The Lemons Market Dilemma

A purchase transaction always relies on some sort of trust between the seller and the buyer.

Why are customers willing to pay a premium price for a new product and significantly less for an old one? According to Akerlof’s theory, it is because of certainty. In a transactional relationship, it always is about risk reduction. When buying a new product, the probability that the product is damaged is very low. When purchasing a used product, the risk of it being damaged in some way is very high. The more complicated the product and the less we understand it e.g. cars, phones, the less we are willing to pay for it.

The Economist George A. Akerlof uses the automotive market to describe this phenomenon. Akerlof describes how ‘Lemons drag the price of good quality cars down. Lemons are bad-quality cars that stand against good-quality cars, which is a great simplification of reality for this model.

Only the salespeople know the product they are selling and its quality. The customer can not differentiate between the Lemon car and the good car. What happens there is described as ‘Information Asymmetry’. The customer can not understand, why one car is 50,000 and the other car is just 20,000 Euros. In theory, the maximum she is willing to pay is 35,000 Euros, the middle between the prices. The customer is not aware of the reason for the price difference. In real life, customers could assume that, because of the vast price difference, there is something fishy about the cheap one, but it could also be, that the 50,000 Euro car salesperson overprices and wants to rip his customers off. So at this point, it gets hard to identify which offer to take, which is a result of the information asymmetry problem.

Economy-wise, this theoretical concept leads the customer to rarely purchase the 50,000 car and purchase the 20,000 car instead. This results in bankruptcy for those who offer good quality cars and the shady business people who sell lemons will spread all over the market.

What can branding change here?

The problem arises based on trust issues from the customer’s perspective. Information asymmetry can be solved by providing the customer with additional proof and easy-to-understand information, that the product is in good condition. The rational customer will take the offer. Customers are not always completely rational and the ‘gut feeling’ always has the upper hand in purchase decisions. Offering guarantees on the product gives the customer a good feeling about purchasing the product.

This is because the company invests something in the customer that only could play out in the future. Thereby the customer gets a good feeling that, in case something happens, the business’s additional investment in a future case like this will take care of everything and maybe beyond.

Creating certainty in the future can be done with multiple signals one of which and possibly most effective is the guarantee. Additional signals are the reputation of a company, the longevity of a company, the costs of the company and so on. Those signals should show the customer, that the business has something to lose if it screws a customer over. This ultimately creates trust because a purchase transaction always relies on some sort of trust between the seller and the buyer.

Show how the product has been used

Communicate to the customer, how the product has been used. One major factor for uncertainty is, that the customer doesn’t know the past of the product. Giving the customer insights into the prior owner of the product and its use, the customer gets a feeling that he knows what has remained unknown otherwise. Besides this, telling this as a story can increase the emotional value of the product tremendously.