*** For a practical guide that uses the principles described here, get my free Repair Or Replace Worksheet. ***
When I first sat down to write about the “repair or replace” dilemma, in the back of my mind there was a vague notion that a simple, calculation-based method would be the ultimate solution. I had heard of the 50% Rule and thought that it (or something like it) would be the obvious centerpiece of the decision-making process.
However, my thinking on the topic quickly evolved. As I reviewed my own history of grappling with “repair or replace,” especially in the context of my role as a CTO, I found it wrapped up in all the glorious complexity of the problems faced by the entrepreneur. The need a machine fulfills is the driving force behind the decision-making process. The myriad ways in which we use machines to satisfy our desires, along with the constraints and benefits presented by a particular situation, are difficult to express in an equation.
Both repair and replacement have a long list of pros and cons associated with them. Depending on the circumstances, the controlling factor that ultimately drives your decision can vary widely. Can a formula take into account all of this complexity, and spit out the correct answer? My first pass left the 50% Rule wanting as a tool: it had no obvious way of incorporating the aspects which I felt were primary considerations, so I completely cut any mention of it from my original piece, “Repair Or Replace?”.
Still, I was determined to revisit the issue and test the 50% Rule as a decision-making guide. That’s because I found so many references to it in various advice columns pitched to everyday consumers. Even the vaunted Consumer Reports magazine cites it as a rule of thumb to resolve the repair or replace conundrum. Perhaps the 50% Rule couldn’t describe the complicated decision matrix used to choose a machine for a particular purpose, but maybe it did have a narrower context in which it should be called upon? I wanted to find out.
It’s Still Worth Something, Right?
Before we get to the 50% Rule, I want to discuss some basic ways to think about the economic value of repair. Let’s start at the beginning, with the broken system itself: it’s easy to forget that, although a machine is broken, it usually retains some worth. If you choose to forgo repair, you can often receive something in exchange for a non-working system. That something is called the salvage value. In accounting, the term has a specific meaning with respect to depreciation: “the estimated value that an asset will realize upon its sale at the end of its useful life.” Of course, whether or not to extend the “useful life” of a machine is exactly the decision we’re trying to make.
Salvage values will vary widely depending upon the type of machine and the market for its components. Many times a car, even in a state of total disrepair, can be sold for parts to a local junkyard. Consumer electronics often fare much worse. For instance, considering a new one can be had for almost nothing, a broken DVD player will likely have no residual worth to others. There’s one more twist: sometimes a machine’s salvage value can be negative if there is a disposal cost involved. While I have sold cars to the junkyard in the past, I haven’t always been successful in this endeavor. I remember when my first mini-van (don’t laugh, it was a pretty sweet ride), which I drove out West when I first moved to San Francisco, was involved in an accident and completely wrecked. I called several local junkyards and was surprised that nobody wanted it—even when I offered it to them for free! I contacted some local tow-truck drivers, who had personal relationships with many more firms than I tried initially, and even they couldn’t give it away. That mini-van ending up having a negative salvage value of several hundred dollars, which included a disposal fee and the cost of a tow.
Scarcity and demand drives the salvage value: you can easily see this in the price paid for vintage cars and their parts. For example, there were only a couple thousand Plymouth Superbirds built. Working or not, these cars are highly sought after by collectors and restorers, commanding a much higher price than similar vehicles from the same era. Finally, on the extreme end of salvage values, I present this fine specimen to you: in 2011, Tata Motors unveiled an insane version of their Nano, slathered in about $4 million worth of precious stones and gold (80 kg, 22 karat!). The grandiose bling-o-rama of this publicity stunt has a curious effect on the salvage value of such a car:
- Working gold-and-jewel-encrusted Tata Nano: $4 million
- Not working gold-and-jewel-encrusted Tata Nano: $4 million
Functional or not, this car is worth about the same. This is one of those rare examples where a machine’s value is independent of its working state.
Whereas a breakdown takes away from a machine’s value, repair should add it back. However, recapturing that added value when it comes time to sell is constrained by the other options available to buyers in the market. You may be objectively improving a machine’s capabilities by having it fixed, but that investment won’t necessarily be recognized by buyers and returned to you later on. Let’s walk through a classic example of an uneconomic repair scenario. You purchase a used car at the righteous price of $500. It may not look like much, but hey, it’s transportation:
After driving it for a few months, it breaks down. After consulting with a mechanic, it is determined that the transmission is bad and needs to be replaced. The total bill (parts and labor) for a new transmission is $2,000. You agree to the repair, thinking “If I spend $2,000 fixing the car, it should be worth at least that amount afterwards, right?” A year later, you want to upgrade your wheels and put the car up for sale, but are unable to find a buyer in the $2,000 range. In fact, the best offer you get is $500, what you originally paid for the car in the first place. What happened to your significant repair investment?
Well, when you bought the car, you had many options of what to do with your $500. Likewise, your potential buyers do as well. Car shoppers won’t care what you’ve spent on the car in the past: they’re only concerned with what their money can buy them now. If the prevailing market price for a similar used car is $500, then that is where you’ll need to price yours if you want it to sell. Sadly, all your $2,000 investment did was to restore the car to the point where it could be considered an equal amongst the other options in the $500 range. Sure, it has a brand new transmission, making it an undeniably better car in that respect, but look at the options from the perspective of a buyer. They could take your asking price of $2,000 and buy four (4 x $500 = $2,000) equally bedraggled chariots, driving each one in turn until it dies.
The lesson here is that the market will limit your ability to recapture the cost of repairs when it’s time to sell. We can describe this situation mathematically and attempt to discover in advance if we’re about to create a loss. I’ll show you the formula for the implied value of a repair, to see how the market values it. First, let’s define a couple of variables:
- msalvage = market value of the broken machine (aka, the salvage value)
- mpost-repair = market value of the machine after repair
- rvalue-added = value added to the machine by the repair
which are related like this:
mpost-repair – msalvage = rvalue-added
For our transmission example, let’s say the salvage value of our car was $100. Sadly, we found out that the resale value of the car, even after making our costly repair, was only $500. Therefore the implied value of the transmission repair was:
$500 – $100 = $400
This fix raised the value of the car from its salvage value of $100 to $500, so we can say that the market value of the repair was the difference: four hundred dollars ($400). I know what you’re thinking: unfortunately, we paid $2,000 for this work!
Let’s prevent this from happening again. We’ll define one more variable:
rcost = the direct, out-of-pocket cost of the repair
and note the relationship for an economically sound repair decision:
rcost ≤ rvalue-added
This inequality says that the improvement in the market value of a machine should be less than or equal to the cost of the repair. In our case, that was not true. We paid $2,000 which resulted in an increased value of only $400. Instead, we might have had more fun losing it at a casino, or created an art film of ourselves burning the money. At least that would have made for a good cocktail party story.
Therefore, we can calculate a profit or loss from a repair as follows:
rvalue-added – rcost = rprofit/loss
In the case of our $2,000 transmission repair, that would be a loss of:
$400 – $2,000 = -$1,600
Ouch. However, if you stay on the sunny side of this equation, there’s also the chance to make gains from your repairs. Let’s say you have an amazing pair of mechanics at your disposal, like the deeply expert Tappet Brothers (perhaps the most famous troubleshooters of our time). They take your hunk of junk, make a few clever jokes (at each other’s expense), and fix the transmission for $50. This allows you to sell it for $500 to some other sucker. Now, the profit/loss calculation (r(value-added) – r(cost) = r(profit/loss)) is a very happy one:
$400 – $50 = $350
A $50 repair that improves the market value by $400 is a slam dunk.
Where Did The Dough Go?
The risk of not recapturing your investment is present in so many different situations in life and business. Home renovations instantly come to mind: you can do the same analysis of a dwelling’s price before and after a remodel. It’s very easy to spend money on renovations that do not increase the value of a home by an equal amount, just like in the transmission repair example above.
But…where did the money go? How can it just disappear? This brings us to a very interesting aspect of making improvements to your possessions. Whether it’s repairing a car, house, refrigerator, or computer, if you intend to resell it, you have become a de facto entrepreneur. No longer is the decision about the subjective value you receive from a successful repair, but rather about anticipating the future needs of buyers and the market conditions when it comes time to sell.
Fixing a broken machine with the intent of eventually reselling it is conceptually no different from what any manufacturer does. A pencil-maker assembles things like brass, cedar, factice, glue, graphite, lacquer, pumice, and wax. Combining and transforming these raw materials with labor, he tries to correctly anticipate the public’s demand for writing instruments, hoping to sell the pencils for a gain. (Please read “I, Pencil” for an eloquent and eye-opening narrative of the coordination and complexity required to produce this consumer staple you’ve probably taken for granted.)
In the case of the transmission repair, even though our product was a one-off, we temporarily became a manufacturer. We took some intermediate goods (a broken down car and replacements parts), hired some labor (the efforts of a mechanic), and created a new product: a lousy car with a brand-new transmission. However, is this something that potential buyers want and are willing to pay for at the price we will offer later on? I think it’s safe to say that the people who desire run-down cars want them precisely because they don’t have brand-new transmissions. That is, they’re trying to save money!
We could drive that car another 500,000 miles until the transmission died again, making the repair solely for our own consumption. In that case, any market-based loss would only be theoretical. Whatever the outcome, devoting resources to the fix could be justified exclusively on our own hierarchy of values. Again, the market price is different from how much a repair is personally worth to you.
Of course, we’d still need to contend with opportunity costs, that nagging suspicion that our money could have been better spent elsewhere. The $2,000 we dropped on the transmission repair could easily have been allocated differently. Our beater could have been sold for its salvage value of $100. That amount plus $400 from our savings could have been spent on another fabulous jalopy. Our transportation problem solved, the remaining $1,600 could then have been used on…a fabulous vacation to Hawaii! No matter how we forked out that $2,000, we always run the risk of deciding, in retrospect, that it could have been better spent.
Now that we’ve laid out the basics for how to think about the value of broken machines and repairs, let’s move on to the 50% Rule. First off, we should define the maxim. The basic idea is that you compare the cost of repair to the cost of replacement. If repair exceeds 50% of a particular threshold, the rule says you should opt to replace. But, if a repair can be completed for less than 50% of the baseline, then you should choose to fix. So, the inequality favoring repair looks like this:
Repair Cost < Replacement Threshold × 50%
Unfortunately, I couldn’t find an official definition of the 50% Rule, at least with respect to the repair or replacement of machines (it seems more well-defined in the world of real estate, insurance, and disaster recovery). What’s especially problematic is that the threshold value that repair is weighed against is variously cited as:
- The original purchase price of the broken machine.
- The current replacement value of an equivalent machine (i.e., a similarly used one).
- The cost of a new machine.
For a given situation, each of these benchmarks could provide a wildly different answer, tipping the scales in either the direction of repair or replace. Figuring out what the standard should be is going to be our first challenge, and we haven’t even gotten to the math and statistics behind the rule.
The (Original) Price Is…Wrong
Using the original purchase price as a standard for the 50% Rule would seem to be the most problematic of all our choices. If a machine is old, inflation will have eaten away at the value of the price you paid for it, making it appear smaller. Using this as a benchmark will sadly tell you more about the misguided policies of central banks and the debasement of your money over time (leading to a wholly different “repair or replace” discussion). While I encourage that introspection, it doesn’t advance our goal of figuring out what to do with a broken machine. Also, it seems like a lot to ask the average consumer to get out a table of inflation statistics and calculate constant dollars, tied to some benchmark year, like economists do. Although, the folks at the US Bureau of Labor Statistics have made it awfully easy to do just that, with this handy web-based inflation calculator.
Counterbalancing the effect of inflation on the original cost is technological change, which will make the original price paid seem much larger. For example, the first all-purpose digital computer was named ENIAC and built at the University of Pennsylvania in 1946. This “giant brain” was built at a cost of $500,000 (about $6 million today). Using that sum to weigh a repair decision, with the idea that you would pay to have another ENIAC built (even just a few years later), is folly. When it comes to industries where rapid innovation is taking place, current designs are often better in all respects and cheaper too. This is definitely the case for most consumer electronics, especially those subject to Moore’s Law.
Get Me Another One Like This (That Works!)
The replacement cost of an identical machine (i.e., a used one in similar condition) would seem like a better choice as a basis for comparison, given that it keeps the variables in play at a minimum. This standard attempts to make an apples-to-apples comparison by asking “How much would it cost to acquire a machine exactly like this?” Of course, you want a machine just like the broken one, with one important difference: the replacement should work! Since the replacement cost is the price as of now, this standard won’t suffer from time-based distortions like inflation or technological change.
However, we should be clear about the practical problems with this as a standard to be employed in real-world situations:
- Finding an available identical replacement is often impossible. You may be contemplating a repair or replace decision for a 2012 Porsche Carrera with 10,000 miles, but what if the closest you can find in your area is a 2011 model with 25,000 miles? To use replacement cost as a benchmark implies that a replacement can actually be purchased! You may be able to look up the theoretical value in a price guide or see recent auction closing prices, but that doesn’t mean that one will be readily available to actually buy.
- Even if you can find an identical machine, it will not have been used the same way. Imagine two cars, rolling off the assembly line one after the other at a car factory. These twin specimens may be the same make, model year, and have the same installed options. However, one car is delivered to a suburban family and the other to the fleet of a taxi company. After 10 years of use, these “identical” machines will be quite different: their wear patterns will reflect their much different working lives.
- For relatively rare machines, there may not be a thriving secondary market from which to obtain pricing information. How much would it cost to buy a 1931 Royal Enfield Bullet? It might have been years since one changed hands! Also, are the parties willing to disclose the price paid? How much is your time worth to obtain this information? Remember the concept of opportunity costs before embarking on a wild goose chase for something rare.
You’ve Moved On
As time moves on, your needs will inevitably change. This is the biggest problem with automatically assuming an old machine (in the guise of replacement cost) should be revived or searched for in the used market. Machines amplify our purposeful intentions; any rule of thumb that doesn’t take this into account is missing the point about why we employ them. Although general purpose, the ENIAC was designed to solve WWII-era problems: the calculation of artillery firing tables. In contrast, the increased power of the later BRLESC-I (Ballistic Research Laboratories Electronic Scientific Computer, launched in 1962) was needed to solve Space Age and Cold War problems involving nuclear weapons, missiles, and satellites. The ENIAC could perform 5,000 operations per second, but the BRLESC-I could do 5 million. Repairing or replacing an equivalent machine isn’t an option when your needs have changed. It doesn’t matter if we’re talking about a supercomputer, toaster, car, or backhoe.
Having a machine that was doing useful work for you malfunction is a loss: the resources you must now devote to its repair or replacement can’t be used elsewhere. While this is a drain, you should make the best of it. Since change is being forced upon you, take the opportunity to fully reassess your needs vis-à-vis the machine in question. Often, you’ll find that things have changed and your purposes could be better served some other way. At these pivot points, I’ve often made the decision to upgrade or downgrade, finding a better fit with either a more or less capable machine. (Please see the section titled “The Need, Reassessed” in “Repair Or Replace?” for the full discussion of this point.)
I’ve also decided to do nothing: that is, to neither repair or replace, opting instead to simply cut ties and sell a machine for its salvage value. Especially for those things we employ for leisure (aka, “toys”), you may find that the “need” was weak and your life is better off without them entirely. Maybe you impulsively bought a boat that you thought you’d use every weekend. But, the maintenance hassles and your busy life resulted in the craft only being used twice a year. Perhaps you’d like the garage space back. Remember the old saying: “The two happiest days in a boat owner’s life are the day he buys it and the day he sells it.” The sentiment behind this adage applies to so many things, not just boats!
Lately, I’ve gained a tremendous satisfaction from reducing the number of “things” in my life. Your stuff has an overhead which may carry an unwelcome cost of ownership, especially if your life is already full. In these cases, a malfunction may be an invitation to simplify and regain the most precious resource of all: your time.
Why Would I Pay More For The Same Thing?
Even though replacement cost has some potential issues, at least we’ve found a basis for comparison that’s internally consistent and up-to-date. Unfortunately, there’s a huge problem with using replacement cost to calculate the 50% Rule: it doesn’t make any sense! Here’s an example that shows why: let’s say you buy a refrigerator and it stops working after the warranty period expires (drat). Yours is a common model that’s sold millions of units, so equivalently used replacements are easily had for $400. The estimate for repair is $240. The 50% Rule is:
rcost ÷ mreplacement < 50%
In our case:
$400 ÷ $240 = 60%
If repair costs $240 and an equivalently used replacement is $400, repair is 60% of the replacement cost. In this case, the 50% Rule says to replace. What?! Think about what this means; we are supposedly comparing apples-to-apples. If you could pay $240 or $400 for the exact same thing, which would you choose? That’s right, the cheaper one! When comparing equivalent items, as long as repair is less than the replacement cost, you should repair (and vice versa). For this reason, there’s no way we can use replacement cost as the benchmark for the 50% Rule. Bizarrely, it recommends spending up to 100% more—for the same thing!
Perhaps instead we should be comparing the cost of repair to buying a new machine. This has great appeal, given the problems often associated with finding a suitable and identically used replacement. Whether on-line, in a local store, or via a phone call to a sales representative, manufacturers make it very easy to buy new. Information for new products is available in abundance: delivery dates, specifications, and, most importantly, pricing details. Return policies are often generous compared to the “as is” nature of used sales. Warranties mitigate the risk of a buying a “lemon” and give predictability to service costs (at least for a limited time). There’s much to be said for buying new.
However, again we run into the fact that choosing new as the standard for comparison of the 50% Rule requires a very important judgement to be made first. Why incur the additional expense of buying new if a used machine will adequately meet your needs?
Aye, here’s the rub: with new as the standard, we’re not comparing apples-to-apples anymore. A new machine will have different capabilities, warranties, maintenance costs, and longevity expectations. Presumably, we’d like to assign a dollar value to these advantages and see if the additional expense was worth it. The only thing the 50% Rule would seem to say about the matter is that used is half as good as new. That’s a pretty crude way to evaluate your choices.
To see how utterly ridiculous things can get when using new as the standard with the 50% Rule, let’s return again to our broken down car that needs a $2,000 transmission. While there’s nothing in the new market that can hope to compare with our finely dented steed, if forced to choose an equivalent new replacement, we’ll go with a lower-end 4-door sedan for $17,000. Let’s see what the 50% Rule (rcost ÷ mreplacement < 50%) says to do:
$2,000 ÷ $17,000 = 12%
Because repair is less than half of the cost of a new one, the rule says to repair. Sorry partner, them’s the rules. Of course, you’d be an idiot to do that given that we’ve shown the market value of such a repair would incur a huge loss. The follies don’t end there: keep in mind that the rule would say that we should consider any repair up to $8,500 (50% of $17,000). More nonsense!
I’m going to stop here and declare the 50% Rule to be a failure as a practical decision-making tool. The rule requires a benchmark and, as I’ve shown, the ones offered all have serious defects. Using them could result in some very flawed outcomes.
If you want numbers to guide you, the value-added model of repair:
rvalue-added – rcost = rprofit/loss
seems like a much better alternative. At a minimum, it should be consulted to warn against expenditures that will not be recoverable when reselling. I think that’s the biggest risk most consumers face and a frequently violated expectation. Because the market value of the machine after repair (mpost-repair) is required to make this calculation, it forces you to consider an important alternative for your money: equivalent replacements available in the marketplace. Finally, the value-added calculation is up-to-date, forward-looking, and incorporates the current state of technological progress, while avoiding the effects of inflation and the temptation to consider sunk costs.
But beyond the numbers, you need to remain in touch with your needs and how a particular machine is serving them. Have those needs changed? What value does a contraption bring to your life or business? How does that compare to the alternatives available (like new models)? These considerations should come before any repair or replace calculations are made, otherwise you will be led by the garbage-in, garbage-out nature of blindly following the results of a formula.
What Do You Think?
I’m perplexed that the 50% Rule is cited as a rule-of-thumb for consumers. If you have a good defense that addresses the problems I’ve uncovered, or points out something critical I’ve missed, I’m all ears. Tell me what you think in the comments section!
*** For a practical guide that uses the principles described here, get my free Repair Or Replace Worksheet. ***
- Header image: “Automobiles. View from front of wrecked automobile.” Theodor Horydczak (ca. 1890-1971), photographer. Library of Congress (LC-H822-T-V01-005).