Academic journal article Economic Inquiry

Strategic Exclusion of the Highest-Valued Bidders in Wholesale Automobile Auctions

Academic journal article Economic Inquiry

Strategic Exclusion of the Highest-Valued Bidders in Wholesale Automobile Auctions

Article excerpt

By restricting bidders to be qualified dealers, wholesale automobile auctions exclude the bidders who place the highest value on the vehicles: consumers. This article provides an explanation for this puzzling entry restriction by modeling the inventory-management decisions of a firm. If an automobile dealer has more vehicles in inventory than is optimal, it cannot reduce its inventory by selling directly to consumers without impacting the demand for the automobiles that remain. However, if the dealer sells his/her excess inventory to a competitor, the demand for his/her remaining vehicles increases as the competitor responds by acquiring fewer additional vehicles. We demonstrate that for any market demand function and any cost of the competitor acquiring additional vehicles, a dealer with excess inventory does better by selling a subset of its vehicles to a competitor rather than directly to consumers. We discuss the market for wholesale automobiles in relation to other markets where goods are also auctioned but where entry is not restricted to qualified dealers. Doing so allows us to compare our inventory-management explanation to common explanations provided by industry practitioners. We find that intuitive alternative stories do not consistently explain practices across markets. (JEL D44, L11, L62)

I. INTRODUCTION

Sellers rarely take steps to exclude buyers from the opportunity to purchase. Even in special cases where entry restrictions are observed, sellers rarely exclude those buyers who place the highest value on the goods for sale. We present one market where this exact type of entry restriction is common and provide a simple rationale. In particular, this article considers the wholesale market for automobiles, where most automobiles are sold in auctions and the majority of automobile auction houses restrict entry such that only licensed automobile dealers are allowed to bid and consumers are expressly excluded. (1) To explain why automobile auctions are closed to consumers, we argue that entry restrictions are a strategic response to the structure of the market for automobiles. Because of fluctuations in the arrival of trade-in vehicles, some dealers in some periods have more vehicles than they find it profitable to sell in that period. As a result, these dealers are willing to participate in dealer-only auctions because these exclusionary auctions allow dealers to reduce their inventory without cannibalizing demand in the secondary market.

We consider this type of entry restrictions to be especially puzzling because a market exists for consumers to pay dealers to get them into automobile auctions. See www.dealerlicensepros.com, who say that potential dealers need a "license so that they can get into dealer-only auctions to maximize profits." As a result, these entry restrictions clearly present a binding constraint because consumers are willing to pay to enter the auction house but are only able to do so illicitly by finding a dealer who is willing to violate the auction rules or by obtaining a dealer's license simply for the purpose of buying a vehicle for their own use. Further examples include www.dealerlicense.com who discusses that unlicensed dealers "are not being able to buy cars at exclusive dealer-only car auctions" and numerous online forums where consumers discuss ways to circumvent entry restrictions by paying dealers who will "sneak" them into an auction for a fee (e.g., see a discussion of fees upwards of $500 for entry to buy a single vehicle, ask. metafilter.com). (2)

Our story is centered around the inventory-management decisions of firms in the automobile industry. If an automobile dealer has more vehicles in inventory than is optimal, it cannot reduce his/her inventory by selling directly to consumers without impacting the demand for the automobiles that remain. However, if the dealer sells his/her excess inventory to a competitor, the demand for his remaining vehicles increases as the competitor responds by acquiring fewer additional vehicles. …

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