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  • Ron Giuntini said More
    As always a good read.
    I have always... Thursday, 25 January 2018

Replacement of Durable Products

Buyers’ Perspective

Sellers’ Perspective

When Price Competition Leads Low Quality to Crowd Out High Quality

How to Sustain Supply of High Quality Products

 

 

I recently bought a new electric hand mixer. The second time I used it, the head of one of the beaters fell off the rod. I know it’s not just me who thinks that they just don’t make them like they used to.

My boyfriend has an old gas heater system for his store that is activated by a pilot light. There’s a thermal coupler (a sensor) on the pilot light that prevents gas from flowing, if the pilot light goes out. Every year he has to buy a new thermal coupler, because they only manage to function for a single season before they break.

And how many stories have you heard about someone who replaced some major household appliance that had lasted for 30 years with a new one, only to have the newer product break down after just a couple of years?

The question here is: can high quality products survive in this day and age, or will the focus on price competition ultimately lead lower quality products to crowd out higher quality products?

Certainly, there has to be a large enough demand for high quality products to support their supply. I’m assuming that the problem is not that there is not enough demand for quality. Rather, the question is: will the need to offer low prices to win market share lead suppliers to cut quality even when demand for quality exists? In other words, are we destined to suffer a “race to the bottom” in terms of product quality?

Replacement of Durable Products

The products at issue here are durable products, which are products that generally last longer than a year.

In “Extending Product Life: Technology Isn’t the Only Issue”, Margaret DeBell and Rachel Dardis examine consumer replacement tendencies of major appliances. They note that at the time a consumer replaces an older major appliance with a new one, the older appliance may either be

  • fully functioning,
  • functioning, but have operating problems, or
  • not functioning.

As such, they hypothesize “that major appliances might be separated into two distinct categories”

Group B1: those appliances that are replaced because they are not functioning properly, and

Group B2: those appliances that are replaced when they become technologically or fashionably obsolete.

As far as major household appliances go, DeBell and Dardis note that

Washing machines, clothes dryers and hot water heaters are likely to fall into the first category [Group B1], while appliances such as refrigerators, stoves and dishwashers are likely to fall into the second category [Group B1].

I would extend this categorization from including only major appliances to including most durable products. For durables in the first group, Group B1, consumers replace products only when they stop functioning properly, such as my electric hand mixer. For durables in the second group, Group B2, however, consumers often replace products even when they are still working, but consumers want designs or functionality that only newer products offer. The latter group includes, for example, most consumer electronics (TVs, cellphones, stereo systems, gaming systems, etc.).

The problem of “they just don’t make them like they used to”, that is, of decreases in the reliability or durability of products over time, is especially a problem when they occur with regard to Group B1 products, since reliability/durability is one of the more important factors buyers are looking for in these products. Decreasing reliability is not quite as much of a problem for products in Group B2, on the other hand, since product breakdowns often provide an excuse for buyers to upgrade to the latest technology. In fact, products in Group B2 are often subject to planned obsolescence (defined in Wikipedia as “a policy of planning or designing a product with a limited useful life, so it will become obsolete, that is, unfashionable or no longer functional after a certain period of time.”) on the part of retailers, so as to force buyers to regularly purchase new models. Additionally, products in Group B2 are prone to feature creep (defined in Wikipedia as “the ongoing expansion or addition of new features in a product”) as competition among sellers intensifies. Finally, products in Group B2 are often sought for purpose of conspicuous consumption, to display one’s wealth or social status.

 

Buyers’ Perspective

Let’s first examine the demand for durables from the consumers’ perspective.

Suppose a consumer, Joe, purchased some durable product, Thingie, during some period in the past, say in year t’. Each year after that, Joe must decide whether or not to replace Thingie. When making his decision, Joe will consider

  • Does Thingie still function as needed?
  • What features do current (newer) versions or models of Thingie offer that Joe’s older Thingie doesn’t, and how much does Joe value those new features?
  • What is the price of current Thingies?

More formally Joe will compare

  • The utility he gets from using his old Thingie during the current period, t, given the current state of functionality and the features of his old Thingie:

(A)      Ut ( Thingie t’ ( State of Function t, Features t ))

  • The utility he would get from buying and using a new Thingie, given the functionality and features of new Thingies, net of the purchase price:

(B)      Ut ( Thingie t ( State of Function t, Features t )) - Price t

If his current Thingie is working well enough, and if he doesn’t need the new features offered by current Thingies, that is, if (A) > (B), then Joe will stick with what he has. Conversely, if his current Thingie isn’t working, or if he values the features of new Thingies more than their current price, so that (B) > (A), then Joe will replace his old Thingie with a new one.

Assume now that Joe decides to buy a new Thingie during the current period.

Each of the different brands of Thingies available offers some combination of

  • price;
  • appearance;
  • size;
  • reliability/durability;
  • brand reputation;
  • recommendations from friends, families, or online forums; and
  • other features.

Additionally, if Thingie is not a new invention, then odds are that most brands of Thingie offer more features or functionality than Joe will need or use.

So how does Joe choose among his various options?

As per DeBell and Dardi, regardless which of the two groups described above Thingie falls into, Joe’s choice will depend on the features, brand reputation and price of the different brands of Thingie. In addition, however, if Thingie falls into Group B1 described above, that is, Joe’s utility from Thingie derives mostly from brute functionality, then Joe will be more concerned with service and reliability when deciding among the various brands. In contrast, if Thingie falls into Group B2, then appearance, size, and other features will be the more important deciding factors.

An important characteristic of most durable products is that before the user buys the product, he has some expectation about what level of quality (i.e., reliability or durability) the product will provide, but he cannot judge the actual quality of that particular product until he takes it home and tries it out. An relevant consideration in this analysis is the fact that in today’s markets, one may pay a price, p*, for a particular product, expecting it to be of some quality q*. However, after getting home and using the product, one discovers -- to his dismay -- that the actual quality of the product, q’, turns out to be less than that expected; that is, q’ < q*. In this case, had one known that the actual quality of the product would be q’, one would not have purchased that particular brand at the price p*. For example, I clearly would not have bought the particular hand mixer I did, if I had known that the head of the beater would fall off soon after I started using it. I will discuss this issue in more detail later in the analysis.

 

Sellers’ Perspective

Each seller participating in the market for a particular durable product must decide what combination of

  • price;
  • appearance;
  • size;
  • reliability/durability; and/or
  • other features

to offer, given that particular seller’s historical brand reputation, the preferences of the buyers, and the offerings of the other sellers in the market.

As I mentioned previously, it will only be profitable for sellers to offer higher quality products, if there are enough buyers in the market who value quality and are willing to pay for it. Assume the market is such that there are enough buyers to support a high quality product at a higher price, and there are also buyers who will only pay a lower price, presumably for a lesser quality product.

In today’s markets, most suppliers (which I refer to as retailers, to distinguish them from the manufacturers who actually manufacture the products) outsource the manufacturing of their products, either onshore (to manufacturers located in the US) or offshore (to manufacturers located outside the US), where a significant portion of offshore manufacturing takes place in China.

For sellers who outsource manufacturing, there are three possibilities:

Group S1:  The sellers direct the manufacturers to provide high(er) quality products, and the manufacturers provide high(er) quality products at a higher cost, CH;

Group S2:  The sellers direct the manufacturers to provide high(er) quality products, but the manufacturers cut corners to save costs, provide the manufacturers with products that are of a lower quality and that, accordingly, cost less to make, CL, but charge the manufacturers for the higher quality products, CH, pocketing the extra profit, CH- CL;

Group S3:  The sellers direct the manufacturers to provide low(er) quality products, and the manufacturers provide low(er) quality products at a lower cost CL

Quality fade is an example of a practice that causes sellers to end up in Group S2. From Poorly Made in China by Paul Midler:

Chinese factories often engaged in this sort of quality fade – the incremental degradation of a product over time. They quietly reduced the amount of materials or else manipulated the quality of raw inputs. The changes were gradual, almost imperceptible. The importer was neither asked for permission nor told. P.96

Retailers who end up in Group S2 – although they want to be in Group S1 – may be able to distinguish themselves from retailers in Group S3 by offering a (free or relatively low-priced) warranty or other good customer service for their products. Retailers in Group S3, on the other hand, will tend either to not stand behind their products or to offer expensive warranties, knowing that a good portion of them may be redeemed.

 

When Price Competition Leads Low Quality to Crowd Out High Quality

There are several market scenarios in which high quality might be crowded out by price competition.

The first is Akerlof’s classic Market for Lemons (Akerlof won the Nobel Prize for his work in this area). In this situation, uncertainty on behalf of buyers as to product quality makes it unprofitable for sellers of high quality products to supply the market. Wikipedia provides a good description of the dynamics of the problem:

Akerlof's paper uses the market for used cars as an example of the problem of quality uncertainty. A used car is one in which ownership is transferred from one person to another, after a period of use by its first owner and its inevitable wear and tear. There are good used cars ("cherries") and defective used cars ("lemons"), normally as a consequence of several not-always-traceable variables such as the owner's driving style, quality and frequency of maintenance and accident history. Because many important mechanical parts and other elements are hidden from view and not easily accessible for inspection, the buyer of a car does not know beforehand whether it is a cherry or a lemon. So the buyer's best guess for a given car is that the car is of average quality; accordingly, he/she will be willing to pay for it only the price of a car of known average quality. This means that the owner of a carefully maintained, never-abused, good used car will be unable to get a high enough price to make selling that car worthwhile.

Therefore, owners of good cars will not place their cars on the used car market. The withdrawal of good cars reduces the average quality of cars on the market, causing buyers to revise downward their expectations for any given car. This, in turn, motivates the owners of moderately good cars not to sell, and so on.

The second situation in which price competition might crowd out quality is when the state of technology outpaces consumer demand. Consider, for example, the current state of technology for PCs. What portion of the population that uses a PC even comes close to using all the features provided in today’s typical PC? In such a case where a large portion of buyers need only minimal functionality, relative to what’s technologically possible -- that is, when products only need to be good enough -- then competition turns to price. While quality may very well suffer relative to its potential as a result of competition on price, the quality provided tends to be good enough to satisfy the needs of most consumers.

The third situation in which price competition might crowd out quality is when sellers end up in Group S2. That is, sellers would like to provide higher quality products, but they end up selling lesser quality versions because the manufacturers of their products cut corners.

The fourth situation in which price competition might crowd out quality is examined by Rachel Kranton in “Competition and the Incentive to Produce High Quality”. Consider the following scenario:

  • Product quality is unobservable to consumers prior to purchase;
  • Consumers base their purchasing decision on price alone and choose randomly among same-priced firms; and
  • The dispersion of sellers’ market shares is high.

Under these conditions, when a seller can generate a large volume of sales by cutting his price during a given period, then the gains from doing so may outweigh any costs associated with decreases in his future market share.

 

How to Sustain Supply of High Quality Products

Fortunately, there are measures that can be taken to prevent price competition from crowding out quality.

Of course, as I mentioned earlier, a market for high quality products can only be sustained if there are enough buyers out there who value high quality and are willing to pay for it. In the rest of the discussion in this section, I assume there are enough buyers who value quality to support sellers of high quality products.

The biggest problem leading to degradation of product quality is the fact that consumers cannot accurately judge the quality of a product before they buy it. Sellers who can overcome this problem should be able to generate the margins needed to sustain supplies of high quality products. The most obvious methods for convincing prospective buyers that products are high quality are to offer customers either (i) product test-drives before they buy or (ii) hassle-free exchanges or money back guarantees.

Sears supplies its Craftsman line of tools, which has long since sustained a reputation for quality, and the tools come with a hassle-free lifetime warranty. According to Wikipedia:

Consumers have ranked the Craftsman brand second (surpassed only by Waterford Crystal) in terms of quality. In 2007, Craftsman was named "America's Most Trusted Brand" and brand with "Highest Expectations". In 2009, the readers of Popular Mechanics named Craftsman their favorite brand of hand tools in their Reader's Choice Awards. Craftsman is the official tool brand of NASCAR and the DIY Network.

Craftsman hand tools have an unlimited lifetime warranty. This lifetime warranty program was instituted by Sears when they began selling the Craftsman line in 1927. This warranty program requires no receipt or dated proof of purchase. If the owner takes the item into a local retail store, it may be replaced or repaired free of charge.

However, a friend mentioned that he has had problems with Sears Craftsman tools over the past few years, so he’s been buying more tools from Harbor Freight, a company that offers lower quality tools, but at a much lower price. I found a online that discusses other people’s recent problems with Craftsman tools. In fact, one guy went so far as to say:

I get a lot of my tools at Harbor Freight or Home Depot. None have broken. I won't pay a premium for Craftsman anymore because their tools are crap. If I am going to have crap tools, I want them cheap.

If my friend’s experience and the experiences of those participating in the online forum are any indication, Sears’ sales have almost certainly suffered as a result of their recent decreases in quality, despite the fact that they still offer a lifetime warranty. So it seems that a warranty isn’t enough unless the quality is there to back it up.

Alternatively, in “3 Easy Ways to Beat Low Price Competition”, Kevin Stirtz suggests sellers educate their prospects as to the quality of the sellers’ products by offering (i) articles and white papers, (ii) seminars, (iii) tests, research, and reports demonstrations, or (iv) tours of your facilities.

A direct cause of quality degradation is unlimited competition on price by product sellers. To counter this problem, sellers can try to limit competition, for example through licensing or permitting requirements. Kranton provides a thorough discussion of how guilds in the past and professional associations more recently have been able to limit competition in their markets and actively monitor the quality of its market participants to ensure the provision of high quality products.

Manufacturers in China are able to get away with cutting corners and degrading the quality of their output for three reasons in particular:

  • Manufacturers are not subject to laws and regulations requiring adherence to minimum standards (i.e., there is no OSHA or FDA in China);
  • There is little-to-no transparency with regard to manufacturing practices (there are no reporting requirements or auditing or inspections procedures); and
  • There is no liability for damages associated with defective products.

In particular, Paul Midler notes

China manufacturing had no concept of punitive damages or penalties for bad behavior… If (or rather, when) the factory was caught in some scheme to manipulate product quality, the only thing that the factory could be expected to do was remake the product properly. The importer would never be reimbursed for damages arising from a loss of business or reputation. The only cost to the factory for getting caught with their hand in the cookie jar was being made to put the lid back on the jar. P.97

Retailers who want to ensure their products are manufactured up to standard have two options. First, they can have their products manufactured in locations where there are standards and accountability. (Here is a directory of products made in the USA.) Second, manufacturers can exert a strong presence or power over their manufacturers to ensure products are made to standard. Apple and Wal-Mart have both taken this latter route.

Incidentally, when I was reading about quality fade and other practices in China that lead to substandard manufactured products, I wondered which retailers in the US didn’t just switch manufacturers when they discovered a problem. The answer is two-fold. First, due to the lack of transparency mentioned above, apparently it’s difficult to find a trustworthy supply. And second, there are large cost associated with switching suppliers, in particular set-up costs associated with establishing a relationship and ramping up operations with a new supplier.

Finally, retailers who want to maintain high quality standards, but still be able to compete on price with sellers offering lower-priced, lower-quality products, might be able to do so. Retailers might accomplish this by keeping their high quality lines, but in addition, adding a new line of lower-quality, lower-priced products specifically to cater to the lower-priced market. This is called brand diffusion. Schmoozy Fox defines brand diffusion as follows:

Diffusion brands are a form of a line extension... They are “step-down line extensions of existing luxury brands, normally less expensive than the main-line merchandise.” They are often called second lines, subbrands and endorsed brands. Think of them as “children” of their more established “parent brands”.

Examples of diffusion brands abound in the fashion world, for instance. Armani launched Armani Exchange, Calvin Klein introduced CK, and Prada started a diffusion brand with a whole new name: Miu Miu. In all of these cases, the important condition for introducing diffusion brands was very high brand loyalty and brand recognition of parent brands.

However, when engaging in brand diffusion, retailers must be careful; otherwise, the new cheaper line can end up diluting the brand name reputation of the luxury goods.

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