Additional competitive forces feed the escalation process. Consider a $1 auction situation. Bidding starts out fast and furious until it reaches $12 — $16. Everyone, except the two highest bidders drops out of the auction.
One bidder bids $16 and the other bids $17. The $16 bidder must either bid $18 or suffer a loss of $16. The uncertain option of bidding seems more attractive than current state of loss, he bids $18.
This irrational bidding continues until the bids are $19 and $20. The auction escalates but both parties lose. Any party quitting bellow the amount would still suffer a loss.
Bidders become indifferent between winning the auctions by overpaying thus losing the auction and suffering a loss in competitive position. In practice, escalation was results in technological, legal, financial and public image liabilities.
Escalation can occur in reverse bid auctions where many sellers compete with one another to offer the lowest price to the buyer. These types of auctions are common in the procurement, legal, construction and consulting industries.
In these situations, bids progressively decline in estimate cost to buyer. Bidders fail to consider the perspective of the other party and continue to bid to justify their initial strategy. The auction ultimately leads to dramatic levels of financial loss. The two parties forget their original objective of earning money and switch to the objective of beating the other party. Desire to win becomes the ultimate goal.
Successful decision makers must learn to identify trap and never make even a very small bid. One strategy to identify the trap is to try considering the decision from the perspective of the other decision maker. With this knowledge, you can accurately predict what will occur and stay out of the auction. You can also develop strategies that discourage escalating behaviour by your competitors. For instance: collude against the auctioneer and divide the profit among the group (i.e. communicate).
Bazerman, M.H. and Moore, D.A., 1994. Judgment in managerial decision making (p. 226). New York: Wiley.