Certified Pre-Owned Cars Positively Impact Market

Using the word "lemon" to refer to something that is of low quality traces back to early 20th-century England. Using the word to talk about a defective car was first done by Volkswagen (VW). In a 1960s print advertisement, they told the story of a VW that missed the boat because of a small blemish on the hood. With "3,389 men" at the factory, no detail is unchecked, leading to cars that "last longer and require less maintenance" than others. It ends with the line, "We pluck the lemons; you get the plums." 

While lemons still exist, a relatively new offering—certified pre-owned programs (CPOs)—is making the used car market more efficient and easier for consumers to navigate.

Carlson School Assistant Professor Natalie (Ximin) Huang and three other co-authors explored these market changes in their recent paper "Lemons, Trade-Ins, and Certified Pre-Owned Programs" published in Manufacturing and Service Operations Management.

Their research found that CPO programs play a big role in offering buyers more information about a used car and thus:

• mitigate the lemons problem, resulting in a higher overall market efficiency;
• offer market incentives to motivate used car sellers to also sell their high-quality cars; and 
• increase the total consumer surplus in the market.

“Although CPO programs cannot directly remove lemons from the market, they offer better options for customers to buy even used cars with more protection and confidence,” Huang says. “In the meanwhile, more importantly, these programs help alter the behavior of used product sellers and mitigate the negative impacts of the lemons problem on the auto-market.”

With CPOs, there are different types of used cars to meet the needs of customers that look for either higher-quality or lower-cost options. By offering more choices for customers in used car sales, dealers can generate higher revenue, which allows them to offer higher trade-in discounts to used car sellers. 

This higher trade-in discount allows for more high-quality products to be traded in, which leads to more used products being sold in the secondary market. In turn, these result in a more efficient automobile market, and more new products are being purchased. Research also shows that these two effects are strengthened as the CPO program size increases.

“Firms can proactively manage their CPO programs by appropriately setting trade-in discounts and managing price discrimination between CPO and non-CPO products,” Huang says. “CPO program qualification criteria can be used to alter CPO program size and, hence, the level of market efficiency improvement induced by these choices.”

CPO programs are a win-win.

“[They] give consumers more options,” Huang says. “[By choosing] to go the CPO route, [consumers] feel fairly confident that they are getting a solid automobile.”