Tesla Is Wrong, Franchise System Is Better

Would car buyers be better off if the dealer franchise system was dismantled? The public seems to think so.

Most consumers believe dealers are unnecessary middlemen who drive up the cost of vehicles. They’re enamored with Tesla’s way of selling cars in its own stores. But the franchise system actually is tilted in the consumer’s favor.

First, some history. Car dealers started banding together under the banner of the National Auto Dealers Association in 1917 partly to protect themselves from the capricious and arbitrary practices of automakers.

Back then, if the car companies found themselves stuck with excess inventory, they were known to take out newspaper ads announcing their dealers would offer discounts the coming weekend, with surprised dealers having no alternative but to go along.

Sometimes automakers would rent empty warehouses and dump excess production at bargain prices – competing directly with their own dealers.

After World War II, NADA began a lobbying effort to enact franchise laws in each state that prohibited automakers from selling directly to consumers. Today, every state protects those franchises. But now Tesla is beginning to carve out exemptions to those laws, with enthusiastic public support.

The public believes Tesla’s approach is better, but they are unaware of how the system actually works. Car buyers are under the misperception that dealers make hefty profit margins. But the average dealer actually made only a 2.2% pre-tax profit last year. Top dealers make about 5%.

Fascinatingly, TrueCar surveyed 5,000 consumers who were asked, “If we removed the dealer’s profit, what kind of tip would be appropriate to leave for the dealer?”

Most said they’d leave an 8% tip. One dealer half-jokingly told me he’d make a lot more profit if he just sold cars at cost and simply asked customers to leave a tip.

Profit margins are thin because dealers have to compete against each other, and this is especially true of dealers selling the same brand.

It’s so easy for shoppers to simply drive down the road looking for a better price. Do you think dealers would compete so heavily if they were factory-owned? No, the factory would set the price and there would be no negotiations – just like Tesla.

Dealers will happily take your used car as a trade-in, no matter what brand it is. They’ll pay you a wholesale price, then turn around and retail it in their used-car lot. Do you think factory-owned stores would be interested in selling used cars from another car company? Never. Just for kicks, go ask your Tesla dealer about handling your trade-in. They send you to AutoNation.

What’s more, dealers are consumer advocates when it comes to doing warranty and recall work because they get paid by the factory to do it. Do you think factory-owned stores would be so consumer-friendly? Of course not. Warranty and recalls would represent higher cost, not more revenue.

Speaking of company stores, over in Europe they have a kind of hybrid retail system, where factory stores are allowed to compete against the independent franchisees. It’s not working. Daimler is being excoriated by the analyst community, which is advising the automaker to dump its company stores. Why? Because they’re not very good at selling cars, and they all lose money.

That’s the biggest irony of the automotive industry. The companies that make cars and trucks don’t know how to sell them. I can’t name one top executive in the global industry who came up on the retail side of the business. Not one! They all think they know how to sell cars, but none of them has ever done it.

I admire Elon Musk’s we’ll-do-it-our-way approach, and besides Tesla is a niche player.

But the real danger is when Chinese automakers finally start selling cars in the American market. They could easily decide to side-step franchise laws because Tesla has set the precedent.

That could really wreak havoc in the car market, which would not be good for automakers or franchisees, but most importantly, it would not be good for consumers. Let’s hope the public wakes up before it’s too late.

John McElroy is editorial director of Blue Sky Productions and producer of the “Autoline” PBS television show and “Autoline Daily,” the online video newscast.