Today let us talk about The Market For Lemons, an economics paper talking about the quality and uncertainty that runs market dynamics.
A Wikipedia excerpt for this paper goes like this,
“Suppose buyers cannot distinguish between a high-quality car (a “peach”) and a “lemon”. Then they are only willing to pay a fixed price for a car that averages the value of a “peach” and “lemon” together (pavg). But sellers know whether they hold a peach or a lemon. Given the fixed price at which buyers will buy, sellers will sell only when they hold “lemons” (since plemon < pavg) and they will leave the market when they hold “peach” (since ppeach > pavg). Eventually, as enough sellers of “peach” leave the market, the average willingness-to-pay of buyers will decrease (since the average quality of cars on the market decreased), leading to even more sellers of high-quality cars to leave the market through a positive feedback loop.”
This is one of my most favorite economic theories out there. Especially for the fact that it was written in 1970 but has never been more relevant today than before. For simplicity, I will refer to this as the lemon market problem going forward in this post.
Social Capital touched on this for publishers a few months back and while it briefly went into digital publishers, I wanted to dive deeper into how it affects all marketplaces in general and how it applies to the Indian context and how marketing, branding and customer support are going to be the biggest drivers in the ecosystem.
The Indian Startup ecosystem has been heavily centered around the marketplace platforms that have emerged in the last decade and a half. If you have been following Indian startups it is almost impossible to ignore the Flipkart vs Amazon or the Ola vs Uber argument that goes on. While these arguments have taken forms of criticism on capital dumping, regulations on startup investments and all other imaginable excuses under the sun, let us look at how the market for lemons influences these competitions.
Buying anything online runs the risk of the deliverance of sub-par quality products. Especially for an aggregator like Flipkart/Amazon which would host multiple merchants on the site, assuring users of the quality of the products sold is not an easy task. In early 2016, Flipkart worked with Lowe Lintas on a campaign specifically designed to address this uncertainty. The campaign titled “Flipkart Matlab Bilkul Pakka”, which loosely translates to “Flipkart means completely guaranteed”, was a big move to assure some of the key concerns faced by modern users. Amazon, on the other hand, has spent two decades focusing completely on the consumer and ensuring that it is perceived as a trustworthy and consumer friendly brand.
For Flipkart in India, this is a much bigger challenge from Amazon than the capital dumping. For a digital marketplace, the single most crucial challenge is to assure the consumer that the purchase would be satisfactory before the consumer actually makes the purchase. The same story has been unfolding in the ride-sharing market in India. The competition between Ola and Uber has been highly dominated by a superior app as well as driver experience provided by Uber as compared to Ola.
While the lemon market problem deals with information asymmetry between the merchant and the buyer in a marketplace, at the core of it, it is a problem about easing decision making for the consumer on a platform with limited information. The way I see it, there are only two ways to ease this process for the consumer
- To make it relatively inexpensive to make a bad decision
- To provide just about enough information for the user to believe in the quality of the platform
The first approach is relatively easier, by lowering prices of an Uber ride, Uber can make it easier for me to take a risk on the platform. This is where the capital dumping argument comes in. This is also not really sustainable because as explained in the above excerpt, this would lead to the peaches leaving the market causing the market to be flooded with lemons and collapse.
The second alternative is really interesting. What kind of information can be provided to a user to ease the decision-making process for a consumer? This is where it gets a little tricky. To a great extent, the user is uninterested in the effort that is put behind the management and sustenance of any given platform. The end user relies heavily on experiences, recommendations, and general perception when dealing with marketplaces. This is where Amazon has the potential to win over its competition. Amazon has built a great experience, paired with a great customer experience to develop trust simplifying decision making for the user.
This is also greatly reflected in digital publishing. The two biggest business models in digital publishing today are ad-based and subscription-based. There is also transaction based but that is difficult to scale for different reasons and I’ll leave it out for some other time. While ad-based has been the traditional source of revenue for digital publishers, not many have been able to transition to subscription-based revenue successfully. One of the most successful transition examples recently has been of New York Time which generated $223m in revenues in 2016 from their digital subscribers while BuzzFeed which is arguably the most viral digital publisher on the planet today made $170m of total revenues in 2016. For BuzzFeed to launch a subscription-based revenue would require them to first convince their readers that paying them a fixed amount of money each month would be worth it, which would again take a lot of brand building and quality journalism effort.
The same can be seen in the India Digital Publishing market. Subscription-based business models are still very rare in this market and most publishers rely completely on digital advertising for their businesses. As a matter of fact, most leading publishers at this point refuse to service your content in the presence of an ad-blocker. This is largely because the digital publishers in India have been traditionally chasing quantity over quality which makes it difficult to trust them to deliver consistent quality content in exchange for money leading to the lemon market problem all over.
In short, wherever a user is expected to pay digitally and trust the platform to deliver a quality product, the lemon market problem can be assured to present itself. And while lowering prices, promising content in bulk etc can be used as an approach to tackle this problem they serve as a short-term solution, which can potentially destabilize the platform in the long term. A more guaranteed path to go down is to work with the consumer to ensure that they over a period of time develop trust in the platform to make transactions regardless of the transaction size or the nature of good to be purchased. This trust of course, helps the platform build a moat for itself against any new players and allow the platform itself to experiment with newer strategies(like NYT did with subscription-based business model) without worrying about losing out on the market share, which is probably the best thing to pursue for in the long term.