Russ Roberts

Cole on the Market for New Cars

EconTalk Episode with Steve Cole
Hosted by Russ Roberts
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Steve Cole, the Sales Manager at Ourisman Honda of Laurel in Laurel, Maryland talks with EconTalk host Russ Roberts about the strange world of new car pricing. They talk about dealer markup, the role of information and the internet in bringing prices down, why haggling persists, how sales people are compensated, and the gray areas of buyer and seller integrity.

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0:36Intro. Buying a new car, Toyota vs. Honda, decided on Honda Odyssy, went online to find the best price, called, drove to buy car. No haggle price didn't include everything--lots of other charges, pinstriping, mudflaps, destination charge. Stood up to leave, dealer went to talk to manager, and offered reduced price. Didn't like being lied to. Explanation: invoice price, removed $2000, removed the holdback--amount that the manufacturer pays the dealership when they sell a car, 2%--removed another $500. Why? Very competitive market: six Honda dealerships within 90 minutes. Extra $500 seems like taking a loss--how can you stay in business? Inventory: Selling '08 cars this month means that more than likely they'll be replaced with '09 cars. Want to have inventory large enough that someone walking in can find the car he wants and walk away with it. So the $500 is viewed as investment in higher-profit cars.
6:56Offered to throw in the options; but also the destination price; and also offered the trade-in. Dealer had originally offered $1800, though CarMax price had offered $3000. Dealer made phone call to used car division, matched price of $3000. Destination price still stood, though. Frustrated by not knowing whether a better price really could be negotiation. About to spend $25,000 plus on a car but still didn't know if it was a good price. Instead of feeling exhilarated, felt like just went 10 rounds with Mohammed Ali. Why not more dealers who just really have a no-haggle price? A lot of consumers don't do their research, walk in unprepared, don't know a fair value for the car they are trading in. But what about that destination charge? Anonymous interview offer. Was there a little more room there? Maybe $100-$200 more. $365 net, net loss as it was; might have been worth it for allocation of 2009 cars; don't want people to voice negative experiences on the internet. Can't afford the possibility of letting the customer walk out so angry he'll broadcast it. Want good word of mouth.
14:50How long have you been a sales manager? Seven years for Honda world. Average profit was about $900-$1000. Over last 4-5 years, with the Internet and high speeds, profit is now about $500-$600 now. What percentage of customers come in prepared? Recent study by Honda, 80-85% of customers who walk in have done some research on the Internet. That still means 15% who walk in haven't. Right to have a fair profit. Average profit is still only 2-3%, probably around the same percentage as Starbucks. Quality of the research people have done probably varies. Just because you read something on the Internet doesn't make it real--it's just your perception. Used car example: you could believe you got a lower price but it might just be a package deal. Many people walk in and ask for the best price with no trade-in. "Ultimately, unless you are prepared to buy the car without doing that, there's really no benefit." Taking away the opportunity for the dealership to look at the whole picture. On the buyer's side, though, confusing, have to learn two prices. How much time do you spend internally trying to figure out what price to offer? Honda is easy to price out because every Honda is built the same way. Have to look at incentive programs.
22:13As we get closer to 2009, many buyers paid a premium above list to get that car. Swings in demand. Must be eager to get new year's model. At the end of the day, it's the consumer who controls the pricing. Honda Odyssey was a huge success, consumers were willing to pay more to not have to wait. Civic Hybrid: None in stock. Do you have meetings once a month? Easy to estimate that other dealers have similar inventory for Accord sedan vs. Accord coupe. How hot is that car right now. How do you decide how much to come down, when to say no? Sales person is not on salary, pretty strictly commission-based. How do you read the customer? Has the customer test-driven the car, has the salesman done a walk-around, is the customer prepared to do business, is there a possibility of doing business right now, e.g., husband or wife, young kid of 19 who might want parent there? Want to find time when all participants are present. Has the customer given you any indication of his thought process? How many dealerships have you been to? Have to start off MSRP (manufacturer's suggested retail price, sticker price) then.
29:00Looked at same car at a competitor: liked that there are three basic cars, vs. Toyota--more choices, great, but more research. Competitor was simply not more aggressive. What did he do wrong? Probably didn't ask enough qualifying questions. Liked the low key approach, but he never got close to telling what the real price was. Probably misreading. Concerned with persona, ability to sell anything, mouth of the south, vs. being nice, possibility of missing the customer who walks in and is ready to buy. Got to ask up front: are you prepared to do business right now? Job is to invest time. Product is the same everywhere; only thing different is the individual's time to get you over your perception when you walk into the dealership. Truth about trade-in quality. Buyers lie about trade-ins. Judgment calls, intelligent individual who had done research but was frustrated and might walk out and maybe not get a Honda at all. People come in with perceptions, expectations. Salesman's ability to empathize goes a long way. How often do you get involved? About 30-40% of the time, closer, coming to talk to people who say they are not ready to do anything right now, explore possibility if they would change their mind if we would do whatever.
37:23Monitor salespeople? Does it just work itself out in commission differences? About $350 per car, more of a volume matter for sales consultants. Look at whole picture. Poor follow-up could still destroy customer base. People don't want to spend that much money and not have any follow-up. How's the car working out? People sometimes don't want to be bothered. Turnover in car business is probably second worst or worse than the restaurant business. Someone sells you a car today and three months later is no longer here. Find out birthdays is an easy one. Warm fuzzy feeling from people who find out about you. What does a great salesperson make? Somewhere between $20,000-$30,000 a year; best make six figures. Someone who wants to make it a career look into referrals, treating it like a business. Previously small air duct business, started by thinking of it as a transient job. First customer even bought him a bottle of wine every Christmas thereafter, adopted child from Africa. Took about four months to understand the whole process. Pleasing the customer vs. consumers' needing a little push to get them going in the right direction. Saturday meeting, the huddle, lay out the floor plan; General Sales Manager mentioned his name, build a community amongst sales managers. Big desire to be successful. How is your compensation set? 100% commission. Clean up problems as well as doing sales; back end: financing.
47:02Seemed to take a loss. Salesperson didn't take a loss: got a flat, got $100. Could spend 6 hours or 10 minutes and get that. Manager gets .01% of the profit of the store. In Russ's case after taking all those things off, was it a personal investment? Incentive to sell cars every single day. Main responsibility is to the salesman, else his time is for naught. Don't want to have to train a new salesperson. Why didn't salesperson tell the truth over the phone? Can't sell over the phone. Have to get the person in to the office. Got him there as a gray area. Would you have taken the time to come in here otherwise? Got to play both sides of the coin.
52:56Gap between sticker price and haggled price: some customers are better informed. But also some come in and get some knocked off and feel great. Ignorance is bliss. Why are cars different from shirts? Grocery store, no negotiation. Only cars and houses negotiated. Why doesn't competition among dealers just force the price down to the same price? Saturn. Why isn't that more widespread? One answer: Customers get exploited. Second answer: unclear at any one time what the right price is, unclear what the market conditions are, what demand for 2009 cars are. World with more information, difference between buyers and sellers. We remember haggling, taught to want to negotiate cars, good negotiator will save you money. Attempts to have one prices have failed miserably because people will go elsewhere. Conditioned to do that from an early age, but not for milk. CarMax, cultural norm, interesting that it persists. Pride with kids, but also flip side. Self-fulfilling prophecy, whether you buy a car or don't buy a car. Grand Caravan, five sales-people, loyalty, one gone, turnover.
1:03:32Tricky things that buyers do. "I was told this price" from another dealer. People take what they hear and only hear what they want to hear. Taxes, tags. Perceptions. Trade-ins, truthfulness. Customer who says a car had never been in an accident, CarFax, easy to check. Leasing. Trouble figuring out if it's a good deal. No different than buying a car. At the end of the period you have options and can go pick out another car or refinancing it. On a conventional buy, you are not paying your first payment for 45 days, so you have interest at 100 percent principal. What proportion are lease? Close to 50%. Low. Total disclosure now. Money factor vs. APR, could equate to a 20% interest rate. Take your money factor, multiply by 2400.

COMMENTS (40 to date)
Steven McDuffie writes:

Very interesting Prof. Russ, but I wonder if you are still considering or working on a podcast on immigration?

If so, I can suggest Gardner Goldsmith. He is a writer, radio show host and economist who is quite sharp on the subject. I can't guarantee he would be interested, but I suspect he would be. I can provide you with his contact info, if you wish.

Bil Thomas writes:

Interesting discussion on the car purchase process. We take a different route. Our Credit Union has a superb buying service (new or used. We always buy new and then drive it into the ground.). We have been able to purchase cars and trucks over the last 12 years and been more the happy with the prices and in several cases we were able to get exceptional deals, not to mention the amount of time we spent in the entire process. We never go to a dealer unless we want to test drive a car. My level of frustration, lies or mistruths as mentioned in the podcast, and run around has turned me off. We generally will rent one form a rental company and drive it for a weekend. We own Volvo’s, Mazda and even a Chevy Pickup

We research the vehicle/s and determine the price and what we would pay. We provide this info to the Buying Service and the hunt some 300 different dealerships and let us know what is available and what is real bottom line price. We decide and let the Buyer Service rep know what options we will pay and the work out the final deal. All of the paperwork and the car is delivered to our Credit Union where it takes less than 30-45 minutes to sign the required paperwork and had the check over. No up selling, no surprises, we walk in the door knowing what the exact cost, and no wasted time. Every car we have purchases has been completed during lunch while at work.

At a dealership the salesperson has the whole dealership and backing them. Using the buying service we have the credit union that facilitates purchases of hundreds of vehicle behind us when finalizing the paper work with us. We have gone back to dealerships while looking for a new truck and realized why it was 10 years since we had talked with one. Dealership follow-up. Most of the dealership follow-up has been great. Dealers make a large portion of the operating profits from the service side so they generally do work to keep in contact for services and such.

The process is very much a study of economics but also psychology of personal interactions in a none monetary view. Very interesting but I intensely dislike the process, but it is fun to watch.

[http://www.sv-makai.com/]

MC writes:

Russ, I must say that this podcast was not up to the usual standard. Unless you intended it as a slice of life presentation--'dealer under glass'. You uncritically accepted every premise offered by Mr. Cole. Was that your intention? For instance, the insistence by the seller that you must appear at his venue, and pay with your time as well as your money. Just like for bread in the soviet union. Why is that a given? Can't I just purchase a car? Arguably, 'time in the showroom' is a sunk cost for the dealer. Just getting you to engage in logrolling is the first of many small victories for the seller. I understand that many of the ploys of the dealer are ways to segment the market (and thus enable deals for some buyers--a group that may...or may not...include you, Mr. Coles' obsequious flatteries notwithstanding).

Ian writes:

Russ, I want to try to answer your question about why car dealerships don't offer a single price.

To maximize profits, every firm would like to price discriminate (charge according to willingness to pay). For product X, there may be 10 people willing to pay $30 and 70 people willing to pay $20. A firm that is unable, for whatever reason, to determine willingness to pay would have to settle for charging $20 to everyone. But the firm can do far better if it can somehow figure out who is willing to pay more.

One way to do that is to ask each customer what she is willing to pay, although this is unlikely to produce an honest answer.

A more successful method is to force customers, usually by proxy, to reveal their willingness to pay.

This method is used by businesses that alter their prices based on age (barber shops, grocery stores, or movie theaters that give student/senior discounts, for example).

It's also used by Drug stores that send coupon flyers to customers. The customers who are willing to spend the time to clip coupons reveal themselves to be less willing to pay. The rest reveal themselves to be more willing to pay.

Banks (with loan rates), car dealerships, and real estate agents force customers to reveal willingness to pay based on the amount of time spent researching. Customers who are willing to pay more (and who probably have a higher opportunity cost of time) do less research and are consequently offered a higher price. Customers who are willing to pay less (and who probably have a lower opportunity cost of time) do more research and are offered a lower price.

alao writes:

I really enjoyed this podcast. I thought the dealer gave a lot of detail in his answers and seemed quite upfront.

It's interesting to see a behind the scenes look at how incentives work in this business.

John S. writes:

In order to get the deal you got, it sounds like you had to spend a lot of time searching the internet, driving around from one dealership to the next, haggling with salesmen, etc. Given what your time is worth, did you really come out ahead?

Jon writes:

I thoroughly enjoyed the podcast... it's good to get a break from pie-in-the-sky economic intellectuals once in a while.

Unit writes:

Maybe the reason why prices are more uncertain for houses and cars is exactly because they're large expenditures that people make only once in a while.
First, since they are rare purchases, people are not used to the current market. Second, since we are talking about large numbers, what is a 2 or 3 thousand dollars difference? Especially if you're planning on borrowing the money anyways. So a lot of buyers have a wide margin of error on what a reasonable price should be and the sellers try to make use of that uncertainty.

Brad Hutchings writes:

Mr. Russell... (I chucked at this slip, but I notice he corrected himself the next time!)

Forgetting how the haggling situation evolved... You can look at why it is difficult to escape from a game theory perspective. Assume for some car C a distribution of prices paid. Presumably, the distribution would be similar across similar dealerships. So, if you're one of those similar dealerships, and you figure out a flat no-haggle price, you've added a piece of information which consumers can only exploit at other dealerships, since you're not haggling. This changes the distribution of prices paid, but still leaves the uninformed buyers as low hanging fruit for the other dealerships. So wouldn't you effectively lose by being the first mover?

In fact, wouldn't you lose bigger because an informed buyer that might be good on the back end (which is more than just the loan and can include service contracts, extended warranties, custom upgrades, and the like) will start his business elsewhere looking for a better price, and if recognized as someone better on the back end, would be picked off at high up front cost by a dealer still playing the haggle game.

Mr. Cole repeatedly highlighted the turnover issue and the transitional career stage of most of the front line sales people. Given that, how could a dealership that went to a no-haggle model differentiate itself from other dealers? Forgetting luxury and high end dealers, of course. There's a Mercedes Benz dealer in Newport Beach who advertises that his sales staff speaks 50-some-odd languages. No Honda dealer is going to compete with that given the turnover.

On another note... I'd love to see some data on how long, on average, the dealer license plate frame stays on the car. I'll have to count some day as I walk through a parking lot, but I bet it's higher than 40% after 3 years. That has to have something to do with Mr. Cole's willingness to let a car off the lot at zero to small net.

Count me as loving this particular podcast. I will be sending this week's episode to lots of people who I wouldn't regularly point to EconTalk.

August writes:

Your experience has me wondering if lying is now an integral part of the car sales protocol. I was lied to but bought anyway too. Perhaps the lie serves to increase our emotional investment in the buying process- it ceases to be just about buying a car and becomes about righting the perceived wrong. Since we feel wronged, we feel the car dealer should sell us the car cheaper than others would in order to absolve themselves. Clearly, part of their strategy is to keep us there until we actually buy. This may be a calculated risk.

I'd like to see a study on this to see how many people actually leave when they are lied to versus how many people stay.

Mark Wonsil writes:

My brother sold cars for awhile and said that the two things that really altered the selling price was: a.) trade-in, which you covered and b.) extras like extended warranty, rust-proofing, audio upgrades, etc. This really was a podcast that lived up to the tag-line: "Economic Podcasts for Daily Life..."

Martin writes:

I recommend the following approach (which works whether or not you have a tradein). First of all, ignore all information on the internet about "invoice price", "dealer holdback", "destination charge". Ignore bluebook value of your tradein.
Instead, treat the problem as a binary search. (Or like the children's game "guess my number")
Each visit to the dealer provides with at most one bit of information (higher or lower). It doesn't matter how much negotiation or how long you spend sitting there, each visit only provides one bit. If your offer was too high they accept. If your offer was too low they let you leave. (Note, if they refuse an offer before you leave, that is no information. It only counts if they refuse your offer and they see you actually walk off the lot.) Any attempt to extract more than one bit per visit is futile and wastes your time and their time.
You can determine the price to pay with log(N/M) visits, where N is your uncertainty about the true price of the car, and M is how close you want to get to the lowest possible price.
Generally 4 or 5 guesses should be sufficient to get you within $500 of the best price.

Jonas writes:

Martin:

What are the units of N and M?
How does one do a binary search without bracketing the range?
Finally, do you not assume that if you offer and they accept that the game is over? So if you go too high (which you would for a true binary search), you lose early.

I'd recommend a linear search from a known-low starting bid, with the delta no more than your tolerance for overpaying.

Martin writes:

Jonas, good points, let me clarify. Let's say you are hunting for their lowest price, and you figure it just has to be somewhere between $20,000 and $36,000, but you basically have no idea where in that range it should be because you have no idea what your tradein is worth and you don't trust anything on the sticker. So you need to search a range of $16000, and I recommend a binary search. Your first guess should be $28,000 and you want to figure out if their best price is higher or lower than this. (That splits the range in half.)
If you offer $28000, and they let you leave the lot (I mean literally leave the lot, i.e. you are in your old car driving out of the parking lot and they aren't running after you), you have learned that $28000 is too low.
The more difficult case is if they accept $28000. You have now learned that the true price is lower. Here it is delicate because they always take pains to make sure you were dead serious when you made the offer. (For exmaple, you probably had to initial in a special square in black magic marker.) But, don't be intimidated, you still must get up and leave. Just be impeccably polite and say you need more time to think about it. You can continue with your next guess either at neighboring dealer, or by coming back the next day.
I think a binary search is must more efficient than a linear search. A binary search runs in O(log(N/M)), whereas linear would be O(N/M).
N is the size of the range of uncertainty. M is how close you want to get to the dealer's true best price.
N and M are both in dollars (or any currency).
In this example, one possible sequence might be $28000 (accepeted), $24000 (rejected), $26000 (rejected), $27000 (accepted), $26500 (accepted and you buy the car).
Here N is 16000, M is 500. N/M is 32. log base 2 of (N/M) is 5.
One other detail: I recommend playing along with one round of negotiation theater (where they run to the back and check with the sales manager while you sit there staring at the brochure). That seems to go over better in practise because it's more natural than simply stating one number and saying you won't budge at all. So, just for theatrics, your first offer should be $27000 but that will quickly be raised in "negotiation" to the $28000 needed for the algorithm.

Brad Hutchings writes:

Has this ever worked for you Martin? Do tell.

Arnie writes:

I loved this podcast. The point of econtalk is to shed light on markets so as to make them more efficient for all involved. That is exactly what you accomplish here. Thank you.

Phil writes:

Great interview. I've bought more cars in my life than I care to remember, and almost never felt good about the process. In the last 3 years I've bought 3, and actually walked away from a dealer who wouldn't honor his trade-in bid.

Another topic that would be worth exploring, particularly since June is graduation time for millions of high school and college students, is the negotiation process when applying for a first job. My son is applying for professional positions and the question "How much do you want" or some variant of it keeps coming up. While there may be some info on the internet re starting salaries in various careers, the range of salaries can be wide, especially when geographic variations are included.

In some ways both of these issues are related to the "winner's curse." In an auction, the winner has paid more than any other willing buyer. When buying a car, you are almost certainly paying something more than the absolute lowest price the dealer would have accepted. When applying for a job you probably are getting a lower salary that the employer was willing to pay to hire you. In the end though maybe the best way to go through life is to determine prices that are reasonable/satisfactory to you. When you reach that price point, stop wasting time trying to get the "best" price. You're also far less likely to have buyer's remorse or to waste time trying to find the "best price" or recriminating over the price you paid. And since time is a very scarce resource, and one that only becomes more scarce as one gets older, this can be a major factor in the decision process in every negotiation.

Also, consider a podcast on the negotiation process in general and the willingness to give up some things to get others. Not just in financial transactions, but in nearly all interpersonal, inter-corporate, inter-governmental, labor/management, or international transactions.

Jonas writes:

Martin, thanks for the clarification. I had assumed that an accepted offer was final (though in practice, there are usually several more opportunities to leave in disgust, with options, financing, etc).

Such a discussion as this would not be complete without a link to Edmunds' "Confessions of a Car Salesman" at http://www.edmunds.com/advice/buying/articles/42962/article.html

Scott Anderson writes:

Thank you for another great podcast. This one was an interesting antidote (or visa versa) to the more theoretical "Hanson on Signalling" but I can't help but think that that this seemingly simple subject of buying a car has many strong linkages to other topics in this podcast series as well as other important economic topics in general as was demonstrated by some of the interesting comments above. The podcast was particularily good timing for me in that I was in the process of buying a new car the day that I listened to this and faced a very similar situation as Russ.

Some important topics contained include: game theory, siganling, decision with incomplete information, search, supply/demand. I saw game thoery throughout in the negotiation process, incentives for dealers and incentives for sales people. The podcast also discussed bragaining and brinkmanship.

I saw signalling in that the customer needs to signal its knowledge of the dealers cost, supply demand and its credible commitment to walk away. On the flip side, dealers need to filter customer inquiries to know how credible they are as a buyer and how much information the customer has to determine quoted price. There was also the Hanson kind of signalling of the buyer wanting to make the statement that they are not a pushover or that a particular car says something about them.

I saw supply/demand in the whole consumer surplus discussion of why dealers discriminate by price and how. And I saw information economics/cost of information in search and bargining.

There are a lot of ways to describe, discuss and learn about a topic, including theory, case analysis, empirical evidence and anecdote. This was a good dose of anecdote/case analysis without the mapping back to the theory. Maybe the some of the mapping back to the theory can be done by the listeners in the blog messages.

Russ Wood writes:

Russ,

This podcast won't please everyone, but I want to encourage you to keep expanding the topics of your show.

I did not learn as much from this episode as I have from others, but I enjoyed it as much as any other show you have produced. I hope it brings many new listeners to Econtalk.

Russ

Steve Cole writes:

Hello everyone!

I'm very pleased that the majority of listeners seemed to enjoy this particular podcast. It is rewarding to be able to have a frank discussion on an experience that most everyone has trepidations on.

If you have any specific questions on purchasing a car or need advice on a transaction already completed, please email me at Steve.cole@ourismanautomotive.com. I will respond to all questions!

Brian-NJ writes:

Good podcast, I like when you take left turns. I contemplated the question as to why the other dealership did not work harder to keep you, or satisfy you. My answer is, I think once the salesperson knows they are the first in the line of fire, the odds are against them. If he/she can sense closing the deal quickly, the sale will be made. However, due to your awareness to certain laws of economics it was impossible for the first salesperson encounter to be successful, and the salesperson knew it. Therefore the incentive wasn't there for the salesperson, because they did not believe they had it in them to convince you they would go the lowest since you had no lowest to set them to.

Mr. Cole, it was a wonderful and brave thing to do the podcast. I still chuckled once your salesperson qualities manifested on the comments page. Great job.

Mark writes:

Great information.

Reading a couple of comments and reading what 'tactics' are used to get a 'good deal' on a new car, it seems so much effort is wasted. The best way to buy a new vehicle for both parties is to simply offer your LOCAL dealership what you consider a fair profit for a particular vehicle. Just like Mr. Cole said, do research! Edmunds.com shows what people are paying on average for any car in almost any area. Be it $500 or $5000 profit over their true cost...Im sure an agreement can be reached fairly quickly based on information you research. This method of going dealership to dealership seems like a complete waste of time, energy, patience, and most of all GAS! Im sure once you purchase the vehicle you will be going to that local dealership anyway for service. Which, Im sure, means savings in service bills during the ownership of the vehicle if you purchased it from them. Why by from a dealer 20+ miles away to save a few bucks? As someone who has spent years in retail sales I know what its like to be burned by customers searching for holy grails of pricing and buy from another salesperson to save $100 after I spend an entire day helping them. To spend 2 -3 hours, maybe more, asking questions, test driving, and spending time learning about a new car with a commissioned based sales person seems like a worthwhile investment to me. Why not provide them with profit to make a living off of? If you insist that car dealers are out to get you or a case of the "cheapness" infects you, at least take care of your salesperson on the side, I am sure he would appreciate it.

My last thought is if you're trying to buy something that seems to be just out of your personal price range...... forgo the sunroof option or something else..... maybe you need to come down in price, not the dealer.

My 2 cents,
-Mark

Matthew Sheldon writes:

Russ -

Great podcast. I love the non-traditional guests. It always interests me the level to which those untrained in economics often internalize the basic concepts into their behavior, through the natural course of trial and error.

There was one question you asked that I thought your guest did not quite get to the real answer, or at least the most fundamental answer. This had to do with why on earth do we negotiate these things when just about everything else is non-negotiable? My view is that it has to do with the labor cost of negotiation, imperfect information and the differing perception of value across buyers and sellers.

On big ticket items, like houses and cars and boats and other things the price is always negotiable. Why? Because the labor effort involved has the potential to produce excess returns in many cases. On a tube of toothpaste, for example, the value of negotiating is not worth the extra 20-30 cents it might take to get it. On a home, where the concessions or gains of 5-10% more in price might be substantial, we are sometimes willing to hire people to do the negotiating for us (certainly in the case of houses).

The part of the answer that was correct, is that expectation does play a big part and buyers, as well as sellers, are willing to spend the time and effort of negotiation with the hope that it will produce a positive return. In an environment with perfect, uniform information the gains would disappear and so would the return on negotiation labor. If we all knew the exact price everyone else was paying, the effort to get me to pay more would be simply wasted. But, as you correctly pointed out, the right price is always a subjective thing.

Even in consumer goods markets, the willingness to pay always differs from consumer to consumer and the desired selling prices for sellers is often different as well. It is just in those cases, the return on engaging in price discrimination tactics and negotiation is low or negative because the transaction value of the good in question cannot warrant the labor cost to execute the price discrimination and negotiation strategy.

In the case of mergers and acquisitions, buyers and sellers employ virtual armies of bankers and consultants to engage in the negotiation efforts, because the potential returns from such a strategy are huge.

So, in my view transactional bargaining will exist where:

A. Imperfect information exists
B. Perceptions of value differ widely across buyers and/or sellers
C. Price discrimination is possible by some feasible means (no cost prohibitive or illegal)
D. The extra cost (investment) in labor, time, opportunity loss, etc. has the potential to produce a substantial positive return to either the buyer or seller, or both.

Just a hunch I had...I would be interested in your thoughts on that hypothesis.

FYI: I studied Economics at Northwestern as an undergrad. I hope I have not embarrassed my beloved Alma Mater!

Again, great podcast!

Matthew Sheldon writes:

Russ -

One additional supporting thought came to mind. This notion of labor cost and the corresponding value of one's time helps to explain why bargaining is so much more prevalent in developing markets where labor costs and wage rates are low.

Here in the US, we rarely, if ever negotiate for the price of a pair of shoes. However, visit China, Brazil, Mexico or any country with relatively low wage rates and you will find plenty of flea markets with vendors haggling over the price of a pair of shoes. Also notice that the wealthy elite tend to not shop in these venues, typically. Why? Their corresponding value of time is somewhat dictated by their wage rates, which of course are higher. They value the incremental savings they might gain less relative to the time spent gaining it. Their value maximizing outcome therefore results in a higher price paid, but less time spent engaging in the transaction. So, they opt for the traditional fixed price, time-efficient venues(of course perceived status and societal stature will play a big role here, but the core reason for that is the perception that shopping in a flea market for non-entertainment purposes suggests a "need" to haggle, and this says to the world that my time is of low monetary value--which speaks to perception of status). Those that do shop and sell in these venues tend to be in the middle and lower class. For them, the value of negotiation is greater, and the potential returns from price discrimination are higher as well--because the wages and corresponding value of time are lower.

A very fascinating study would be to observe transactions in such an environment, measure the close rates and the time invested in negotation relative to the starting price of a good and the final price agreed to. Then, once the transaction is completed, one could survey the buyer quickly and correlate how closely the "return" on the time spent corresponds to their average wage rate or other qualitative measures of their value of time. Of course, at the same time you could monitor sellers to see how quickly they gave concessions based on qualitatively observable factors like perception of income, presence of children, ringing cell phone or other indicator that time is more highly valued. I have to think that such a study must exist, if not, there is a freebie (price = value, I know...haha).

Why is it good to not appear wealthy in such situations? It indicates some level of price insensitivity or ability to pay a premium, but more importantly, it suggests to the seller that you will trade your time more valuably than the typical buyer would. You will be unwilling to spend the extra time to negotiate a better deal, you will give up sooner because your time is worth more to you than the seller's time is worth to him.

Any takers?

Matthew Sheldon writes:

Ok -

This is my last post, I promise. All of this thinking brought me to among the most tried and true car-selling tactics of them all. The waiting game...here is what I mean.

If you have a trade in, how long did it take you to value it online at NADA or Kelley Blue Book? Maybe 5 minutes?

Now, when you give all the details of your trade, see how long it takes the salesmen. They do this several times a day. How long? 15, 20 minutes sometimes? Certainly never 5 minutes and alway much longer than someone who should be very fast. Watch them while they are over there at the desk... They are chatting. They are deliberately going slowly.

How long does it take for the them to provide a counteroffer? They have all the numbers right over there. It should take them 2 minutes to do the math. Is it ever 2 minutes? No way. It is 10 minutes, probably 15 in many cases. Are they this bad at math? Not at all. They are just doing a different kind of math than you think.

While you are waiting, you are making an investment, but you may not perceive it. Any good investor wants a return on any investment, right? You are investing time. How much time you are willing to invest is the best indicator for how much you might be willing to pay.

Are you willing to sit it out for an extra $200? They are going to find out...

They offer you coffee. That takes 10 minutes. Test drive? Already did one? Let's do another. When you start to get frustrated, they know it is time to start moving. By then, they can probably guess where you will settle out.

But, they are using something against you. For every minute you sit in that seat, you willingness to get up and walk away diminishes. You have a sunk cost that will not get a return until a deal is done.

To get up and walk away, or at least acting like you will, is an indication that you are willing to take a loss on that investment, and they will almost always stop you before you get to the door...or if they have your phone number you will get a call very shortly, probably with a message that something changed and they will agree to your price.

The problem is that most people are not willing to take a loss on that investment, even when their own research shows them that they are still paying too much. Are you going to waste your whole Saturday and come away empty? What is the value of all that time you just spent? Is it $200? Well, you just added around $200 to the price of your car...the longer you sit, the less you must value your time. People who value time less are more likely to be able to afford less.

If Steve Cole is reading this, I would love your thoughts. Although this might be seen by some as an unethical tactic, and certainly a frustrating one but it is no different than Lowe's putting a flier in the Sunday newspaper with a great deal on a Wet/Dry vac. Some are willing to take the TIME to look, scour the ads, and save a buck. Some value their time too much to spend an hour flipping through ad circulars to save $5 on a vacuum.

The more you value your time...the more you are likely to pay for things. Fortunately, it probably also means that you make, or have, a decent salary, so you are still doing ok...

My tips...do your research, tell them how many similar vehicles they have on their lot, and mention how many the nearest several dealers have on their lots as well.

Tell them you want to do a deal today. Act a little preoccupied, maybe a little distracted to suggest you have other appointments in the next hour. Set an expectation in their mind that it should take them a few minutes tops to come up with the numbers..."I am sure you guys are good at Math, this should take you 30 seconds to figure out." Therefore the longer they take, the stupider you must think they are. When they come back with a terrible offer, express your desire to leave, perhaps murmuring that you think are going to head back over to , because you were so close to that price you offered and your time is better spent finishing up that deal.

See what happens...

Steve Cole writes:

Yes, I have been reading posts. I spend 12 to 14 hours a day discussing, analyzing and reviewing deals and negotiating.
So it is extremely fascinating to get a peek into the perspective of individuals who go through this process on an average of once every 3 or 4 years.

A comment on the time issue. I teach that selling is the ability to change or alter someones mind or perception. There are many tools that can be used to accomplish this, but the most influential by far is time! In every facet of the process I am looking for an investment of time by the consultant and the consumer. The more time I am able to have both parties invest, the greater return in that investment will be acheived. That return may manifest itself as greater profit, an opportunity to create a sale, a desire by the consumer to avoid going through this process at another dealership or even teaching the consultant to treat every opportunity like it may be thier last for the day. Although I do not intentionally try to lengthen the time necessary to complete any part of the transaction, I also do not try and expedite any part either. Again, attempting to change thier mind or expectations-in otherwords SELLING!

Is it frustrating for the parties involved? Probably in most cases yes, but again a well informed individual will reduce this investment of time substantially. I will still attempt to "sell" our product in a way that maximizes the opportunity, but your research if properly done will offset most of those attempts.

I enjoy the pyschological aspect of the negotiating process and am happy to "close" a deal regardless of the profit margin involved.

Matthew I hope that answers your question on the time aspect of purchasing a vehicle.

Steve Cole writes:

One final comment before I call it a day. Quite a few of these posts refer to "some study" should be done to quantify or explain "X" in the process. I personally find the profit margins broken out by socioeconomic status as the most telling of all statistics. The more influential and educated the buyers are, the margins are significantly less than the average. Although I have never found any study that examines and supportd this trend, I can assure you it exists.

I'd like to second Unit's comments.

Perhaps the reason negotiation still common in the purchase of cars and real estate is that the combination of their rare occurrence (relative to cups of coffee) and large ticket price means negotiation is the only way to determine market price.

I think your conversation with Mr. Cole pointed in that direction. Especially as he described the array of places where he could rationalize changing his price downward.

Schepp writes:

Russ,

An interesting perspective on the Honda dealer that did not get your business. May be he was smarter than first appearance. Mr. Cole condeded that he "lost money". The first sales man may have seen that his cut would be minimal (or even negative) with your skill and chose not to deal for good reason. Great podcast, your skill at presenting different aspects of economics is always impressive.

I love my Honda, especially with knowledge of the founder of Honda's contrarian perspective and fight against government backing for other Japanese car firms.

Ed writes:

This was a good podcast. It's good to see economics applied to a real world situation, especially one which many dread to face.

Snaporaz writes:

Wow, what a great interview. Thanks to Steve and Russ for what I think is a rather unlikely pairing.

Econtalk is one of my favorite podcasts, thanks Russ.

Alex J. writes:

For contrast with Russ's experience, a price discrimination anecdote relayed to me by a car salesman: A man and his daughter walk into an Audi-Jaguar-Porsche showroom. He tells her to pick one out. She points to the Jaguar convertible, and says "I'll take that one." $160,000.

Steve writes:

I'm fascinated, and appalled.

I guess it just goes to show you that being a PhD in economics doesn't make you a wiz at personal finance. I was amazed to hear that Russ would buy a new car, period. Compare the real difference in how much Russ would enjoy and appreciate a 3 year old car compared to a new one, versus the drop in price of a 3 year old model compared to the new one.

I have never bought a new car, never made a car payment, and I doubt I ever will. I won't buy a car that is less than 3 years old. There are many reasons, some of which are; the depreciation curve is way too steep on a new car, new models are "unknown quantities" under three years, you'll never get a better deal than a personal sale, you'll never get a better return on your used car ("trade in") than a personal sale, and the 3 year old car has revealed whether or not it has problems.

I make a car payment to myself, and I earn interest on my car fund as long as it's building, meanwhile the price of whatever I want only falls as long as I hold my fund. Every month I drive my car once it's paid for is like getting paid to drive my car.

And leasing is a whole other ball of wax. There's no way I'll ever shell out that kind of money and not have any equity in something.

Aaron writes:

As a salesman, albeit in a different market, I see Mr. Cole's philosophy as:

1. Get you in the door. Because if he doesn't get to talk to you, there is no sale. That is why he "lied" to you - he figures he can overcome that problem face to face. Pretty amazing, but I know from competing with Chinese companies that routinely quote outrageous prices to get orders and then change that price again and again, that this works with some customers, probably the more price sensitive ones. Personally, if I get a lie - I would walk out. But that's just me.

2. Make sure you have the power to make the decision and make sure you if you actually are at that stage, i.e. ready to commit and buy. Classic salesmanship.

3. Change your perceptions = get you to make the decision NOW rather than leave his showroom and "come back later" when you have a low probability of coming back. (Most likely you will buy from the last guy you talk to.) I love to schedule customer appointments on the last day of their trip to the Orient. You are more likely to get business rather than just be shopped. This happens in furniture stores a lot, and occasionally I will use a tactic where upfront I say I am ready to buy from them at a reasonable price. Since I am in the business a bit myself, I probably can judge that easier than others, but I think it helps the store know they aren't just spinning their wheels.

Also, as a small businessman myself, I really don't mind if people make a profit. In fact, I would not like to have Mr. Cole lose money on that deal. (I also wonder if he really lost money - I never trust people who claim they sell at a loss.) My best customers always remind me that we should all make money. My worst customers always try to claim that it will be good for volume or "help them out", or some such nonsense where they make all the money and I make none.

TripleHash writes:

Steve's post on 6/23 on buying new is a good point!

Although Russ didn't say if he financed the purchase of the car there are many people who do. There are very rare occurrences where an individual benefits by using debt to purchase a depreciating asset. A person well versed in business would only enter a transaction like this if the cost of debt and depreciation were to be offset by revenue that is derived by the purchase of this new vehicle. In the case of a new family car, that is rarely ever achieved.

(Of course somebody has to buy new cars for there to be used cars for the rest of us. So thanks Russ.)

Ned Batchelder writes:

I liked this podcast, if only because it was a nice change from the academics you usually host. I do have to take issue with one point: you allowed Mr. Cole to claim that the lie about extra charges was a "gray area". No it isn't: it was a lie plain and simple. He justified it by saying he needed to get you into the showroom, but where does it leave the dealer who told the truth? He also wanted to get you into his showroom, but was denied the opportunity by an unfair competitor.

Tony Barbarisi writes:

Your expose on car dealers' tactics was outstanding. I was very surprised by the sales manager's candor and disappointed that he felt no remorse about taking advantage of uninformed buyers.

Neo Malthusian writes:

Enjoyable podcast Russ.

Was the car's 'impact on the environment' a consideration in choosing the car or was it purely a decision on behalf of your family?

Simone Roche writes:

Hmmmm...good podcast...but when I emailed Mr. Coles for more information he didn't even reply. Maybe I asked the wrong questions. Oh well....

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