Watch Out for New Records

By TAN Kee Wee

(MediaCorp 938LIVE’s Money Talks, Thursday, 18 October 2007, 7.45 am and 7.20 pm)

In April this year, a 1950s Omega platinum watch was auctioned off for US $351,000. It was the highest price ever paid for a brand that is well-known for selling mass-produced watches.

Newspapers publicized the record price fetched at the auction in Geneva. Omega publicly claimed that a “Swiss buyer” bought it. What Omega did not mention was that the “Swiss buyer” was none other than itself.

It took a while before the public found out about this. What we now know is that there was a tie-up between Omega and a Geneva auction house by the name of Antiquorum Auctioneers.

Basically, Antiquorum organized the public auction of Omega watches. And Omega would step in to bid anonymously if they wanted prices to go up to a certain level.

As more details of the auction surfaced, it turned out that Omega was not the only watchmaker with such an arrangement. Many famous Swiss watchmakers also had such an arrangement with the auction house.

Such price fixing is known to most of us. But unknown to most of us, the publicity given to such record prices has a powerful influence on the behavior of subsequent buyers.

In economics, we call this type of behaviour “informational cascade”. It is a situation in which a person would copy the action of the person before him, even if that action goes against his private belief.

Let me illustrate. In the popular gameshow “Who Wants To Be A Millionaire?”, the majority of the studio audience usually knows and votes for the right answer. But suppose, instead of the audience voting silently together, they voted out loud, one after another. Let’s suppose the first person gets it wrong.

If the second person isn’t sure of the answer, he’s likely to go along with the first person’s wrong answer. For the third person, he’s also likely to go along with the wrong answer because he assumes that the first two persons know more than he does.

Thus begins this cascading effect. Because of this, a group is prone to reach mistaken conclusions even when most people in the group start out knowing better.

Studies have shown that even if 60% of a group knows the right answer, there is a one-in-three chance that the group will cascade into a wrong answer.

Informational cascade happens in financial markets where it can feed excessive price speculation. For instance, a person will not pay $3,000 per square foot for a HDB apartment in Sengkang as he may consider it too expensive. But once someone else has bought it at this price, he would buy it.

This cascading effect is also commonly found in medicine. Doctors like to take their cues from other doctors, leading them to over-diagnose certain illnesses, and over-prescribe certain treatments.

A good salesman, like our Geneva auction house, knows how to use this cascading effect to make money. Of course, it can also be used to destroy. In Nazi Germany, it was used against the Jews. We are all equally guilty of using it. We use it to stereo-type people from other religions, countries and professions.

The question is: Why are we so vulnerable? The simple answer could be that most of us are unable to keep up with the rapid flow of information coming at us.

So we look for guidance from someone who we think knows better. This might well serve us most of the time. But once in a while, we will blindly follow the wrong choice and ruin ourselves.