“I mean it’s just absolutely designed to manipulate people into idiotic behaviour” – Charlie Munger
Warren Buffett has always been very vocal about his thoughts on auctions. Famously stating in the 2016 annual letter to Berkshire Hathaway shareholders “we don’t participate in auctions.” Charlie Munger, his business partner shares the same thoughts and in a speech to Harvard students in 1995 titled “The Psychology of Human Misjudgement.” It outlines in greater detail certain subconscious biases that wreak havoc on our ability to make day-to-day rational decisions.
In that speech, he referenced a number of tendencies that occur during an open-outcry auction for businesses. He states “The open outcry auction is just made to turn the brain into mush. You get social proof; the other guy is bidding. You get reciprocation tendency; You get deprivation super reaction syndrome; the thing is going away. I mean it’s just absolutely designed to manipulate people into idiotic behaviour.”
In this short article, I will elaborate more on the psychology forces at play when bidding at auctions for property
The Psychological Factors at Auction
“The five most dangerous words in business are: ‘Everybody else is doing it.’”- Warren Buffett. As we walk through life, we constantly reassess the decisions we have made. Uncertainty drives hesitation and when combined with high-stakes decisions such as the purchase of a property. We look to anyone, anywhere for guidance despite knowing that they are just as unsure as you are. This concept is known as social proof.
In an auction scenario, if we can see that someone else is bidding for a property it reinforces that it is a desired asset worthy of such bids. The opposite is true when no one bids. In Robert Cialdini’s book Influence he writes that “the greater the number of people who find any idea correct, the more the idea will be correct.” We are willing to place a huge amount of trust into the collective knowledge of the crowd. Especially when we draw similarities with that crowd.
This is an ancient psychological concept which helped humans create civilisations and worked tremendously well. At an individual level it wreaks havoc on your psychology. Cialdini states that humans feel an obligation to return favours even if they were unwanted; as soon as it is accepted you are indebted. At an auction, you may see a coffee cart offering free coffee before bidding begins. These are strategically placed here so when the auctioneers asks you to bid against yourself by declaring your bid of $10,000 is insufficient, you are obliged to increase it another $10,000 to $20,000. The free strata report or building inspection report operate in the same manner. If you intend to bid at auction buy your coffee along the way.
Deprivation super reaction syndrome
Deprivation super reaction syndrome is an extremely potent psychological bias employed. Throughout a sale campaigns a prospective buyer imagines themselves in the property to work out whether it would suit their particular lifestyle. Is the backyard big enough for the kids to play? The buyer will then imagine their kids playing in the backyard. As days go by this feeling gets stronger and stronger as they go through the usual steps to prepare for the auction, by the time it is the day of the auction, the buyer can almost believe that the property is theirs to lose.
For humans the feeling of loss is far greater than the feeling from any gain. If an auctioneer frames a statement such as “imagine if you are the highest bidder for this property,” It is not as emotionally powerful as “Imagine losing this property for such a small amount.” As bidding continues the property gets further and further away, you are losing it. When you hear “going once, going twice…” it creates a sense of urgency, to bid or risk losing the property even if the property is not ‘on the market’ yet. Auctioneers will also bring up its scarcity value many times through the auction. This is a ‘one in a lifetime opportunity’ ‘never to be repeated.’ By focusing on the uniqueness of the property it heightens the impact of deprival.
As Charlie Munger stated before, we you get a combination of these psychological tendencies working together it turns your brain into mush. What is so scary about this, is that it is so unassuming and so ingrained into the process that it is not easy to identify especially when you are part of the process.
When you arrive at the auction, you see everyone helping themselves to a complimentary coffee, so you indulge as well. The auction starts, with no bids. Someone then makes a bid which is knocked back. Another buyer makes a bid and the auctioneer continues. After three bids the auctioneer exclaims “going once, going twice…” You then make a bid to make sure it doesn’t sell. The auction continues with bids in increments of $20,000. You make a $10,000 bid by which the auctioneer replies at this early stage of the auction that we continue with $20,000 bids, to which you oblige. The auction begins to slow.
The auctioneer reiterates the ‘unique opportunity’ that this property presents and to “lose this property for only $5,000, how would you feel?” You feel that the property is slipping through your fingers. The agent comes to you and suggests that a strong last bid will knock out the competitors. You make the bid, but it is met by another bidder. How did it come to this?
As a spectator, look out for these psychological tendencies next time you are at an auction.