Now that ICANN’s Last Resort Auctions are becoming an imminent reality, more and more applicants with gTLDs in contention are coming to the conclusion that they would be better off in a private auction. As a result, there is a renewed discussion of the various approaches that have been proposed. Interesting new suggestions have also been made within the gTLD applicant community.

Innovative Auction‘s offering, the Applicant Auction, has been used to resolve contention for 21 gTLDs to date, and we have good reasons for continuing to recommend the approach taken in these past auctions.

However, we are open to implementing other auction designs applicants would like us to run for them, and we have explored other options. We are sharing our conclusions from these efforts to help applicants decide what works best for them.

In designing a private auction, several different decisions have to be made:

• Auction Design—Sealed Bid? Ascending Clock?
• What happens with the winner’s payment?
• How does the settlement process enforce the auction outcome?

Auction Designs

In Sealed Bid auctions, each bidder makes a one-time bid. The highest bidder wins, and pays either the price they bid (a “First Price” auction) or the second highest price (”Second Price” auction). A First Price auction is easy to understand, but difficult to bid in—the best bidding strategy involves trying to guess what the others will bid and then bidding just a little bit more. Bid too much, and you overpay if you win. Bid too little and you won’t win—and, worse, possibly watch someone else win for less that you were willing to pay. (Economists call this particular outcome “inefficient”—it fails to reach a fundamental goal of an auction, which is to put a good in the hands of whoever values it the most.)

A Second Price auction doesn’t have that problem—you can bid as much as you think the gTLD is worth to you, and if you win, you only pay the amount necessary to win. This simplifies the bidding strategy and results in a more efficient outcome. This is one of the reasons why ICANN chose a Second Price auction.

Live Auctions are a kind of second price auction—when only one bidder is left, the auction ends, and the winner pays the second highest price (plus a small bidding increment). However, a key difference between a traditional live auction and an online auction is that there is more excitement. One skill a traditional auctioneer has is to engage bidders emotionally and viscerally in a competitive live auction environment to induce competition-maximizing revenues for the seller.

Most Online Auctions (for example, those offered by eBay) are also Second Price auctions; bidders outbid each other, and can use proxy bids so that they don’t have to bid again when outbid. The winning price is the second highest of all bids plus a small increment. A drawback of this kind of auctions is “sniping”—expert bidders use automated services to place a bid during the last second of the auction, depriving less savvy bidders of their chance to bid and producing an inefficient outcome.

Let’s compare all these approaches to the Simultaneous Ascending Price Clock Auction that ICANN chose for their Last Resort Auctions, and that the participants chose for all Applicant Auctions held so far as well. As in the Second Price sealed bid auction, you can enter the highest amount you are willing to pay, once. You can then walk away knowing if your bid was the highest, you win, without overpaying as you would in a First Price auction. And as in a live auction or an eBay style auction, you don’t have to disclose to anyone how much you were willing to pay. The auction runs online, and there is no risk of sniping, because there is no benefit to placing your bid at the last moment. Finally, you don’t have to make a big decision up front—as the auction progresses, you can decide along the way if you would like to continue bidding, and you even get some feedback on how much demand there is for the domains for sale in the auctions.

Distribution of the winner’s payment

One critical issue related to any auction design is the disposition of the winner’s payment. For ICANN’s Last Resort Auction, the answer is clear: ICANN keeps the money, leaving the issue of what ICANN does with it to be addressed later by the ICANN community.

For private auctions, the money can be distributed among applicants who did not win, either in equal shares or proportionally to the amount bid. In the proportional case, your payout increases if you bid more—this can incent people to bid more than they otherwise would, potentially resulting in higher payments and inefficient outcomes. Payment in equal shares means that even if you bid $0 in the auction, you receive an equal share of the winner’s payment.

Opinions differ regarding the fairness of this—one argument is that each applicant for a gTLD has an equal right to it, so they all should be paid the same for giving up that right. We believe that equal payments will result in a more efficient outcome, and that winners will pay less than they would at a Last Resort Auction.

Another idea some applicants have discussed is to contribute some or all of the winner’s payment to one or more third parties of the applicants’ choice (e.g. charity, industry association, etc.). For example, with a three-applicant gTLD, the rule could be that each of the two applicants who didn’t win receives a set minimum amount, and the remainder is transferred to the third party. This would compensate the sellers for their time and effort put into the gTLD with a third party benefitting as well.

Settlement

A third aspect unique to private auctions is how to ensure that the results of the auctions become reality—how can the winner trust that in exchange for paying, it will become the sole applicant, and how can the others trust that they will be paid for withdrawing?

An essential element of this is the bidding deposits each participant makes. ICANN requires this, too—the main purpose of the bidding deposit is to ensure that applicants can’t bid up the price, win, and then not pay. Such behavior can expose how much the other bidders were willing to pay, completely undermining the second price nature of the auction.

The bidding deposit is usually a fixed percentage of the highest amount the bidder can bid—for example, 10%. Some applicants worry that this gives an indication of how much they are willing to pay. This is one of the arguments for setting a maximum deposit that allows unlimited bidding.

Another element of a settlement procedure is how long the winner’s payment stays in escrow. One possibility is to pay out the non-winning applicants once ICANN has announced the withdrawal of all non-winning applications in the auction. The rationale is that at this point, the winner has become the sole remaining applicant—and the privilege to be in this position is what the winner is paying for. This is the approach that found a consensus for all of the 21 auctions that we are aware of to date—but of course, this is a policy that can be set by applicants on a per-contention set basis.

Summary

We have now covered the most commonly discussed different ways in which private auctions can be conducted. The three different elements (auction design, disposition of auction revenues, and settlement) can all be evaluated separately.

Some auction designs are harder to implement than others (for example, an ascending clock auction requires specialized software), but for the most part, all providers can offer the same auction designs.

Disposition of revenues and some of the settlement terms are a matter of negotiation and consensus finding between applicants.

For all three elements, but in particular for the settlement process, the auction provider’s experience in settling private gTLD auctions is an important factor.

We hope gTLD applicants find this article helpful in structuring their thinking on which approach works best for them, and for communicating this to the other applicants in the contention set.

Ultimately, the most important success factor is unanimous participation, and clear communication will help build a consensus more quickly. The Last Resort Auctions are happening soon—there is not much time left.

The last opportunity to participate in the Applicant Auction before ICANN’s first auction is February 18th. If you are interested in participating, please contact us immediately—the cut-off for participation is January 31st.