Considerations for the State of Texas
Consumer Benefits of the Independent versus Factory-owned New Car Retailer
April 9, 2013
My name is Maryann Keller. I am the Managing Partner of Maryann Keller & Associates LLC, a management consulting firm specializing in the automotive industry. I have served in this position for more than twelve years. My firm is and has been engaged on a wide variety of consulting projects for clients including automotive OEMs, lenders, private equity firms, government agencies, and retailers. Several law firms and one US government agency have engaged me to provide expert witness testimony in support of litigation. I have never served as an expert witness in any litigation involving or related to auto retailing or auto dealers.Before my employment at priceline.com, I worked as an automotive industry analyst on Wall Street for 28 years. I served as Chairman of the Society of Automotive Analysts from 1994-1999. During my Wall Street tenure, I was ranked as an All-Star Analyst 12 times by Institutional Investor magazine. I have authored two books on the industry. My first bookRude Awakening: The Rise, Fall and Struggle to Recover at General Motors, was published in 1989 and received the prestigious George S. Eccles prize for Excellence in Economic Writing from Columbia University. My second book, published in 1993, is entitled Collision: GM, Toyota, and Volkswagen and the Race to Own the Twenty-first Century.
The Texas Auto Dealers Association asked me to submit my comments for your consideration as to the benefits of the franchised dealer system for consumers. I can unequivocally state that the consumer is best served by the franchise dealership system for the reasons elaborated herein. My opinions are based upon my four decades of involvement with the automotive industry, particularly within the United States, during which time I have witnessed challenges to the franchised dealer model, including a somewhat recent experiment by Ford that proved both the value and superiority of the franchise dealership over a factory–owned store.
All too often the debate about what is the better retail solution of the car buyer is couched in vague goals: lower distribution costs, more control over the ownership experience, consistent experience in every store, etc. But this ignores the actual car purchase and ownership experience for the vast majority of new car buyers who acquire a new car every four to six years and in doing so links him or herself to the dealer expecting that dealer to resolve all repair issues, manage recalls and warranty claims, and be their advocate in resolving issues with the manufacturer.
Buying a car is not akin to shopping at Target, Wal-Mart, or Tiffany where the transaction is paid by credit card and requires no further relationship with the seller. Buying a new car is a thoughtful process often involving months of online research and visits to multiple dealerships to test drive vehicles under consideration. Even with the enormous amount of easily accessible information on the characteristics and features of every make and model, retail and invoice pricing, projected residual values, quality ratings etc., the process is different. With a new vehicle, most customers are making significant emotional and investment decisions which require assistance in obtaining new financing and disposal of an existing vehicle often including extinguishment of associated debt. The new car purchase experience is far removed from any other retail purchase as to the unique needs of every shopper and the regulatory and disclosure requirements for each sale.
Further, the customer relationship with any new vehicle (and some used vehicles which offer extended manufacturer warranties) and the selling entity – a new car dealer – extends well beyond the initial acquisition. There are elements of warranty repair, manufacturer recalls (from time to time), and even silent recalls which are addressed at service visits. Warranty periods are generally at least three years in length (subject to mileage limits) or longer with some components, such as powertrain, emissions and occupant safety systems, having manufacturer warranty coverage over an even longer period. Warranty and recalls are exclusively handled only by dealers authorized to represent the manufacturer. And for lease customers, one end-of-lease option includes returning the vehicle to manufacturer’s captive fiancé company or other lender through its dealer network. It is also interesting to note that while General Motors, Ford and others have abandoned some brands in recent years, the remaining franchised dealers were designated to perform the above required functions for the owners of Oldsmobiles, Saturns, Hummers, Pontiacs and Mercurys.
There is a strong consumer interest in having independently-owned dealerships acting on behalf of the manufacturers. The primary reasons result from the following:
- Desire by the independent dealer to find a solution that best meets the transportation requirements for all customers regardless of income, creditworthiness, available cash, or trade value;
- Competition among dealers drives product and service pricing to a true market level and offers the consumer a choice among vendors; and
- Value preservation for both the manufacturer’s brand and dealer’s brand drives behavior to seek customer satisfaction with the dealer acting as in intermediary between the manufacturer and the consumer.
As such, the dealer – as the franchisee – must conform to the standards expected by the franchisee. Yet, unlike other franchise systems such as McDonalds or 7-11, the automotive dealer also has his own local, regional, or even nationwide brand to support and maintain. In this manner, the dealer acts as both a “system operator” selling and servicing an automotive brand for a manufacturer but also on his own behalf to support his or her own brand. Think of the local car dealers in your districts. You likely do not think of them as just the “Ford” or “Nissan” store but that of “John Doe Ford” or “Jane Doe Nissan” owned and operated by businesses distinct from their manufacturers. They and their employees are members of the community where they continue to represent the automaker’s brand as well as their own.
This is a singularly different element of the franchised automotive dealer system as opposed to most other franchise businesses. No one goes to a McDonalds or a Fairfield Inn and cares who the actual owner might be – the reputation is solely that of the franchisor. The nature of their products and services are such that there is little variance, if any, among franchisees, the product or service is rapidly consumed (and at relatively low cost), and there is no long term on-going relationship of daily use.
Any new car though is expensive, has a long duration ownership cycle, and warranty claims can only be satisfied at a franchised dealer. The relationship with a new car dealer extends well beyond the initial purchase, and maintaining customer satisfaction with the vehicle becomes not only the responsibility of the manufacturer but that of the local dealership as well, even if different from that where the vehicle was purchased. Hence, new car dealers are different from other franchise operators in that there is usually a name attached to the franchise brand that is promoted, advertised, and carries its own reputation separate and distinct from the vehicle brand. Hence, the new car dealer actually serves two masters – that of his manufacturer and that of his or her own creation.
This distinction is extremely important for one reason: the dealer’s desire to maintain his or her own reputation serves as the buffer between the customer and the manufacturer. It is in the dealer’s interest to ensure the complete satisfaction of the customer during the duration of vehicle ownership – and this may involve satisfaction of warranty claims, policy work as goodwill from time to time (for vehicles out of warranty), and expeditious handling of recalls and technical service bulletins as they arise. The franchised dealer often can be the advocate for the consumer with regard to issues that may be a result of action (or inaction) by the manufacturer to provide redress.
Second, the franchised dealer network – among any given brand – provides choices for the customer as to both sales and service. While different brands compete for customers, within a given brand, a consumer can pick and choose among different dealers offering the exact same products and services. So price competition exists between not only different vehicle companies (e.g., Chevrolet versus Toyota) but between dealers within the same brand as well. The vast majority of new car purchases are done in major metropolitan regions. Here, shoppers generally have access to several dealers of the same brand within a 25 mile radius who compete with each other and while providing convenient access to service without forcing the owner to drive long distances for repairs.
Competition permits true price discovery by consumers for the best deal among different brands. But such competition also exists among the dealers of any specific brand to promote their best deals. Thus, dealers provide a service to all shoppers that may see such promotions – and hence force competing dealers to respond. Here again, the consumer is served by independently-owned franchisees competing for business from consumers in a local market. Likewise with service, dealers compete for such business and drive prices to a market level as consumers have a choice.
I note that while all new vehicles are required by federal law to display a Manufacturer Suggested Retail Price, the reality is that most new vehicles are sold at prices somewhat below the suggested price. Further, the actual market pricing for a given vehicle can vary among markets for a number of different reasons – changes in local demand associated with local economies, regional manufacturer incentives, equipment match (or mismatch) with regional needs and desires, excess or insufficient inventory stock, or simply response to new models from competing brands at the local level. With so many variables in the dynamic automobile marketplace no company or dealer can fix a price over long periods of time. The presence of competing dealerships allows this market-based pricing to occur among brands, models and among dealers.
Third, the franchised dealer system has generally served customers very well. Everyone who wants to buy a vehicle – a necessity for many – is generally accommodated in some fashion. For new and used car buyers, the franchised dealer provides the inventory and financing to provide transportation for many even if means offering an alternative to a new car purchase for some. But as independent businesses, the franchised dealer owns his inventory of new and used cars. There are often hundreds of vehicles available sale – which gives customers same day access to transportation. Because such inventory is owned by the dealer – there is a strong incentive for the dealer to make sure that each and every customer can be satisfied. Once again, the consumer benefits from broad selection, immediate availability, and the on-site services the dealer provides to take trades and arrange financing for the customer.
Furthermore there is no evidence that the vast majority of car buyers are willing to wait weeks or months for a build to order vehicle. The purchase of a new car is often prompted by a life changing event: a new job, relocation to the another city, a move to a new home, the birth of a child, marriage, divorce, a death in the family, or an accident rendering the car a total loss or resulting in high repair costs. We know that the shopping process can begin months before the actual purchase, but once the decision has been made the customer wants the car as soon as possible. The franchised dealer, with his inventory, is generally able to accommodate every customer’s needs and pocketbook. Even if a dealer doesn’t have the exact car in stock, the dealer is generally able to find and deliver that exact car the customer desires within a couple of days. This past October, my sister, having just moved to CT from AZ, decided prior to her move to purchase a specific make and model. I accompanied her and my brother in law to the dealer where they settled on the trim level and color they wanted which this dealer didn’t have in stock. My sister needed a car quickly and couldn’t wait for the next factory shipment. However, within ten minutes, the dealer located the exact vehicle 60 miles away in New Jersey and arranged with the NJ dealer to flat bed the car to CT the next day. Within 48 hours of entering the CT dealership for the first time, she and her husband drove out of the store with their desired vehicle.
One of the arguments made by vehicle manufacturers seeking to control both distribution and service can generally be described as follows:
We can offer a compelling customer experience while achieving operating efficiencies and capturing sales and service revenues incumbent automobile manufacturers do not enjoy in the traditional franchised distribution and service model. Our customers deal directly with our own factory-employed sales and service staff, creating what we believe is a superior buying experience from the buying experience consumers have with franchised automobile dealers and service centers. We believe we will also be able to better control costs of inventory, manage warranty service and pricing, maintain and strengthen our brand, and obtain rapid customer feedback. Further, we believe that by owning our sales network we will avoid the conflict of interest in the traditional dealership structure inherent to most incumbent automobile manufacturers where the sale of warranty parts and repairs by a dealer are a key source of revenue and profit for the dealer but often are an expense for the vehicle manufacturer.
The fundamental problem with this argument is that the consumer has no choice but to deal with the factory itself for both sales and service. There is no opportunity for price discovery by consumers for a new car or for service as there is no competition among stores and service centers all are owned by the factory. All new cars are priced as set by the factory – and not determined by the marketplace among competing sellers. Second, the factory also determines service rates, parts costs, and makes its own determination as to whether a claim is valid for warranty coverage. There is no independent arbitrator that can act on behalf of the consumer as in the case of the independent franchised dealer system. And last, the factory owned store has little impetus to accommodate customers that cannot afford their new vehicles – in contrast to the franchised dealer which has a strong motivation to satisfy each and every customer with a transportation solution. There is yet another problem with the factory-owned model of distribution and service. Since the factory controls both the parts supply as well as the technical training for the mechanics, there is little impetus for the factory to provide such to independent third party agencies. In effect, the factory service locations and its own mechanics (whether based at a service center or delivered through mobile repair trucks) forces all customers to utilize its labor and needed parts at prices it solely determines. The customer is effectively trapped within the network solely controlled by the vehicle manufacturer.
This is in contrast to the franchised dealer system where a customer can access parts and labor among competing independently owned service centers – at prices that are determined by the market. Further, franchised dealers also sell factory original parts to vehicle owners, independent mechanics, and even to other dealers. Some franchised dealers have large wholesale parts inventories and supply factory parts to various professional buyers, thus supplementing the manufacturer’s own parts distribution system. In contrast, the factory-owned store system, as a sole source, has no incentive to do so in order to maximize its own revenues and eliminate potential competitors from servicing its vehicles. Again, not only are customers deprived of the right to shop for the best service price (and experience) but other third parties – such as independent mechanics or other dealers – are deprived of the right to service and support vehicles sold and serviced only by the factory.
Last, there is no inherent conflict between the factory and the franchised dealer with regard to warranty and service. It is true that warranty work can generate a profit for the dealer – and the desire to provide warranty service is a motivator, not detraction for such independent dealers as it is a solution which optimizes customer satisfaction. In the factory-centric model, as a single source provider of service, such motivation to supply and support warranty service becomes diminished as it is only a cost to the factory, not a revenue stream.
There is a notion that factory stores eliminate costs in the factory-owned distribution system that can be passed on to consumers. It is easy to find essays written by uninformed professors on the topic that have helped to perpetuate this notion. One has to ask exactly where those savings might arise. It is also merely hypothetical to assume that the automaker would be altruistic and pass any “realized” savings on the consumer.
There are certainly no savings in fixed assets such as the dealerships land, buildings, or equipment. Nor would there be a reduction in employees. Variable costs such as advertising would remain unchanged. So the question is whether there would be savings in inventory. The “build to order” model remains a theoretical ideal. Currently auto companies are paid immediately for their output by their dealers. Each dealer is then obligated to find the market clearing price for vehicles in high demand as well as models that might be at the end of the production cycle facing intense competition and requiring heavy discounting.
Auto assembly is capital intensive which requires large facilities and skilled workforces. It is called auto assembly because vehicles are assembled from parts and components produced by suppliers that fabricate them in equally capital and labor intensive production plants. Parts producers bid contracts based upon annual production volume targets. They make investments to support projected volumes. Neither the supplier community nor the automakers themselves can rely upon a fixed price retail model based on “build to order” as a way to manage or reduce costs. For both assembler and parts suppliers steady output above breakeven optimizes profits. Stop start production raises unit costs because of the high fixed costs associated these factories. Every product has a life cycle whether an Apple iPhone or Chevrolet Silverado. Demand for individual products varies not only because of macro economic factors but also competition. So to assume that there are savings from a perpetual order bank is simply not credible or supported over the long term even by models like Dell Computer. Dell Computer’s build to order model worked as long as there was no iPAd.
Both GM and Ford experimented with factory ownership of retail stores during the late 1990s. Ford’s ill-fated Auto Collection experiment proved conclusively that factory ownership did not work well. Ford ended its experiment after a couple of years of market share losses amid mounting evidence that its factory stores did not deliver a better customer experience nor reduce costs. GM, perhaps after watching Ford’s travails, and despite repeating the same nonsense about reduced costs through factory ownership, canceled its own planned takeover of 10% of its franchised dealers.
In summary, the independent franchised dealer system does provide the best solution for consumers for the reasons elaborated above. Of course, I recognize that the franchised system is not perfect – and there are and will always be a few dealers which do not provide high levels of customer satisfaction. Yet the franchise system has survived for over 100 years and best serves customer needs.
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