ACV Auction, Akerlof's Lemons, & Used Car Adverse Selection

In 1970, George Akerlof published ‘The Market for Lemons: Quality Uncertainty and the Market Mechanism’ which later won him a Nobel Prize. There are a few core attributes of a ‘lemon market’:

1. Asymmetry of information between buyers and sellers
2. Incentives for sellers to misrepresent low-quality for high quality products
3. A wide range of sellers across different levels of quality
4. Difficulty for sellers to signal quality
5. Lack of regulation, guarantees, or warranties

The used car market is the perfect example of a Lemon Market and one that Akerlof uses in his paper. There are many quality grades of used car sellers but few tools for buyers to judge the quality of prospective purchases. When such asymmetry of information exists, ‘lemons’ can drive out good products and distort the functioning of the market.

Used car adverse selection is one reason online car retailers like Carvana, Auto1, and Cazoo are winning market share from incumbents. Each company aims to increase transparency in the car buying experience with no price-haggling, centralised inspection and reconditioning facilities, free warranties, and money-back guarantees. This builds trust and helps reduce uncertainty around the quality of cars sold.

The five attributes above of a lemon market also pertain to the wholesale used car market. These are vehicles that are sold between dealers and fleet or rental companies. ACV Auction (ACV), the leading online dealer-to-dealer wholesale auction marketplace, has a similar mission to Carvana: 'to bring trust and transparency to the entire used vehicle industry’. We interviewed a Former Regional Manager to understand how ACV’s auction differs from the traditional physical auction process.

There are over 22m wholesale vehicles sold each year in the US with 14m sold dealer-to-dealer and 8m from commercial consignors to dealers. Of the 14m, nearly two-thirds is sold via dealer-to-dealer auctions such as KAR, Manheim, and pure-play online auctions like ACV, Backlot, and TradeRev. Of the 9m vehicles sold via wholesale auctions, it’s estimated that ADESA and Manheim have 67% share of the volume, online-only platforms have 10%, and regional and independent auction houses have the remainder.

The ADESA and Manheim physical auction buying experience is complex. Sellers have to transport vehicles to the auction house and buyers have to be present to join the bidding. Although incumbents claim the majority of buying is ‘online’, which includes vehicles sold in transit, on TradeRev, or ADESA Simulcast or DealerBlock, the traditional process is still plagued with adverse selection. The asymmetry largely stems from the difficulty of buyers to inspect the vehicles they are bidding on.

ACV aims to solve this problem by running an extensive 100-point vehicle inspection before it’s listed for auction. This creates a data report, True360, which is more detailed and reliable than those provided by Manheim: