How much should the buyer know?

COMMENT
Jeremy Anwyl is president of Edmunds.com Inc. in Santa Monica, Calif.

A debate about information has been bubbling away in the auto industry.

On one side are consumers who like free access to information in order to make decisions more confidently.

On the other side are some people at the auto companies who believe that controlling information creates a competitive advantage.

A few would even suggest that facilitating consumers' access to information undermines the position of dealers and, ultimately, the franchise system.

Giving this debate new relevance is the fact that this year's Nobel Prize for economics was awarded to three professors for work related to just that issue - what economists call asymmetric information (when a seller has more information than a buyer). It takes on special importance at a time when the industry is forced to take a hard look at costs.

Here's why: One of this year's laureates is George Akerlof, now a professor at the University of California at Berkeley.

In 1970 he published a paper titled "The Market for Lemons" that dealt with the information involved in a used-car transaction.

For the sake of simplicity, let's assume that otherwise identical used cars consist of two types: Cars in good condition and cars in poor condition (lemons). Let's further assume that used-car buyers would be happy to pay $10,000 for a car in good condition and $5,000 for a lemon.

'Adverse selection'

Sellers, on the other hand, may want $8,000 for their good-condition car and $4,000 for a lemon. If buyers had the information to tell the two types of cars apart, they could strike fair bargains with the sellers, and everyone would be happy.

But if buyers cannot tell the difference, as is often the case, there is only one market for used cars. In this example, buyers will be willing to pay only the average price of a good car and a lemon (or $7,500). That is less than the sellers of the good cars require, and they are taken off the market, leaving only the bad cars.

That phenomenon of bad quality pushing good quality from a market as a result of an information gap is known as adverse selection.

Those principles should interest more than economists. For example, Akerlof's insights go a long way to explain why new cars depreciate so precipitously from the moment they are sold (often by 20 percent). It is often impossible for buyers to tell the good from the bad.

The excessive depreciation hurts not only new-car buyers but also manufacturers that lease vehicles and end up being forced to prop up residual values expensively.

Costs are high, but hidden

The uneven supply of information adds costs throughout our industry: At used-vehicle auctions, where vehicle history and build data are not readily available; on the dealers' showroom floors, where lack of information or conflicting information confuses consumers and slows down the sales process; at the factory, etc.

In many cases, the costs are insidious. They can't be found on a balance sheet, but every year, the impact amounts to hundreds of millions of dollars.

As in many things, the debate about access to information has an undercurrent. Underneath the arguments about competitive advantage are the reflexive fears about losing power and control.

Taking the arguments at face value, they only allow information hoarders the advantage on a transaction-by-transaction basis. The arguments ignore the systemic costs such hoarding introduces, and those costs are huge.

Let's face facts: The reality is that restricted access to information adds costs and complexity in an industry that is struggling to reduce both. And it shouldn't have taken Nobel Prize-winning economists to point that out.

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