Auto Mafia: State Bans On Tesla Sales Expose Monopolistic Nature Of Franchise Laws
Tesla Motors CEO Elon Musk, poses beside a Tesla in New York, Wednesday, Sept. 17, 2014. Photo: Richard Drew/AP
On Sunday, Tesla Motors, the producer of the world’s first fully electric sports car, pitted one of its luxury sedans, a Model S P85D, in a quarter-mile drag race against a Dodge Challenger Hellcat. The P85D, which is capable of running from 0 to 60 miles per hour in 3.2 seconds with 1g of lateral acceleration, set a new world record with the National Electric Drag Racing Association as being the fastest production electric car in the world, topping off at 114.6 MPH. The Hellcat, on the other hand, burned out its 707 horsepower, unable to gain traction.
This race demonstrated a notable shift in the way electric cars are perceived. Once thought to be a fad for the environmentally conscious and the socially pretentious, a growing population is giving battery-driven vehicles a second look. In September, for example, Tesla’s shares hit an all-time high after receiving praise from analysts.
Yet electric vehicle sales have failed to keep pace with auto sales in recent months. This, in part, is due to dropping gasoline prices. With global crude oil prices hitting their lowest levels since May 2009, gas prices are far from the theoretical $5 per gallon most Americans have indicated would be the threshold for embracing a new technology, such as electric vehicles. On a more fundamental level — and particularly in the case of Tesla — the slumping sales may be the product of industry favoritism.
Tesla has opted away from the dealer network system that has been used by other auto manufacturers in favor of direct sales. Hoping for a low-pressure sales environment, where education and direct communication with the consumer outweigh the need to draw commissions, Tesla founder and CEO Elon Musk chose to remove the middleman.
“We actually train people to educate,” explained Musk. “We always wanted to be a really low-key kind of friendly environment, where we’re not constantly trying to close deals.”
“It takes them [dealers] at least twice as much effort to sell someone an electric car and to educate them as to why an electric car is good. And so if we were to go through the traditional dealer path, the result would be a disaster.”
The problem with Tesla’s sales model lies in the fact that most states have laws to protect car dealerships. Known as franchise laws, these state-level pieces of legislation make it difficult for manufacturers of specific products to sell their products to local consumers without the help of a local distributor or reseller.
In broad terms, franchise laws are investment protection regulations, designed to protect established dealers — who invested heavily in the establishment and promotion of their dealerships — from being cut out of the sales process. However, the results of such laws make the entry costs for new dealerships exceptionally high, strangle innovation and marketplace entry for new manufacturers, increase labor and logistics costs for existing manufacturers, and reduce competitive pricing opportunities for consumers.
While franchise laws are mostly used in new car sales, franchise law restrictions exist in other industries such as cable television, alcohol distribution, gasoline service stations, soft-drink bottlers and heavy equipment sales. For many, this antiquated system of profit protection creates near-monopolistic control of both sales and production and vests it not in the hands of the consumer or the manufacturer, but the middleman.
The cost of doing business
In Pennsylvania, consumers have been experiencing gas prices significantly higher than the national average. In part, this is due to a 10 cents per gallon increase in oil company franchise taxes passed in 2013 to support improvements to the state’s transportation infrastructure. While the intention of this law was to raise funds for needed repairs without having to raise taxes or draw funds from the general budget, in reality, the cost of this tax increase was passed in its entirety to the consumer. The result of this is that only New York, California and Connecticut have higher gas prices.
Franchise taxes are typically regarded as the fee for doing business in a state. For paying the fee, business owners receive a degree of liability protection under state law. In the case of oil companies, these fees help to improve state and local coffers without an explicit move by legislators to collect the needed funds directly from taxpayers. However, the actual cost of these fees is that either federal or state taxes or franchise taxes represent 30 to 40 percent of the cost of gas.
But franchise taxes generally speak to unconventional or unsavory relationships between business and government. Cable franchise fees are just one example of this. Typically, the local municipality owns the right-of-way for the lines and feeds that provide cable television service to the community. In exchange for the right to use public property for private use, cable companies are charged an annual fee. However, cable companies are permitted to recoup this fee through assessment to the customers, meaning that — in actuality — customers are paying a fee to use public property. This passing off of the fee lent the impression that the fee is not so much a “cost for doing business,” but a legitimate tax on utilizing cable services.
As the cable industry is a major political contributor, this relationship is unlikely to be questioned or challenged. However, questions of corporate influence and whether profit should outweigh commitment to the customer loom large, even if they’re not answered.
“The problem in dealing with a profit motive is that it shields against innovation,” said Alex Buck, the owner of DD Forge, a business efficiency consultancy, to MintPress News. “True innovation fills unmet or under-met customer needs. Innovators want to get as close to the customer as they can. Requiring a middleman builds a buffer in between innovators and customers. Dealerships are not in the business of solving customers’ problems; they are in the business of clearing their inventories.”
While many states, such as Texas, have indicated their desire to continue to support the franchise tax, others are seeking different options. West Virginia, for example, has announced plans to help improve its unemployment rate and increase its business investments by eliminating its Business Franchise Tax.
“The Business Franchise Tax, created in 1987, was one of the taxes that made it difficult for West Virginia to compete for new and expanding businesses,” said West Virginia Gov. Earl Ray Tomblin during the announcement of the tax break in late December. “Coupled with the reduction in the Corporate Net Income Tax and the dramatic decrease in workers’ compensation rates, these changes have helped our state secure additional investments and will continue to pay dividends now and for years to come.”
The majority of most states are unlikely to follow West Virginia’s example. But as the nation moves more toward an info-centric society, the means of economic transactions must also change.
One example of such change occurred in the 1990s. Prior to the introduction of Dell Direct, personal computers were sold in computer shops in already configured packages. Dell Computers’ Dell Direct gave the consumer the opportunity to customize their devices — a tactic embraced as an industry standard today — while reducing the cost per unit for PCs.
The dealers’ monopoly
According to automotive dealers, the franchise law model is beneficial to the consumer.
“The franchised dealer model is the best and most efficient way to sell new cars and trucks, and it benefits consumers, manufacturers and local communities alike,” Jonathan Collegio, vice president of public affairs for the National Automobile Dealers Association, said in a statement to MintPress.
“Consumers benefit from price competition between same brand dealers, which wouldn’t exist if manufacturers operated their own stores. Manufacturers get a free and extremely efficient distribution and retail sales network for their products, and local communities enjoy the benefits of locally-owned and operated small businesses that provide a variety of well-paying jobs averaging more than $53,000 a year plus benefits.”
From an objective point of view, the dealer network model makes sense. By separating the cost and responsibility of setting up a sales network, manufacturers can focus exclusively on production. Additionally, manufacturers can count on the franchise fees from the dealers as a positive source of income. The dealer network model, at least on paper, would put the risk of sales and maintaining inventory on the dealer themselves.
However, the relationship between the dealer and the manufacturer is less clear-cut. Following the near-collapse of the auto industry in 2008 and the resulting government bailout, General Motors and Chrysler sought to close 2,200 dealerships in order to reduce operating costs. The motivation behind this is the fact that supplying vehicles to fill a dealer’s lot fails to take into account current market conditions and demands. As noted in an analysis from the U.S. Justice Department’s Economic Analysis Group of the Antitrust Division, in 2008, the nation’s 20,700 franchised new car dealers had an inventory of approximately $100 billion. The annual cost to carry that inventory was approximately $890 million.
This is a cost that is passed directly to the consumer. According to a 2000 Goldman Sachs analysis, as quoted by the EAG report, direct order-to-delivery from the manufacturer would save approximately $2,225 on a $26,000 new car. The implications of this are seen with General Motors and its direct sale of its Chevrolet Celta in Brazil.
The Chevrolet Celta
Since 2000, Brazilian customers have been able to order the Celta via a website that directly links to both the assembly plant and the nationwide dealer network. This system allowed GM to build the vehicle to demand, reducing inventory costs and lowering production expenses, as vehicles no longer had to be continuously produced. Since the vehicle is purchased online, the price to consumer typically represents a no-haggle price that is an average 6 percent below that of the traditional dealer network. Dealers are only required to keep two Celtas on hand at any time — one for the showroom and one for test drives, which reduced the dealerships’ costs.
The Celta is the second-most affordable car in Brazil and one of the nation’s best-selling models.
Financial and political realities make it difficult for direct sales to be considered in the United States, though. In many states, it is a criminal offense for an auto manufacturer to sell a new car to anyone but a state-approved dealer. Likewise, in all states but Maryland, a manufacturer cannot own a dealership, terminate a dealership agreement without “good cause,” consent to the establishment of a new dealership in an area that an existing dealership has geographic domain to, or permit the out-of-state sale of a new car by a dealership. With new car sales representing, on average, 20 percent of a state’s sales tax and 8 percent of the total retail employment, this gives dealers extraordinary influence over local legislatures.
Historically, car dealers have lobbied politicians more than car manufacturers, with $3.49 million in political spending being allocated in 2012 by the dealer industry. This, in part, explains why many of the new car laws favor dealerships — particularly in red states.
When asked, consumers support the notion of direct sale. According to a 2000 J.D. Power and Associates study, more than 70 percent of the surveyed Internet-savvy car buyers would buy straight from the manufacturer if the savings amounted to more than $3,000. Even if there were no savings, almost half would still opt to buy online, as doing so would allow them to avoid the process of having to negotiate with a dealer or settle for features that are not desired.
“It is always best when a manufacturer can speak directly to the customer,” said Buck, of the business efficiency consultancy. “The dealership model does not just represent the presence of a middleman, but also the presence of an information broker that is controlling the flow communications between the producer and the end user.
“Innovation cannot thrive in such a scenario, in which the dealer’s personal interests can color or taint market perceptions.”
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