Tesla’s dealer franchise problem

Tesla lost a significant battle last week in the state of New Jersey when the state decided to block direct sales of Tesla vehicles. Tesla has prided itself on having tight control over its branding and marketing, even bringing in Apple’s former head of retail Geroge Blankenship to help design its retail stores. And in order to do so in the automotive space, it chose to flout state laws which require automakers to use middle men—independent dealer franchises—to sell cars.

Tesla says that because electric vehicles are such a new technology the company needs to be able to communicate directly with prospective customers. It’s a reasonable argument, and there is a reality to the fact that it’s a much more advantageous position for Tesla to be able to educate the public with consistent marketing and consumer experiences across all stores, something that’s impossible to do should it have to deal with tens or hundreds of individual dealers.

Unfortunately, Tesla is dealing with a system that is entrenched.  A 2010 article in The Journal of Economic Perspective by Francine Lafontaine at the University of Michigan’s business school and Fiona Scott Morton at Yale’s School of Management make a couple simple points about the current incentives for states to perpetuate the system.

First states can earn up to 20 percent of all sales tax revenue from new car dealers. States can still collect sales tax on direct to consumer sales but the sting of many states’ lengthy battle with Amazon may still be present when any consideration of setting a precedent for dismantling a decades long system that has shown proven tax revenue is on the table. Additionally auto dealerships can account for 7 to 8 percent of all retail employment. Those folks vote. And lobby.

From the economic perspective of the automakers, dealer franchises eat into their margins as they have to share profits with middlemen. Distribution costs are also likely higher since automakers don’t control dealer locations. It also makes automakers much less nimble in marketing and controlling their retail channels.

Some studies suggest that ultimately dealer franchises lead to higher costs for consumers though there’s also an argument that in areas with multiple competing dealer franchises, there’s the prospect of competition between various franchises for customers, which should lower prices. Though given the diversity of automobiles for sale today, one could question whether there’s any actual obligation for an automaker to be part of a system that may make their car less expensive by promoting competition among dealers. The granting of exclusive territories to certain franchises almost certainly raises prices for consumers.

Ironically, it wasn’t Tesla that got folks reconsidering dealer franchise laws. It was the period between 2009 and 2011 when it was unclear whether the automakers would survive the financial crisis. Many had to consolidate brands, which meant consolidating dealerships, something that proved much more complicated given the fact that they didn’t control dealers.

Additionally, there was great anger over the bailout money. Lafontaine and Morton wrote in 2010:

Prior to the auto industry bailout in 2008, franchise laws protecting auto dealers transferred profits from manufacturers and consumers to dealers. Now, these laws also effectively transfer bailout funds from taxpayers to auto dealers.

Historically there were arguments for greater protection of dealer franchises. Due to the power of automobile manufacturers in the 1950s, many were able to draft unfair contracts with franchises that didn’t even require the manufacturer to supply automobiles and allowed them to cancel those contracts at any time. After failing in the court system in multiple suits with manufacturers, dealer associations were formed and sought improved bargaining power with manufacturers. And ultimately, legislation. It’s these same dealer associations that are fighting Tesla today.

By 1956, the dealers had been successful, earning federal passage of The Automobile Dealers’ Day in Court Act (ADDICA), which gives dealers the right to sue manufacturers for not acting in good faith in complying with the terms of the franchise. Dealers also were successful at the state level and even a recent 2009 estimate indicated that dealers have legislation pending in two thirds of state legislatures.

No doubt Tesla knew it had a major fight on its hands, trying to go against almost sixty years of legislative history, entrenched dealer associations, and major lobbying powers.

What interests me is whether any of the big automakers might be willing to risk their relationships with franchises (along with some nasty lawsuits), and support a reform of dealer franchise laws in the interest of having better control of their marketing and distribution. That’s pretty unlikely. And for many of the automakers, particularly those in the luxury market, I’m betting they’d rather Tesla just go away. Which is equally unlikely.

So until then, what we have is the first shot in a longer battle and hopefully a conversation about the impact of dealer franchises on competition, consumer benefits, and that automotive industry as a whole. That the first shot came from a company focused on innovation and next generation technology is, at this  point, par for the course.

Relevant Analyst
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Adam Lesser

Cleantech Curator Gigaom Research

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