Tesla vs. The Auto Franchising System – Part 2, Consumer Interests

As a consumer, you are a stakeholder. See also the Introduction and Part One. This is Part Two on what consumers stand to gain or lose.

A Better Way?

Tesla’s no-haggle, fixed price sales model has been seen as liberating, saving buyers the stress of negotiating lowest prices.

Presented as a peoples’ choice by those who like the idea and want the option, cries of democracy and free market ideals have been wrapped around talking points in defense of Tesla’s alternative.

We’ll touch on philosophical economic ideals as we go along, but for now, the fact is state lawmakers have established a time-honored third-party owned franchise system and some have barred Tesla from direct ownership of its retail stores and service centers.

While Tesla is licensed in several states for its own stores, the National Auto Dealers Association says 29 states have statutory prohibition on factory franchise ownership. Beyond this, 48 have at least some form of restriction and supporters of the system are outspoken that laws are valid and should be upheld.

Tesla CEO Elon Musk has suggested however they are archaic laws, a holdover needing to be changed where needs be.

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Everything is couched in terms of consumer freedoms and a better experience, but some are fighting Tesla. Others – including restrictive Arizona, New Jersey, and Texas – have shown recently they’re having second thoughts. Not hurting things is a $5-billion-plus Gigafactory Tesla is considering in states including Arizona and Texas.

In Texas, where Tesla was sorely defeated last year with fewer than 10 legislative sponsors to a bill that could have given it an exception, the auto dealer association is sticking to its guns. And its reasons why it’s defending the franchise system, it says, apply to the nation, even if others disagree.

Will You Save Money?

Looking at what’s in it for consumers, Texas Auto Dealer President Bill Wolters said no one should expect Tesla to save them money, but rather the opposite, and suggested Tesla’s gambit is about power, profits, and control in the guise of freedom, choice, and opportunity.

Unlike the common dealership paradigm where consumers may find the manufacturer’s cost and negotiate down, under Tesla’s model, Wolters said they will never be able to find the wholesale price, let alone pit one Tesla store against another.

Tesla dearly wants to establish this, Wolters said, to avoid one layer of competition as it seeks 25-percent profits and more, depending on how it does the accounting. Generally, Tesla is shooting for the stars and hoping to hit moon-high profits.

Citing 2013 data from the National Auto Dealers Association – more recent than 1980s and 90s data provided by the Consumer Federation of America opposing dealers – Wolters showed the average profit margin reported by 17,635 U.S. dealerships was 3.78 percent.

Average price-range new cars at MSRP now hover around 10 percent profit, he said. This has been driven down through intense dealer-to-dealer competition.

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“Over the past 25 years, 99.76 percent of the increased cost of a new vehicle has come from the manufacturer. The manufacturer has added $17,578 to the cost of the average new vehicle retail price and the dealer has added $42 or 0.24 percent of the increased cost,” said Wolters noting traditional dealer margin fell well behind the rate of inflation, and Tesla is seeking to do far better and like any manufacturer, is looking out for number one. “The dealer competition created by the franchise laws has given car and truck buyers the very lowest price from the dealer who must pass through the increased cost from his or her manufacturer if they want to remain in business. Consumers never see what goes on behind the scenes between the dealer and the manufacturer and don’t realize that the markup on the average new vehicle has gone from over 20 percent of MSRP to less than 10 percent in a period of 30 years, hence the 3.78 percent profit margin.”

Wolters said he is otherwise in an awkward position having to maintain peace with manufacturers.

“We don’t want to criticize the manufacturers,” he said of automakers in general. “They’re doing an amazing job on the production and quality side.”

However, the dealers have been demonized and caught in the middle in a fallacious battle based on half-truths that does not contemplate myriad nuanced issues, he said.

Tesla has masterfully turned this into free publicity alleging “backroom dealing” and crooked lawmakers, said Wolters, without presenting proof of sweeping conspiratorial allegations and consumers are getting a fraction of the whole story.

Never forget, said Wolters, that Tesla is first a corporation, and consumers ultimately pay prices based on escalating costs passed on by the manufacturer. Tesla’s fiduciary responsibility is first to its bottom line, not consumers, he said, and this is a conflict of interest.

“Their obligation is not to cut the price to the customer, it’s to send back to their bottom line, to raise their stock price and put it in stock dividends or to pay their executives’ bonus roll,” said Wolters. “Nobody believes that the factory would pass any savings onto the consumer even if it was there.”

Tesla has said it wants to make service as close to no profit as possible, but it “it will have to make money somewhere else,” said Wolters. Is Tesla’s model really better, he asked, or just different?

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Wolters added that consumers hoping for front-end savings due to factory direct would be further delusional, because Tesla also incurs costs of operating its retail businesses.

No matter how small Tesla retail store and service center footprints are compared to some of the palaces auto franchises set up, this is a cost it is absorbing which diminishes its ability to save for the consumer. Further, it was said, Tesla is incurring high costs attempting to maintain top customer satisfaction ratings.

Thus it’s made the service side both expensive and unprofitable, and auto dealer association leaders in Texas and New Jersey have openly wondered what shareholders think of that.

Even Musk has conceded it is costing Tesla more to do what it’s doing in bucking the system.

“In many respects, it would be easier to pursue the traditional franchise dealership model, as we could save a lot of money on construction and gain widespread distribution overnight,” wrote Musk in Oct. 2012. “Many smart people have argued over the years that we should do this, just like every other manufacturer in the United States.”

Musk went on to say why he wasn’t doing this, we’ll address that in another segment, but Wolters said Musk omits critical info when painting a picture of how he’s looking out for the consumer.

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So far Tesla is only a boutique maker, said Wolters, and its high-level customer satisfaction ratings have been easier to manage compared to what Tesla could do as a mass marketer.

It’s coddling customers, also making Supercharging free forever, and basically is saying trust us, we care, as it contemplates a far larger market presence as soon as possible.

Managing the growing empire as a mass marketer will also present myriad challenges which could adversely affect customer experience, it’s been widely said.

What Is a ‘Fair’ Price?

Under pure free market rules, a fair price is as much as the seller can get away with.

In contrast, it is also the least a consumer can pay.

Consumer advocacy groups have often advised pure self interest, and telling a dealer how much he should make on a deal or to name his “best price” so the shopper could use that as leverage against the next dealer.

Wolters said car dealers already have a fixed price, MSRP, and it appears today’s MSRPs involve thinner profits than what Tesla is shooting for.

But consumer groups and buyers themselves want the car for less, and dealers by long-standing tradition oblige customers to make the sale.

Many early 20th century car dealers entered the business from the horse trade, and that’s partly where the whole haggle thing got started. Dealers are now largely demonized for being caught up in a system that’s bigger than them.

Essentially, said Wolters, dealers are blamed either way they turn.

Tesla says its way is altogether better, and unknown is whether this is really true.

For all anyone really knows, it could be, but so many people are ready to sign off on precedents without really knowing sufficient facts, Wolters said.

Needs, Wants, Desires

Last decade GM’s Saturn division also tried a no-haggle price. Its buyers generally liked the business model, but it would seem it appealed to those who prefer not to negotiate and avoid adversarial feelings.

In 2006, a CNN news report cited a Kelley Blue Book survey which on one hand found two-thirds of consumers would prefer to pay a single price, but on the other hand, only 12-percent said “full sticker price” was fair.

Essentially, consumers wanted it both ways.

Ironically, Tesla has bandied the term “free market,” but the dealer competing against dealer franchise system operates under free market rules from which Tesla could escape.

A car dealer is actually a capitalist with his own self-interests to serve just like every other stakeholder – consumers, automakers, and yes, even Tesla.

Since dealers sit on the opposite side of the table, and have to smile at buyers who they may perceive are not being fair or honest either, it’s been an awkward situation.

There’s a phrase that’s been said in the business: “All buyers are liars.” When deciding who is the real good guy, one focused only on self interest can easily find fault with the other side. Fact is, every individual in a transaction has a measure of personal integrity and sense of fair play. You can focus on one side or the other depending on where you sit, but a big picture view contemplates all angles.

As it is, even if a dealer was to offer a car for zero profit or a loss, many buyers would take it with no care for whether the dealer can survive with such a policy or not.

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Short of that, Tesla will save customers the stress, but you can be sure it won’t volunteer zero profit or a loss.

The philosophical free market argument selectively applied here is customers can still walk away if they do not like the price, just like they don’t have to buy an Apple computer.

People can become passionate over this point, and in the abstract it appeals somewhere down deep inside to a sense of free market justice and fair play.

And not without reason. On one level, it is true people can walk away, and theoretically competitors can either come try and catch Tesla, or not.

That is free market philosophy. But there are no head-to-head competitors for the Model S now or on the horizon, only remotely similar alternatives.

People now are primarily focusing on all the good that will come bringing loosely analogous arguments in citing deregulation in other sectors and saying mostly good can come.

This may be, and perhaps even Tesla will goad latecomers to build their own all-electric cars? Toyota and Honda are talking fuel cells as “the future,” so who knows?

We’ll have more on possibilities later, but, said Wolters, Apple makes fat profits, so it would be an illusion to think anything less is intended by Tesla now and into perpetuity whereas the cut-throat franchising system delivers far more savings on the sales price for consumers.

Just Scratched The Surface

In opening the can of worms on what consumers stand to gain or lose, there’s more at stake than just price and profits.

Tesla blog posts have insinuated franchising laws are an archaic holdover protected by crony capitalists.

There may be some truth to this, but it’s definitely not the whole truth and nothing but the truth.

Regulators impose licensing fees on dealers, and make sure they meet certain requirements before letting them operate a car dealership, and none of these are at the request of the dealer lobby.

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Beyond this, automakers have also placed costly demands on their franchisees, tying them up in legal contracts, and have had much to say about how dealerships are structured.

While dealers have been painted in black-and-white terms as pure villain “middlemen,” a big-picture view might suggest they are being treated as an all-too-easy and convenient target as the monkey in the middle, meaning reality is shades of gray.

These aspects and a further look at questions of democracy, free trade, and individual freedoms will be dealt with in our next installment on what consumers stand to gain or lose.

This article is based on info and interviews provided by Tesla proponents and opponents and also those with no direct stake. Tesla did not reply to repeated requests for an interview or commentary.