Psychoauction.com– how do “giveaway” auctions work?

Thanks to a colleague of mine, I came to know about this new auctioning website - Psychoauction.com. At the first glance, I understood why my colleague got so excited about it. I could see an iPhone 3GS won by someone for a mere $5.56 and a Sony Vaio laptop was won for $ 26.13. These are just few examples and there are many other electronics won by bidders for a fraction of the actual price. You can check the following URL

http://www.psychoauction.com/mainmini.php?page=historic

Is this website a sham? If not, how can this kind of business model survive? Apparently, the founders are, in fact, making lots of money from this.

Here is how – Psychoauction.com is based on pay-to-bid auction format. That means, every time a bidder increases the auction price (or start bidding) they would be charged a fee. So, bidding fees are the primary sources of revenue for the seller! (Not the margins from the actual item they sell).

In case of Psychoauction.com, the membership is free (though premium accounts are charged) & sign-up gets you 2 bids for free. Thereafter you will have to buy bids (each bid costs you $1). Items generally start at a very low price & once a bidder bids on it, there will be a window of 3 minutes for others to submit a competitive bid (you don’t specify the offer amount, but you just express interest by using one of the bid points you have. i.e., spend a $1). If someone bids in that 3 min window, the item price goes up by $0.01 (yes, 1 Penny!!) and the 3 minute clock resets again. It goes on until no one else bids & the last bidder gets the item.

If you see the economics of this whole process, it makes perfect sense for the website owners (of course, the membership volume crosses a critical volume for this to work). For example, there is this Laptop worth $1000 put on the auction at a base price of $10. The fractional price point attracts many users (though they may not even need a laptop). Everyone tries their luck by spending their bid points (which they purchased for a $1/bid point) and in the end, one user (the lucky one) wins it for say, $25 (That means there were 1500 users that bid on this item, as each bid rises the price by $0.01). So the owners of the website, actually made $1500 (through bid points) and then “gave away” a laptop worth $1000 for a mere $25 for one of the users. That’s a $425 profit right there ($1500+$25-$1000)!!

No wonder, PsychoAuction.com is started by an ex-investment banker! :)