event going—either in full flow (big-bang) or slowly (gradualism). The first leads to huge perceivable benefits early on, but could have some severe consequences later. In the second case, the benefits are smaller, but severe consequences, if any, could be limited. Economists preferred the first approach initially, but have leaned towards the second with time. In IPL, the big-bang approach has been followed. And only time will tell whether it is successful or not.
(Amol Agarwal is an economist with IDBI Gilts Ltd. Comments are welcome at firstname.lastname@example.org)