# Depreciation and second-hand markets for bicycles

Probably the answer to this question is "business as usual", but I've observed of late that the market for bicycles is pretty weird.

You can buy a brand new factory-produced bicycle in the US (I'm really only talking about the US here) for anywhere from \$50 (when not on sale) to maybe \$10,000 (depending on where you want to draw the line between "production" and "custom" bikes). Some of this difference is due to actual quantifiable value -- the more expensive bikes generally are lighter, handle better, have advanced features, and are marginally more durable (though the cheap bikes are remarkably durable). However, much of the difference is clearly "glitz" -- the latest features, fancy (though oddly impractical) arrangements of spokes in the wheels, etc.

More to my point, however, is what happens to the value of a bike once you "drive it off the lot". A "moderately priced" bike (say \$500-1000) will lose (very rough figures -- I've not done any rigorous research) maybe 50% of its value each year, such that it's market value (if in perfect condition) is less than \$50 after 5 years. The net result is that lower-end bikes are not deemed worth selling when unused, and they tend to accumulate (even worse than other possessions) in basements, garages, and backyard sheds.

I became involved in this "market" because I work with a small group which reconditions used bikes and distributes them to various charities (primarily Christmas Anonymous). Our small group, consisting of about 8 active members working two afternoons a week 8 months out of the year, manages to rehabilitate 200-300 bikes a year. But we get donations of at least twice that amount, with the surplus being sold for scrap. Currently we have so many bikes that many must be stored outside, and it is somewhat disheartening to see, say, a very nice looking bike in good condition, which sold originally for maybe $800, standing in a field of weeds, rusting away. So I get to thinking that there must be some economic principle at work here, beyond simple supply-and-demand, to cause such a skewed market. Why can something of such inherent value (and so highly valued by the purchaser when new) become valueless so rapidly? But I admit that not only do I not have a clue what it might be, but I find myself failing to even describe my perplexity adequately. What principles are at work here? Is there anything "interesting" or instructive in the scenario? (I'm guessing that many will instantly shout "Technology!" -- that technology makes last year's bike much less valuable -- question answered!. But I've observed that "technology" is the last (or is it first?) refuge of scoundrel economists -- technology hardly ever has the economic effect claimed.) • I've noticed the same problem in Sydney - I wanted to buy a used bike but very little shops sell it, and the few that do have restored to the semi-new level (completely new paint job, breaks, rims, etc.). You can barely find used average bikes: only new ones from China, in Target, for 80 AUD, or the new and semi-new ones for 600$+ – JoaoBotelho Sep 27 '17 at 3:55
• @JoaoBotelho - I haven't closely checked local bike shops recently, but my impression in the US is somewhat similar in that 10-20 years ago most shops carried a modest collection of good trade-ins, but the selection had diminished if not disappeared entirely. However, bikes are still available from garage sales and the like (though likely in lower numbers than before). – Hot Licks Sep 27 '17 at 11:43

## 2 Answers

Interesting observation. Perhaps a part of the answer lies in Akerlof's lemons' problem?

Admittedly judging the quality of a 2nd hand bike is easier than that of a car, but from what you're describing in the US there doesn't seem to be a well functioning market for 2nd hand bikes in the US. Moreover, bikes are becoming more and more like cars in that respect with all the gadgets and technology that one cannot fix in their own shed or backyard.

Perhaps it also plays a role that US citizens are not used to bikes and therefore have a harder time judging their quality (just guessing here, and perhaps stereotyping too much). Here in the Netherlands we seem to have a well-functioning market for them that serve all segments (including, I might add, a high theft rate), but everyone rides a bike here, so we should be better at judging their quality.

• With regard to "lemons", I'll note that we see a very distinct "ridden once; put away" (ROPW) phenomenon with some of these bikes -- a bike is purchased, ridden at most a handful of times, then "put away" in its (semi-permanent) storage place. This can be seen by the lack of wear one the bike. When examined, maybe a third of these bikes have some obvious problem (a department-store bike assembled incorrectly, eg), but others are perfectly fine, save for any problems acquired during storage. Basically, the rider decided they didn't really want a bike after all (or were "too busy" to use it). – Hot Licks Sep 20 '17 at 11:57
• "ridden once; put away" is known as ROPA, or a bike that rarely comes out can be termed a "Garage Queen or Princess" – Criggie Mar 11 '20 at 6:43

This is a really engaging question. Not only does it identify an observable pattern (regarding the "depth" or lack-thereof of the second-hand market of bicycles) it also associates that pattern with 'value' (in-use and intrinsic).

"...what happens to the value of a bike once you "drive it off the lot (...) Why can something of such inherent value (and so highly valued by the purchaser when new) become valueless so rapidly?"

Although asymmetric information (see answer by @Maarten Punt) is definitely in play (the seller knows more about the condition of the bike than the potential buyer) I don't think that the second hand market for bicycles is as shallow as described in the question for reasons predominantly related to quality.

Buying a second-hand bike is not as complicated as buying a second-hand car. The potential buyer can readily identify quality characteristics or pinpoint possible mechanical or design failures. The 'lemons' in the bicycle second-hand market are probably less sour than are their mechanical cousins, the automobiles.

The flow of services that a bicycle delivers can be quantified in a roundabout way. Namely, we can-in a sense-use an envelope of services that are substitutes for bicycle services to encapsulate the value of owning a bicycle. In the Appendix of this note we have identified three activities that are used as proxies for the value of a bicycle, namely 'transportation', 'exercise' and 'leisure activities'. The flow of services an average bicycle delivers over the period of one year is calculated to be equal to \$1,834.6. Then, after having decided what the value therein is, we can subtract its price and then obtain a measure of the residual value that the consumer is left with, after assuming the costs needed to obtain a bicycle. As far as the second-hand market for bicycles is concerned, there are three grades of relevant commodities: 1. used bicycles 2. refurbished bicycles 3. scrapped bicycles A 'used' bicycle, is a bicycle that has been purchased relatively recently and is resold by its owner in the secondary market. As far as its quality characteristics are concerned, they are close enough to the respective characteristics of a brand new bicycle of the same make. 'Refurbished' bicycles, are used bicycles that have undergone a-more or less extensive-repair and revamp process. Finally, 'scrapped' bicycles are bicycles that are either sold for parts or recycled altogether. In the Appendix of this note we have obtained a measure of the value of 'refurbished' and 'scrapped' bicycles. They are valued at \$160.278 and \$11.25 respectively. ## Pricing second-hand bicycles Buying a new bicycle can be treated as an investment. By incurring the costs of the investment (the retail price of the bicycle) the user is entitled to 'harvest' the remaining (or residual) value by virtue of ownership rights. Now, the residual value (= \$1,834.6 - price) is subject to depreciation. Buying a bicycle and locking it up in a closet will not retain its residual value intact. Value, dissipates. The rate at which this happens is different for different makes of bicycles. Also, different riders, have different subjective valuations regarding the speed of that process.

What does that mean for an eg. \$600 bicycle? The following graph shows the different value regions that are relevant to pricing the \$600 bicycle in the second-hand market.

The rate at which value dissipates is denoted by $\delta$. Given the price of the bicycle set at \$600, different values of$\delta$imply different time scales for value dissipation. The following three graphs show what happens to the residual value of a \$600 bike under different values of $\delta$.

There are three things to note here.

• First, as $\delta$ increases, the residual value after one year drops (notice the y-intercept at $n=1$). This is true for all the graphs. For moderate values of $\delta$, this point is above the price level.

• Secondly, it takes considerable time for the residual value to cross the \$600 line for moderate values of$\delta$. This can be interpreted as the point when a commodity (the bike in this case) stops being new, in an economic sense. That point is reached when the residual value equals the price. Note, how for$\delta=0.54$in the last graph, the commodity becomes old even before the first year of use ends • Lastly, the number of years it takes for the residual value to fall below the price and become equal to the refurbished value (the x-intercept), falls as$\delta$increases. This is clearly seen in the third graph. What is relevant for the task at hand, is the fact that high rates of depreciation of residual value (high$\delta$'s) imply that the commodity becomes old (obsolete) faster and 'force' it to approach the boundaries of the refurbished market rapidly. This implies that the time it spends in the territory of the 'used' segment is really short or virtually non-existent (notice how on the third graph for$\delta=0.54$, the bicycle, after two years of use-or storage, for that matter-has a residual value that is approx. equal to the refurbished price). Therefore, what happens to used bicycles is heavily dependent upon the relevant value of$\delta$. It seems that relatively high values for the residual value depreciation parameter will scrap the value of a moderately priced bicycle real fast to the point where it becomes worth-less relatively fast. The real question is what sets the particular value of$\delta$at relatively high levels, in the first place. ## Appendix ## Intrinsic value and value-in-use of new bicycles People will use a bicycle for different reasons. All in all, we can think of three obvious use cases for bicycles: 1. transportation 2. exercise 3. leisure activities For small distances (less than 10-20 miles) perhaps it would make more sense to use a bicycle than go on foot or-worse even-use the car. Obviously, substituting cycling for driving (or walking) depends on a host of parameters (like availability of bicycle lanes, average road congestion, cultural attitudes towards cycling, availability of other transit alternatives for small distances, crime rates related to petty theft etc) and relative prices. The price of a gallon of gas seems to be equal to$2.152 (approx.).

Assuming the relevant distance covered by an individual using a gas powered vehicle (small car or other motorized two-wheeler) is 20 miles a day and that in a year this use case of the vehicle is applied two thirds of the time (ie 240 days approx.-because you don't go every day eg to the grocery store) then with an average figure of miles per gallon around 60, operating a vehicle for small distances over a year costs \$172.2 (= 240 days 20 miles/day / 60 miles/gallon$2.152/gallon).

Average annual exercise costs can be as high as \$696. As far as leisure time is concerned, people tend to do different things that suit their personalities, tastes and social backgrounds. According to this time use survey by the BLS, 0.3 of an hour per day is spent in 'Participating in sports, exercise and recreation' activities while 0.415 of an hour is spent in 'Other leisure and sports activities, including travel' (average for both sexes). It seems that the later activity takes 38% more time than the former (0.3 hour 60 min /hour = 18 min and 0.415 hour 60 min / hour = ~25 min). We are going to assume that the costs associated to 'Other leisure and sports activities, including travel' are, also, 38% greater than the costs associated with 'Participating in sports, exercise and recreation', namely they equal \$966.7 (approx.) on an annual basis.

## Labor costs

The minimum wage in the US is on average equal to \$7.55/h. Having 8 persons working for 3-5 hours a day for 2 days a week for 8 months a year amounts approx. to an annual value equal to \$14,850.

## Materials' and equipment costs

From here we get that changing the tires and inner tubs of a bicycle, changing the saddle and break pads and replacing a wheel costs approx. \$80. Treating in the same way 250 bikes amounts to costs for parts of \$20,000. We figure that since the \$80 price tag is a retail price, we'd be eligible for a wholesale price discount say for 40% of the retail value. Thus we calculate that costs for parts would amount to \$12,000 per year.

## Financing costs

So far we've calculated labor costs and materials' costs and haven't included figures for tools and facilities costs or utility expenses etc. We are abstracting from those costs and we assume that financing will need to cover one year of operating expenses, namely \$34,850 (= \$14,850 + \$20,000). The interest rate charged will be LIBOR +/- 2.25% spread. Also, we assume that the loan will have to be repaid in 7 years. With a base rate of 1.7676 (we ignore the spread) the annual financing costs are equal to \$9,601.4.

## So, what's the imputed price of a refurbished bike?

Combining the scrap value of the frames and the costs associated with the process of restoring bicycles to operating condition, should provide a lower bound for the value of a refurbished bicycle. It is a 'lower' bound because there are certainly other costs and overheads we didn't include in our calculations and also because our calculations are rough and not precise.

With that in mind, \$160.278 seems to be the (opportunity) cost of a refurbished bicycle (assuming a 3% profit margin on labor and materials' cost). • Please keep the comments civil. Please do not threaten to flag people and just flag things quietly. – Kitsune Cavalry Oct 8 '17 at 19:09 • It is still better not to tell someone you are wanting to flag them. It can only bring more arguing. – Kitsune Cavalry Oct 8 '17 at 19:19 • If I have time later I'll try to come back to this question. – Kitsune Cavalry Oct 8 '17 at 19:55 • You conclude by saying "The real question is what sets the particular value of δ at relatively high levels, in the first place.", where δ is the depreciation rate. I thought this was exactly what the poster was asking, albeit in plain English. – M3RS Oct 12 '17 at 19:41 • You are saying that a high value of δ is a possible explanation for the high depreciation rate for bicycles. But δ is the depreciation rate, so this is saying nothing. Think about it for a bit. The question is why δ is high for bicycles, which is left unanswered. On your first point, the poster has a pretty clear idea of "what happens to the value of a bike once you "drive it off the lot"", so this is not one of the questions. He writes, "A "moderately priced" bike (say$500-1000) will lose maybe 50% of its value each year". – M3RS Oct 12 '17 at 21:36