Buying Or Selling A Car

Psychological and economic studies have shown that we don’t think and behave as rationally as we might like to believe. It turns out we humans are a mess of irrational impulses and biases. This has big effect in how we go about transacting, for example, buying and selling a car.

This is according to Colin Morgan, director at used car retailer getWorth, who says that experts have identified a number of different types of errors of judgement that people can make – called ‘cognitive biases’. Below Morgan gives examples of some of these effects in the car market.

Anchoring

You mind has a tendency to latch onto an initial piece of information and then base your future judgements around that. In the car industry, that anchor is normally a price. Think of yourself walking into a new car showroom and driving out in a new car, proud and happy that you got it for a R30,000 discount. Discount off what? Off the manufacturer’s recommended sticker price.

It’s an anchor and has little to do with the intrinsic value of the car.

Studies have found that properties that were listed for higher prices ended up selling for more on average than comparable properties listed for lower initial prices.

The same is true in the car industry – one can see this in used cars, where one can find huge variances in price for an almost identical car listed by different dealers. Chances are that the dealers who list their cars higher also achieve higher average sold prices – it’s good for the dealer, less so for the buyer.

Endowment effect

Once we own something, we give it much more value than when we don’t own it. In a famous study, half a class of undergraduates was given a coffee mug. They were asked what they would sell their mug for, and the other half of the class (those without mugs) were asked what they would buy one of the mugs for. The sellers averaged $5.25, while the buyers were only willing to pay more than $2.25 to $2.75.

In the car industry, we see this with trade-ins. Customers are much more focused on getting a good price for their current car than the new car. Car dealers are not blind to this, and some even have a deliberate strategy of pricing their existing stock above market levels so that they have ample room in the deal to subsidise what they can pay for a trade-in.

Loss Aversion

We tend to overvalue gains and undervalue losses. Simply put, we prefer to win. Imagine yourself in two scenarios. Your boss calls you in and gives you a R1,000 raise. Or, your boss calls you in and says your salary is being dropped by R1,000. The level of upset you’d feel at the salary cut is probably a lot greater than the happiness at the raise.

In the car industry, one often sees this in marketing offers or in high-pressure sales tactics such as: ”Hurry up and buy now, or you lose this deal!” Insurance and warranty products use the same logic – that people are willing to pay a premium to reduce the effect of possible future losses.

Bandwagon effect

We are hardwired to fall in line with something if we believe it is popular with others. One doesn’t need academic studies to see the effect – just look at fashion fads, or the hot new kids toy this season.

Cars are no exception – a model perceived as popular will hold its value a lot better than one that isn’t. We can see that this is a result of perceptions – it is common to find the relative resale values of two different cars being very different in a foreign market where their popularity is reversed.

Left-digit bias

If we see a number, we tend to focus most strongly on the left-most digit – there’s a good reason that most cars (and prices in general) are marked something like R79,999, rather than R80,000. One Canadian study – Heuristic thinking and limited attention in the car market found a similar trend in car mileages and prices.

For example, they found that cars with odometer values between 79,900 and 79,999 miles are sold on average for approximately $210 more than cars between 80,000 and 80,100 miles, but for only $10 less than cars with mileage between 79,800 and 79,899.

In Conclusion

We’d like to believe we’re different, but we all have these biases to a greater or lesser extent. The best you can do is be aware of them and question your own views.