Planned Obsolescence

One thing that you will hear a lot of non-economists talk about is the idea of planned obsolescence. This is the idea that companies deliberately design products to have a limited shelf life. The argument that non-economists use to justify this argument is that firms do this because it allows the firm to maximize its profit. The more frequently the good has to be replaced, the more often it has to be purchased. Thus, higher profits.

Economists are often quick to dismiss these claims. Durability has value. People should be willing to pay for it. For example, if I am choosing between two lightbulbs, I will be willing to pay a higher price for the lightbulb that lasts longer. So doesn’t planned obsolescence lead to lower prices? Is that necessarily good for the firm?

Similarly, what we know about brand names and reputation would seem to suggest that planned obsolescence is a poor strategy. High-quality products that last a long time are likely to bring value to the firm’s brand. The present discounted value of the profit from a loyal customer is almost surely greater than the profit earned by selling the same consumer a product that is deliberately designed to have a short shelf life.

It would seem from these arguments that the typical economist’s argument wins out. Once you consider the dynamic relationship between firms and their customers, why would any firm try to create a product that has a deliberately short shelf life? Logically, the economists seem to have won this one. However, empirically, the non-economist has a point.

We know that there are products out there that are designed to become obsolete. I learned of a great example of this from Doug Allen. Apparently, in the late 1990s, a seed company issued a patent that uses genetic modification to limit the germination of seeds. The technology literally prevents plants from producing seeds that can produce additional plants. The plant is sterile.

This seems like precisely like the sort of thing that the standard economist argument would rule out. It is not immediately obvious why this would be beneficial to the seed producer. Wouldn’t farmers be willing to pay a higher price for seeds that do not have this feature?

Where is price theory when you need it? How in the world is price theory going to explain this when the standard arguments I described get it wrong?

As usual, the answer finds its origin at UCLA. This time with Harold Demsetz. When we think about exchange, we are thinking about the transfer of property rights. Many times, we are simply taking property rights as given. In fact, sometimes we examine the implications for exchange when private property rights are absent. But whether property rights are present or not is simply taken as given.

Demsetz argued that we should think about the reasons why private property rights do or do not exist. To do so, we need to think about the costs associated with the establishment and enforcement of property rights as well as the value of the property itself. According to Demsetz, property rights will be only be established and enforced if the benefits of ownership exceed the costs of establishing and enforcing ownership. Furthermore, the value of the property can be thought of as the difference between the value it would have in a world of zero transaction costs and the cost of maintaining and enforcing property rights. If the costs of establishing, maintaining, and enforcing property rights exceed the value of the property in a zero transaction cost world, then no private property rights will be established.

The reason that this is important is that it suggests that reducing the costs of enforcing property rights can increase the value of the good. Thus, even with goods for which private property rights already exist, there is an incentive of the owner to try to reduce the costs of maintaining and enforcing the property rights.

With that as a backdrop, let’s go back to the example of the seeds that produce sterile plants and therefore prevent reproduction. Why would anyone create such a thing?

Seeds that produce plants that reproduce are valuable to the farmer because it means that seeds purchased today are not only good for one period, but subsequent periods as well. The farmer cares about the present value of all of the future crops that these initial seeds will produce. Since the present value of plants that reproduce is greater than the present value of a seed that produces a plant for only one period, the farmer would be willing to pay more for these seeds (all else equal). However, all else isn’t equal. These higher valued seeds also create costs for the farmer. These seeds require storage and are subject to the risk of theft.

By offering farmers a seed that only lasts for one period, they are getting a seed that has less value to them, but they are saving the storage costs and avoiding costs associated with the possibility of theft. The farmers are getting much of the same benefit as before (although paying for it period-by-period), but the costs associated with maintaining and enforcing property rights decline. Thus, the seed company is increasing the value of the seeds for farmers.

At the same time, since these seeds have a lower present value than the old seeds, their use not only reduces opportunities for theft (less seed storage), but also reduces the rate of return that thieves generate from theft.

In this case, planned obsolescence benefits consumers and harms thieves.

Of course, this is not to say that the standard economic argument is wrong when it comes to planned obsolescence. For most goods, the standard economics argument likely applies. Applying the logic of Demsetz and Allen, we have a testable prediction about when we should and should not expect planned obsolescence to be observed. Specifically, we should expect planned obsolescence to occur whenever this characteristic significantly reduces the costs of establishing, maintaining, and enforcing private property rights.