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Used goods, not used bads: Profitable secondary market sales for a durable goods channel

Abstract

The existing literature on channel coordination typically models markets where used goods are not sold, or are sold outside the standard channel. However, retailers routinely sell used goods for a profit in markets like textbooks. Further, such markets are characterized by a renewable consumer population over time, rather than the static consumer population often assumed in prior literature. We show that accounting for these market characteristics alters the optimal contract form as compared to the contracts derived in prior research. In particular, when new goods are sold in both the first and second periods of our model, the optimal contract differs from those in prior literature in that it can exhibit a negative fixed fee in the second period and requires contracting over the resale price in the second period. The model shows that the manufacturer makes higher profits from allowing used-good sales alongside new-good sales than from shutting down the retailer-profitable secondary market, and that unit sales expand with a profitable secondary market over those achievable without a secondary market. Furthermore, in contrast to previous investigations of durable goods markets that ignore the possibility of a retailer-profitable secondary market, we show conditions under which the manufacturer would optimally choose to sell no new goods in the second period, ceding the market entirely to the used-goods retailer. This research thus expands our knowledge of how durable goods markets work by incorporating the profitable operation of a retailer-run resale market.

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Notes

  1. 1.

    This information comes from personal interviews with textbook managers from college bookstores.

  2. 2.

    In the textbook industry, for example, the periods are easily defined by academic term.

  3. 3.

    Previous literature (e.g. Desai et al. 2004) assumes a perfectly competitive secondary market in which consumers trade goods without the retailer. In such models, neither consumers nor the manufacturer profits from the trading of used goods. However, for markets like textbooks, the retailer will profitably sell both new and used goods, and we reflect this in our model.

  4. 4.

    The text for this course was newly revised and therefore no used copies were available (as in our period 1). Interestingly, in other courses these students were taking concurrently, where used copies of required books were available (as in our period 2, described below in the text), students failed to buy 40% of their required books on average. Clearly, a non-buyer segment exists in both periods.

  5. 5.

    In this model it is assumed that the firms and the consumers have the same discount rate which is normalized to one without loss of generality. Analyzing the equilibrium outcome when consumers and firms have different discount rates is reserved for future research.

  6. 6.

    While the emergence of the internet has decreased search costs, online dealers only represented 13.2% of total U.S. used book sales in 2003 (Siegel and Siegel 2004). The sentiments of two University of British Columbia students represent why consumer-to-consumer trading hasn’t made a greater impact: “I’ve tried the bulletin board thing and ...the UBC Bookstore is a lot more convenient and I’m willing to pay the extra cost for that.” “I wanted to get my books quickly, as classes were starting, and I didn’t know anywhere else to go” (McRoberts 2004).

  7. 7.

    As shown by Conlisk et al. (1984), examining a renewable population of consumers in period 2 obviates the need to deal with the well-known Coase conjecture (Tirole 2001), which shows that forward-looking consumers will rationally wait until price equals the firm’s marginal cost of production unless the monopolist manufacturer can commit to a price. In a market like textbooks, the Coase problem does not exist, because (for example) the consumers who bought a marketing management textbook for fall semester are a different population from those taking the course in the spring semester.

  8. 8.

    We assume that when the new good is used and retained, its value is the same as a used good that is retained. For example, in the textbook market, a new book has greater value than a used one for various reasons such as having no highlighting or notes written in it and having its spine and cover in perfect condition. However, once the book is used by the owner, it now has the owner’s notes or highlighting in it and the cover becomes frayed. Now, it is in the same condition as the book that is purchased used. We show in the Technical Appendix that allowing for a used-used good to offer lower value to consumers than a used-new good does not have a qualitative impact on the results in this paper.

  9. 9.

    To see that there cannot be a segment of first-period consumers who delay purchase until the second period if there are consumers who sell back their good as used, note that a consumer can gain positive utility from waiting and buying a used good in the second period only if \( \alpha \phi _{1} \geqslant p_{{2u}} \geqslant c_{u} \geqslant \alpha \phi _{{1s}} \). However, if there are consumers who sell back their good as used, then the consumer located at 1s buys a good in the first period implying that all consumers with α 1 ≥ α 1s will prefer to buy new in the first period rather than wait to buy used (as evident by simple comparison of utilities). Therefore, if some consumers sell their book back to the retailer, there will not be any consumer who gets greater utility from delaying purchase than buying in the first period.

  10. 10.

    The critical values of c are defined as \( c^{*} {\left( {\gamma ,\alpha ,\theta } \right)} \equiv \frac{{\gamma {\left( {1 + \alpha } \right)}{\left( {2\alpha - \alpha \theta + \theta - \theta ^{2} } \right)}}} {{2\alpha + \theta }} \) and \( c^{{**}} {\left( {\gamma ,\alpha ,\theta } \right)} \equiv 1 + \alpha - \gamma + \frac{\alpha } {{\alpha + \theta }} \).

  11. 11.

    For \( c > 1 + \gamma {\left( {\alpha + \theta } \right)} \), which is greater than c**(γ, α, θ), the marginal cost of production prohibits the profitable selling of the good. In this case, the firm abstains from operating a market of any kind. We restrict our attention to values of c low enough so that production is in fact profitable.

  12. 12.

    Note that both c*(γ, α, θ) and c**(γ, α, θ) are decreasing in θ (recalling that α < θ), and increasing in α. Then intuitively, as new and used goods become closer substitutes (i.e., as θ increases in value), this focusing of production in period 1 alone becomes more attractive (so that the c threshold drops). For new-good sales in the second period nevertheless to be positive, the marginal production cost of new goods must be low enough to compete with used goods in period 2. In contrast, a higher α value means that the period-2 value of the good to a period-1 buyer increases. This means that the retailer has to offer a higher buyback price (c u ) to induce period-1 buyers to supply units to the used-good market, which makes new-good production in period 2 relatively more attractive, even at higher marginal costs. Also notice that c*(γ, α, θ) increases with γ. The increase in consumer gross valuations and market size associated with γ makes it such that serving the higher valuation consumers with new goods is attractive to the firm, even at a higher marginal cost of production. Conversely, c**(γ, α, θ) decreases with γ because the greater market size increases the demand for used goods and thus creates a greater incentive to buy back all units sold as new in the initial period.

  13. 13.

    It is important to note that such a contract is not per se illegal (Felsenthal 1997). In the State Oil Company v. Khan case of 1997, the Supreme Court ruled that maximum resale price restraints are permitted (Blair and Lafontaine 1999). Resale price maintenance is acceptable if it is unilaterally applied to all downstream partners and if it is not anti-competitive (Coughlan et al. 2006; Nagle and Holden 2002).

  14. 14.

    Proof of this statement is in the Technical Appendix.

  15. 15.

    The fixed fee is presented in its entirety in the Technical Appendix.

  16. 16.

    This practice was discussed in personal interviews with textbook managers from college bookstores.

  17. 17.

    One may argue that the commitment by the manufacturer is legally binding, but that the retailer and manufacturer may choose to renegotiate after the first period if there is the potential to increase the profits of each. However, we know from existing literature on repeated games that the future value of continuing a relationship can prevent opportunistic behavior (Friedman 1971; Radner 1981). Potential gains from renegotiating and ignoring first-period consumer expectations can be eliminated by the loss in profit due to re-formed second-period consumer expectations. We show this in the Technical Appendix.

  18. 18.

    We thank a reviewer for suggesting this avenue of analysis to us.

  19. 19.

    The monopoly producer assumption is also used by Padmanabhan and Png (1997) in their model of returns product returns in the book market, reflecting the inherent differentiation among all books.

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Acknowledgements

The authors thank Fabio Caldieraro, Gregory Carpenter, Preyas Desai, Benjamin Handel, Karsten Hansen, Oded Koenigsberg, Canan Savaskan, David Soberman, Miguel Villas-Boas, Rajiv Lal and an anonymous reviewer for helpful comments on an earlier draft.

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Correspondence to Jeffrey D. Shulman.

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Technical Appendix

Used goods, not used bads: Profitable secondary market sales for durable goods channel QMEC 124R (PDF 239 kb)

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Shulman, J.D., Coughlan, A.T. Used goods, not used bads: Profitable secondary market sales for a durable goods channel. Quant Market Econ 5, 191–210 (2007). https://doi.org/10.1007/s11129-006-9017-x

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Keywords

  • Channels of distribution
  • Game theory
  • Durable goods
  • Used-goods markets
  • Channel coordination

JEL Classification

  • M31