European Journal of Operational Research 154 (2004) 251–270

www.elsevier.com/locate/dsw

O.R. Applications

Pricing combinatorial auctions

a,* b,1 c,2
Mu Xia , Gary J. Koehler , Andrew B. Whinston
a
Department of Business Administration, College of Commerce and Business Administration, University of Illinois at Urbana-Champaign,
Champaign, IL 61820, USA
b
Department of Decision and Information Sciences, Warrington College of Business Administration, 351 STZ,
P.O. Box 117169, University of Florida, Gainesville, FL 32611, USA
c
Center for Research in Electronic Commerce, Department of Management Science and Information Systems,
University of Texas at Austin, Austin, TX 78712, USA
Received 9 October 2001; accepted 5 September 2002

Abstract

Single-item auctions have many desirable properties. Mechanisms exist to ensure optimality, incentive compatibility
and market-clearing prices. When multiple items are offered through individual auctions, a bidder wanting a bundle of
items faces an exposure problem if the bidder places a high value on a combination of goods but a low value on strict
subsets of the desired collection. To remedy this, combinatorial auctions permit bids on bundles of goods. However,
combinatorial auctions are hard to optimize and may not have incentive compatible mechanisms or market-clearing
individual item prices. Several papers give approaches to provide incentive compatibility and imputed, individual prices.
We find the relationships between these approaches and analyze their advantages and disadvantages.

2002 Elsevier B.V. All rights reserved.

Keywords: Combinatorial auction; Bidding; Pricing; Incentive compatibility

1. Introduction to combinatorial auctions single buyer, in the form of a reverse auction. 3

Most auctions, both online or offline, are used
to trade individual items, one at a time. Either
there are multiple buyers competing for one unit of
a good from a seller, or there are multiple sellers
competing for the right to sell a unit of good to a
*
Corresponding author. Tel.: +217-333-2878; fax: +217-
244-7969.
E-mail addresses: mxia@uiuc.edu (M. Xia), koeh-
ler@ufl.edu (G.J. Koehler), abw@uts.cc.utexas.edu (A.B.
Whinston).
1
Tel.: +352-846-2090; fax: +352-392-5438.
2
Tel.: +512-471-8879; fax: +512-471-0587.
Either way, there is only one good involved in the
auction and on one side of the market there is only
one trader. The buyer with the highest bid or the
seller with the lowest bid gets to buy or sell the
good. However, there are circumstances where it is
not efficient to hold only single-item auctions. One
such scenario is when there exist complementari-
ties between different goods. When positive
3
Reverse auctions are often used in government procure-
ment, in which a government agency specifies exactly what it
wants, and invites companies to bid for the right to do business.
Usually, whoever can meet the specification with the lowest
price gets the contract.

0377-2217/$ - see front matter
2002 Elsevier B.V. All rights reserved.
doi:10.1016/S0377-2217(02)00678-1
252 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270
complementarities exist, two goods are worth
more to a bidder if she acquires both than the sum
of the individual value of each to her alone. Such a
bidder desires the complete bundle of goods. If she
bids on and acquires components individually,
rather than as a bundle or combination of goods,
she faces a possible exposure (Rothkopf et al.,
1998). The exposure problem can result when a
bidder places a high value on a combination of
goods but a low value on strict subsets of the de-
sired collection. She may pay more for a subset of
goods in individual auctions than they are worth
to her in an unsuccessful attempt to obtain her
desired bundle.
One way researchers have proposed to solve the
exposure problem is to allow combinatorial bid-
ding (Rothkopf et al., 1998). In a market where
heterogeneous goods are to be traded, each bidder
can specify a combination of goods she wants to
acquire and a price she would pay for the combi-
nation. The market tries to allocate the set of
goods so as to maximize the total revenue of the
auction, which is in line with the overall social
welfare.
However, there are many challenges associated
with combinatorial auctions. The first challenge is
solving the winner determination problem (WDP).
It is well known that the problem can be formu-
lated as a multi-dimensional knapsack problem
(MDKP). Although this can be a difficult problem,
it can be solved up to moderate sizes using a va-
riety of different approaches such as optimization,
intelligent search and heuristics. Although it is
computationally challenging when the size be-
comes large, it is not hard to conceptually under-
stand.
When the objective of the WDP, the profit for
the seller, is maximized, the allocation is also effi-
cient, as the goods are allocated to bidders that
value them most. 4 However, this is true only when
the biddersÕ bids reveal their true valuation. Thus,
the overall efficiency is dependent on the biddersÕ
reported valuation. If any bid does not reflect a
4
However, in general it is not always true that a revenue
maximizing allocation is efficient. They are often competing
objectives.
bidderÕs true valuation, the resulting revenue may
not be the best the seller could expect. A bidder
can potentially better her utility by misrepresent-
ing her true valuation on a bundle. When this
happens, the optimization result of the WDP is no
longer overall efficient. Therefore, one has to con-
sider how to ensure the truthfulness of all bidders,
in addition to solving the WDP to optimality.
Mechanisms that ensure this are termed incentive
compatible.
Thus, a second objective of auction mechanisms
is to ensure incentive compatibility. An effective
way to achieve incentive compatibility is to adjust
winning bidderÕs final payoffs so they would not
gain any utility by misrepresenting their true val-
uation. In other words, bidding truthfully becomes
their dominant strategy.
Finally, after the completion of an auction,
determining prices for individual goods is also
valuable because: (1) they help explain the auction
result––why a certain bid lost and another won;
and (2) they can serve as a price guide for future
auctions. 5 Ideally, these individual prices should
satisfy a market-clearing condition. First, the sum
of all prices for the goods in a bundle of a winning
bid should be greater than or equal to the winning
bundle price (i.e., the initial bid price before any
incentive compatible adjustments). Likewise, the
sum of all prices for goods in a bundle of a losing
bid should be less than or equal to the bid price.
Hence, the ideal auction mechanism for com-
binatorial auctions provides the following three
features:
• An efficient winner determination mechanism.
• Incentive compatible bid pricing mechanism.
• A way to determine imputed prices for goods.
When all the goods are divisible, the WDP is a
linear programming problem. It is known that
bundle prices computed from the dual model of
the LP are asymptotically incentive compatible
5
However, as an anonymous reviewer points out, since
allocations are based on bundle bids, prices for individual items
cannot accurately reflect the conditions that make one bid win
and another lose.
 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270 253

(Fan et al., 2000). The value of LP dual variables WDP1

also gives individual prices. So all three criteria are m 1
n 2X
X
easily (asymptotically) satisfied by the WDP. Z ¼ max pij xij
However, the indivisible case is not so accom- i¼1 j¼1
modating. When goods are indivisible, the well-
X
s:t: wj xij 6 1 ð1Þ
known duality gap of integer programming (IP) i;j
assures us that a solution and corresponding dual X
xij 6 1 j ¼ 1; . . . ; 2m  1 ð2Þ
prices satisfying all three desired characteristics i
exist only in special cases, one of which is when
xij ¼ 0; 1 i ¼ 1; . . . ; n and
the integer solution is also a solution to the linear
m
programming relaxation achieved by removing the j ¼ 1; . . . ; 2  1
integrality constraint. Moore et al. (1972) proposes
xij is a binary variable, indicating whether bundle j
a pricing algorithm for resource allocation in a
is awarded to bidder i. pij is the bid price for
non-convex economy, which can also be applied to
bundle j from bidder i. wj is a vector of size m
combinatorial auctions. This algorithm, however,
where ðwj Þk is one if good k is part of bundle wj
either finds a set of prices with the desired char-
and zero otherwise. These bundles range over all
acteristics or results in an infinite loop. In general,
2m  1 possibilities (with the zero-valued bundle
it is still desirable to specify procedures that at-
being ignored). Constraint (1) is the resource
tempt to achieve some of the three desired features
availability constraint for each good––only one
while perhaps compromising on others.
unit of each item is available for sale. Constraint
This paper will examine the existing approaches
(2) reflects the condition that each bidder gets at
of pricing combinatorial auctions, the relation-
most one bundle.
ships among these approaches, as well as their ties
The second model places no restrictions on how
with traditional auction pricing theory such as
many bundles each bidder can obtain as long as
Generalized Vickrey auctions (GVAs). Our goal is
the availability constraint is satisfied. Thus, we can
to provide a comparison of methods to help re-
regard each bundle as coming from a unique bid-
searchers understand the role of various pricing
der. Therefore, the number of bidders is the same
mechanisms in combinatorial auctions. We start
as the number of bids, n. The model is as follows:
by reviewing each of the three aforementioned
criteria in more detail. WDP2
n
1.1. The winner determination problem
X
Z ¼ max p j xj
j¼1
Arguably, the most important challenge with n
X
combinatorial auction is solving the WDP. Hence, s:t: wj xj 6 1
this aspect has received most attention from re- j¼1
searchers. xj ¼ 0; 1 j ¼ 1; . . . ; n
For simplicity, we assume only one unit of each
good is available in the auction. From the litera- xj is a binary variable that indicates whether
ture, there are two general models for the WDP. bundle j gets traded. pj is the bid price for bundle
The first type (e.g., see Wurman and Wellman, j. wj is a bundle vector of size m formed as de-
1999) limits the number of bundles a winner may scribed above. All bid/bundle submissions are in
win to, at most, one bundle. The second approach the formulation so a particular bidder may have
(e.g., see DeMartini et al., 1999) allows multiple several xj Õs associated with her. Or equivalently,
winning bundles per winner. each bundle can be regarded as coming from a
Let m be the number of unique goods being unique bidder. While the two models have different
traded and n the total number of bidders. The first assumptions, their goals are the same, i.e. to de-
model is as follows: termine which bundles should be selected for trade
254 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270
in order to maximize the social surplus. Further-
more, WDP1 is just a special case of WDP2 be-
cause constraints (1) and (2) can be combined and
the resulting columns re-interpreted as bundles
with m additional dummy goods corresponding
to the original (2) constraints.
WDP1 has an advantage over WDP2 in de-
scribing XOR bids. XOR bids are bids sharing an
‘‘XOR’’ relationship, i.e. a bidder is interested in
getting only one bundle out of a given set. When
such bids are allowed WDP2 has to add a new
constraint (which can be considered as a dummy
good) to represent the XOR relationship among
such bids in the same form of the other item
availability constraints. WDP1 can accommodate
such relationship because each bidder gets only
one bundle in the first place. Moreover, when
complete valuations are present, i.e. every bidder
has a valuation for every possible bundle, WDP1
has an added advantage of ruling out the possi-
bility of any bidder getting her preferred allocation
in more than one bundle (for a lower total price)
and then re-assembles them. WDP2, however,
cannot prevent any bidder from doing this from
the model design perspective.
WDP2 represents the most widely studied sin-
gle-unit (each item is unique and there is only one
unit for sale each), single-sided (one seller and
multiple buyers) case. It is a set packing problem
(SPP), a well-known NP-complete problem (Garey
and Johnson, 1979), which is difficult to solve
when the problem size is large. While researchers
such as Hoffman and Padberg (1993) have devel-
oped various algorithms and techniques to solve
some moderately-sized or special cases of SPPs, in
general there is no guarantee the problem can be
solved to optimality in an acceptable time. If we
relax the single-unit constraint, the WDP problem
becomes the MDKP. Lin (1998) offered an excel-
lent survey article on solving the MDKP.
Much of recent research on solving the WDP has
been carried out by applying artificial intelligence
(AI) techniques such as intelligent search (Sand-
holm, 1999; Sandholm et al., 2001; Fujishima et al.,
1999; Leyton-Brown et al., 2000). These papers test
their algorithms on generated data sets and claim to
have good results when solving single-unit, single-
sided combinatorial auctions. Andersson et al.
(2000) show using a commercial IP solver (CPLEX)
one can also solve the WDP reasonably fast, while
Gonen and Lehmann (2000) apply the well-known
branch-and-bound procedure to solve the WDP as
an IP problem. A natural question is: how do the
AI approaches compare to the optimization ap-
proaches? A recent paper (Xia et al., 2001) dis-
cusses, both theoretically and experimentally, the
differences of the two approaches.
In any case, examining algorithmic approaches
to WDP is not our goal. We are primarily inter-
ested in determining incentive compatible pricing
and market-clearing prices. We focus on WDP
only insofar as it impacts these issues.
1.2. Incentive compatibility
After the WDP is solved, an important issue
is how to price the winning bundles to achieve in-
centive compatibility. Although it is straight
forward to sell the winning bidder her desired
bundle at the bid price, it may leave room for bid-
ders to mask their true valuations and possibly get
the bundle at a lower price. As a result, the opti-
mization allocation may not be efficient overall.
Thus an important issue is how to devise a rule for
pricing the bundles in order to induce each bidder
to state their true valuation. Termed incentive
compatibility, it is the most desirable feature in
mechanism design (Mas-Collel et al., 1995). In
general, as is the case in most auction literature, if
we assume each bidderÕs utility function to be quasi-
linear, we can denote the utility for any agent as:
U ðB; qÞ ¼ lðBÞ  q
where B denotes the bundle, lðBÞ the value of the
bundle and q the price paid by the agent to get
the bundle. To ensure incentive compatibility, the
monetary transfer to each bidder has to be set so
that the expected utility of bidding truthfully is
always greater than or equal to the utility when the
valuation is misrepresented. By adjusting selling
prices for each bundle traded (and even those
not winning), effectively we are creating monetary
transfers between bidders, which can also be con-
sidered as redistribution of the trade surplus. Hence,
we will approach the incentive compatibility issue
by focusing on the final pricing of winning bundles.
 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270
One of the earliest works on auction pricing
(and auctions in general), is the seminal paper by
Vickrey (1961). Vickrey proved that in a sealed-
bid, single-item auction, where each bidder has her
own private valuation, if the highest bidder wins
the good and pays the highest losing price, it is
incentive compatible in that bidding oneÕs true
valuation is a weakly dominant strategy for each
bidder. We denote the highest bid as p1 and the
second highest bid as p2 . Taking the highest losing
bid as the price in effect redistributes part of the
trade surplus, p1  p2 , from the seller to the win-
ner, thus making underbidding (in hope of paying
less for the good if one is a winner) unnecessary.
From the buyerÕs point of view, the winner is
awarded the surplus she brings to the auction,
exactly the difference between her bid and the
highest losing bid.
The Vickrey auction offers great insight into
single-item auctions. It is powerful in that it makes
few assumptions other than private valuation and a
sealed bid––there is no assumption on the distri-
bution of the biddersÕ valuations. Using this mech-
anism, each bidderÕs truthful bidding of their
valuation is a weakly dominant strategy. A mecha-
nism with these characteristics is very desirable from
an economic perspective. Naturally economists
have extended the concept to encompass more
general models.
The Groves–Clarke mechanism, proposed sep-
arately by Clarke (1971) and Groves (1973), is a
generalization of the Vickrey auction to social
choice problems. By considering the auction out-
come, i.e. the allocation of the indivisible re-
sources, as a social choice, a combinatorial auction
is a special case of the social choice problem. When
applied in an auction setting, the Groves–Clarke
mechanism is also called the GVA. The basic idea
of the Vickrey auction carries over––the price
should be set such that oneÕs bid can only impact
oneÕs payoff by affecting the social choice out-
come, but have no effect on the price it pays. The
winning bidder is rewarded with the surplus she
contributes to the trade.
In particular, in the combinatorial setting, if we
adopt WDP2, an incentive compatible price for
winning bundles, using the Groves–Clarke mecha-
nism is straightforward. First WDP2 is solved, then
255
for any winning bundle j, the price is set at:
qj ¼ pj  ðZ  Zj Þ, where Z is the optimal auction
revenue and Zj is the optimal revenue for the
auction without bundle j included. The main chal-
lenge of solving the pricing problem using this ap-
proach is the computational burden––one has to
solve (n þ 1) WDPs optimally to get the price vec-
tor, one for the original WDP, and one for each
bidder. Taking into account the complexity of
solving a WDP, it is thus usually impractical to
implement.
1.3. Imputing individual item prices
Another issue of interest is imputing prices for
individual items from winning bundle prices. First
we define prices that clear the market.
Definition 1. For combinatorial auctions, a set of
item prices is called market clearing or equilibrium
if all the winning bids are greater than or equal to
the total price of the bundle items and all the
losing bids are less than or equal to the total price
of the bundle items.
Individual prices of combinatorial auction items
can provide insights into a combinatorial auction,
which may be useful for understanding the value
of bundles.
The prices for bundles or individual goods,
however, are not readily computed when the WDP
is solved. This is due to the duality gap of IP caused
by the indivisibility of the goods. Equilibrium pri-
ces may not exist (Nemhauser and Wolsey, 1988). In
addition, the two different WDP models may yield
different prices. For WDP1, if there are m unique
goods, there is a price for each of the 2m  1 bundles.
For WDP2, it is unlikely that all 2m  1 bundles
receive bids, thus in order to compute prices for each
bundle, one has to have prices for individual goods.
Therefore, how to best approximate such individual
prices becomes the focus of researchers.
In this paper, we will review some notable ex-
plorations of imputing item prices in combinatorial
auctions and compare advantages and disadvan-
tages of using various approaches. To gain more
insight into the matter, we examine the relation-
ships between these models.
256 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270
The paper is organized as follows. In Section 2 we
focus on the incentive compatibility issue by ex-
amining bundle pricing approaches found in the
literature. In Section 3 we focus on the imputed
prices for individual goods. In both cases we start by
reviewing their approach, and then compare, con-
trast and look for commonalities in these ap-
proaches. Finally, we end with a conclusion.
2. Bundle pricing approaches
Bundle pricing, as its name suggests, is used to
compute a final price for each bundle. Wurman
and Wellman (1999), Bikhchandani and Ostroy
(2001) and Parkes (2001) take this approach. Ba
et al. (2001) compute bundle prices in a public
good combinatorial double auction.
By having a price for each bundle but not each
individual component, one does not have to assume
anything about the complementarity or substitut-
ability among the components in a bundle. How-
ever, as bundles overlap, one does have to have
some additional assumptions beyond the individual
pricing approach. These assumptions range from
auction rules to distribution of valuations. They
include:
• Every bidder must bid on every bundle: Without
this constraint, all bundles may not receive bids.
It would be hard to price a bundle that receives
one bid or no bids at all. However, having to bid
on every one of the 2m  1 bundles could be very
burdensome for a bidder who is interested in
only one or a few bundles, unless some rule is
used to automatically generate consistent bids
on other bundles. Typically, to avoid having to
specify all the valuations one by one, a bidder
can report only valuations for interesting bun-
dles and have a computerized agent (or the auc-
tioneer) fill in valuations for the remaining
bundles according to some rule. 6 For example,
in a combinatorial auction to sell three goods X ,
6
A similar scheme of automatically adjusting bid prices for
other bundles is also proposed by Wurman and Wellman (2000)
in the AkBA mechanism.
Y and Z, if bidder 1 is interested in getting only
bundle ðX ; Y Þ for $10 and it is free to dispose of
unnecessary goods, then the valuation for bun-
dle ðX ; Y ; ZÞ might also be set at $10 and the val-
uations of ðX Þ, ðY Þ and ðZÞ might be set at zero.
• Each bidder gets, at most, one bundle in the re-
sulting allocation: This is an auction rule im-
posed on all bidders. It is aimed to prevent
bidders from underbidding when they value a
set of complementary goods. Without this con-
straint, bidders may submit only single-item
bids even when they value a combination much
more than the sum of all individual component
items, attempting to acquire all the individual
items separately at a lower price and pocket
the value of the complementarity without hav-
ing to pay for it. While the constraint automat-
ically accommodates exclusive-or (XOR) bids, 7
the same feature can be achieved in combinato-
rial auctions by adding a dummy good corre-
sponding to the XOR constraint.
The goals for determining bundle prices for com-
binatorial auctions are:
• Market clearing: Under these prices, the total
surplus is maximized (so the allocation is effi-
cient), and it is a competitive equilibrium in that
not every bidder can be better off selecting an-
other bundle to trade other than what she is as-
signed. Note the definition of market clearing
when imputing individual prices, shown in Def-
inition 1, is different.
• Incentive compatibility: Given the prices, there is
no incentive for any individual bidder to mis-
represent her valuation in order to better her
outcome.
One incentive compatibility research effort on a
model similar to WDP1 was done by Leonard
(1983). The paper investigated incentive compati-
ble prices of the well-studied assignment problem
in operations research. His model is:
7
When bids from the same bidder are XOR bids, the bidder
is only interested in getting at most one bundle out of the set.
 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270 257

m X
m
X Section 2.5, we provide comparisons based on the
VIP ¼ max pij xij review and our results.
i¼1 j¼1
m
In the following, denote the price for bundle j
as qj ; the winning bundle set Bþ ; the losing bundle
X
s:t: xij 6 1 i ¼ 1; . . . ; m
j¼1 set B ; and the bidder set A with winning bidder
m
X set Aþ and losing bidder set A . Let ZðA n iÞ be the
xij 6 1 j ¼ 1; . . . ; m optimal revenue without bidder i.
i¼1

xij ¼ 0; 1 i; j ¼ 1; . . . ; m 2.1. Wurman and Wellman (1999)

The assignment problem is an IP problem that is Wurman and Wellman (1999) (henceforth WW)
totally unimodular, and, hence, can be solved as a discuss the bundle pricing problem based on the
linear programming problem. Its dual is: winner determination model WDP1 as listed ear-
Xm m
X
! lier. We first review the proposed algorithm.
min ui þ vj
i¼1 j¼1 2.1.1. Model and algorithm review
s:t: ui þ vj P pij i; j ¼ 1; . . . ; m The WW bundle pricing algorithm has four
stages.
ui ; vj P 0 i; j ¼ 1; . . . ; m
Due to degeneracy of the primal problem, 1. Solve the WDP. Since there is at most one bun-
however, the shadow prices associated with posi- dle won by each bidder, there are two sets of
tions, i.e. the dual variables vj , are not unique. bidders in the optimal allocation: those who
LeonardÕs paper identifies
Pm a set of shadow prices, win a bundle and those who do not. There are
which maximizes j¼1 vj , that not only clears the also two sets of bundles, those assigned to some
market but also provides incentive compatibility. bidder and those unassigned.
Regard i as the index for individuals and j as the 2. Create a dummy good /i for each losing bidder
index for positions. The shadow price for position j i 2 A . Set each bidderÕs valuation for every
is the difference between the optimal value to all dummy bundle to zero. Let U ¼ f/i ji 2 A g.
individuals of all positions plus another position of Consider the assignment problem, illustrated
type j, VIPþj , and the value of the current positions, in Fig. 1, which matches the bundle set G ¼
VIP : qj ¼ VIPþj  VIP . An individual to which posi- U [ Bþ with A ¼ Aþ [ A . Each bundle in Bþ is
tion j is assigned in the optimal solution, as denoted assigned to the corresponding winning bidder
by i, will not be better off if she misrepresents her in Aþ ; each dummy bundle in U is matched with
values. If the represented value does not change the its corresponding bidder in A . LeonardÕs (1983)
assignments, then the result will remain the same. price determination method discussed earlier
Otherwise, if the assignment result is different, the can be applied to this assignment problem.
individual can only be worse off. LeonardÕs result is
regarded as either a special case (in Bikhchandani
et al., 2001) or a basis (in Wurman and Wellman,
1999) in the bundle pricing approach.
Although the above goals and assumptions are
the most common in the bundle pricing approach,
each of the following models differs slightly from
the others. Next we study each in more detail. In
Sections 2.1–2.4, we first review these approaches
in a unified framework, followed by discussions
and, in some cases, new results that help to elu-
cidate the relationship between approaches. In Fig. 1. The pseudo-assignment problem in WW.
258 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270

3. The following two problems are solved: they are not incentive compatible. In step 2,
Q is LeonardÕs incentive compatible price for
LPmin
X the pseudo-assignment problem. But because this
Q ¼ argmin qg pseudo-assignment problem comprises dummy
fqg jg2Bþ g g2G bundles for the losing bidders, even if we take Q as
s:t: si þ qg P pi;g 8i 2 A and g 2 G the price for winning bundles, once the losing
si ; qg P 0 8i 2 A and g 2 G bundles are added back to the problem, the prices,
X X although still market clearing because of step 3, are
si þ qg ¼ Z no longer incentive compatible. In other words, the
i2A g2G
Leonard approachÕs incentive compatibility result
and does not carry over to this case, due to the trans-
formation of step 2.
LPmax After the WW procedure, every bundle, winning
X
Q ¼ argmin qg or losing, is assigned a price. But are these prices
fqg jg2Bþ g g2G equally informative? Probably not, as the prices for
s:t: si þ qg P pi;g 8i 2 A and g 2 G winning bundles are the result of the dual of an
assignment problem, but those for the losing bun-
si ; qg P 0 8i 2 A and g 2 G
X X dles only need to satisfy one constraint (in step 4).
si þ qg ¼ Z In fact, the prices for losing bundles can be infi-
i2A g2G nitely large so long as they prevent all bidders from
buying them. As a result, prices for the losing
Z is the optimal objective value of WDP1; pi;g is bundles are less indicative of the true value of the
iÕs bid on bundle g 2 G; qg is the price for bundle bundles than those for the winning ones. Thus,
g and si is bidder iÕs maximum surplus. Both Q without the information as to which bundles are
and Q are vectors of jBþ j. They are market- won and which ones are not, these prices have little
clearing prices of winning bundles for the guidance value for helping the potential bidders
pseudo-assignment problem. (LPmin ) is a direct valuate different bundles.
application of LeonardÕs (1983) model, while Wurman and Wellman claim the prices for dif-
(LPmax ) gives an upper bound of the market- ferent bundles are anonymous, as opposed to
clearing prices. WW proves that any linear GVA, which is discriminative pricing because it is
combination of the two prices, kQ þ ð1  kÞQ based on the agent that wins the bid. They define
ð0 6 k 6 1Þ, is also market-clearing. anonymity as ‘‘every agent has the opportunity to
4. For each remaining unassigned bundle g, the purchase the same object at the same price’’. They
price pg is calculated by qg ¼ maxi2A ðpi;g  si Þ. give an example in which GVA would lead to dif-
With such a price, no bidder would be better ferent prices for the same bundle for different
off if she chose to buy this bundle, because buyers. This may be an important issue if bidders
8i 2 A; si P pi;g  qg . In other words, given such perceive fairness, defined as ‘‘every agent has the
prices, no bidder, winner or loser, will have any opportunity to purchase the same object at the
incentive to deviate from her allocation deter- same price’’, as a requirement for auctions, such as
mined by the optimal solution of the combinato- in government procurement auctions. 8 However,
rial auction. the notion of anonymous price for a bundle may
have limited meaning in the bundle auction setting.
2.1.2. Discussion Suppose bidder i is the winner of Bundle g, and the
WW prices are market clearing, because the price is pg , then if another bidder j bids the same
prices support the optimal allocation, and nobody price pg , would he/she be able to get the bundle? It
will choose a different bundle to buy given these
prices. From step 2, there are multiple market
clearing prices for the auction problem. However, 8
We thank an anonymous referee for pointing this out.
 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270 259

is not clear, because the whole auction is changed
and needs to be solved again. Very likely the auc-
tion result will also change, which leads to a new
price for the bundle.
2.2. Bikhchandani and Ostroy (2001)
Bikhchandani and Ostroy (2001) (henceforth
BO) discuss the package assignment problem. They
call the bundles ‘‘packages’’, which can be reserved
for a specific bidder instead of everyone. When the
assignment is a ‘‘first-order assignment’’, which is a
special case of the package assignment problem, it
is indeed exactly the WDP1 formulation.
In this model, l denotes both a partition of the set
of goods and an assignment of the components of
the partition to bidders. Let C denote all such
partition-assignment pairs, dl ¼ 1 if the partition-
assignment pair l is selected. (4) dictates that for
bundle j to be assigned to bidder i in the auction,
the pair (i; j) has to belong to a partition-assign-
ment pair l that is selected. (5) reflects the fact that
no more than one partition-assignment pair can be
selected. The formulation is stronger than WDP1
in that (4) and (5) implies (2). This can be shown
by adding (4) for all bundle–bidder pairs:
X X X X
xij 6 dl 6 dl 6 1
i;j ði;jÞ l:ði;jÞ2l l2C

2.2.1. Model and algorithm review But because each allocation will have partition-
To get prices using LP duality, they add auxil- assignment pairs, every solution for WDP1 will
iary variables to the original IP problem. In ad- also be a solution for BOWDP. Hence, the two
dition to all the assumptions of WW, they provide models are equivalent.
a sufficient and necessary condition for the pack- BO prove that under the condition that buyers
ages to have market-clearing and incentive com- are substitutes, the LP relaxation of BOWDP gives
patible prices. This requires valuations to satisfy integer solutions. Moreover, the optimal value of
a ‘‘buyers are substitutes’’ condition. The term, dual variables associated with condition (3), de-
‘‘buyers are substitutes’’, first used by Shapley noted by vi , is the Vickrey discount for each bid-
(1962), means that the marginal product of any der, i.e., vi ¼ ZðAÞ  ZðA n iÞ.
buyer subset is greater than the sum of its indi-
vidual buyerÕs. 2.2.2. Discussion
X For each winning bidder i, assuming she is as-
8S A : ZðAÞ  ZðA n SÞ P ðZðAÞ  ZðA n iÞÞ signed bundle j in the auction, the price she pays
i2S
the auctioneer to get j is exactly
(ZðAÞ denotes the total auction revenue with all qj ¼ pij  vi
buyers, while ZðA n iÞ is the auction revenue
without bidder i.) where pij is iÕs bid for bundle j. For each losing
Based on this assumption, BO construct the bidder i, the payment is zero, as ZðAÞ ¼ ZðA n iÞ.
following model: We can use qj as the price for the winning
bundle j. It is not only market clearing, but also
BOWDP incentive compatible, since it is the Vickrey price.
While the paper does not compute prices for losing
bundles, it can be easily done using the last step of
XX
ZðAÞ ¼ max pij xij
i2A j2B WWÕs procedure.
X Although BO imposes an additional constraint,
s:t: wj xij 6 1 8i 2 A ð3Þ
j2B
the paper does get a very powerful result. It is a
X direct application of the GVA (MacKie-Mason
xij 6 dl 8j 2 B; 8i 2 A ð4Þ and Varian, 1994).
l:ði;jÞ2l
X Another paper by Bikhchandani et al. (2001)
dl 6 1 ð5Þ observes that BO is not the only way to add aux-
l2C iliary variables to WDP1 to get the Vickrey dis-
xij ; dl ¼ 0; 1 8j 2 B and l 2 C count. They propose another model as follows:
260 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270
BOWDP2
ZðAÞ ¼ max
XXX
pij xij
r2P j2r i2A
X dummy bundles are zero, i.e., qð/i0 Þ ¼ 0, 8i0 2 A .
s:t: xrij 6 zr 8i 2 A; 8r 2 P
j2r
X i 2 A. Therefore, 8j 2 Bþ and xij ¼ 1, g0 2 U pij 
xrij 6 zr 8j 2 r; 8r 2 P
i2A
X
zr 6 1
r2P
XX
wj xrij 6 zr 8i 2 A
r2P j2r
xrij P 0 8j 2 r; 8i 2 A
zr P 0 8r 2 P
Here, P is the set of partitions of the goods. For
any partition r 2 P, j 2 r means bundle j is part
of the partition r. Let zr ¼ 1 if partition r is se-
lected, zero otherwise. Set xrij ¼ 1 to mean that r is
selected and bundle j is assigned to bidder i in
partition r. Let vi be the dual variable associated
with (9). Bikhchandani et al. (2001) prove
BOWDP2 has an integral optimal solution. Under
the condition that ‘‘buyers are substitutes’’, the
dual variable for (9), vi ¼ ZðAÞ  ZðA n iÞ, is ex-
actly the Vickrey discount of the bidder i. One can
easily compute prices for winning bundles as be-
fore, by subtracting the Vickrey discount from
the winnerÕs bid.
Since both BO and WW base their pricing pro-
cedure on WDP1, it is worthwhile to compare the
two approaches. First, WW prices are market
clearing but not incentive compatible, while BO
prices are both market clearing and incentive
compatible, given that buyers are substitutes. Sec-
ond, BO prices support the optimal allocation of
the pseudo-assignment problem in step (2) of WW.
This is shown as follows.
Theorem 1. Under the assumption of buyer substi-
tutes, the Vickrey price for the winning bundles also
supports the pseudo-assignment problem’s allocation.
Proof. Let Q denote the sets of prices for winning
bundles, i.e., Q ¼ fqj ; j 2 Bj9i 2 A, s.t. xij ¼ 1g in
the original combinatorial auction problem. Since
Q is the Vickrey price for the original auction
problem, it is also competitive. Thus, 8i s:t: xij ¼ 1,
pij  qj P pij0  qj0 8j0 6¼ j, j0 2 B. In WWÕs pseudo-
assignment problem, the new bundle set G ¼
Bþ [ U. As shown by WW, the prices for the
ð6Þ Since pi/ 0 ¼ 0 8i 2 A, i0 2 A , pig  qg ¼ 0, 8g 2 U,
i
ð7Þ qj ¼ vi P 0 ¼ pig0  qg0 . 
ð8Þ Although the Vickrey price for the winning
bundles from BO supports WWÕs pseudo-assign-
ð9Þ ment problem allocation, it may not be either of
the two prices given in WW, or a linear combi-
nation of the two prices. We can show this through
an example.
Consider the following combinatorial auction
where {X ; Y ; W } is the set of individual goods for
sale and {1,2,3} is the set of bidders. Each bidderÕs
valuation for every bundle is listed in the table. A
best allocation, apparently, is assigning items X
and Y to bidder 1 and item W to bidder 2 with
bidder 3 getting nothing, as highlighted in Table 1.
The auctionÕs optimal revenue is 16.
The Vickrey prices for the two winning bundles
are
qðXY Þ ¼ p1 ðXY Þ  ðZðAÞ  ZðA n 1ÞÞ
¼ 10  ð16  16Þ ¼ 10
qðW Þ ¼ p2 ðW Þ  ðZðAÞ  ZðA n 2ÞÞ
¼ 6  ð16  15Þ ¼ 5
The pseudo-assignment problem of WW, is as-
signing G ¼ fðXY Þ; ðW Þ; /3 g to the three bidders.
Solving ðLPmin Þ and ðLPmax Þ, one can get Q ¼
fqfXY g ; qfW g g ¼ f6; 4g and Q ¼ fqfXY g ; qfW g g ¼ f10;
6g. WW proves that any price that is a linear
combination of Q and Q is also an equilibrium price
that supports the allocation and is competitive.
If we denote the Vickrey price for the original
auction problem as QV , it is apparent that QV 6¼
kQ þ ð1  kÞQ 80 6 k 6 1. That is, the Vickrey
Table 1
A combinatorial auction example
Bidders Items
X Y W XY XW YW XYW
1 6 6 5 10 7 8 12
2 7 3 6 8 9 6 11
3 4 2 4 5 7 9 12
 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270
price, although supporting the allocation, is not a
linear combination of the two WW prices.
2.3. Parkes (2001)
Parkes (2001) (PARK) proposes another bun-
dle pricing scheme as part of an iterative ascending
bundle auction model.
2.3.1. Model and algorithm review
In his approach, he imposes the same set of
assumptions as WW does. However, he argues
that while the GVA gives incentive compatible
prices, it needs complete information of bidder
evaluation on every bundle desired. Yet, it may be
too costly for bidders to evaluate all the bundles.
Moreover, bidders may not be willing to reveal
their full valuation. In such cases, GVA would not
work because of incomplete information.
Parkes proposes a two-stage procedure with it-
erative ascending combinatorial auctions to ap-
proximate the GVA. In the first stage, an iterative
combinatorial auction is held for all bundles. At
the end of this stage, the auction terminates with
an outcome close to the optimal allocation. A part
of the Vickrey discount is calculated. In the second
stage, the rest of the Vickrey discount is computed,
for those winning bidders whose absence from the
auction would cause some other winning bidders
to lose also.
2.3.2. Discussion
Using this approach, bidders do not need to
reveal complete information of their valuation at
the beginning of the auction. This is an attractive
feature as bidders may be either unwilling to do so,
or they may not absolutely certain about their
valuation at the beginning. In the latter case, as the
auction continues, bidders have more information
to help determine the valuation.
While the process does give incentive compatible
prices in some special cases, it is still an approxi-
mation to the original GVA mechanism. The ap-
proximation is perfect only when the bid increment
goes to zero, yet, that in itself can make the iterative
bidding process too long to hold and participate in.
Just as a bidderÕs submitting approximate valua-
tion makes the GVA outcome inefficient, as poin-
261
ted out in the paper, the value of an approximate
incentive compatible outcome is also uncertain.
2.4. Ba et al. (2001)
The three approaches we outlined above all deal
with private-good combinatorial auctions. It is
interesting to consider a public good auction. In
another related paper, Ba et al. (2001) proposes a
market mechanism for knowledge production and
allocation within an organization. The knowledge
goods are traded in bundles; thus, possible com-
plementarities among components can be taken
into account. Since the knowledge components
within a firm must be considered as public goods,
once a product is purchased, it can be freely shared
by all departments within the firm. The combina-
torial auction model is different from WDP1.
The combinatorial auction model is:
MP
n
X
max pj xj
j¼1
s:t: max fwi;j xj g þ min fwi;j xj g 6 0
j¼1;...;n j¼1;...;n
8i ¼ 1; . . . ; m
xj ¼ f0; 1g 8j ¼ 1; . . . ; n
This is a combinatorial double auction, in that
there can be multiple buyers and sellers, and pos-
sibly, hybrid traders that both buy and sell in one
bundle. The model is similar to WDP2, with the
only difference being the goodÕs public nature. The
vector, wj ; represents the content of a bundle: if
wk;j ¼ 1, the kth good is to be bought in bundle j; if
wk;j ¼ 1, the kth good is to be sold in bundle j;
otherwise the value is 0 meaning item k is not part
of the bundle. The constraint ensures that for a
component to be bought, it has to be supplied by
a bundle.
Here, the issue is how to price the knowledge
bundles so that all bids are incentive compatible.
The difficulty lies in both the combinatorial nature
and the free-riding problem brought about by the
public-good nature, since bidders may try to
under-represent their true value on a knowledge
component in the hope of getting it for free.
262 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270

The original formulation MP is a non-linear plication of the Groves–Clarke mechanism

programming problem. To get prices, an additional
assumption has to be made. The paper assumes that
each knowledge component is provided by only one
seller (a unique provider). Under this assumption,
the pricing problem becomes the dual of a network
flow problem. The dual variables correspond to
prices for knowledge bundles. Moreover, they are
incentive compatible. It is shown that it is an ap-
(Groves, 1973 and Clarke, 1971).
2.5. Comparison of the four bundle pricing ap-
proaches
To compare the above four approaches of bun-
dle pricing, we create Table 2 listing their charac-
teristics.

Table 2
Comparison of different bundle pricing approaches
Wurman and Wellman (1999) (WW) Bikhchandani Parkes (2001) Ba et al. (2001) (BA)
et al. (2001) (PARK)
(BO)
Bundle auction Private goods; direct revelation Private goods; Private goods; Public goods; combinatorial
model combinatorial auctions direct revela- iterative as- double auctions
tion combina- cending combi-
torial auctions natorial auc-
XX tions X
Optimization ðWDP1ÞZ ¼ max pij xij Same as Buyers bid on max pj xj
formulation X
i2A j2B WDP1 all bundles it- j2B

s:t: wj xij 6 1 8i 2 A eratively; auc- s:t: max wj xj þ min wj xj 6 08i

j2B j2B
j2B tioneer needs
X
to solve WDP1 xj ¼ 0; 1 8j 2 B
xij 6 1 8j 2 B
i2A for provisional
xij ¼ 0; 1 8i 2 A; 8j 2 B winners

Assumptions Bidder bids on every bundle; at most one Buyer substi- Same as WW Unique provider (UP)
bid is awarded to each bidder tute in addition
to all assump-
tions in WW
Need to solve Yes Yes Yes Yes
the WDP first?
Transformation Constructing pseudo-assignment problem Adding auxil- No transfor- With the UP assumption, the
to get prices by keeping only the winning bundles and iary variables mation. Leave problem is the dual of a net-
adding dummy bundles for the losing to make the burden of opti- work flow problem. However,
bidders; then getting prices for the WDP unimod- mization with prices do not correspond to
assignment problem ular so the LP bidders individual knowledge compo-
relaxation can nents due to the transforma-
be solved to get tion
prices
Prices incentive No Yes In general, no; Yes
compatible? in special cases,
yes
Prices for Yes No, but such No No
losing prices can be
bundles? easily derived
Relationship None An implemen- Approxima- Application of GC
with Groves– tation of the tion of GC;
Clarke Mech- GC under spe- implements
anism (GC) cial assump- GC only in
tions (buyer special cases
substitute)
 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270
2.6. Advantages and disadvantages of the bundle
pricing approach
The advantages of bundle pricing are:
1. There is no assumption on the bidderÕs bundle
evaluations;
2. With a price for every bundle, by comparing
prices, one can gain some insight into the value
of complementarity in different scenarios. For
example, if for bundles X and Y , qðX Þ ¼ 5,
but qðX [ Y Þ ¼ 25, then there is a very strong
complementarity between A and B. However,
if qðX [ Y Þ ¼ 5 instead, then very little comple-
mentarity exists.
The disadvantages of bundle pricing are:
(1) The number of combinations any bidder has
to evaluate is exponential to the number of goods.
For example, when m ¼ 4, one has to bid on 15
bundles. It is extremely burdensome and imprac-
tical to ask anybody to evaluate so many bundles,
especially those she is not interested in at all. A
way to get around the tedious bid evaluation and
expression process is to preset all bids to zero, so
an agent needs to bid only on bundles she is in-
terested in. One way of relieving bidders from the
burden of having to bid on every bundle is to have
a computer program that automatically updates
the bid for all the bundles according to a rule
given by the bidder every time a bid is submitted.
For instance, the rule may be that the bidderÕs
valuation is monotonous on bundles, i.e. bidder iÕs
valuation on a bundle j is not less than that of any
of its subsets j0 j. Therefore, if the current bid
for a superset is less than the bid, then it is set to
the latter. More specifically, when a bidder i bids pi
on bundle j, then 8j0 , s.t. wj0 < wj iÕs utility on j0
must be updated to be at least pij , i.e. pij0
maxðpij0 ; pij Þ.
(2) Not every bundleÕs price is equally infor-
mative: prices for unassigned bundles carry less
information than those for assigned bundles, as
they need only to ensure that bidders do not get
distracted from getting the bundle they are as-
signed. If one is given only price information
without knowing which price is for winning bun-
dles and which is for losing bundles, the value of
263
this information is very limited. Take WW for
example. The losing bundleÕs price can be anything
greater than the pg proposed and all the results still
hold, while for the winning bids, prices are within
a finite closed range.
(3) Since the prices are for bundles, there is little
information on the value of individual goods that
make up a bundle. This is especially true if there is
no single-item bundle in the optimal allocation.
(4) For bundle pricing to be effective, it has to
be strictly enforced that: first, the bidders will pay
the bundle prices dictated by the seller; second,
there is no opportunity for collusion, in which a
group of buyers submit one bid for a set of goods
then divide them up later to improve their pay-
offs.
3. Individual pricing
The bundle pricing approach gives prices only
for bundles. So, if no winning bundle contains
only a single component of interest, bundle pricing
does not provide a way to determine an individual
component price. Because individual component
prices can serve as benchmarks for combinatorial
bids, they are desirable. Next, we review one
proposed approach and another general IP ap-
proach and compare them to find their relation-
ship. In Section 3.1 and the first part of Section
3.2, we review the models and algorithms of the
DeMartini and OÕNeill approaches. In the latter
part of Section 3.2, we compare their relationship.
Section 3.3 discusses the advantages and disad-
vantages of using the individual pricing ap-
proaches.
In the following, let M ¼ f1; . . . ; mg represent
the set of items being auctioned. Here we restrict
bidders to bidding on one bundle and notationally
represent the bidder set as equivalent to the bundle
set. 9 As earlier, we denote this set by A. The vector
corresponding to individual imputed item prices is
denoted as p.
9
Actually, a bidder can place two different bids, and can
possibly win both if the bids do not overlap––we can treat the
bidder as two different bidders, one for each bundle. In that
regard, there is no restriction on how many bids a bidder can
place.
264 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270

3.1. DeMartini et al. (1999) solve (K ¼ U)

max y
DeMartini et al. (1999) proposes a pricing y;p
scheme for all individual goods in a combina- s:t: p0 wj ¼ pj j 2 Aþ
torial auction, by approximating the prices in a
p0 wj þ gj P pj j 2 A
divisible case. Their scheme first solves the
WDP2. p 0 1i P y i 2 M
The paper proposes the following three-step p0 1i ¼ pi i 2 K
process to determine prices. 10 y; p P 0
Step 1: Given pj and the values Aþ , A , and xj
resulting from the solution to WDP2,
find the lowest z that bounds the discrep- Let K fi : pi ¼ y  g and M M n K. If M is
ancy: empty, stop. Otherwise go to step 3 again.

min z We present a simple example to illustrate the

z;p;g
process. The bids are:
s:t: p0 wj ¼ pj j 2 Aþ
0
p wj þ gj P pj j 2 A
1
02 3 1
gj 6 z
ðw1 ; p1 Þ ¼ @4 1 5; 30A;
B6 7 C
z; p; gj P 0
0
If z ¼ 0, go to step 3.
0
02 3 1
Let K be the empty set and J ¼ fjjj 2 A ðw2 ; p2 Þ ¼ @4 1 5; 30A;
B6 7 C
and gj ¼ z g. If J ¼ A , go to step 3. Otherwise go
to step 2. 1
Step 2 : Given pj and the values Aþ , A , and xj re- 1
02 3 1
sulting from the solution to WDP2, and J ,
ðw3 ; p3 Þ ¼ @4 0 5; 30A;
B6 7 C
solve
1
min z 1
02 3 1
z;p;g

s:t: p0 wj ¼ pj j 2 Aþ ðw4 ; p4 Þ ¼ @4 1 5; 39A

B6 7 C

p0 wj þ gj P pj j2J 1
0 
p wj þ gj ¼ pj j2A nJ
gj 6 z Winner determination gives
z; p; gj P 0
2 3
0
If z ¼ 0, go to step 3. Let J J [ fj 2 A n 607
   
J : z ¼ gj g. If J ¼ A , go to step 3. Otherwise go x ¼6
405
7
to step 2 again.
1
Step 3 : Given bj and the values Aþ , A , and xj re-
sulting from the solution to WDP2, and J
from step 1, DeMartini Prices are then determined as fol-
lows.

10
We rewrite some of the original notation using a vector
format. Aþ ¼ f4g; A ¼ f1; 2; 3g and M ¼ f1; 2; 3g
 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270 265

Step 1: 3.2. O’Neill et al. (2001)

Solve:
OÕNeill et al. (2001) discusses pricing for the
min z
z;p;g P 0 more general resource allocation problem with
s:t: p1 þ p2 þ g1 P 30 non-convex objective functions. The main idea is
to associate a cost with each positively valued
p2 þ p3 þ g2 P 30
integer variable. In particular, after the resource
p1 þ p3 þ g3 P 30 allocation problem is solved, add a new equality
p1 þ p2 þ p3 ¼ 39 constraint for each positively valued, optimal
g1 6 z; g2 6 z; g3 6 z integer variable, setting the variable to its opti-
mal value. The new LP problem has the same
pP0
optimal solution as the original IP. Next solve
The solution is: the dual for the new LP. The price is the sum
2 3 2 3 of all the composing items plus the additional
13 4 dual variable corresponding to the integer vari-
  
z ¼ 4; p ¼ 4 13 5 and g ¼ 445 able.
13 4 We apply the approach to combinatorial auc-
so J ¼ A , K ¼ U. tions. It produces prices by the following process.
Step 3: First solve WDP2
Solve: n
X
max p j xj
max y j¼1
y;p P 0
n
s:t: p1 þ p2 P 26
X
s:t: wj xj 6 1
p2 þ p3 P 26 j¼1

p1 þ p3 P 26 xj 2 f0; 1g j ¼ 1; . . . ; n
p1 þ p2 þ p3 ¼ 39
(pj is the bid price for bundle j; wj is a vector
p1 P y; p2 P y; p3 P y
representing the items in bundle j.)
The solution is: Then solve

p 0 1 þ g 0 x
2 3
13 min
 p;g
y ¼ 13 and p ¼ 4 13 5
13 s:t: p0 wj þ gj P pj j ¼ 1; . . . ; n
pP0
Stop.
The DeMartini approach attempts to compute p is the price vector for individual goods.
a set of prices such that (1) for any winning The same example presented in Section 3.1 gives
bundle, the sum of the prices of its comprising
individual items is equal to the bid; (2) for losing
bundles, the discrepancy between the sum of in- min p 0 1 þ g4
p;g
dividual item prices and the bid, if the bid is
s:t: p1 þ p2 þ g1 P 30
greater than the sum, is minimized. The model
in step 1 results in a set of prices with the p2 þ p3 þ g2 P 30
above features. But because the model may have p1 þ p3 þ g3 P 30
multiple solutions, steps 2 and 3 iteratively elim-
p1 þ p2 þ p3 þ g4 P 39
inate multiple solutions and ensure the unique-
ness. pP0
266 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270

and has a solution Proposition 3. When some goods are unallocated in

2 3 the optimal solution, if the DeMartini prices for the
2 3 12
9 6 0 7 unallocated items are zero, then the DeMartini price
 
p ¼4 9 5 and g ¼6
4 0 5
7 is also an O’Neill price.
21
0
Proof. Let us rearrange the indices of items so that
the first set of indices is for items sold in the op-
Some observations on the above two individual
timal solution (denote as A), and the second set for
pricing approaches are presented in a sequence of
unsold items (denote as U). From the DeMartini
theorems as follows.
model, the optimal auction revenue
Proposition 1. O’Neill price is not unique.
X X X
Z ¼ pj ¼ p0L wj ¼ p0L wj
j2Aþ j2Aþ j2Aþ
In the above example, any price that satisfies
p1 þ p2 þ p3 ¼ 39 and g4 ¼ 0 is an OÕNeill price. In the OÕNeill model, we can still set
j 2 Aþ

Proposition 2. When all the goods are sold in the  0
gj ¼
optimal allocation, it is always true that the De- p j  p L w j j 2 K n Aþ
0

Martini price is an O’Neill price.

Then, when j 2 Aþ , p0L wj þ gj ¼ p0L wj ¼ pj and
Proof. When all the goods are sold in the optimal when j 2 K n Aþ , p0L wj þ gj ¼ p0L wj þ pj  p0L wj ¼
allocation, let the DeMartini price be pL and the pj .
optimal revenue be Z  . We have, in the DeMartini Thus ðpL ; g Þ is a solution to the OÕNeill model.
procedure And the corresponding objective value is
0
X X X
pj ¼ p0L wj 8j 2 Aþ p0L 1 þ g x ¼ p0L 1 ¼ pLi þ pLi ¼ pLi ¼ Z 
i2A i2U i2A
Thus
X X X Since Z  is the optimal objective value of the
Z ¼ pj ¼ p0L wj ¼ p0L wj ¼ p0L 1 ð10Þ OÕNeill model, ðpL ; g Þ is an optimal solution to
j2Aþ j2Aþ j2Aþ the OÕNeill model. Therefore, pL is also an OÕNeill
(The last ‘‘ ¼ ’’ is due to the fact that all goods price. 
are sold.)
Conversely, in the OÕNeill procedure, if we set Proposition 4. When some of the goods are not al-
located in the optimal solution, if the DeMartini
j 2 Aþ price for the unallocated items is positive, rearrange

0
gj ¼ the indices of items as before and write the De-
pj  p0L wj j 2 K n Aþ
Martini price as
where K is the set of all goods.
 
pA
Then, when j 2 Aþ , p0L wj þ gj ¼ p0L wj ¼ pj and pL ¼
pU
when j 2 K n Aþ , p0L wj þ gj ¼ p0L wj þ pj  p0L wj ¼
pj . Therefore, ðpL ; g Þ satisfies where pU is the price vector corresponding to the
unallocated items. We claim
p0L wj þ gj P pj 8j 2 K  
pA
pR ¼
and 0

p0L 1 þ g0 x ¼ p0L 1 þ 0 ¼ Z  is an O’Neill price.

so the DeMartini price, pL , is also an OÕNeill Proof. From the DeMartini model, the optimal
price.  revenue
 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270 267

for this unallocated item is 1. Denote this itemÕs

X X X
Z ¼ pj ¼ p0L wj ¼ p0L wj
j2Aþ j2Aþ j2Aþ price as p1 ðp1 > 0Þ. Denote the OÕNeill price for
the rearranged indices as
For the OÕNeill model, if we let  
p1
pR ¼
j 2 Aþ

 0 p2
gj ¼
p j  pR w j j 2 K n A þ
0
(Note p2 is a vector of (m  1).) Because it is
þ an OÕNeill price, there exists g ; such that ðpR ;
then when j 2 A ,
 0  0 g Þ is an optimal solution for the OÕNeill prob-
pA pA lem.
p0R wj þ gj ¼ wj ¼ wj Next we show that there is another feasible so-
0 pU
lution that yields a smaller objective. Denote
(The last equality is due to the fact that unallo- N ¼ fj : w1j ¼ 1g as the set of bids that include the
cated items do not appear in any winning bundle.) unallocated item. jN j ¼ k. Rearrange the indices of
But bids so the bids of N are the first k bids. Partition g
 0
pA as
wj ¼ p0L wj ¼ pj
pU
gN
 
Therefore p0R wj þ gj ¼ pj , 8j 2 Aþ . When j 2 Kn 
gN
Aþ ,
p0R wj þ gj ¼ p0R wj þ pj  p0R wj ¼ pj where gN is the vector consisting of gj Õs corre-

sponding to N and gN the rest of gj Õs. N  A ,
So because the unallocated item cannot be part of a
winning bid. Let
 
pA
pR ¼
0 0 1
p1
is a feasible solution to the OÕNeill model. More- gN ¼ gN þ @ . . . A
over, the corresponding objective value is p1
 0
0 0 0 pA X X 
gN

pR 1 þ g x ¼ pR 1 ¼ 1¼ pLi ¼ p0L wj g ¼
0 i2A j2Aþ

gN
¼ Z
and
Thus,  
  0
pA pR0 ¼
pR ¼ p2
0
is an OÕNeill price.  then ðpR0 ; g Þ is also a feasible solution to the
OÕNeill problem, because when:
Proposition 5. In the O’Neill procedure, the prices  0
0
corresponding to the unallocated items are always þ 0 
j 2 A ; pR0 wj þ gj ¼ wj þ gj
zero. p2
 0
p1
Proof. Suppose there exists an optimal solution to ¼ wj þ gj P pj
p2
the OÕNeill problem in which not all prices for
unallocated items are zero. Then there must exist (The last ‘‘ ¼ ’’ is due to the fact item 1 is unallo-
at least one unallocated item, with a positive price. cated thus not in any winning bundle; the last
Rearrange the indices of the items, so the index ‘‘ P ’’ is due to the feasibility of ðpR ; g Þ.) When
268 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270

0 Since a price is associated with each unique

0

j2 N ; p0R0 wj þ gj ¼ wj þ gj þ p1 good, one can use the price to compute a value
p2
 0 for any bundle even if it had not received any
p1 bids in the last round.
¼ wj þ gj P pj
p2
The disadvantages of individual prices are:
and when

0
0 1. Since a bundleÕs value is the sum of all compo-
j 2 K n ðN [ Aþ Þ; p0R0 wj þ gj ¼ wj þ gj nents, complementarities between components
p2
0 are not accounted for in the individual price
p1

approach;
¼ wj þ gj P pj
p2 2. In general, incentive compatibility cannot be
achieved due to the existing duality gap for IP;
(The last ‘‘ ¼ ’’ is because item 1 does not appear in 3. If there are additional constraints in the bids,
any bundle in j 2 K n ðN [ Aþ Þ.) such as an XOR constraint, they can be mod-
At the same time, the objective value corre- eled as dummy components so that the model
sponding to ðpR0 ; g Þ is is still in the form of WDP2. In addition, indi-
 0  0 vidual pricing approaches will assign a price
0 0
1 þ g0 x ¼ 1 þ g0 x ¼ Z  for each constraint. Thus the prices correspond-
p2 p2
ing to the additional fictional components will
(The first ‘‘ ¼ ’’ is because g differs from g g only become part of the bundle price for those bun-
in losing bids; the last ‘‘ ¼ ’’ is due to the feasibility dles involved in the constraint, e.g. an XOR
of ðpR0 ; g Þ.) Thus, ðpR0 ; g Þ yields a smaller ob- constraint. Therefore, a bundleÕs price may
jective value than ðpR ; g Þ. This conflicts our as- not be the sum of all prices for the real compo-
sumption that ðpR ; g Þ is an optimal solution to the nents.
OÕNeill problem. 

From the above propositions, we can see that
for single-unit single-sided auctions such as
WDP2, the DeMartini price is, in some sense, a
special case of the OÕNeill price.
3.3. Advantages and disadvantages of individual
prices for goods
The advantages of having individual prices for
goods are as follows:
1. The model does not place any restriction on the
number of bundles a bidder can bid on or ac-
quire. Thus a bidder is free to place bids on
two disjoint bundles, and possibly win both, if
there is no complementary existing between
the goods in the two bundles.
2. Individual prices give guidance to bid formation
and evaluation for new entrants and losing bid-
ders. If the assumption of WDP2 is adopted,
some possible bundles do not receive a bid.
4. Summary and future research
In this paper, we reviewed several pricing ap-
proaches for combinatorial auctions with indivis-
ibilities. Prices using a bundle approach all clear
the market, while aiming to achieve incentive
compatibility. Such prices, when historical, help
potential bidders evaluate the bundles before bid-
ding when complementarities between products
are unclear. Yet, because prices for losing bundles
do not give as much information as those for
winning bundles, the value of the prices for bun-
dles without winning bids is greatly reduced.
All of the bundle pricing schemes are either an
application or an extension of the Groves–Clarke
Mechanism. However, in order to achieve incen-
tive compatibility, either more assumptions have
to be made, or only approximations can be at-
tained. The rest of the approaches cannot claim
incentive compatibility at all. Moreover, the as-
sumptions that one has to bid on all possible
 M. Xia et al. / European Journal of Operational Research 154 (2004) 251–270
bundles and that win at most one are too restricted
in a combinatorial auction.
The above disadvantages, along with the fact
that the bundle approach does not reflect the value
of individual components within a bundle, make
the individual component pricing approaches ap-
pealing. Under individual pricing, two approaches
are examined. One (DeMartini et al., 1999) spe-
cifically aimed to provide imputed prices for
combinatorial auctions while the other (OÕNeill
et al., 2001) is a general IP method which one can
apply to the combinatorial pricing problem. Pa-
pers using these approaches usually do not have
any restrictions on how many bundles a bidder can
bid on, and how many she can win. In some special
cases, e.g. the single-item, single-sided case, we
have found that prices from one approach
(DeMartini et al., 1999) are a subset of the other
approach (OÕNeill et al., 2001). Since the OÕNeill
approach almost always gives non-unique prices,
we feel the DeMartini approach is better.
Nonetheless, the individual pricing approaches
have disadvantages also. Among them is the in-
ability to gain insight into item complementarities.
However, due to the potential duality gap of IP,
incentive compatibility cannot always be achieved
in this approach. Moreover, if there are additional
constraints in the model, for example, one that
reflects the exclusive-OR relationship between two
bids, the total price of a bundle will not be the sum
of all individual item prices.
Future research is needed to meet the short-
comings of these pricing approaches. Bundle
pricing approaches could be modified to not only
generate incentive, compatible prices but also
provide estimates or bounds for individual prices.
Furthermore, losing bundle bids could provide
information, perhaps helping to provide tighter
bounds on individual, item prices.
Individual pricing approaches suffer several
drawbacks that should be further investigated.
Conceptually, of course, estimated item prices
from a prior auction may have little predictive
value for future auctions. Factors that diminish or
enhance their predictive value could be investi-
gated. The inability of individual pricing models to
capture complementarities is also a severe restric-
tion. Non-convex programming methods for
269
working with duality gaps might prove useful for
providing estimates and/or bounds on comple-
mentarities.
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