Hyundai

A while back I prattled on about the economics of asymmetric information. I wrote about how asymmetric information might affect the market for used cars. And about how the World Series of Poker is a great illustration of how to infer, based on someone's actions, what their information must be.

And here's a great NPR story combining the two ideas.

Hyundai, the Korean carmaker, had big quality problems in the late 1980s. Throughout the 1990s, the firm invested heavily in figuring out how to make better cars, and by 1998 Hyundai's cars were plums, not lemons. But perceptions are hard to change. A consumer won't pay a plum price for a car that he or she believes to be a lemon, even if the seller knows that it's a plum.

Hyundai had to figure out how to credibly communicate the "We are selling plums" message.

They did it with an aggressive warranty program. How does that work? Suppose you are a firm and you know that you haven't solved all of your quality problems. Offering a 100,000 mile warranty would be suicide --- because your cars will break down and you'll have massive repair bills. Even if offering the warranty allows your firm to fool consumers into paying plum prices, the time bomb of looming warranty obligations will kill you.

But if you know that you have solved your quality problems, then the warranty offer won't be as costly down the road.

Important point: A warranty program is prohibitively costly for a firm selling lemons. It's not prohibitively costly for a firm selling plums.

This means that only a plum-seller will be willing to offer it.

And this means that consumers --- seeing an aggressive warranty --- will infer that quality problems have been solved, because only a plum seller would be willing to make an aggressive warranty offer. The warranty is therefore a credible signal of product quality.

To tie this back to the earlier poker discussion, Hyundai had to figure out what action it could take that would cause consumers to infer that Hyundai cars were plums. It had to find some action that made economic sense for a plum seller, but didn't make economic sense for lemon seller. And the warranty is just the ticket.

The NPR story describes this as a "marketing move," which it is. But to understand why it's so smart, you need to understand information economics. And this illustrates why economic reasoning is useful across all functions of management.