Are Trailing Digits Legal?

Rafi Mohammed is one of the leaders in the pricing community.  His book The Art of Pricing is a worthwhile read and his blog often contains interesting commentary.  His most recent one describes an FCC auction for bandwidth in which bidders used the last three digits of a bid to signal their level of interest or their intent to fight hard for a particular piece of the spectrum.  For example, if a bidder wanted the Chicago market, it would add the numbers 234 to the end of the bid.  Research showed that bidders that did this had a much higher likelihood of winning that particular spectrum.

 Sellers use auctions to maximize the returns that they get from a sale.  More recently, buyers use “reverse auctions” to obtain products and services at the lowest possible costs.  Whether they are conducted on line or with an RFP process, the problem for sellers and buyers on the other side of the auction is that there are often so many bidders of differing level of quality and support that it is difficult for them to make any money if they should win.   Author Richard Thaler called this The Winner’s Curse in his book of the same name (the book is required reading for astute pricing managers!).

Because of “The Curse” (not to be confused with the Curse of The Bambino which was lifted for the Red Sox in 2004) many bidders will try to do things which limit the damage.  This is a common problem for sellers and they often have no legal response.   Sophisticated firms in competitive markets will often use Pricing Communications Systems (Discussed in Chapter 7 of Pricing With Confidence).  As part of those systems, they use “constituent communications” aka, signaling to try to influence the behaviors of competitors. 

Many industries use constituent communications to limit the damage of aggressive pricing behavior.  The steel and airline industries are two good examples.  The problem in the airline industry is that often competitors have dramatically different cost structures and the legacy airlines will try to signal that they are changing prices but the low cost airlines won’t follow.  This tactic has worked quite well, however, in the steel industry where a lead competitor like Nucor will announce in advance that they are raising prices and let other competitors follow.  Because of this, the steel industry has stabilized and until recently, has been making money through the downturn.  They recently saw a dip in profits when they misread the market turnaround and opened up too much capacity too soon–prices and profits dropped.  This type of communications is generally legal and it works.

The question I posed to Rafi is whether he thought trailing digits bidding was legal.  Gene Zelek of Freeborn and Peters in Chicago is one of the leading experts in this area–we’ll get him to weigh in on the subject too.  I’m not a lawyer but my sense is that it is legal.  As long as the communications is done one way and in a public venue, it’s not a conspiracy in the eyes of the law.  We’ll se how Rafi and Gene respond. 

The problem is that many pricing managers and senior executives don’t understand how critical knowledge of this area is.  A simple and innocent discussion about a customer and price between two competitors at a health club or a convention over drinks can represent a conspiracy.  I recall one case in Maryland where a Real Estate Broker stood up at a meeting of other brokers and said  that he was raising his rates to 7%.  Several attendees did the same.  That represented a conspiracy and they ended up being fined and going to jail.  They just didn’t understand the law.  Some companies have learned their lessons and have simple policies in place which educate and prevent employees from simple mistakes like this.  Companies that don’t put their executives and the actual companies at risk since the damages are tripled in some cases.

This is an important subject area that doesn’t get discussed enough.  As a result, many firms are unknowingly both at risk and in some cases in violation.  This is one area where an ounce of prevention is worth a pound of cure.  

Thanks to Rafi for bringing this point up and starting the discussion.