VCs Love Penny Auction Sites, But Will Users Stay Smitten?

Numerous startups have come up with innovations based around online transactions, including payment platforms like Offerpal Networks, exclusive luxury shopping sites like Gilt Groupe, and group-buying businesses such as Groupon and its many clones.

But the newest class of e-commerce startups to capture the attention of VCs are so-called penny auction sites, which combine online auctions with game mechanics. Users of these sites — hoping to land expensive items at a deep discount — make small bids on the wares during limited windows of time.

Five-year-old Swoopo, a German penny auction site now based in Cupertino, Calif., is one such “entertainment shopping” site. Its users buy various packages of 75-cent “bids” for between $22 and $525. Each bid made on an item increases the item’s price by 15 cents and prolongs the auction countdown by up to 20 seconds (creating more time for others to bid). When the countdown finally winds to zero — it sometimes take a full hour — the auction is won by one customer. The losing bidders see the money they bid go to Swoopo, left with the cold comfort of knowing they’ve been “entertained.”

While it’s hard to believe that more than a million people have registered for the service, it’s less surprising that Swoopo last year landed a $10 million round from August Capital and $4 million from Wellington Partners before that. After years of financing startups with amorphous monetization strategies, the allure of a company that collects more than $20 from every user before they do a thing must be pretty damn strong for investors.

In addition to Swoopo, similar sites to garner VC include London-based, which raised $6 million from Atomico Ventures in July, and San Francisco-based, which raised $4.5 million from Foundation Capital, First Round Capital and Mayfield Fund last year and sealed up another (previously undisclosed) $10 million from its investors in February.

Competitors that have sprung up in the past year include BidRival, BidRodeo, BidCactus, and Beezid. None has disclosed any venture funding — yet.

And while their models vary -– drops the price of an item with each bid, while BidRodeo has promotions, such as promising 50% more bids for users’ second purchase of bid packages — each is premised on enough people bidding on the same item to both cover the item’s cost and produce a healthy profit for the startups.

One of the most interesting companies in the space is BigDeal, which is trying to establish itself as the White Knight of the industry — an industry that’s viewed with some skepticism by users and observers alike. (For example, Swoopo offers a “Myths & Facts” page on its site. One “myth” it addresses is the assertion that “Swoopo employees bid on auctions to keep them going.” Swoops “has a strict company policy prohibiting employees, and their immediate family members, from bidding on all Swoopo auctions,” it states.)

To distinguish itself from sites like Swoopo, BigDeal lets users who’ve lost auctions to use their unrefundable bid dollars in BigDeal’s virtual “loyalty” store, where they can apply them toward buying items like $200 necklaces. (Put another way, users can recover their bid dollars by spending even more money.)Users who get outbid for an item on BigDeal can also apply their bid money toward a “buy item now” option, paying the same price for the product that they would at, say, Amazon.

“If you’re going to buy an iPod, why not try to win it at a discount of up to 75 percent off first,” says BigDeal’s CEO, Nicolas Darveau-Garneau. “If you win it, great, but if you don’t, then you pay the normal retail price.”

Of course, the model assumes that a shopper has 25 minutes to an hour to try and get a deal, which Forrester Research analyst Sucharita Mulpuru believes to be a severely limiting factor in terms of user growth. “Most people don’t want to sit around and make 50 bids to buy an item.  That’s why most of what sells on eBay now is fixed price,” she says.

In fact, the biggest gamble seems to be on how broadly appealing sites like BigDeal can become. BigDeal, which launched 15 months ago and runs roughly 300 auctions of mostly electronic goods each day, has more than half a million registered users, says Darveau-Garneau. He declines to ballpark how many repeat users the site has, but he says it has already established a “very loyal customer base,” and that “we get a lot of good referrals” through it.

In the meantime, BigDeal, whose margins are “about the same as they’d be on Amazon,” isn’t yet profitable partly because “some auctions we make some money and some, we lose,” says says Darveau-Garneau. Still, it has big ambitions to become the “Zynga of e-commerce,” in part by broadening its offerings to include housewares and luxury items like fine jewelry, as well as by layering in a number of other new “games” into its paid-auction model.

It’s a perfectly logical roadmap. VCs are banking on the auction sites’ abilities to establish a portfolio of new ways for people to shop beyond price comparison. The question is whether enough people will find them interesting, for long enough.

Forrester’s Mulpuru doesn’t think they will. “These [sites] are likely fads — nothing significant,” she says. “They’ve been around for awhile and haven’t really captured the sort of traction that Gilt and Groupon have. They’re not even that compelling from a value standpoint.”