Fighting to Eliminate Burdensome State Regulation

The cost of the auto distribution system in the United States has been estimated as averaging up to 30 percent of vehicle price, with 15 percent on the end of the manufacturer (in the form of advertising, loans, and rebates) and the other 15 percent solidly on the side of the retailer, or dealer. This 15 percent of the total price of a given vehicle is due to the cost to dealers of financing inventory, paying for insurance, advertising, and paying commissions.1

Early in the history of the US auto industry, most manufacturers sold their vehicles directly to the consumer. However with the advent of Ford’s assembly line and the mass-production of automobiles, distribution was more efficient through retailers since manufacturers mainly had just one or two factories located near resources like steel mills (making the assessment of demand and provision of customer services easier for retailers).

In these early days, this franchise system was conducted through voluntary contracts between manufacturers and dealers. However since then, virtually every state has codified the automobile franchise system, making it illegal for manufacturers to sell automobiles directly to the consumer; largely because states earn around 20 percent of their sales taxes from automobile retail, but also because car dealerships account for, on average, 7-8 percent of employment.2

This model was beneficial to both manufacturers and retailers until the advent of the Information Age in the late nineteen-eighties. With the arrival of global instantaneous information sharing and online automobile sale, disintermediation occurred—that is, the role of the retailer became superfluous (or at least very much different). Cutting back on its number of dealerships has been a key means for GM to reattain profitability.3

Yesterday, Automotive News reported that Tesla Motors CEO Elon Musk (the same billionaire entrepreneur who plans to build a colony on Mars and die there himself, “just not on impact”) will “consider federal options” in his battle to overturn automobile franchise laws. He tweeted a link to a petition calling for the same on the White House’s website (as of this writing it had just over 5000 signatures). Musk runs Tesla Motors on a “mall-based” retail network, which dealers in Texas and elsewhere have alleged violates many states’ laws.

David Hyatt, a spokesman for the National Automobile Dealers Association, responded to this petition’s claim that franchise laws “stifle the auto industry, keep prices of new vehicles up and reduce consumer choice,” stating that “the franchise system is good for consumers, good for communities and good for the economy. Manufacturers that sell their vehicles directly to consumers – and don’t let anyone else sell that vehicle – eliminate competitive pricing.”4

Yet allowing manufacturers to sell cars directly to the consumer could very well reduce inventory costs, and whether it does should be left to be seen. In other words, if retailing actually increases competition and lowers prices, then dealerships will survive the deregulation of the automobile franchising system.

By Asher

References

(1) Saloner, Spence and Marti (2000).

(2) Lafontaine and Morton (2010)

(3) Bodisch, DOJ-EAG (2009)

(4) Wilson, Automotive News (2013)

2 comments to Fighting to Eliminate Burdensome State Regulation

  • Whether dealers are “necessary” is something we’ll talk about; it’s good that you picked up the Tesla, which is attempting to circumvent state franchise law with Texas as a test case. Auto distribution was a key, probably the key, institution in the development of franchising; fast food is strictly post-WWII but as we’ll read, autos date to the 1920s. The case is much more complex than just physical distribution and inventory costs; on a regional basis swapping among dealers addresses the latter, because you can (potentially) sell cars held by others, but selling out of inventory is more profitable. However, a dealership also provides for the purchase of used cars (and then their sale), arranges finance, and handles service. “The Factory” has found that an impossible business to run as part of a large organization, and not just in the US but also in Japan, Germany, the UK and emerging markets such as China, Brazil and India. That ought to suggest that the issues are rather more complex.

    So we might instead ask: what might make Tesla different? Or is this a transitional pattern (which, by the way, ties up a lot of capital)?

    A trivial thing, but look at the “Readings” tab for a sample bibliographic form. The Lafontaine & Morton (2000) article should be cited as:

    Lafontaine, Francine and Morton, Fiona Scott (2010). “State Franchise Laws, Dealer Terminations, and the Auto Crisis.” Journal of Economic Perspectives 24:3 (Summer), 233–250.
  • […] mall-based retailing, and dealers may have a serious problem on their hands. This harkens back to this article I wrote earlier about Tesla’s fight with dealers on state regulation, in that the information age […]

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