Automotive News recently published an article about Tesla and its nontraditional distribution model for its high-end electric cars. Usually, automobile manufacturers establish relationships with independent businesses to sell vehicles in a particular market and do not sell vehicles directly to consumers. There are a host of reasons why manufacturers would want to do this. Dealerships are very capital-intensive. They typically have large overhead costs because of the size requirements of a typical dealership (display areas, utilities, service areas, showrooms, offices, etc), high staffing costs because of the number of employees required to operate the dealership, and high inventory costs. Automobile dealerships purchase their new vehicle inventory from their respective franchisor, and payments are due upon release of the vehicles from the factory. So, by shifting these costs and risk to the independent dealership, the manufacturers can expand into new markets with little to no significant increases in cost.
Tesla has taken a different approach. Instead of seeking out independent businesses to sell Tesla vehicles through a franchise arrangement, Tesla will sell vehicles directly to consumers. Tesla selected several strategic locations that allow consumers to get information on the vehicles and experience them firsthand. Some states do not allow manufacturers to own dealerships directly. In these states Tesla seeks to operate a showroom to display the vehicles but claims it will not offer the vehicles for sale from these locations. Many state dealer associations have challenged the legality of Tesla’s showrooms in their respective states.
Tesla’s distribution model presents a novel question of legality since most state franchise laws were written to address steps taken by manufacturers to sell vehicles outside of franchise agreements with independent businesses (a case study of Ford’s activities that gave rise to the modernization of many state franchise laws can be found here.) Since Tesla does not have any franchise agreements with independent businesses, there are questions regarding if many state franchise laws apply to Tesla’s practices.
There are numerous arguments for and against the franchisor/franchisee arrangement and car sales. I’m not going to address those arguments here. Instead I will illustrate why this distribution method may be harmful to many parties. Consider the following scenarios:
- Suppose an offshore manufacturer sets up dealerships in malls and sells vehicles to consumers that end up having serious flaws. Said offshore manufacturer then terminates its leases at its mall locations and ceases all operation in the United States. The US holding company handling the offshore manufacturer’s presence in the US has no assets. Consumers have nowhere to turn to seek relief for their damages.
- Suppose Ford, taking a cue from Tesla’s success against state dealer associations, decides to create a brand called “Continental” that will be sold at high-end malls, storefronts in ritzy parts of town, etc. Ford will continue to make Lincolns, but it is clear that Continental receives the lion share of Ford’s investment in non-Ford branded vehicles and Lincoln suffers accordingly. A few years pass, and Continental never pans out for Ford as planned. Ford decides to discontinue Continental but keeps Lincoln because of state franchise laws make termination of a brand costly. Consumers that purchased Continentals are now left with cars that have reduced value and may or may not receive after sales support (service and parts). Depending on how Ford structured its subsidiary, consumers may have no redress against Ford for issues with Continental. Ford-Lincoln dealers are harmed because the value of the Lincoln brand was greatly diminished by lack of investment (that was diverted to Continental).
As the scenarios above illustrate, direct selling shifts a lot of risk to consumers. Many states require manufacturers to compensate dealerships for the termination of brands, and make termination of dealerships very difficult. These protections are very beneficial to consumers as well. They ensure that smaller markets can be serviced by existing dealerships and they make manufacturers think twice about exiting a local, state or the national market. In particular, the second scenario that hypothesizes a new luxury brand by Ford is the more likely of the two scenarios to happen should Tesla prevail against state dealer associations. If manufacturers were free to develop brands for sale outside of their existing network, they would effectively obliterate state franchise laws that protect both dealerships and consumers. Manufacturers could create and kill brands with ease, leaving customers with assets with little value and little recourse.
While it may not be such a big deal for seasonal retailers like Halloween and Christmas stores to come and go from a community, many state and local governments don’t want the same for businesses selling vehicles. Auto retailing is highly regulated by federal, state and local governments. Vehicle sales entail title and licensing requirements, and dealerships have to comply with a host of other regulatory requirements. The majority of these regulations serve to protect consumers, which complement the protection afforded by state franchise laws mentioned above.
Dealerships and manufacturers alike seek to make purchasing a car as easy as possible. Nevertheless, buying a car is an infinitely more complex transaction than purchasing an iPhone, PS3, or sweater. There is no question we can do better to make the sales process more consumer friendly. What we shouldn’t do is make the transaction more risky for the consumer.
Source: Automotive News (linked to in this post).
Image Courtesy of Gawker