“The Market For Lemons” was an economics paper written by George Akerlof. It is useful today for explaining why individual “bad apples” can decrease profitability for online businesses and how they may ultimately destroy entire markets. To start, let’s find out a little background about “The Market For Lemons.” First off, a “lemon” by definition is a product that looks decent enough, but at its heart is a sour-tasting, piece of junk. They are most commonly referred to in car markets, but lemons can also apply to many other kinds of goods such as web and information products. Now back in the sixties, George Akerlof started thinking about lemons while he was an assistant professor at Berkeley. He wrote the paper and, at the time, no one considered it important. Akerlof even had trouble getting it published at all. Things have changed since, however, as Akerlof received a Nobel Prize in 2001 for his contribution to economics.
The central example Akerlof seizes on in “The Market For Lemons” is the used car market. This is a market where only the seller has true knowledge of the car’s worth (since you only know if a car is good until you’ve driven it a while.) In time, someone may realize they can make more money selling a lemon than a quality used car. In theory, the effect of this devalues the entire used car market. If people are worried about getting lemons, it reasons that they’d be less willing to shell out their hard-earned money. In turn, it can become impossible for sellers of good used vehicles to get back their car’s worth. Even if it’s a good car after all, you can never know until later.
Eventually, the net effect of these falling dominoes is to drive the good vehicles out of the used car market. The repercussions also mean that honest dealers may not be able to survive market conditions. At its worst, the market of lemons completely crashes, as there is no value left in it. At that point, no one buys a used car anymore.
The idea behind “The Market For Lemons” is important today. Take the recent rash of fraud with online camera dealers for example. On the Internet there is no real guarantee of quality. You don’t know if you’re getting a good deal until after the transaction is completed. Since the anonymity of the Net makes it easier for crooks to exist, the consequences often aren’t heartwarming. You can expect people to pay less in general for online goods. Thus, an honest dealer who sells a quality product may not be able to compete in the online world.
Certainly, the law of lemons is not the end all, be all for Internet retail. More people earn a living off the web now than ever. However, it does merit caution as the pricing and standards for Internet commerce tend to be lower than those of traditional business models. That is why it is critically important to have a strategic, professional plan before entering the Internet marketplace.