Yesterday I was talking to my partner about the lack of videos available for her iPod. I was prattling on about how there probably isn’t many videos because the penetration of the video iPod is probably quite low. The reason I believed that the penetration was quite low, was because I couldn’t see lots of people forking out for a new iPod with video – when the old iPod would still do the main bit of playing music.
My partner then said they should do trade-ins for the old iPod, so you can get the new one more cheaply. At first I was dismissive of this idea, stating that, unless you could get money back for the parts what was the point. However, I soon realised that I was completely wrong – there are a large number of circumstances where my partner was right and a trade-in deal made sense.
Now, I haven’t actually seen any trade-in deals for iPods, but I certainly have for the xbox and playstation. As a result, I’m going to discuss why firms that sell durable goods may want to have trade-in deals.
Durable goods, timing, and substitutes
If you currently own an iPod, or an xbox, the payoff from buying another iPod or xbox is quite low. This implies that a purchased iPod is competition for the purchase of other iPod’s in the future!
Now this extends to product types. For most people, an old iPod without video is a substitute for the iPod with video – ultimately, people will value the one with video more and the price will change to reflect this.
As a result, people that do not own iPods will have a different willingness to pay for an iPod that plays video than people without iPods. If we assume that everyone gets the same satisfaction from the consumption of an iPod over a period of time – then people who do not have them will be willing to pay more.
If this is the case, Apple could set up a trade-in deal, where people can “upgrade” for less. This allows Apple to set a higher price for people buying the good without trading in (people who do not own an iPod) – this is called price discrimination.
Fundamentally, the trade-in deal would allow Apple to set two different prices for people with different willingness’s to pay. As the individuals have the incentive to reveal their willingness to pay (by deciding whether to trade in or not), then using these two prices will increase the profit the firm makes.
Why don’t they do it with iPod’s then
Well I can think of a couple of reasons.
Firstly, the gains from this forms of price discrimination may not be worth the cost of setting up the promotion 😛
Secondly, the willingness to pay may not be structured exactly in this way. For example, people who currently have an iPod may value a new iPod more than those that don’t have an iPod – as they were the ones that actually went and brought one in the first place. If the pool of people that don’t own an iPod value the product at a sufficiently lower level – then there is little to no advantage to be gained from this sort of scheme.
What do you guys think?