Scientific American Mind has a cool article, that Mindhacks.com pointed me to, about research on eBay, by Prof. Dr. Axel Ockenfels from the University of Cologne. The paper is focused on fraud in eBay, specifically causes and solutions. However, I think some of the findings help explain some of the angst experienced by car buyers.
One of the essential findings in Ockenfels’s Equity, Reciprocity and Competition (ERC) theory is that, in addition to other economic motivations, people are also motivated by fairness. As Scientific American put it, “people not only try to maximize their gains but also watch to see that they get roughly the same share as others: they are happy to get one piece of cake as long as the next person does not get two pieces.”
This gives good insights into the consumer psyche while buying a car; in addition to being able to afford a car, the consumer is also concerned about getting an equitable deal. Consumers are faced with a moral hazard situation because the dealer knows more than the consumer, the public, therefore, has a difficult time evaluating what to pay. In real estate an agent can pull up “comps” to show what others paid for similar houses. Comparable services exist with cars, such as KBB, but they do not provide the same level of granularity. Interestingly, this same study helps to explain some of the success of eBay and Carmax in car sales.
According to SciAm, “People will forgive a biased outcome if it comes about by chance rather than through a deliberate act.” Think eBay. People are okay paying more for a car than the market might dictate because the final price was decided by the auction process, although they might feel buyer’s remorse. With Carmax, every consumer gets the same deal because of no haggle pricing. While it may have been possible to pay less for a comparable car at another dealership, it would not have been possible to pay less at Carmax. In both cases, people may pay more while feeling good about the situation because the system brought out that outcome, they were not singled out.
Outside of poor treatment, consumers are hesitant buying cars because they do not know how they are being treated relative to their peers. Dealers that either treat everyone the same (no haggle) or let outside market mechanisms take care of pricing (eBay) are likely to have happier customers.