Question

From Tesla’s website in 2014: “A year ago, Tesla introduced a Resale Value Guarantee that gives customers the option to return their Model S after three years for a known value. When combined with a car loan provided by Tesla’s banking partners, this program gives customers the functional equivalent of a lease.” Discuss how this program might help Tesla to solve the durable good monopoly problem described by Ronald Coase. Carefully explain the durable good problem and how this type of policy might relate to it.

Answer 1

Tesla Motors, Inc.TSLA has terminated the Resale Value Guarantee program for new vehicles purchased after Jul 1 in North America, according to sources. The program guaranteed the resale value of a Tesla Model S after three years of purchase through one of the automaker's loan financing programs.

The program which had been updated guaranteed that the value of the vehicle being resold will be higher than that of premium vehicles of manufacturers including BMW, Audi, Lexus, and Jaguar models. Tesla had introduced this program to reassure the buyers of Model S about the resale value of the vehicles in the market. The automaker also considered that this program would help it control its secondary market. Generally, premium vehicles' customers resell their old vehicles for latest upgraded models within a few years of purchase. This makes resale value an important point of consideration for customers.

Tesla has undertaken this strategy in order to keep interest rates low as well as to offer a compelling lease and loan program to customers, per a company spokesperson. According to the company, the program was initially necessary to reassure customers, but now its vehicles are holding their value. Therefore, the program is no longer required.

The resale value liability had been increasing over time, and this proved to be challenging for the electric carmaker. As of Mar 31, the liability due to the resale value guarantee was $1.58 billion. In fact, the resale value liability increased by more than 20% since year-end 2015.

Durability problem

Once a durable-good manufacturer sells a product to a consumer, it faces a challenge to convince this consumer to purchase another good. A consumer needs one refrigerator, one razor, a limited number of shirts, and so forth. Durability, therefore, may mean limited prospects for businesses. Ronald Coase argued that because of the durability problem a durable-good monopolist may not be able to exploit its market position and charge monopolistic prices. His thesis is known as the Coase Conjecture. The durability problem is not limited to "monopolists" in the strict sense of the term. It may happen in all markets for durable goods, although it is easier to understand it with a single seller.

To overcome the durability problem, durable good manufacturers must persuade consumers to replace functioning products with new ones or to pay them money in other ways. Replacement of functioning goods refers to business strategies that persuade or force consumers to purchase new products. One category of strategies is contrived durability that refers to product design that intentionally shortens the product lifetime before it is released onto the market. In most instances, durability is built into a product by the manufacturer through its choices of inputs and production procedures. Another category of strategies refers is planned obsolescence that refers to shortening the lifetime of a product after it is released onto the market. Under this strategy, the manufacturer “convinces” the consumer to replace an old product with a new one, thereby rendering the lifetime of the old product shorter than its actual useful lifetime. Annual style changes of cars and revised editions of textbooks are prime examples of planned obsolescence. Although contrived durability and planned obsolescence are different in many ways, they are often confused, which is not surprising considering the article on planned obsolescence defines planned obsolescence as a "policy of planning or designing a product with an artificially limited useful life", which would be prior to the release of said product barring the existence of a time warp machine.

Another strategy that is frequently used by durapolists is tying: a sale (or lease) of one product or service on condition that the buyer (or the lessee) take another product or service. Durable-good manufacturers tie to their durables non-durables and can boost profit. Razor and blades is favorite example. Durable-good manufacturers also use financing strategies (leasing, complex payment terms) to extract payments from consumers.

That why Tesla adopted this strategy to increase the resale value of the car.