Perspectives from ISB

When buying a new car, does the decision to trade-in your old car matter for the price of the new one? Recent research by Prof. Anthony Dukes of the University of Southern California and the Indian School of Business suggests that it does. He and his co-authors Prof.Ohjin Kwon, Prof. S. Siddarth, and Prof. Jorge Silva-Risso found that a consumer with a trade-in hands over more money to the dealer than consumers without a trade-in.

In the article, “The Informational Role of Product Trade-Ins for Pricing Durable Goods”, forthcoming in the Journal of Industrial Economics, Prof. Dukes and co-authors theorize that sellers of durable goods for which dealers accept trade-ins — like cars, boats, home appliances and musical instruments — can utilizea inferences about the buyer’s willingness to pay based not only on his or her decision to trade in the old good but also on its characteristics. The researchers focused on automobiles, testing their theoretical model with data from new-car transactions in the premium midsize sedan category between 2001 and 2005.

The results indicate that dealers infer a higher willingness to pay and charge higher prices to consumers who trade in a used vehicle than to those who do not.

“The most important finding of our research is that your decision to trade in your old car tells the dealer something about you and your insensitivity to price,” said Prof. Dukes. “It might be why car salespeople often ask you, soon after stepping into a showroom, whether you’re trading in your old car — even before you discuss terms of the new car.”

Moreover, dealers charge even higher prices to those consumers who trade in used cars similar to the new one.

“For example, if you’re buying a new Toyota and trading in an old Toyota, the dealer may infer that you were happy with your old Toyota and probably are not considering Honda, Nissan, or any other competitive brand,” Prof. Dukes explained.

How significantly does this information affect the final price? Buyers with a trade-in pay an average of $329 more than those who do not trade in their used cars. In addition, compared to a buyer who trades in a vehicle of a different make and model than the new one, a buyer pays $51 more if the trade-in is the same make as the new car and $110 more if it is the same make and model.

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