Technology Lemons

Bruce Schneier posted a good article entitled “A Security Market for Lemons”.

He talks about the lack of the lack of quality “signals” in the security market which prevents buyers from distinguishing good products from bad products. The crux of the theory behind the lemon market are well summarized in the following paragraphs:

In 1970, American economist George Akerlof wrote a paper called “The Market for ‘Lemons'” (abstract and article for pay here), which established asymmetrical information theory. He eventually won a Nobel Prize for his work, which looks at markets where the seller knows a lot more about the product than the buyer.

Akerlof illustrated his ideas with a used car market. A used car market includes both good cars and lousy ones (lemons). The seller knows which is which, but the buyer can’t tell the difference — at least until he’s made his purchase. I’ll spare you the math, but what ends up happening is that the buyer bases his purchase price on the value of a used car of average quality.

This means that the best cars don’t get sold; their prices are too high. Which means that the owners of these best cars don’t put their cars on the market. And then this starts spiraling. The removal of the good cars from the market reduces the average price buyers are willing to pay, and then the very good cars no longer sell, and disappear from the market. And then the good cars, and so on until only the lemons are left.

In a market where the seller has more information about the product than the buyer, bad products can drive the good ones out of the market.

This makes is really hard for good products (which are expensive to design and build) to distinguish themselves from poor products in the market, since consumers gravitate towards the cheaper products assuming that they are as good as the expensive ones.

He suggests that we need to develop “signals” to enable customers to distinguish the wheat from the chaff:

How do you solve this? You need what economists call a “signal,” a way for buyers to tell the difference. Warrantees are a common signal. Alternatively, an independent auto mechanic can tell good cars from lemons, and a buyer can hire his expertise. The Secustick story demonstrates this. If there is a consumer advocate group that has the expertise to evaluate different products, then the lemons can be exposed.

And concludes that this is not easy because while poor or bogus products are easy to spot, this becomes harder for good products.

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