On Tesla, Michigan And Factory Stores

Mike Smitka
by Mike Smitka

Bloomberg’s op-ed “ Detroit Fights Innovation — Again” is not about the Detroit Three of GM, Ford and Fiat Chrysler [merger consummated Oct 12th] or even manufacturers, but about Michigan and (indirectly) automotive dealers. It makes the very tenuous claim that a ruling blocking Tesla from running company stores (which is in fact in line with existing state law) is tacit protectionism that represents a step backward. Indeed, the article implies that the restriction is ultimately aimed at preventing a Chinese invasion. In fact the policy is misguided because history shows that there’s no need to fear factory stores, at least as long as they’re not set up by a car company so as to undermine their own existing dealers.

First, there’s the red herring: China. The editors – there’s no by-line, though David Shipley is listed at the bottom – ignore that GM and VW are the biggest players in China, and that purely domestic firms are in a tailspin (Warren Buffett has thrown away a pile of money on BYD [ 比亚迪汽车]). The camel’s nose is well inside the tent: all of China’s major players are multinationals who already have dealerships spread across all 50 states. Indeed, two firms, Honda and Volvo, are already exporting from China. And the policy is to protect the Detroit Three? Don’t the editors realize that last month they held but 46% of the US market?

Second, the important point: multiple automotive firms in multiple countries across multiple decades have tried and failed with factory stores. If you read carefully, you’ll even find Elon Musk talking about defects with Tesla’s distribution model. A modern dealership is comprised of six interlinked businesses: new vehicle sales, used vehicle sales, used car wholesaling (trade-ins), finance & insurance [including warranties], repair services, and parts sales, both retail and wholesale. (Some add a seventh to the mix, body shops, which in practice are a very different business from service & repairs.) So a manager must handle trade-ins, push used car sales and otherwise place a priority on things other than selling new cars in order to make a profit. On top of that, dealers are in a constant battle over what sort of physical “store” is needed, how much and what kind of advertising is necessary, and many other decisions important from a financial or strategic perspective. All this requires an ability to say “no” to the factory. No company has ever granted the manager of a factory store that level of discretion.Note 1

More important for potential new entrants, independent dealers provide billions in financing to a car company, because they hold inventory. The real estate is theirs as well, again not a trivial investment. Any potential new entrant that needs a large distribution footprint — that is, any company outside of the supercar niche — can’t afford to ignore that. If Elon Musk wasn’t so good at bilkingmilking investors, he would need that money, too.

So the Bloomberg editors are accurate that Michigan — which is far from being in the vanguard on this issue — should not concern itself with Tesla’s retail strategy. They are however accurate for the wrong reasons: factory stores have been a bloodbath for all who have tried, and will remain so. In practice, independent dealers are critical to a car company’s long-run financial viability. Contrary to the editorial, it’s not incumbent car companies that should be concerned, or existing dealers. It’s Tesla shareholders and bondholders who should worry.Note 2

  1. The factory rep who has actually sold a car to a real customer is the rarest of creatures. To my knowledge there are none with the experience of running an independent dealership. Then there are incentives. A factory rep is not offered compensation commensurate with what the principal of a (successful) independent dealership can earn. Instead they work for a salary, and their career depends on saying yes to their boss. So both corporate incentives and practical knowledge stand in the way.
  2. In the past week Toyota sold some of its 2.4% stake while Daimler sold all of its 3.9% stake.
Mike Smitka
Mike Smitka

Mike Smitka is an economist at Washington and Lee University in Lexington, Virginia. He's been a judge of the Automotive News PACE supplier innovation awards since they began in 1994. His household's vehicles are a 2014 Chevy Cruze, a 2013 Honda CR-V and a 1988 Chevy pickup. Find his auto industry course at <a href="http://econ244.academic.wlu.edu/">Econ 244</a>; he also blogs with David Ruggles at <a href="http://autosandeconomics.blogspot.com">Autos and Economics</a>.

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  • Dr. Kenneth Noisewater Dr. Kenneth Noisewater on Oct 26, 2014

    I don't buy it. If franchise middlemen are the clear winner in the marketplace, then let them prove it by outcompeting factory stores rather than running to mommy government to exclude factory stores. If franchise middlemen fear OEMs messing with the value of their franchises (which is legitimate, as OEMs have done so in the past), then let franchise-protection laws only protect actual franchise agreements. Tesla has no franchises, so they should not be subject to franchise agreement protection laws. It's not the place of the State to dictate how an industry does business, only that those doing business abide by contract law and consumer protection. There's enough competition among carmakers that any anti-monopoly consumer protections have long since become obviated by the marketplace. Tesla should be able to sell direct if they haven't sold any franchises. Let the marketplace then show whether or not middlemen provide more value to the auto buyer. Anything else is just corporate crony socialism, and rent-seeking dealers pleading for special treatment are just fucking commies.

    • Bimmermax Bimmermax on Oct 27, 2014

      "If franchise middlemen are the clear winner in the marketplace, then let them prove it by outcompeting factory stores rather than running to mommy government to exclude factory stores." Already proven. Factory run stores don't provide any inherent advantage to the consumer over a franchise dealer. "If franchise middlemen fear OEMs messing with the value of their franchises (which is legitimate, as OEMs have done so in the past), then let franchise-protection laws only protect actual franchise agreements." Problem is that legal precedents can undermine franchise agreements and laws. that is what the dealers fear. "It’s not the place of the State to dictate how an industry does business" Actually, the State would disagree. Right now, Tesla is a boutique car maker that loses money on every car it sells. Eventually, if they survive to be a full line car co, they WILL have to embrace the franchise system. the cost of selling cars is just too high not to.

  • DeadWeight DeadWeight on Oct 26, 2014

    I think WordPress is now eating entire articles as well as comments, since there are hardly any new articles, reviews or essays Brunton posted on TTAC for the last week or so. Jack! Jack! Reinforcements needed, Jack! Where's Steve Lang, Murilee, etc.? JACK!!!!

  • Carson D I hadn't seen a second-generation Courier with a Mazda engine before. I've seen a few with Ford engines. There was one at the Cox Driving Range that they used to collect golf balls. Golf would definitely be more entertaining to watch if they used moving targets.
  • Tassos ooops, Tim, you missed this one. Would make a lovely "Tim's used car of the day". It satisfies all the prerequisites except the wildly overpriced bit.
  • Tassos ASTON AND BOND BY A MILE. While Aston Martin sells a TINY FRACTION of what even the rarified Ferrari and Lambo sell, it is unbelievably well known. Credit the idiotic, but hugely successful and sometimes entertaining James Bond Movies.
  • Tassos 1988? Too young for me. It's all yours, Tim... BAHAHAHAHA!
  • Gray Awesome. Love these. But, if I had the money for a Fox-body, there is a clean '84 GT 350 here for little more than half the price.
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