Competition in durable goods markets: The strategic consequences of leasing and selling

In marketing durable goods, manufacturers use varying degrees of leasing an d selling to consumers, e.g., cars, photocopiers, personal computers, airpl anes, etc. The question that this raises is whether the distinction between leases and sales is simply one of price, or whether the proportion of leas es and sales effects a firm's ability to compete in the market. In this pap er we use two approaches to argue that leasing and selling: create strategi c consequences that extend beyond prices. First, we develop a stylized theo retical model that shows that the optimal proportion of leases and sales de pends on the competitiveness of the market and on the inherent reliability of the firm's product. And second, we find support for the implications of our theoretical model with data from the automobile industry. The U.S. automobile industry has seen a large increase in leasing over the last five years. However, the extent to which leasing has been embraced var ies widely across manufacturers. For example, in 1993 the sport utility seg ment had the following lease percentages: Ford Explorer, 29%; Jeep Grand Ch erokee, 24%; Toyota 4-Runner, 11%; and Chevrolet Blazer, 9%. In addition, m anufacturers often vary lease percentages across models. For example, in 19 93 Ford leased 22% of its Crown Victoria model, 35% of its Taurus model, an d 42% of its Probe model. A popular argument for why we see these differenc es is that higher priced cars are leased more often because leasing makes t hem more "affordable." However, this rationale is not compelling in the fac e of our data. For example, the Ford Probe was priced significantly lower t han the Crown Victoria and yet it was leased almost twice as often. To develop a better understanding of why we observe differences in the prop ortion of leasing, we develop a two-period model of a duopoly in which each manufacturer chooses its optimal quantity and the fraction of units it wan ts to lease. We find that in equilibrium neither firm leases all its units- either they use a mix of leasing and selling or they use only selling. Our analysis suggests that the fraction of leased cars decreases as the manufac turers' products become more similar and the competition between them incre ases. The intuition for this result is that a higher fraction of leases put s the firm at a competitive disadvantage in the future. This occurs because , unlike firms that sell their product, firms that lease are at a price dis advantage. Another important finding in this paper is that the extent of leasing chose n by a manufacturer depends on the reliability of its product. In particula r, all else being equal, the lower a product's reliability, the lower its p roportion of leases. Within the context of the automobile industry, this su ggests that more expensive cars may be leased more often because they are o f higher quality and not necessarily because they are more expensive. Finally, we test the implications of our theoretical model with data from t he U.S, automobile market. In particular, for 1993 model year cars, we deve lop a measure of reliability using data from Consumer Reports. In addition, we develop a measure of the extent of competition in each segment of the a utomobile market. We support our hypotheses by finding that the extent to w hich a car model is leased depends strongly on its predicted reliability an d on the competitive intensity within the segment.