早稲田大学 IT 戦略研究所
Research Institute of IT & Management,
Waseda University

December 2005

Cyber “Lemons” Problem and Quality-Intermediary Based on
Trust in the E-Market—— A Case Study from AUCNET (Japan)―Yong Pan
Professor of Henan University of Finance and Economics, China
RIIM Working Paper No.17

Working Paper

Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

Cyber “Lemons” Problem and Quality-Intermediary
Based on Trust in the E-Market—— A Case Study from AUCNET (Japan)
byYong Pan ∗Abstract
The web makes it easier for buyers to purchase products from distant seller. But, theinability of the buyer to examine the merchandise brings on the cyber “lemons” problem
resulting form the asymmetry of information. However, it’s a pity that we merely idolize theconvenient such as the products customization or personalization from the technology of
the Internet and ignore these problems. Based on the lemon principle put forward by
American economist George Akerlof, who is one of Nobel economics prize laureates in
2001, the paper analyzes the inherent mechanism in eliminating the cyber lemons. For
providing empirical evidence, the paper discusses a case from AUCNET (Japan). The
paper concludes that the quality-intermediaries as a trusted third party in electroniccommerce may play an important role in eliminating the cyber “lemon”. The Internet
maybe become a fertile field for quality-intermediaries’. A successful intermediary in the
e-commerce market is the establishment of trust for market participants. That Japanese
accept the online used-car market (AUCNET) completely lie in the trust for the web
AUCNET. The trust as the firm specific resource can form and consolidate competitiveedge. At last, the paper puts forward individual view about higher price and quality
distribution of the used car in AUCNET.

∗ Yong Pan is a Visiting Scholar of Graduate School of Commerce; Waseda University.He is also a
professor of Henan University of Finance and Economics, China. The author especially thanks to Prof.
Tatsuyuki Negoro of the Waseda University for his advice and help on this paper.

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Table of contents
1. The “Lemons” Problem .............................................................................................................3
1.1 Akerlof’s “Lemons Market” Model ....................................................................................3
1.2 “The Internet is a Lemon”...................................................................................................4
1.3 Cyber ‘Lemons’ Problem....................................................................................................5
1.3.1 The Reasons Resulting In Cyber Lemons........................................................5
1.3.2 Facts and Current Study .....................................................................................6
2. Remedies for the "Lemons” Problem and Quality-Intermediary .........................................6
2.1 The Possible Strategies or Approaches ...............................................................................7
2.2 Quality-Intermediary...........................................................................................................8
3. AUCNET: A Case Study ............................................................................................................9
3.1 Profile of AUCNET ............................................................................................................93.1.1 Used Cars Market in Japan ................................................................................93.1.2 History of AUCNET and Business ...................................................................10
3.1.3 The AUCNET Earnings Model..........................................................................11
3.2 Quality-Intermediary Model and Trust Strategy ...............................................................123.2.1 Rigorous Inspection that Support AUCTION Credibility ...............................123.2.2 The Third Party ...................................................................................................143.2.3 The Quality-Intermediary Model and Trust Strategy .....................................15
3.3 Competitive Edge..............................................................................................................17
3.4 Conclusions.......................................................................................................................18
3.5 Discussions .......................................................................................................................18
References ....................................................................................................................................19
Appendix: How to Use AUCNET ?.............................................................................................21

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1. The “Lemons” Problem
The “lemons” problem in the information economics refers to the informational
asymmetries resulted from the products quality uncertainty in the traditional markets.
Akerlof’s article, “The Market for Lemons: Quality Uncertainty and the Market Mechanism”(Akerlof, 1970) has analyzed a market for a product where sellers are better informed
than buyers about the quality of the good. In his paper Akerlof initiated “lemons market”
model.

1.1 Akerlof’s “Lemons Market” Modelz Quality uncertainty and prices
Akerlof looked at the market for used cars. In the used car market, seller (owner)
knows more about the true quality of car than the buyer. Suppose (for modelling simplicity)that there are two types of used cars -- bad used cars (“lemons”, a colloquialism fordefective cars) and good used cars (“peaches”). Potential sellers know which type her car
is, but buyer cannot distinguish between types.
Generally speaking, a buyer is prepared to pay higher price for peach than lemon. If
she cannot distinguish between the two, she may contemplate paying an “average price”.
However, at the average price, owners of peaches may be reluctant to sell, while ownersof lemons are happy to. The cars actually in the market are mostly lemons. Anticipating
this, buyers must reconsider paying less than the average price.
z Market Outcome: Adverse Selection
The selection of cars offered in the market is adverse from a buyer’s viewpoint. The
market works fine for lemons, but the market for good quality cars disappears: lemons
drive out peaches from the markets. Akerlof called this phenomenon Gresham’s law in theused car market①. Adverse selection② is a consequence of informational asymmetry
between buyers and sellers, and the problem of trust.
After Akerlof’s article has been published, “lemons” has become a well-known
metaphor in every economist’s vocabulary. With the “lemons markets” model, Akerlof
indeed explains many economic institutions and many important aspects of uncertainty.
“Lemons” theory illustrates the result of asymmetric information: adverse selection leads
to decline of market efficiency and market economy is not sufficiently effective.

Figure 1“Lemons” Problem — Resulting from the Products Quality Uncertainty①
Gresham’s law means “Bad coinage drive out good out of circulation”, which was known by
English financier, Sir Gresham (1519-1579).
②
The concept initially come from the insurance market (Rasmusen, 1994), which means theselection by the consumer when faced with the circumstance of asymmetric information.

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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market‘lemon’?

The lemons problem in the information economics refers to the informational
asymmetries resulted from the products quality uncertainty in the conventional markets.
But, how about the lemons problem in the e-commerce markets that is based on theInternet?

1.2 “The Internet is a Lemon”《 Fortune 》 has published a paper “The internet is a lemon”( MccLea andWheat,2000).In this paper, the authors have pointed out a phenomenon that there aremany consumers only just use the Web to research cars but not to buy them via theinternet. They have compared the different consumer’s behaviors in the e-commercemarkets (see table 1).
Although the paper mainly discussed the channel conflict between the tangible andinternet market, the figures in the table shows that the consumers online worry about thequality of online products much more than other products online — especially the autos —so they make the adverse selection.
This fact illustrates that there exist the “lemon” problems resulting from asymmetry of
quality information in the e-commerce market especially for the product, which of thequality is judged difficultly by the Internet.

Table1

Consumer’s Behaviors in the E-Commerce Markets

Research Online

Buy Online

Books

31%

30%

Airline tickets

35%

19%

Hotel reservations

29%

13%

Computer hardware

24%

13%

Autos

31%

1%

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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market(Source: MccLea and Wheat, Fortune, 2000)

1.3 Cyber ‘Lemons’ Problem
In fact, all the products online have the quality uncertainty. When we triumphed about
the convenient and the high efficiency from the internet we are up against a predicament:
Because the network gets rid of the limit of space-time and bring up the unreality in thee-marketing, the informational asymmetries from the qualitative uncertainty are likely todeteriorate.
Figure 2

Cyber “Lemons” Problem

Cyber “lemon” ?

1.3.1 The Reasons Resulting In Cyber Lemons
The reasons are as below:z E-Commerce changes the nature of transactions
In e-commerce the buyers and sellers are geographically separated, they do notinteract face-to-face. So it is hard to physically inspect the quality of the good prior tobuying it. There is temporal separation between exchange of merchandise and cash.
z Unclear identity for online producers
In the Internet the cyber-store can be built in one day, and disappear simultaneously
too. For this type of uncertainty, the marketing efficiency in e-commerce will be extremely
low. Unclear identity for online producers makes us not know well the products quality.
z The subjectivity of evaluation about quality online
There is no doubt that the personalized service in the Internet enables customers more
frequently and more convenient. However, the personalized services make it difficult todiffuse the reputation built in a customer to other customers, which strengthen theinformational asymmetries about product quality.

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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

z Alternating personality of producers in network
Unlike the tangible products, the online goods are produced and sold by the virtual
persons, who exist in short time or numerously. All the users are the potential producers
or vendor by the individual homepage or web server. Hence in the e-commerce market
the lemons problem will be serious.
z The influence of “information paradox”
Because the digital products mostly are experience goods, their quality is known
clearly only after being used. However, once consumers acquaint oneself with its quality
they unwillingly buy it – this is an insuperable barrier in producing the digital commodities.
This attribute makes the manufacturers find no good methods to guarantee their products
quality to customers. Despite a great deal of advertisements and product’s news, thecustomers still not accept manufacturers’ speaking and unlikely buy it.
1.3.2 Facts and Current Study
Despite the network market has many advantages, especially the high information
efficiency, it not implies that there should be high marketing efficiency. E-consumers may
have stronger “lemons sensitivity” than the tangible market. However, few analysts to datehave published papers about the cyber lemons in mainstream journals.
Huston and Spence (2002) have study the online coin auction market in American.
They find that higher quality coins are less likely to sell than lower quality coins. This factshows that buyers are clearly aware that sellers could be offering a lower quality coin thanclaimed. They also find that, of the coins which do sell, price rises with quality but only by
87 cents for each dollar of claimed quality improvement, they suggest that consumers
discount seller claims of increased quality. Also, the more highly grade coins fetch lower
price relative to their market value. Their empirical evidence indicates that a greater
informational asymmetry results in more substantial lemons problem in internet market.
According to the "China Statistical Survey Report on Popular Internet Issues"③, in
China e-commerce market, the quality of online goods is the problem that e-consumers
concerns most. Recent three times report shows that the proportion of “thinks thebiggest problem in e-commerce market is good quality” is 43.8% (2004-11), 42.5%(2005-1) and 48.4% (2005-7). It has seriously affected the development of the Chinese
electronic commerce. The fact ask us attach importance to it.

2. Remedies for the "Lemons” Problem and Quality-Intermediary
What are possible remedies for the lemons problem? According to Akerlof (1970),
there are numerous mechanisms or institutions to do this. He has given some example toillustrate these mechanisms or institutions such as insurance market, employment of③

This report published by China Internet Network Information Center (CNNIC).
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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

minorities, credit markets in underdeveloped countries and counteracting institutions.
Akerlof (1970) has concluded:” we have been discussing economic model in which ‘trust’is important”.

2.1 The Possible Strategies or Approaches
Since the lemons problem results from asymmetric information, i.e. buyers don't havethe same information as sellers, the obvious remedy is to inform—and convince—buyers
about the product quality, i.e. to crate the trust between seller and buyer.
Now we discuss the possible strategies or approaches creating trust:z Diffusing Signal
The firms would like to signal that they are trustworthy. Of course, anyone can saythat they are trustworthy. So in order to signal trustworthiness effectively, they must do
something that less trustworthy firms cannot do.
z Guarantees
One way manufacturers signal quality effectively is by offering guarantees. If you
know your product to be good, offering a guarantee has low expected costs. If you know
your product to be a lemon, guarantees are costly. So presence (or length) of guarantees
can signal private information about quality.
z Brand Names
Firms can also invest in building brands: these can serve as transmitters of trust. A
firm with a valuable brand name has more as stake: it risks losing more if it lets down its
customers. Knowing this, consumers feel more comfortable dealing with branded firms.
Branded firms can charge more (Amazon, for instance)z The Role of Regulations
Governments can legislate consumer protection, and create dispute-resolution
processes that help the trust. For instance, After Akerlof’s article (1970), many “lemonlaw” has been enacted in American④. Consumers can use state and federal lemon laws toqualify for money back, or a replacement for lemon.
z The Standard of Quality
In the conventional market the government and the consumer association always set
up some certified standard about the product quality to guarantee the quality. But thisstandard virtually put forward a lowest request that merely indicate if the product can beused, not a quality standard in nature. So the manoeuvrability of this method will be
relatively poor.
z Trusted Third Parties
Instead of setting quality standards, trusted third parties can provide detailed quality④

http://www.lemonlawamerica.com/
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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

information by comparing each brand as does the Consumers' Union who publishes
Consumers' Reports. Similarly, a trusted mechanic may examine a used car to determine
whether it is a lemon. The common criterion is that third parties need to be neutral,
trustworthy, and equipped with a necessary expertise to evaluate products.
The strategy or approaches above have happened in conventional market. For
example, in conventional market, diffusing signal, brand, guarantee and so on candistinguish their self-product from the ‘lemon’. Yet, in the e-market the effect of thesemethods may be restricted. For instance, the signal, guarantee and brand mostly areindirect information, whereas these indirect signals in the e-market are unfurnished orchange constantly, so the approaches that are available in the conventional market are no
better than unworthy. In addition, while it is easy to build brand recognition throughmarketing, to preserve reputations is not easy and requires recurrent expenditure.
Reputations may be very fragile in cyber-space. One consumer’s bad experience caneasily be communicated to others through chat groups.
In a related approach, trusted third parties (public or private) can provide detailed
quality information. As a trusted third party, the quality intermediaries may play a very
important role than other methods in the e-commerce market. Because they profit byevaluating product quality in the network they need supplying credible information topreserve their reputation.

2.2 Quality-Intermediary
In conventional market, Intermediaries create value by providing a range of services.
For example, if a specific trade would not take place without the help of an intermediary,
then the intermediary, the buyer and the seller all have a claim to the value created by thetrade. Clearly, if new kinds of intermediaries are possible in e-commerce, the issue ofvalue capture will be important. Changes that reduce the value of intermediaries will also
be important to analyze.
Intermediaries as experts operate more frequently in certain types of markets(Biglaiserb,1993). They are common where the difference between low-quality andhigh-quality products is large, giving a larger profit margin from the two expected prices.
Also, if there are more low-quality goods than high-quality goods, the cost to search for ahigh-quality good may justify the use of an expert intermediary. In contrast, experts add
little value if products are in general of a high quality.
Thus, a successful intermediary must assure buyers of product quality. In fact we canprove that, the more difference quality of product-online, distributes the more quality
intermediaries are needed in the network market. The more severe the uncertainty about
the quality is, the stronger the need for an efficient intermediary will be in electroniccommerce (Yong Pan, 2005). The used-car markets should need this type intermediary inpoint, because no two used cars are considered to be alike —— “one used car has one
quality”, such as make and model, color, registration year, mileage, model options, andowner care.

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3. AUCNET: A Case Study“E-commerce is nothing new at AUCNET. In 1985, we invented the TV used car auction,a feat we proudly look back on now as perhaps the first e-commerce business model in theworld. …… Our growth has been rooted in our reputation as a fair and reliable source of
information. As most buyers never physically inspect vehicles prior to a purchase, they rely on
us completely for accurate information. We meet this demand with our exclusive inspection andevaluation system, a set of standards that is highly regarded throughout the automobile
industry.”

Kiyotaka Fujisaki, president of AUCNET(Source: http://www.aucnet.co.jp/e/pm/index.html)

3.1 Profile of AUCNETAUCNET is an electronic intermediary for used-car transactions in Japan, which wasestablished in March 1984. In 1998, AUCNET entered its 14th year in business as theundisputed leader of the used car auction industry.
First we need to introduce the background of AUCNET appearance.
3.1.1 Used Cars Market in Japan
Japan used cars were previously sold at 140 auction sites, where buyers and sellers
convened together. The conventional auction markets adopt a POS (point of sales)
system, introduced in late 1970s, in which buyers press a POS button to register their bid,
instead of raising their hands. But sellers had to bear high transportation costs to move acar to the auction site, and back again if it was not sold. About 45% of cars brought to theauction sites remained unsold. Because Japanese consumer’s preference was to deal
with a reliable, substantial business and avoid the risks of hidden defects, so most buying
dealers personally inspect the cars prior to the auction.
The maintenance of cars was strictly regulated and the inspection costs for older cars
were higher. A new car could be driven in private use for three years, after which an
inspection was required, and every two years thereafter until the car was ten years old,when an inspection was required every year. The required inspection typically cost about¥80,000 (Warbelow A., Kokuryo J., and Konsynski B., 1996).
On the side, Japan’s crowded streets made direct exchanging difficult. To attend car
auctions, most car dealers typically had to leave their offices and travel to distant auction
grounds off in the suburbs. Many dealerships, however, were small, family-run businesses
that found it difficult to hire more than a few part-timers on a regular basis. Having their car
inventory transported to conventional auctions for liquidation also confronted dealers withtrucking expenses. That was okay as long as someone bought the merchandise.

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3.1.2 History of AUCNET and Business
Masataka Fujisaki（the current AUCNET president's elder brother）had started in theused auto business in 1967, building Flex Auto, Inc. into a major used car retailer in Tokyo.
He still owned several retail stores. A subsidiary called Flex Japan was established to
trade in used personal computer in 1982.
As part of a decision to expand Flex Japan into computer systems and otherelectronic equipment, AUCNET was established as subsidiary of Flex Japan with Orient
Finance Inc. as a second principal shareholder in 1984. The goal was to establish an auto
auction business utilizing computers and advanced communication technology to be usedby auto dealers to buy and sell inventory in the wholesale market. After a year ofdevelopment, the first TV auction was held in June,1985 and were converted to asatellite-based system in 1989. Profits had been doubling every year since.
AUCNET’s network auctions consist of TVAA and network AA (Live Link Auctions
and Internet Bidding Services).
TVAA are real time network auctions led and managed by AUCNET and arecharacterized by the preponderance of high end cars (i.e., late model year and limited
mileage cars in good condition).TVAA members can consign and bid on vehicles up forauction through dedicated terminals in the comfort of their homes or offices. TVAA car
auction membership has grown to 7,200 members (as of the end of December 2004).
The Live Link Auctions has signed agreements with 30 on-site auction sites locatedthroughout Japan (as of December 2004) to provide live links for members to bid on
consigned vehicles through dedicated terminals. The number of vehicles broadcasting topartner auction sites per year has reached approximately 1.95 million units, and thenumber of vehicles sold is growing yearly, given the variety of vehicle models and types
consigned.
Internet Bidding Services do not use a dedicated terminal, but instead provide bidding
services for consigned vehicles on behalf of members over the Internet at TVAA or at 59
participating on-site auction sites (as of December 2004).

Table 2The AUCNET Lineup

1985. 6～

TVAA (TV Auto Auction)

1989. 8～Began using satellite-based system for TV used car auctions

1993. 6～

Used motorcycle auctions

1997. 5～

Fresh flower auctions

2001. 1～

Live Link Auctions

2001. 9～Internet Bidding Services

2005. autumn

Used PC auctions

Subsequently, the company has expanded into used motorcycle auctions (from 1993)

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and fresh flower auctions (from 1997), and fresh flower auctions were converted to abroadband Internet-based auction system from November 2004.
AUCNET’s used car business is centred on network auctions. Used car auctions
account for 76.4% of total sales.The characteristic of network auctions is that auctions canbe conducted real time utilizing the multiple address characteristics of communication
satellites.
The TVAA business, which is AUCNET’s main business and the major source of
earnings, is characterized by the fact that AUCNET leads and manages these networked
auctions. Now the AUCNET are planning to begin Quick Auto Auction (second version of
TV auction). Unlike conventional TV auto auctions, each quick auction will be restricted toa particular vehicle category. Their aim is to capture synergies that can raise the numberof vehicle consigned and sold. They also plan to offer more types of TV auctions bybuilding a network of alliances with on-site auctions such as Live Auction Broadcast andInternet Bidding Service.
3.1.3 The AUCNET Earnings Model
AUCNET generates earnings from auction commission ， which consists ofmembership fees , consignment fees, purchase fees and bidding fees. Consequently,
earnings growth is dependent on membership growth and the number of participants in
auctions, as well as a growing number of vehicles consigned to auction. Growing
membership involves providing services that meet the needs of used car dealers, while
expanding earnings involves providing attractive auctions that increase the number ofvehicles consigned and purchased through auction. In addition, AUCNET is expanding
sources of revenue by providing new services that meet the needs of its members (seetable 3).

Table3

AUCNET’s Basic Revenue(2004 Results of Operations)

Auction transaction fees

Yen

TV auctions (¥7,000 per vehicle paid by buyer and seller)

14,000Live link auctions (per-vehicle fee paid by buyer)

7,000

Web bidding service (per-vehicle fee paid by buyer)

18,500

Vehicle consignment fees

Yen

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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

TV auctions (per-vehicle fee, including inspection fee, paid by seller)

10,000Broadcasting fee (alliance partner auction firm pays per-vehicle fee)

100

Membership fee

Yen

TV auctions (monthly fee per member)

39,500Live link auctions (additional monthly fee for TV auction members)

5,000

Web bidding service (monthly fee per member)

6,800

Initial costYen

TV auctions (cost of purchasing one terminal)

550,000

autoBank

Yen

autoBank System software (cost per license)

720,000

autoBank System information fee (monthly fee per license)

9,800

Rental fee for old AUCNAVi system (monthly fee per terminal)

39,500* TV auction consignment and inspection fees and bidding fees are for Japanese vehicles.
* Fees for live link are for typical situations.
(Source: Information Meeting for 2004 Results of Operations, Aucnet Inc.,2005)

3.2 Quality-Intermediary Model and Trust Strategy
The need for an intermediary is often dismissed in the direct seller-to-buyertransaction model and often envisioned for Internet commerce. However, a market-driven
solution to the lemons problem involves relying on an intermediary who has an incentive
to provide truthful information about quality in the manner buyers can trust. AUCNET as
an intermediary that collects and disseminates information does not change the product,
but it creates value by improving the quality of the transactions that take place. The
company matched buyers with sellers, or informed buyers about the quality of products
sold, thereby mitigated the lemons problem. Then information adds value to market
transactions. Not surprisingly, we can think the AUCNET’s success mainly resulted fromit’s trust model and strategy.
AUCNET’s trust strategy and quality-intermediary model are as follows.
3.2.1 Rigorous Inspection that Support AUCTION Credibility
As AUCNET’s auctions beginning with TVAA are conducted through satellite
networks or over the Internet, participants are not able to physically view vehicles
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consigned. At conventional auctions, buyers had opportunities to stroll around and visually
examine the cars entered for sale before the auction bidding process actually got underway. In televised auctions, still photos provided the only means of identifying car entries,
and they did not allow buyers an adequate means of gauging car quality. These
differences make it extremely difficult for auto dealers to purchase used cars.
In order to reduce these transaction risks “Cyber Lemons” that resulting fromuncertain product quality, AUCNET established a rigorous car inspection process.
AUCNET from its earliest days continually honed its car inspection skills and sought tofoster trust in its inspection results. AUCNET know that the absolute reliability of
information is essential for vehicle transactions without a personal inspection.
z Automobile Inspection System (AIS)First of all, AUCNET realized that the important solution was the establishment of anevaluation system able to accurately determine the condition of each vehicle. In 1997,
AUCNET began working to improve the quality and competence of its inspection
personnel by establishing AUCNET Inspection Services Co., Ltd. (AIS), a company
devoted to training aspiring inspectors, setting inspection standards, and refining related
technologies. AIS’s inspections are respected within the industry for their high standards
and thoroughness, as over 250 checklist items are evaluated on the results in terms ofnumerical scores (form 0 to 10 , see table 4). These inspections have the credibility ofover 3 million vehicles inspected to date, and AIS’s inspections provide an importantunderpinning for AUCNET’s auction transactions.
These AIS inspection standards are being provided to the used car dealer affiliates ofmajor automobile manufacturers, such as Toyota, Honda, Nissan and Mazda, and are
helping to establish an industry standard. Thus, AIS inspection standards are steadily
gaining widespread acceptance and have been adopted by manufacturer-related auctions(where AIS provides outsourced inspection services). In addition, an increasing number ofused car dealers are beginning to display AIS inspection certificates on the used cars they
display, which is helping to promote the use of AIS as a public third-party inspection
certificate.
z Inspectors
AUCNET has employed eight full time inspectors, and had 64 contract agents who
did inspections all over Japan. The AUCNET inspectors were used mostly to train new
inspectors, and to fill in case of emergency or illness. New inspectors were selectedbased on knowledge of the used auto business, and an eagerness to learn and work.
Masanori Tokuhashi, chief vehicle inspector for AUNNET has discussed the train
process:“First they learn about the AUCNET system, wth special emphasis on the inspector as
the heart of the system. Then we teach about the vital contact between the inspector and thecustomer. We start them with the spiritual stuff – we “brainwash” them although that might not
be a good word! Finally we teach them the technical aspects of inspecting cars. There is no
specific test afterwards, we just let the participant think about whether they are able and willing,

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and if not, they quit. The trainee then undergoes an apprenticeship which may last three weeks
to three months, traveling with an AUCNET inspector – it is on the job training.
Inspection work is physical labor, a tough job. It is done outside, and often in bad weather.
That is why people willing to do the job are limited. So AUCNET is trying to raise the social
status of the inspector, coupled with increasing reliability, so that customers can feel safe thatthey are trying a good car.
An inspection on average took 7 minutes, and the top inspectors averaged around 130 cars
per week. Inspectors in rural areas often worked part time at other jobs, and inspected fewercars. Most inspections were done Sunday through Tuseday, but inspectors were free to arrange
their own schedules, and FAX reports on their activity back to headquarters.
Each inspector was given an exclusive geographic area. Within that area, they served as
the sales force for AUCNET, calling dealers and encouraging them to list cars. If an inspector
was particularly busy one week, or unable to respond quickly to an important customer in afringe area of his territory, AUCNET would dispatch an inspector from headquarter or an
adjacent area to fill in.”(Source: Warbelow A., Kokuryo J., and Konsynski B., AUCNET: TV Auction Network System,
Harvard Business School,1989. Rev.1996)

In conclusion, AUCNET’s business is built on the credibility of these inspections. The
vehicle inspection process was fundamental to AUCNET’s success.
Figure 3

Automobile Inspection System (AIS)

3.2.2 The Third Party
In order to ensure the impartiality of used car bidding, AUCNET has introduced a third
party to resolve disputes over the condition of a car sold by its system. When cars aredelivered, buyers have five days to register complaints with AUCNET. If consumer
complaint missing parts in the car or other mechanical defects, AUCNET then has the car
assessed by a third partyand to obtain a judgment of the car's condition and estimate to
repair it. This third party usually maybe is a manufacturer's dealer. The consignment
contract requires that AUCNET members abide by AUCNET's decisions in such matters.
If either party is not satisfied by this arbitration, AUCNET allows them to appeal to aclaims committee. The committee consists of peer dealers and makes a final decision
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over the claims, which assures neutral and trustworthy.

3.2.3 The Quality-Intermediary Model and Trust Strategy
The implement of trust strategy needs support from advanced technology. The key tosuccessful e-commerce of AUCNET is his technology and services that transform “virtual”
into “real”. These technology and services realize the organic integration of technology,
convenience and confidence, and finally form a specific quality-intermediary model (seefigure 4).

Figure 4

Quality-Intermediary Model

Comprehensive
Convenience
Alliance

Technology

Competitive

Trust

Advances

Edge

andDiversification

Consumer
Confidence

Quality-Intermediary(Trust Strategy)z Technological advances
AUCNET’s unique communication network based on satellites and terrestrial lines
connects a host computer with 7,000 used car dealers throughout Japan. Auction bid
signals received from dealers in all parts of Japan are reliably delivered to the host in realtime. This technology guarantees the fairness that is an indispensable element of any
auction. The sharp images and excellent performance and convenience of the auction
terminals provide bidders with the feeling of actually being at an auction site.

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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

z Comprehensive convenience
High efficiency is a must in payment processing, vehicle delivery and the submissionof legal documents such as registrations. To ensure quick and efficient processing,
AUCNET manages all formalities related to vehicle transactions. This system reduces
volume of work at used car dealers and creates a high level of satisfaction. AUCNET also
acts as an intermediary between dealers in settling claims, thereby promoting reliable andaccurate communications among all parties involved in network transactions.
As a real-time bidding system with a nationwide network, TV auction business allows
people to participate in auctions (submit vehicles and bids) from their places of businessand supports logistics and brokerage services (logistics service, documentation delivery,
settlement service, financing).
z Customer’s trust
Can a Used Car Be Trusted? Potential problems involving used cars are countless—— turning back odometers, selling stolen vehicles to unsuspecting customers, illegal
modifications, and much more. This is exactly the ”lemons” problem that AUCNET face!
Although IT infrastructure was a necessary factor for AUCNET's success, the firm's
ability to translate technical feasibility into institutional realities was real challenge increating new electronic intermediary services. In conventional auto auction markets, allvehicles are brought to a market site for evaluation and buying dealers personally inspect
cars in the market location. In contrast, AUCNET does not allow a buying dealer to "kickthe wheels" to formulate personal assessments of used-car qualities. Buyers in AUCNET
have to make purchasing decisions based upon information alone without physicallyinspecting cars, thus facing risks of incomplete and distorted information by sellers.
How to create the trust between seller and buyer? How to build the trust strategy?
According to Kiyotaka Fujisaki, president of AUCNET:“ …… Early on, we realized that the only solution was the establishment of an evaluation
system able to accurately determine the condition of each vehicle. This is why we have worked
hard on establishing reliable automobile inspection standard ever since our establishment.
Despite our efforts, we have not yet achieved our goal of putting in place uniform
inspection and assessment standards across the used car industry. This is an issue that affects
the entire industry. Leading our drive to establish uniform standards has been subsidiary
AUCNET Inspection Service. To better position this company as an organization dedicated toserving the entire used car industry, we changed its name to Automobile Inspection System inAugust 2003. To set the stage for the new name, we established uniform inspection andassessment standards covering the used car operations of Toyota, Honda and Nissan. Our
goal now is to make our system the de facto standard for the entire Japanese used car industry.
We believe our mission is to refine these standards to the point where they are used not only
by used car companies and dealers, but also for transactions between individuals.
For many years, we have also been addressing such pressing issues as the prevention ofsales of stolen cars and odometer fraud. More work remains. I am confident that AUCNET has
the resources to continue making headway in creating a used car market that is sound andRIIM Working Paper

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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

trustworthy. I am convinced that this process is the best means for us to achieve growth in theyears to come.”(Source: http://www.aucnet.co.jp/e/ir/pm/index.html)

So at AUCNET, “trust” is what defines their operations. They have created anenvironment in which used cars can be bought and sold solely on the basis of reliable
information, eliminating the need to inspect vehicles in person. AUCNET as a quality
intermediary creates an open and trustworthy market for used-car transactions and gives
the consumers confidence for this company. The absolute confidence of the customer inthese inspection criteria backs up the smooth transactions at all AUCNET auctions. They
will soon reach the point where an AUCNET-inspected used car is synonymous withabsolute reliability in the minds of buyers. AUCNET is determined to leverage this strength
to make the used car market an even more active and fair place to do business.

3.3 Competitive Edge
The organic integration of technology, convenience and confidence has resulted in
the following competitive advantages:z First, AUCNET have created the inspection and appraisal system permits
worry-free purchases. They have a nationwide network of 150 certified inspectors. The
basic inspection standards are the same as those of Toyota, Nissan, Honda and othermanufacturer-affiliated used car companies.
The inspection process was the key factor for AUCNET. According to Masanori
Tokuhashi, chief vehicle inspector for AUNNET:“The reliability of the inspections is at the heart of the system. If someone tried to copy us,
even if they had the hardware, the inspections would be our competitive edge. Originally wecopied the inspection criteria of the auction sites, but this has been adjusted based on claims
and experience- it is now much more rigorous… We leave them for the auction sites, and havecontinued to increase the rigidity of our inspections.”(Source: Warbelow A., Kokuryo J., and Konsynski B., AUCNET: TV Auction Network
System, Harvard Business School,1989. Rev.1996)z Second, the company have an exclusive, internally developed IT and auction
system. They unified the system by supplying terminals to other companies andcompatible with many communication infrastructures.
z Third, they have a nationwide coverage, which has about 10,000 companies
involved in the auto business are members. They also have alliances with 30 used car
auction sites all over Japan.

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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

3.4 Conclusions
The success of AUCNET tells us that the quality-intermediaries in electroniccommerce may play an important role in enhancing market efficiency by providing productinformation. The Internet maybe becomes a fertile field for quality-intermediaries. There
are also quality-intermediaries in the conventional markets. But we need much more
online intermediary which has superior knowledge and skills to evaluate quality, especiallyfor online product that has multiple levels of quality--such as the used-car market --“oneused car has one quality”.
The successful intermediary in the e-commerce market is the establishment of trust
for market participants. That Japanese accept the online used-car market completely lie in
the trust for the web AUCNET. The quality-intermediary as a trusted third party needs atrusted mechanic examining the goods-online to determine whether it is a lemon. The
common criterion is that third parties need to be neutral, trustworthy, and equipped with anecessary expertise to evaluate products that buyers may not trust seller-provided
information.
The success of AUCNET also tells us that if firms must compete on price alone, it isunlikely that the firm with the lowest price is going to be the most reliable (i.e. trustworthy).
Indeed, low prices are often viewed as “suspiciously low”. Competing on price alone may
not be a viable strategy. Problem may be quite acute for goods and services whose
quality is hard to determine, because the qualitive implication of online price is lower than
the tangible market (Yong Pan, 2005). New firms that try to undercut on price may not
succeed. The industry structure could be concentrated.

3.5 Discussions

Lee (1998) used archival data acquired from AUCNET and concluded that prices
were higher for vehicles sold via AUCNET than for those sold via conventional auctions.
The paper show that consumers are willing to pay a higher price for a product that hasgone through a strict evaluation system before being put up for sale. The author point out
the quality of cars this market attracts has risen significantly, and since the number ofpotential buyers is increased manyfold, the sellers tend to set a price that is nearly double
the price in the conventional market. I agree his view about the price. Further, I think thereason of the higher price is because of the price including a “ reputation rent “ that is the
specific resource of AUCNET, which shows a basic rule that “ high price incents the highquality “.
This phenomenon also arouses another problem about AUCNET: the firm focused onhigh-quality used car more than low-quality. Such as Masanori Tokuhashi, chief vehicle
inspector for AUNNET has said: “We ended up weeding out low quality cars, because
they were thehardest to describe accurately by inspection.” Actually they just pay attention
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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

to the used car that the quality score is S to 3.5 (see table 4). The average purchase pricethrough auction is ¥1,460,000 (for 2004), which is the highest average price in the industry.
We think AUCNET should focus on all quality degree used car, for my model has showedthat the more difference quality of product-online distributes, the more quality
intermediaries are needed in the network market. Another reason is that the people use
the car longer before selling the new car now.
Table 4QUALITY SCORE

S

6

5

4.5

4
3.5

AUCNET’s Quality Score

CAR CONDITIONS
same as a new car; less than one year old,
odometer under 5,000km
less than two years old, odometer under
20,000km; best condition for a used carless than three years old, odometer under
40,000km; no need for repairs

Many Transactions through TVAA

less than five years old, odometer under(Late model year luxury cars)

60,000km;minor damage
odometer under 100,000km; some conspicuous
damagesome scratches, dents and other damage; some
repairs needed3

many scratches, dents and other damage;repairs needed

Few Transactions through TVAA
(older model year economy cars)2

1

considerable damage; significant repairs needed
major repairs and replacements needed
Only Traded through the E&R

0vehicle has been repaired following and accident(Export & Reasonable) Corner∗ In addition to the above score, additional ratings from S to E are assigned depending on the conditionof each vehicle’s exterior and interior.

References
Akerlof, George A., The market fo r‘lemon’： qualitative uncertainty and the market
mechanism, Quarterly Journal of Economics, 1970,84(3), pp.488-500.
Biglaiser, G., Middlemen as experts, RAND Journal of Economics, 1993, 24(2, pp.212-223.
Choi, S. Y., Stahl, D. O, and Whinston, A. B., The Economics of Electronic Commerce,
Macmillan Technical Publishing, Indianapolis,1997.
Ho-Guen Lee, Do electronic marketplaces lower the price of goods? Comm. ACM
1998,41(1), pp.73-80.
Huston， John H. and Spence, Roger W, Quality, Uncertainty and the Internet: the Market for
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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

Cyber lemon, American Economist, 2002, 46(1), pp.50-60.
Ian Molho, The Economics of Information: Lying and Cheating in Markets and Organizations,
Oxford: Blackwell, 1997.
Jeffrey F. Rayport and John J. Sviokla, Managing in the Marketspace, Harvard Business
Review, 1994, November-December, pp.142-150.
MccLea, Bethany, Wheat, Alynda, The Internet is a lemon, Fortune, 2000,13, pp.146-153
Warbelow A., Kokuryo J., and Konsynski B., "AUCNET: TV Auction Network System,"
Harvard Business School, 1989. (Rev.1996)
Yong Pan, Research on the ‘Lemon’ Problems in the e-marketing, Proceedings ofInternational Conference on e-Business（ICEB2002）, Beijing Institute of Technology Press,2002,
pp.236-241.
Yong Pan, The Evolution Tracker of the Lemons Market Model and its Latest Progress in
Cyber Market, Economics perspectives,2004,2, pp.50-58. (in Chinese)
Yong Pan, Adverse Selection in E-Marketing: Analysis Based on the ’Lemons Market ‘Model,
Economic Management Press, Beijing, 2005. (in Chinese)
http://www.aucnet.co.jp/

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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market

Appendix: How to Use AUCNET ?
For selling dealers to use AUCNET system, the first step in the process is to apply forthe consignment to offer cars through AUCNET. Once the consignment application isreceived, AUCNET dispatches one of its mechanics to inspect the offered vehicle.
The inspector assesses the condition of cars and takes several photos of the vehicle.
The inspection results are then entered into AUCNET central computer for the auction
catalogue editing. The auction catalogue is transmitted to all members prior to theelectronic auction. If a dealer is interested in a specific car listed in the catalogue, he or
she can access text-based information and can preview its mages from his/her computer
terminal.

Figure 5

Auction Screen display

When auction is started in AUCNET, buyers and sellers remain at their respective
businesses. Buyers use joysticks in their dedicated terminal that are connected to thecentral computer of AUCNET (see Figure 5). Each button of joysticks increase the current
bid by ¥3000. If the bid price approaches the reserve price, the system informs the bidders
that the car would actually be sold. If the time between bids reaches a certain threshold,the system selects the last high bid as the winner, and the auctioneer announces that the
car is sold with text signal of "SOLD" flashed on the screen. This real time auction with aused car auctioned every 20 seconds.

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Yong Pan (2006) Cyber “Lemons” Problem and Quality-Intermediary Based on Trust in the E-Market●早稲田大学ＩＴ戦略研究所

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