By this time next year the allocation of the new Internet namespace will be complete. Several hundred contention sets, ranging from likely blockbusters like .WEB to somewhat less obvious money-makers like .UNICORN, will be decided by some method.

One way to resolve contention is to form a joint venture. We are in the process of doing this with Uniregistry for .country. That works well when there are only two competitors and there’s a good basis of trust, and it’s a great solution because there are no losers. But if there are three or more competitors, or if you don’t like and trust your prospective partner-to-be, this really isn’t an option. Realistically, there will be only a limited number of joint ventures.

It may happen that you and a competitor are head-to-head on two strings and if so, a second method for resolving contention is a straight-across trade. It’s not a bad solution: it’s cashless, it’s quick, and each party gets something. But it’s not as easy as it might at first appear. Some people want to win everything, so they view this solution as a loss. And who gets to pick first? Is a random draw an acceptable solution?

If you can’t manage one of these two solutions, you’re left with either arranging a private deal with someone (again, not very realistic if there are more than two parties), or else you’re going to auction. There are two kinds of auction being talked about: ICANN’s “mechanism of last resort,” or a “public auction” as it’s often called; and the much-debated private auctions.

The ICANN auction is simple enough: it’s an ascending floor auction. The auctioneer asks (electronically) who’s in at $100K, $250K, $1M, $2M, and so on. The last one left standing pays their money and walks away with the TLD. The losers walk home with nothing except some memories and a 20% refund on their application fee. ICANN walks away with a bundle of cash to add to the dragon’s hoard of $350M that they have already reaped in application fees.

A private auction is just an auction between companies, but without ICANN. The parties involved decide on the rules, so it may be in any auction format, but the favorite today is to ape the ICANN format exactly—with one important difference—instead of ICANN getting the money, it’s split evenly among the losers.

If you have more than one or two applications, a little money can go a long way (it’s also good for single applicants, see below). Let’s suppose, for example, that you are head-to-head with someone for .tremendous. The bidding goes up and up, but in the end your competitor likes it more and pays you $2M for .tremendous. The next day, you and your competitor are back again for .fantastic. This time, you value it more, and you win, again for $2M. Result: you both have $2M and you both have a TLD. Except for the auctioneer’s fee, it ends up being a cashless transaction.

Across multiple private auctions, this recycling of cash is writ large. With a modest war chest, you can lose more auctions and walk away with more money than you started with; you can win and lose in equal monetary proportions and end up cash-neutral; or you can try to win more value than you lose and spend your war chest in exchange for TLDs. As long as auction prices are stable relative to one another, then even a modest amount of cash will enable you to walk away with a return. Compare to ICANN auctions, where you get nothing if you lose and winning one auctions could mean that you’re unable to compete in any others.

Is this analysis only relevant for portfolio players like us? On inspection, the logic of the benefit holds no matter how many strings you are in contention for. If you have a single string, you should bid up to that string’s value—given your financial resources—in either a public or private auction. In each case, a competitor who places a higher value on the TLD, who has the financial resources, will ultimately beat you. The question is:, do you want to be compensated for that loss?

It took us a while to get our heads around private auctions. Actually, auctions of any kind take some time to understand, but at first blush an auction under the aegis of ICANN seemed safer; private auctions provoked a lot of questions. For instance, what if someone overbids in order to drive the price up and get a bigger payout from you? If you win, why should your money go to a competitor who might use your money to beat you at the next auction? Are the bid prices in general going to be higher or lower in a private auction?

The basic answer to all these questions is that you should bid up to what you think a TLD is worth, and no more. If you follow that rule, you should do well in a private auction. Auction participants must have an idea of what they believe a TLD is worth. For example, if Minds + Machines bid on .awesome, we would estimate how many .awesome registrations we could sell in a given year, how many premium .awesome names we could sell, and what the brand uptake might be for a .awesome sunrise. We would then translate that into a discounted net present value for the TLD, and in no case bid higher than that in either a public or private auction. Keeping this in mind should spare you all kinds of woe, and it’s equally valid in an ICANN or a private auction.

What about someone overbidding to drive up the price? If you were up against Awesome Industries, the 10-billion-dollar king of awesome products, you might be tempted to overbid for .awesome in a private auction with the view of getting a higher pay out. But that’s a dangerous strategy, because the reality is that at any instant Awesome could drop out, leaving you with a very, very expensive bid for something you don’t think is really that… awesome. Everyone has their limit, even Awesome Industries.

On the flip side, you might worry that by winning .great for $2M in a private auction you will be providing cash to your competitor for the next auction, for .amazing. But if they overbid on .amazing, beating you, you should be pleased to take their money—leaving you with a bunch of cash as well that you think is the tld that is more amazing than .amazing.

Nobody likes the idea of enriching the competition. But consider these options, you can either:

• Give money to the competition if you win, but you get money if you lose; or
• Give your competitors nothing if you win, but you get nothing if you lose.

Which is the rational choice? Game theory says that it’s the first choice.

There’s another important point in favor of private auctions: we believe that our competitors will do more to promote the TLD space in general (thereby helping us) than ICANN will. So we’re actually happy about paying our competitors instead of ICANN, as we view it as an investment in the promotion of the entire new gTLD program.

We struggled for a while with the question of which auction process, ICANN or private would produce the higher winning bids. We think that private auction prices will be lower, for the simple reason that people who’ve been at this as long as we have are going to inevitably fall victim to the dreaded sunk cost fallacy and are going to hate the idea of walking away with nothing. The loser’s consolation prize mitigates this effect, we think, and works to prevent people from overbidding to prevent being totally skunked.

Even larger corporate players like Google or Amazon have an economic incentive to enter private auctions, because overall it will lower their cost of acquiring their name portfolios. We don’t believe that Google will pay any amount for .LOL—and even Google and Amazon could find themselves outbid for some strings which are not core to their business models.

Then there is the issue of anti-trust. Do private auctions constitute bid-rigging? I talked to the Justice Department, who told me that they might or might not issue a letter giving guidance, which might or might not say that private auctions were good or bad. In other words, they told me nothing at all. We’ve all seen opinions issued by lawyers on both sides of the question, and we’ve had our own lawyers opine as well. It’s clearly an untested area, and that means it carries some risk. In the end, we decided that while we are bound to follow the law, we are not bound—in fact we’re not qualified, and neither is anyone else—to decide what the law might or might not become. In our experience, successful startups do not succeed without taking risks, and they do not succeed if they let themselves be ruled by lawyers pointing out potential risks—that way madness lies. Collusion carries with it an implication of secrecy, of back-room deals, but private auctions are advertised and anyone with a contested application can join in. ICANN, perhaps the most conservative, risk-averse, lawyer-driven organization in our industry, clearly encourages applicants to “work it out” and we think that private auctions are a fair and open way to do so. The first private auction is being held in a few days, and we’ll see if anyone gets a letter or phone call from the government. We feel that it’s a remote possibility.

Minds + Machines will proceed with private auctions. We won’t participate in the first set of private auctions: given ICANN’s history of delays, and the fact that it has not yet delegated a single new gTLD, we don’t see any need to enter private auctions just yet. But we intend do so when the time is right: it’s to our benefit, to the benefit of our competitors and to the industry generally. We also believe it’s to ICANN’s benefit and to the benefit of consumers, because while the ICANN auctions would leave applicants even more depleted of cash and unable invest in marketing, research, and technology, private auctions will provide money to create healthy vigorous registries that will fulfill ICANN’s mission to create choice and competition in the top-level namespace.