Archives For direct distribution

Dan Crane: Fact Checking Kessler’s “Fact Checking” on Direct Distribution

Dan Crane —  25 February 2015

The following post was authored by Dan Crane, the Frederick Paul Furth, Sr. Professor of Law at the University of Michigan Law School and an occasional TOTM contributor.

Last week, I released a public interest group open letter in support of Tesla’s right to distribute its cars directly.   The letter attracted quite a bit of media attention because of its “strange bedfellows” coalition.  Signatories included pro-consumer and pro-competition groups (American Antitrust Institute, Consumer Federation of America, Consumer Action, and Consumers for Auto Reliability and Safety), pro-business or free market groups (Americans for Prosperity, Institute for Justice, and Mackinac Center), environmental groups (Sierra Club and Environment America), and a pro-technology group (The Information Technology & Innovation Foundation).  The diversity of this coalition—joining scores of prominent economists and law professors and the staff of the Federal Trade Commission, among others—in supporting direct distribution, is a powerful testament to the fact that the appeal of the right to engage in direct distribution is not, and should not be, a partisan political issue.  It should have broad appeal whatever one’s political inclinations.

Yesterday, the Media and Public Relations Director for the National Automobile Dealers Association (“NADA”) forwarded me a link to a blog post by Glenn Kessler, a Washington Post blogger who runs a “Fact Checker” blog, entitled Key Report in battle over car dealer sales is bizarrely outdated.  The thrust of Mr. Kessler’s blog is that a 2009 paper on direct distribution published by Gerald Bodisch, then of the DOJ’s Economic Analysis Group, contains an inaccuracy.  Mr. Kessler finds it “astonishing” that the report has nonetheless featured “prominently” in much of the public advocacy in favor of direct distribution.  (One of the places that Mr. Kessler identifies it being featured is in a “Cato Institute Report,” which is actually not a Cato Institute Report, but an article I wrote in Regulation Magazine which is published by the Cato Institute. Kessler mentions the article being cited in a news story, although he omits to mention another news story in which the article was favorably cited . . . perhaps because it was in the Washington Post?).

Here’s the inaccuracy that Kessler reports, quoting from the Bodisch paper: “Since 2000, customers in Brazil can order the Celta over the Internet from a site that links them with GM’s assembly plant and 470 dealers nationwide.”  Kessler’s blog points out that the statement was no longer true in 2009 when the Bodisch paper was published, since GM discontinued online sales in Brazil in 2006, six years after launching the program.

Kessler is well within his rights to correct an inaccuracy in the Bodisch paper.  But the emphasis and tone of his blog post are bizarre.  He seems to suggest that any citation of the Bodisch paper on the possible cost savings from direct distribution is inherently flawed.  That’s way off base for two reasons.

First, the Bodisch paper did not make claims solely based on GM’s Brazilian experience.  It also made claims from general economic principles and from other empirical studies, such as a 2000 Goldman Sachs report on the potential cost savings from direct distribution.  The Kessler blog gives the impression that all of the recent citations to the Bodisch paper are repeating specific claims about GM in Brazil, whereas most of them are simply citing the Bodisch paper for the general proposition that direct distribution could result in cost savings to consumers.

Second, Kessler seems to assume that GM’s discontinuation of the Internet sales program in Brazil in 2006, after running it for six years, disproves all of the ostensible virtues of the program identified by GM at the time.  That Bodisch neglected to mention that GM had discontinued the program after six years would hardly be worth featuring in a “fact checking” blog unless the fact of the discontinuation undermined the reason the GM program was discussed in the first place.  So why did GM discontinue the program?  Kessler cites a GM spokesman who identifies two reasons, “federal and state tax changes in the country” and “the infrastructure costs to maintain distribution centers.”  The blog post then goes on to talk about how “wildly complicated” the Brazilian tax code is, including an obligation of paying a VAT based on the location of the merchant rather than the location of the customer.

I’m certainly no expert on GM’s Brazilian distribution strategy or the Brazilian tax code, but I can’t for the life of me understand Kessler’s point here.  If GM launched a direct distribution model that created the efficiencies cited in the article and was successful for six years (involving hundreds of thousands of Internet sales) until Brazil made changes to its tax code that resulted in unfavorable tax treatment for Internet sales, how does that remotely show that direct distribution doesn’t result in consumer benefits?  To the extent that the Brazilian tax changes killed the Internet distribution model, this would be just one more example of poor regulation killing an efficient model, not the model being inefficient.

Given that his own account of what happened seems to defeat his central point, I’m left perplexed by why Kessler decided to run this “fact-checking” story.  I’m not perplexed by NADA’s use of it—they no doubt see this as somehow undermining the recent momentum in favor of direct distribution.  As I’ve explained above, it does little to the basic thrust of the Bodisch paper.  But it’s also important to understand that argument in favor of the right to engage in direct distribution is by no means predicated on any particular claim in the Bodisch paper.

Here’s a quick recap of the debate.  In the many fora in which I’ve advocated in favor of the right to engage in direct distribution, I’ve never argued that direct distribution is in fact preferable to dealer distribution as a general matter.  Rather, the argument has always been that consumers benefit when manufacturers can choose the most efficient distribution method for them given their position in in the market.  The dealers have repeatedly made the absurd argument that laws mandating dealer distribution are necessary to break the manufacturer’s “monopoly” over distribution of their cars and hence lower prices to consumers.  As scores of outstanding economists have explained many times—without rebuttal from a single credible economist—that argument misunderstands that a manufacturer cannot increase its profits by charging a retail mark-up over and above whatever market power premium it embeds in the wholesale price.

Further, proponents of the right to engage in direct distribution have argued that, if anything, direct distribution would lower rather than increase consumer prices.  The core of this argument is that vertical integration eliminates double marginalization.  A second part of this argument is that there could be marginal cost savings to the manufacturer from direct distribution—as suggested in the Goldman Sachs report and elsewhere.  A third point is that the dealers themselves are fully aware—and have conceded—that the general effect of direct distribution is to lower rather than raise market prices.  When the dealers have sued to block Tesla in places like Massachusetts, they have alleged that direct distribution leads to “inequitable pricing.”  What they mean, of course, is that it leads to prices that are too low.  (If inequitable pricing meant prices that were too high, the dealers wouldn’t suffer injury and therefore wouldn’t have standing).

In sum, let me repeat that Mr. Kessler is well within his rights to “fact check” whatever he wants and to point out any inaccuracies that he observes.  The thrust of his blog post, however, is way off base.  It is his blog post, not citation to the Bodisch article, that is bizarre.

In Antitrust & Competition, Federal Trade Commission, Justice Department, Regulation, Vertical Restraints ,
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The car dealers’ sneak attack in Michigan

Dan Crane —  17 October 2014

As we have reported frequently on this blog (see, e.g., here, here, here, here, here and here) the car dealers have been making remarkably silly arguments in their fight to prevent Tesla from distributing its electrical vehicles directly to consumers. Now, I’m embarrassed to report that they’ve succeeded in moving from silly to disingenuous in my home state of Michigan.

Here’s what happened. In May of 2014, a bill was introduced in the Michigan Legislature to amend the statute dealing with car manufacturer-franchisee relationships. The bill did only one thing substantively—it prohibited manufacturers from coercing dealers not to charge consumers certain kinds of fees. Nothing at all to do with Tesla or direct distribution. Then, on October 1, in a floor amendment, the bill was altered to add a provision at the end of statute reading “this section applies to a manufacturer that sells, services, displays, or advertises its new motor vehicles in this state.” In a single day and as far as I know without any debate, the bill was passed with this new proviso 38-0 in the Senate and 106-1 in the House.

There was only one motivation for the addition of the proviso. Since losing in the Massachusetts Supreme Court in September, the dealers have recognized that decades-old dealer protection statutes may not be interpreted to apply to a company that wants to distribute its cars without using dealers at all. They saw an opportunity to bolster the statute in a way that would make it harder for Tesla to win under the existing law as it did in Massachusetts. And they realized that, on the eve of a close election contest in Michigan, no one would be paying attention to the seemingly innocuous language slipped into an uncontroversial bill at the last minute.

The bill is now sitting on Governor Rick Snyder’s desk for signature or veto. I wrote him a letter today asking him to veto the bill, if for no other reason than to allow the issue to be fairly and openly debated in Michigan. There’s mounting evidence that almost no one in the Legislature had any idea that they were taking sides in the Tesla wars.

What’s particularly infuriating is that the dealers are apparently arguing that the amendment has nothing to do with Tesla. Their argument apparently is that since the original statute already applied to Tesla, the amendment can’t be about Tesla. Instead, they assert, it’s just meant to clarify that “all manufacturers” are covered by the statute. This is beyond disingenuous. There’s no doubt that the dealers inserted this language to deal with their fear of a repeat of Massachusetts in Michigan. There’s no other logical explanation for the amendment. I mean, if not Tesla, who’s the manufacturer they were worried might not be covered by the existing legislation? GM? Ford? Sorry, guys, we’re not idiots.

Politics is dirty; crony capitalism is often the way of things. We shouldn’t be shocked. But nor should we stand for this kind of nonsense.

In Antitrust & Competition, Monopolization, Regulation, Resale Price Maintenance ,
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Tesla Wins Big in Massachusetts

Dan Crane —  18 September 2014

On September 15, Tesla won a big victory in Massachusetts. As we have previously chronicled at length on TOTM ( see, e.g., here, here, here, here, here and here), the car dealers are waging a state-by-state ground war to prevent Tesla from bypassing them and distributing directly to consumers. The dealers invoke 1950s-era franchise protection laws that are obsolete given the radical changes in automotive market in the intervening years and, in any event, have nothing to do with a company like Tesla that doesn’t use dealers at all. In Massachusetts State Automobile Dealers Ass’n, Inc. v. Tesla Motors MA, Inc., -2014 WL 4494167, the Supreme Judicial Court held that the dealers lacked standing to challenge Tesla’s direct distribution since the Massachusetts statute was intended to protect dealers from oppression by franchising manufacturers, not from competition by manufacturers who didn’t franchise at all. As we have previously detailed, there is no legitimate pro-consumer reason for prohibiting direct distribution.

What I found most telling about the Court’s decision was its quotation of a passage from the dealers’ brief. As readers may recall, the dealers have previously asserted that prohibiting direct distribution is necessary to break up the manufacturer’s “retail monopoly,” create price competition, and ensure that consumers get lower prices — arguments that are facially ludicrous as a matter of economics. But now listen to what the dealers have to say in Massachusetts:

Unless the defendants are enjoined, they will be allowed to compete unfairly with the dealers as their model of manufacturer owned dealerships with remote service centers will allow Tesla and Tesla MA financial savings which would not be available to Massachusetts dealers who must spend considerably to conform to Massachusetts law. This could cause inequitable pricing which also [could] cause consumer confusion and the inability to fairly consider the various automobiles offered.

Translation: Direct distribution leads to cost savings that are reflected in lower (“inequitable!”) prices to consumers.

Surely right, since a Justice Department study found that direct distribution could save over $2,200 per vehicle. But coming from the car dealers?  Who would have thunk it?

In Antitrust & Competition, Law & Economics, Monopolization, Regulation, Resale Price Maintenance ,
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Replacing the economic absurdity of New Jersey’s Tesla direct sales ban with a callous reward for rent-seeking

Geoffrey Manne —  19 June 2014

Earlier this week the New Jersey Assembly unanimously passed a bill to allow direct sales of Tesla cars in New Jersey. (H/T Marina Lao). The bill

Allows a manufacturer (“franchisor,” as defined in P.L.1985, c.361 (C.56:10-26 et seq.)) to directly buy from or sell to consumers a zero emission vehicle (ZEV) at a maximum of four locations in New Jersey.  In addition, the bill requires a manufacturer to own or operate at least one retail facility in New Jersey for the servicing of its vehicles. The manufacturer’s direct sale locations are not required to also serve as a retail service facility.

The bill amends current law to allow any ZEV manufacturer to directly or indirectly buy from and directly sell, offer to sell, or deal to a consumer a ZEV if the manufacturer was licensed by the New Jersey Motor Vehicle Commission (MVC) on or prior to January 1, 2014.  This bill provides that ZEVs may be directly sold by certain manufacturers, like Tesla Motors, and preempts any rule or regulation that restricts sales exclusively to franchised dealerships.  The provisions of the bill would not prevent a licensed franchisor from operating under an existing license issued by the MVC.

At first cut, it seems good that the legislature is responding to the lunacy of the Christie administration’s previous decision to enforce a rule prohibiting direct sales of automobiles in New Jersey. We have previously discussed that decision at length in previous posts here, here, here and here. And Thom and Mike have taken on a similar rule in their home state of Missouri here and here.

In response to New Jersey’s decision to prohibit direct sales, the International Center for Law & Economics organized an open letter to Governor Christie based in large part on Dan Crane’s writings on the topic here at TOTM and discussing the faulty economics of such a ban. The letter was signed by more than 70 law professors and economists.

But it turns out that the legislative response is nearly as bad as the underlying ban itself.

First, a quick recap.

In our letter we noted that

The Motor Vehicle Commission’s regulation was aimed specifically at stopping one company, Tesla Motors, from directly distributing its electric cars. But the regulation would apply equally to any other innovative manufacturer trying to bring a new automobile to market, as well. There is no justification on any rational economic or public policy grounds for such a restraint of commerce. Rather, the upshot of the regulation is to reduce competition in New Jersey’s automobile market for the benefit of its auto dealers and to the detriment of its consumers. It is protectionism for auto dealers, pure and simple.

While enforcement of the New Jersey ban was clearly aimed directly at Tesla, it has broader effects. And, of course, its underlying logic is simply indefensible, regardless of which particular manufacturer it affects. The letter explains at length the economics of retail distribution and the misguided, anti-consumer logic of the regulation, and concludes by noting that

In sum, we have not heard a single argument for a direct distribution ban that makes any sense. To the contrary, these arguments simply bolster our belief that the regulations in question are motivated by economic protectionism that favors dealers at the expense of consumers and innovative technologies. It is discouraging to see this ban being used to block a company that is bringing dynamic and environmentally friendly products to market. We strongly encourage you to repeal it, by new legislation if necessary.

Thus it seems heartening that the legislature did, indeed, take up our challenge to repeal the ban.

Except that, in doing so, the legislature managed to write a bill that reflects no understanding whatever of the underlying economic issues at stake. Instead, the legislative response appears largely to be the product of rent seeking,pure and simple, offering only a limited response to Tesla’s squeaky wheel (no pun intended) and leaving the core defects of the ban completely undisturbed.

Instead of acknowledging the underlying absurdity of the limit on direct sales, the bill keeps the ban in place and simply offers a limited exception for Tesla (or other zero emission cars). While the innovative and beneficial nature of Tesla’s cars was an additional reason to oppose banning their direct sale, the specific characteristics of the cars is a minor and ancillary reason to oppose the ban. But the New Jersey legislative response is all about the cars’ emissions characteristics, and in no way does it reflect an appreciation for the fundamental economic defects of the underlying rule.

Moreover, the bill permits direct sales at only four locations (why four? No good reason whatever — presumably it was a political compromise, never the stuff of economic reason) and requires Tesla to operate a service center for its cars in the state. In other words, the regulators are still arbitrarily dictating aspects of car manufacturers’ business organization from on high.

Even worse, however, the bill is constructed to be nothing more than a payoff for a specific firm’s lobbying efforts, thus ensuring that the next (non-zero-emission) Tesla to come along will have to undertake the same efforts to pander to the state.

Far from addressing the serious concerns with the direct sales ban, the bill just perpetuates the culture of political rent seeking such regulations create.

Perhaps it’s better than nothing. Certainly it’s better than nothing for Tesla. But overall, I’d say it’s about the worst possible sort of response, short of nothing.

In Antitrust & Competition, International Center for Law & Economics, Law & Economics, Monopolization, Regulation, Resale Price Maintenance , , , , , , , , ,
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Lambert and Sykuta Talk Tesla in the Kansas City Star

Thom Lambert —  15 May 2014

Mike Sykuta and I, both proud Missourians, recently took to the opinion section of the Kansas City Star to discuss pending state legislation that would bar automobile manufacturers from operating their own retail outlets in the Show Me state.  The immediate target of the bill is Tesla, but the bigger concern of the auto dealers, who drafted the statutory language we criticize, is that the big carmakers will bypass independent dealers and start running their own retail outlets.

The arguments in our op-ed will be familiar to TOTM readers.  We begin with three fundamental points:  (1) Distribution is an “input” for carmakers.  (2) Producers, if left to their own devices, will choose the more efficient option when deciding whether to “buy” the distribution input (i.e., to sell through independent dealers, who pay a discounted wholesale price) or “make” it (i.e., to operate their own retail outlets and charge the higher retail price).  (3) Consumers — who ultimately pay all input costs, including the cost of distribution — will benefit if the most efficient option is selected.  In short, the interests of carmakers and consumers are aligned here: both benefit from implementation of the most efficient distribution scheme.

We then rebut the arguments that a direct distribution ban is needed to break up monopoly power, to assure adequate aftermarket servicing of vehicles, or to encourage appropriate safety recalls.  (On these points, we draw heavily from International Center for Law & Economics’ letter to Gov. Chris Christie regarding New Jersey’s proposed anti-Tesla legislation.)

Go read the whole thing.

In International Center for Law & Economics, Law & Economics, Regulation , ,
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Auto Dealers Dealing Tesla MO Roadblocks

Michael Sykuta —  9 May 2014

Our TOTM colleague Dan Crane has written a few posts here over the past year or so about attempts by the automobile dealers lobby (and General Motors itself) to restrict the ability of Tesla Motors to sell its vehicles directly to consumers (see here, here and here). Following New Jersey’s adoption of an anti-Tesla direct distribution ban, more than 70 lawyers and economists–including yours truly and several here at TOTM–submitted an open letter to Gov. Chris Christie explaining why the ban is bad policy.

Now it seems my own state of Missouri is getting caught up in the auto dealers’ ploy to thwart pro-consumer innovation and competition. Legislation (HB1124) that was intended to simply update statutes governing the definition, licensing and use of off-road and utility vehicles got co-opted at the last minute in the state Senate. Language was inserted to redefine the term “franchisor” to include any automobile manufacturer, regardless whether they have any franchise agreements–in direct contradiction to the definition used throughout the rest of the surrounding statues. The bill defines a “franchisor” as:

“any manufacturer of new motor vehicles which establishes any business location or facility within the state of Missouri, when such facilities are used by the manufacturer to inform, entice, or otherwise market to potential customers, or where customer orders for the manufacturer’s new motor vehicles are placed, received, or processed, whether or not any sales of such vehicles are finally consummated, and whether or not any such vehicles are actually delivered to the retail customer, at such business location or facility.”

In other words, it defines a franchisor as a company that chooses to open it’s own facility and not franchise. The bill then goes on to define any facility or business location meeting the above criteria as a “new motor vehicle dealership,” even though no sales or even distribution may actually take place there. Since “franchisors” are already forbidden from owning a “new motor vehicle dealership” in Missouri (a dubious restriction in itself), these perverted definitions effectively ban a company like Tesla from selling directly to consumers.

The bill still needs to go back to the Missouri House of Representatives, where it started out as addressing “laws regarding ‘all-terrain vehicles,’ ‘recreational off-highway vehicles,’ and ‘utility vehicles’.”

This is classic rent-seeking regulation at its finest, using contrived and contorted legislation–not to mention last-minute, underhanded legislative tactics–to prevent competition and innovation that, as General Motors itself pointed out, is based on a more economically efficient model of distribution that benefits consumers. Hopefully the State House…or the Governor…won’t be asleep at the wheel as this legislation speeds through the final days of the session.

In Regulation , , , , , , , ,
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The Revelations of GM’s Anti-Tesla Letter

Dan Crane —  27 March 2014

As Geoff posted yesterday, a group of 72 distinguished economists and law professors from across the political spectrum released a letter to Chris Christie pointing out the absurdities of New Jersey’s direct distribution ban. I’m heartened that both Governor Christie and his potential rival for the 2016 Republican nomination, Texas Governor Rick Perry, have made statements, here and here, in recent days suggesting that they would support legislation to allow direct distribution. Another potential 2016 Republican contender, has also joined the anti-protectionist fray. This should not be a partisan political issue. Hopefully, thinking people from both parties will realize that these laws help no one but the car dealers.

In the midst of these encouraging developments, I came across a March 5, 2014 letter from General Motors to Ohio Governor John Kasich complaining about proposed legislation that would carve out a special direct-dealing exemption for Tesla in Ohio. I’ve gotta say that I’m sympathetic to GM’s plight. It isn’t fair that Tesla would get a special exemption from regulations applicable to other car dealers. I’m not blaming Tesla, since I assume and hope that Tesla’s legislative strategy is to ask that these laws be repealed or that Tesla be exempted, not that the laws should continue to apply to other manufacturers. But the point of our letter is that no manufacturer should be subject to these restrictions. Tesla may have special reasons to prefer direct distribution, but the laws should be general—and generally permissive of direct distribution. The last thing we need is for a continuation of the dealers’ crony capitalism through a system of selective exemptions from protectionist statutes.

What was most telling about GM’s letter was its straightforward admission that allowing Tesla to engage in direct distribution would give Tesla a “distinct competitive advantage” and would create a “significant disparate impact” on competition in the auto industry. That’s just another way of saying that direct distribution is more efficient. If Tesla will gain a competitive advantage by bypassing dealers, shouldn’t we want all car companies to have that same advantage?

To be clear, there are circumstances were exempting just select companies from a regulatory scheme would give them a competitive advantage not based on superior efficiency in a social-welfare enhancing sense. For example, if the general pollution control regulations are optimally set, then exempting some firms will allow them to externalize costs and thereby obtain a competitive advantage, reducing net social welfare. But that would only be the case if the regulated activity is socially harmful, which direct distribution is not, as our open letter explained. The take-away from GM’s letter should be even more impetus for repealing the direct distribution bans across the board so that consumers can enjoy the benefit of competition among rival manufacturers who all have the right to choose the most efficient means of distribution for them.

In Antitrust & Competition, Exemptions, Law & Economics, Monopolization, Regulation , , , ,
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Over 70 economists and law professors sign letter opposing anti-Tesla direct automobile distribution ban

Geoffrey Manne —  26 March 2014

Earlier this month New Jersey became the most recent (but likely not the last) state to ban direct sales of automobiles. Although the rule nominally applies more broadly, it is directly aimed at keeping Tesla Motors (or at least its business model) out of New Jersey. Automobile dealers have offered several arguments why the rule is in the public interest, but a little basic economics reveals that these arguments are meritless.

Today the International Center for Law & Economics sent an open letter to New Jersey Governor Chris Christie, urging reconsideration of the regulation and explaining why the rule is unjustified — except as rent-seeking protectionism by independent auto dealers.

The letter, which was principally written by University of Michigan law professor, Dan Crane, and based in large part on his blog posts here at Truth on the Market (see here and here), was signed by more than 70 economists and law professors.

As the letter notes:

The Motor Vehicle Commission’s regulation was aimed specifically at stopping one company, Tesla Motors, from directly distributing its electric cars. But the regulation would apply equally to any other innovative manufacturer trying to bring a new automobile to market, as well. There is no justification on any rational economic or public policy grounds for such a restraint of commerce. Rather, the upshot of the regulation is to reduce competition in New Jersey’s automobile market for the benefit of its auto dealers and to the detriment of its consumers. It is protectionism for auto dealers, pure and simple.

The letter explains at length the economics of retail distribution and the misguided, anti-consumer logic of the regulation.

The letter concludes:

In sum, we have not heard a single argument for a direct distribution ban that makes any sense. To the contrary, these arguments simply bolster our belief that the regulations in question are motivated by economic protectionism that favors dealers at the expense of consumers and innovative technologies. It is discouraging to see this ban being used to block a company that is bringing dynamic and environmentally friendly products to market. We strongly encourage you to repeal it, by new legislation if necessary.

Among the letter’s signatories are some of the country’s most prominent legal scholars and economists from across the political spectrum.

Read the letter here:

Open Letter to New Jersey Governor Chris Christie on the Direct Automobile Distribution Ban

In Antitrust & Competition, International Center for Law & Economics, Law & Economics, Monopolization, Regulation, Resale Price Maintenance , , , , , , , ,
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Dealer protectionism in New Jersey

Dan Crane —  13 March 2014

Last summer I blogged here at TOTM about the protectionist statutes designed to preempt direct distribution of Tesla cars that are proliferating around the country. This week, New Jersey’s Motor Vehicle Commission voted to add New Jersey to the list of states bowing to the politically powerful car dealers’ lobby.

Yesterday, I was on Bloomberg’s Market Makers show with Jim Appleton, the president of the New Jersey Coalition of Automotive Retailers. (The clip is here). Mr. Appleton advanced several “very interesting” arguments against direct distribution of cars, including that we already regulate everything else from securities sales to dogs and cats, so why not regulate car sales as well. The more we regulate, the more we should regulate. Good point. I’m stumped. But moving on, Mr. Appleton also argued that this particular regulation is necessary for actual reasons, and he gave two.

First, he argued that Tesla has a monopoly and that the direct distribution prohibition would create price competition. But, of course, Tesla does not have anything like a monopoly. A point that Mr. Appleton repeated three times over the course of our five minutes yesterday was that Tesla’s market share in New Jersey is 0.1%. Sorry, not a monopoly.

Mr. Appleton then insisted that the relevant “monopoly” is over the Tesla brand. This argument misunderstands basic economics. Every seller has a “monopoly” in its own brand to the same extent as Mr. Appleton has a “monopoly” in the tie he wore yesterday. No one but Tesla controls the Tesla brand, and no one but Mr. Appleton controls his tie. But, as economists have understood for a very long time, it would be absurd to equate monopoly power in an economic sense with the exclusive legal right to control something. Otherwise, every man, woman, child, dog, and cat is a monopolist over a whole bunch of things. The word monopoly can only make sense as capturing the absence of rivalry between sellers of different brands. A seller can have monopoly power in its brand, but only if there are not other brands that are reasonable substitutes. And, of course, there are many reasonable substitutes for Teslas.

Nor will forcing Tesla to sell through dealers create “price competition” for Teslas to the benefit of consumers. As I explained in my post last summer, Tesla maximizes its profits by minimizing its cost of distribution. If dealers can perform that function more efficiently than Tesla, Tesla has every incentive to distribute through dealers. The one thing Tesla cannot do is increase its profits by charging more for the retail distribution function than dealers would charge. Whatever the explanation for Tesla’s decision to distribute directly may be, it has nothing to do with charging consumers a monopoly price for the distribution of Teslas.

Mr. Appleton’s second argument was that the dealer protection laws are necessary for consumer safety. He then pointed to the news that GM might have prevented accidents taking 12 lives if it had recalled some of its vehicles earlier than it eventually did. But of course all of this occurred while GM was distributing through franchised dealers. To take Mr. Appleton’s logic, I should have been arguing that distribution through franchised dealers kills people.

Mr. Appleton then offered a concrete argument on car safety. He said that, to manufacturers, product recalls are a cost whereas, to dealers, they are an opportunity to earn income. But that argument is also facially absurd. Dealers don’t make the decision to issue safety recalls. Those decisions come from the manufacturer and the National Highway Traffic Safety Administration. Dealers benefit only incidentally.

The direct distribution laws have nothing to do with enhancing price competition or car safety. They are protectionism for dealers, pure and simple. At a time when Chris Christie is trying to regain credibility with New Jersey voters in general, and New Jersey motorists in particular, this development is a real shame.

In Antitrust & Competition, Apple, Law & Economics, Monopolization, Platforms, Regulation, Resale Price Maintenance , , , , , , ,
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Tesla and the Auto Dealers Lobby

Dan Crane —  24 June 2013

In Continental T.V. v. GTE Sylvania (1977), Justice Powell observed that antitrust law should go easy on manufacturer restraints on dealer resale because manufacturers could always decide to integrate forward into distribution and bypass dealers altogether.  As anyone who has followed electric car manufacturer Tesla’s recent travails will know, Justice Powell’s observation is not true of the auto industry.  Dealer franchise laws in most states require car manufacturers to sell through independent dealers.  Tesla apparently would like to bypass the traditional dealership model and sell directly to customers, which is landing the company in legal hot waters in many states, including traditionally “free market” states like Texas, Virginia, and North Carolina.

Tesla is the offspring of the South African-American entrepreneur Elon Musk, who also brought us Pay-Pal and SpaceX.  The company’s luxury electric cars have caused a sensation in the auto industry, including a review by Consumer Reports calling Tesla’s Model S the best car it ever tested.  Extraordinarily for a startup, in the first quarter of 2013, Tesla Model S sales exceeded the top line offerings of the established German luxury brands, Mercedes, BMW, and Audi.  Indeed, more Teslas were sold than BMW 7 series and Audi A8s combined.

One would imagine that Tesla’s biggest problem would be economic and technological—creating the infrastructure for battery-pack swap and charging facilities necessary to persuade customers that powering their Teslas will be as seamless as pumping gas at a filling station.  (Telsa’s recently announced 90-second battery pack swap will go a long way in that direction).  Alas, Tesla’s major stumbling block seems to be more legal than technological.  Tesla wants to open its own showrooms and sell directly to customers.  The powerful car dealers’ lobby has been invoking decades-old dealer franchising laws to block Tesla’s progress, insisting that Tesla must sell through independent, franchised dealers like other car companies do.  Tesla has been lobbying for legislative reforms at the state level, thus far with mixed success.

The basic economics of the problem are straightforward.  As Ronald Coase taught us, whether a car manufacturer keeps the distribution function in house or buys distribution services on the market is a question of the agency and transactions costs of those respective forms of distribution.  There are many reasons why manufacturers might prefer to distribute through independent dealers.  This shifts the investment in distribution to someone other than the manufacturer, allowing the manufacturer to focus on its core competence in research and development and manufacturing.  It shifts managerial decisions to managers with local market knowledge.  It may create economies of scale or scope as dealers sell several different brands under a single roof.

But there are also good reasons why a manufacturer might prefer to sell directly to consumers.  The manufacturer may be concerned that the dealers will focus more on short-term sales maximization rather than long-term investment in building the brand.  (This could be particularly concerning to a company like Tesla that is introducing a disruptive new technology that still needs to be proven in the market).  The manufacturer may worry that independent dealers will be insufficiently loyal and push other brands.  It may fret that local dealers will be unsophisticated about new technologies and that training and monitoring will be easier if retail distribution stays in house.

There is no a priori reason to favor one model or the other, and I have no idea whether Tesla is better off distributing through traditional dealer networks.  But I find it hard to fathom any good reason why the law should prohibit a car manufacturer from picking whatever distribution model it thinks best.  As a newcomer to these state dealer laws, I’ve been trying to keep an open mind that they might be supported by some legitimate policy concern and not pure protectionism.  Unfortunately, whenever a dealer-aligned speaker opens his mouth to defend these laws, the case that it’s just protectionism gets stronger.

One argument I’ve seen attributed to the auto dealers—and I sincerely hope that there’s some mistake and this is not actually an argument they’re making—is that creating “competition” in retail distribution of Tesla cars is necessary to prevent Tesla from price gouging customers. The idea that a vertically integrated manufacturer has a “monopoly” over the brand’s retail distribution that needs to be broken up by outsourcing the retail function to independent dealers is farcical.  If Tesla has market power, it will extract the full monopoly profit regardless of whether it sells to dealers or end users.  (It will be fully embedded in either the wholesale or resale price).  Since retail distribution is just a cost of doing business, Tesla will increase its monopoly profits by minimizing the cost of retail distribution since then it will sell more cars.  If anything, as economists have long recognized, outsourcing the retail distribution function to locally dominant automobile dealers could lead to double marginalization and increased prices.

A second argument is that having local dealers is necessary to ensure that customers are adequately served.  For example, Bob Glaser of the North Carolina Automobile Dealer’s Association has asserted that the restrictions are a form of “consumer protection,” since “a dealer who has invested a significant amount of capital in a community is more committed to taking care of that area’s customers.”  The obvious rejoinder is that Tesla has as much or more of an interest as the dealers in seeing that customers get the level of service they’re willing to pay for.   If Tesla gets a bad reputation for quality, it will fail.  I suppose that one might worry if  Tesla were a fly-by-night operation selling customers an expensive durable good at a high price and then fleeing with its profits and leaving customers without support.  But that’s obviously unlikely of a company that’s pouring billions of dollars into the creation of a new product and a recharging and battery swapping infrastructure.  Car manufacturers make considerably larger fixed capital investments than do dealers and I’m sure that the dealer failure and exit rate is considerably higher than that of manufacturers.

A related argument is that dealers play an important role in complying with local laws regarding titling and safety inspection.  But this argument doesn’t work either.  First, observe that at present most states only prohibit manufacturers from opening their own dealerships—they don’t prohibit online sales from outside the state.  (North Carolina recently passed a statute banning online sales as well).  There’s no reason why a manufacturer-owned dealership should be less capable of complying with local laws than an independent dealer.  Second, why should Internet sales involve evasion of state titling and safety inspection laws?  Internet sales can just as easily be subject to the same titling and inspection requirements as dealer-initiated sales.

Another argument I’ve heard is that prohibiting manufacturers from integrating forward into distribution is necessary to prevent them from competing unfairly with their own franchised dealers by undercutting them on price.  The logic of this argument is a little fuzzy. What would a manufacturer set up franchised dealers only to undercut them ruinously?  I suppose it might be some variant of the usual free-rider arguments—the manufacturer would set up independent dealers, free-ride on their local brand promotion, and then cut them out once the brand was established.  (Why the dealers can’t contractually bargain for protections from this isn’t clear).  But all of this is a lark for present purposes.  It clearly doesn’t apply to Tesla, which wants to avoid franchising altogether.  At most, if one were worried about “undercutting,” the rule should be a prohibition on manufacturer retail operations for manufacturers that also franchise, not for those that bypass franchising altogether.

Some people have quite fairly complained that Tesla shouldn’t be given special exemptions when other car companies are bound by the dealer restrictions.  For sure, but that cuts in favor of amending or repealing these laws altogether, not enforcing them against Tesla.  If anything, if it’s true that Tesla would obtain a competitive advantage by bypassing traditional dealer networks, consumers should want this advantage available to all car companies.  To put it other way, this argument is basically an admission that the dealer laws are raising car prices.

The last argument I’ve heard—and it’s a real doozy—is that independent dealers are civic bastions of local communities and therefore deserve to be specially protected.  Never mind the fact that many auto dealerships are owned and operated by large regional chains rather than local Boy Scouts troopmasters.  Why on God’s green earth should we single out automobiles for economic protectionism in order to subsidize local civic participation?  Why stop with automobiles?  Why not household appliances, twinkies, and lingerie?   And who is to say that Tesla will be any less civic minded than franchised auto dealers?  Further, if the model of direct distribution is so superior to franchised distribution that eliminating legal restrictions would put the dealers out of business, there must be something systematically inefficient about franchised distribution.  In that case, both consumers and local communities would be better served if state legislatures just levied a tax on auto sales and distributed them pro rata to local civic organizations.

Since the arguments for dealer laws are so weak, I’m left with the firm impression that this is just special interest rent-seeking of the worst kind.  It’s a real shame that Tesla—seemingly one of the most innovative, successful, and environmentally correct American industrial firms of the last decade—is going to have to spend tens of millions of dollars and may eventually have to cut shady political deals for the right to sell its own products.  I’m ordinarily a fan of federalism and states’ rights, but if the current debacle continues, it may be necessary for Congress to step in with preemptive federal legislation.

In Antitrust & Competition, Exemptions, Federalism, Law & Economics, Monopolization, Regulation, Resale Price Maintenance , , , , , , , ,
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