Will CPAP Cure that Lemons Problem?

A Lemon Using CPAP

To most people CPAP stands for Continuous Positive Airway Pressure, a medical device which assists those diagnosed with sleep apnea. Am I suggesting that lemons could benefit from CPAP treatment? No. I'll explain.

One of the most important insights in economics comes from an economist and Nobel laureate named George Akerloff. His most famous paper dealt with a situation where consumers do not have perfect information about a product before they purchase it.

George Ackerloff

Akerloff's insight is that imperfect information could actually result in an outcome where prices are very low and only the lowest quality version of a product is available.

 Akerloff motivated his seminal paper on this topic with an example drawn from the used car industry. Suppose there are only two types of used cars: cherries which are perfect and worth $10,000 and lemons which are only worth $2,000. Suppose that there are equal numbers of cherries and lemons but there is absolutely no way for a buyer to determine which car is which. This is an example of an information imperfection, albeit a severe one. A buyer would rationally only be willing to pay $6,000 for a car because there is a 50% chance it is a cherry and a 50% chance it's a lemon. So the average value of the two car types is the prevailing price.

But then nobody brings their cherries to market because they can't earn what a good car is worth! This changes the composition of car types available and all that is left are the lemons. So the outcome we ultimately see is one in which only low quality versions of a product are sold and prices for the product are low.

Is That a Lemon on Your Wrist Or Are You Just Angry to See Me?

What the heck does this have to do with watches? Well, one solution to Akerloff's "lemons problem" is to solve the information imperfection. An impartial mechanic could perhaps help buyers distinguish cherries from lemons. Or, as many many car companies have discovered, a certification program from the original manufacturer would be another option. We see all kinds of interesting solutions to the lemons problem. Online customer ratings and restaurant health inspection letter grade are still more examples.

NYC Restaurant Inspection Grades

 We now turn to an interesting development in the used watch market: the recently announced Certified Preowned Audemars Piguet program. CPAP! This probably isn't the official acronym but it's certainly no worse than AP's own CODE 11.59 acronym (Challenge, Own, Dare, Evolve). The CEO of AP, François-Henry Bennahmias, recently appeared on the Nightly Business Report TV program, here isthe transcript of his comments:

"ROBERT FRANK, NIGHTLY BUSINESS REPORT CORRESPONDENT: The luxury watch industry is under pressure from slowing growth and trouble in Hong Kong, the world`s largest Swiss watch market. But one segment is booming, online sales of pre-owned or used watches. Analysts say pre-owned sales are now growing twice as fast as new watch sales and will soon top the $20 billion a year in Swiss watch exports. So, watchmakers — well, they`re fighting back. Audemars Piguet, one of the most elite and profitable brands, is launching a new program to buy and sell pre-owned watches in their retail stores. They will buy a watch back from a client who may be trading up. They`ll refurbish and repair it and then offer it for resale with a warranty. It`s a bit like certified pre- owned cars because like cars, new jewelry and certain watches can fall percent or more in value once they leave the store. Now, Audemars is starting small, given the cost and time of restoring watches. The company says the move is less about added profits and more about better serving clients, cracking down on counterfeits, and managing resale prices for watches that can cost six figures.

FRANCOIS-HENRY BENNAHMIAS, AUDEMARS PIGUET CEO: Brands only to care of their first child and never the second one. So, basically, we the whole watch companies, left the secondary, the pre-owned business to outsiders. And I think it`s about time that we are bringing these back home."

I'd like to first comment on the notion that watchmakers are "fighting back" against online sales of pre-owned watches. I find this notion extremely weird. Auction houses sell pre-owned watches online. Are brands now fighting auction houses? In another post I showed that consumers demand extremely expensive watches, in part, because they serve as a wrist-portable, convenient source of liquidity. A healthy ecosystem of watch dealers online is a big part of that liquidity. Destroying the online resale industry is akin to punching yourself in the face. And, frankly, watchmakers should draw lessons from the implosion of brick and mortar retail if they're thinking about attacking online markets. I can't really think of a more quixotic endeavor.

Now let's turn to the idea that AP will begin buying, refurbishing, certifying and re-selling pre-owned timepieces directly. Bennahmias does not exactly describe the strategy driving this new service aside from an us / them remark. But we know that these sorts of certification services are fundamentally designed to address the lemons problem.

An Idea Whose Time Hasn't Come

Manufacturers such as AP already offer a service which helps separate lemons from cherries in preowned timepieces. For example, auctioneers will generally consult with the original manufacturer in order to verify the authenticity of a timepiece and the manufacturer will typically offer a certificate. If manufacturers begin to play in the secondary watch market they will then face a conflict of interest with respect to this authentication service. They have every reason to shut it down so that more watches come their way. Having a monopoly on authentication will give their resale services a distinct advantage.

Although there is a risk that manufacturer entry into the secondary market will serve as a threat to the existing industry of preowned dealers we must ask if the lemons problem is severe enough that a certified preowned service is actually something consumers will respond to. I have many reasons to doubt this is the case.

Recall that the lemons problem is fundamentally the consequence of imperfect information about the quality of a product. So we must ask whether preowned watches are plagued by severe information problems. I don't believe this is the case. First, much of the value of a watch comes from cosmetics and brand identity. These things are not difficult for a watch consumer to ascertain just by reading online and actually seeing a timepiece.

The other source of value in a watch comes from the movement itself. It is here that uncertainty is perhaps greatest for a consumer. The movement (and case for that matter) could be counterfeit. Parts may have been replaced inappropriately (the same is true for hands, dial, crown, etc). And the service history of the watch may be unknown or poor. So we must ask: is this uncertainty resolvable through a process which would cost less than one in which the manufacturer buys the watch, ships it back to Switzerland (potentially) for refurbishment and inspection and then re-sells it in a boutique somewhere (or online)? Because the answer to that question tells us whether the lemons problem is severe enough to warrant direct involvement by brands.

My assessment is that information imperfections in preowned watches are not very hard to resolve. The great thing about the watch industry is that watchmaking professionals are available to help a watch buyer assess the state of a movement. For example, in the United States alone there are approximately 2,600 watchmakers or roughly 52 per state earning an average of $21 an hour in 2018 (Bureau of Labor Statistics).

 It is true that watchmakers may vary in their experience level or expertise. But for roughly $100 you could buy five hours of a watchmaker's time to inspect a preowned watch you are thinking about buying. It just isn't that hard or expensive. I find it very unlikely that AP, or any manufacturer for that matter, could buy a preowned timepiece in one of its boutiques, ship it to a repair facility, inspect a watch, certify it, and return it to a boutique for purchase for under $100.

This implies that any preowned certification service offered by a luxury watch manufacturer is at a competitive disadvantage. It will likely struggle to offer enough value added compared to alternatives such as auction houses or private party exchange involving an impartial watchmaker. Moreover, as I discussed previously, one of the surest signs that the lemons problem is plaguing a market comes in the form of low prices caused by consumers unwillingness to risk paying a high price given the possibility that a product is faulty. Currently a new AP Royal Oak 15400ST carries a price of $17,800 on AP's web page. According to Watchrecon over the past five months a preowned examples of this reference sold for $23,100 plus or minus $1,400. That is 6% uncertainty in price. Chrono24 indicates an even higher price at $28592 with only 2.7% variance.

Chrono24 Price Estimate for AP Royal Oak

With these high and stable preowned prices there simply is no reason to believe that the lemons problem exists.

If It Ain't Broke Don't Fix It

In conclusion, it is true that the preowned watch market involves information imperfections of the type described by Ackerloff's lemons model. However, given the importance of easily ascertained surface cosmetics  and the widespread availability of relatively inexpensive independent horological expertise to help with technical matters it is unlikely that information asymmetries are really that severe in the watch industry. I am not inclined to believe a manufacturer certified preowned service will thrive. It certainly could be more convenient and perhaps manufacturers could use certain perks or business practices to keep it alive. But the fundamentals simply aren't there. Perhaps this is why the "announcement" of CPAP first emerged in 2018 but to this day it has not been implemented.