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Car Dealer Franchise Laws:

One major problem currently faced by automakers is that they are stuck in economically irrational permanent contracts with franchised auto dealers. These arrangements were not created by bargaining, but by legislative fiat. My father Jerry Kopel explains the problem in Colorado, and a new bill which would make the problem even worse. The column originally ran in the Colorado Statesman, Colorado's weekly political newspaper.

My father served 22 years in the Colorado House of Representatives, representing northeast Denver. One of the most liberal members of the legislature, he was (and is) a strong champion of consumer rights. Among other things, he was the lead sponsor of Colorado's adoption of the Uniform Consumer Credit Code. As a consumer advocate, he observed how professional licensing is frequently used as a tool to exclude competition, rather than to guarantee professional quality. Accordingly, he sponsored the first Sunset law in the nation, requiring that professional licensing boards automatically expire after a period of years, unless they are renewed by an affirmative act of the legislature.

Redman:
Couldnt an automaker reject those dealership executory contracts in Chapter 11?
2.5.2009 11:50am
John Jenkins (mail):
Mr. Kopel, I think you meant the "Uniform Consumer Credit Code;" it specifically excludes commercial transactions.


[DK: Of course you are right. Thanks for spotting that.]
2.5.2009 12:15pm
TruePath (mail) (www):
Well I guess this is why we have federal preemption.

Hmm, but I guess most members of the house still will have an incentive to favor their local dealers.

Ok, so maybe we *really* should send GM and the rest into bancruptcy and have other car companies just buy the pieces.
2.5.2009 12:50pm
ChrisIowa (mail):
A question. Would someone explain why too many dealers is a problem? If GM sells 1,000,000 cars in a year why does it matter to GM whether 10,000 dealers sell 100 cars each or 5,000 dealers sell 200 cars each?
2.5.2009 12:52pm
John Jenkins (mail):
Chris, the difference is in transportation costs and the administrative infrastructure to handle the dealers (account managers and whatnot).
2.5.2009 12:54pm
Preferred Customer:
ChrisIowa:

Think about it the same way you'd think about any business-economies of scale. Higher volume stores can afford more investment in facilities, advertising, and so on.

But, part of GM's problem is not too many dealers exactly, it's too many different KINDS of dealers. Chevy dealers, Pontiac dealers, Saturn dealers--each of these dealer groups exerts pressure on the company to produce a full line of cars, which leads to splintered efforts in marketing and R&D, and/or badge engineering (e.g., the Pontiac Torrent and G5, both of which are warmed-over Chevys produced at the inistence of dealers).

The contracts with dealers also make it difficult or impossible for GM to shutter these brands. Closing down Oldsmobile was hugely expensive, in large measure because of the payouts that had to go to dealers.
2.5.2009 1:00pm
MarkField (mail):
I don't understand what is meant by "legislative fiat". All laws are "legislative fiat".

That aside, statutory frameworks such as the CA New Motor Vehicle Board or the Dealer's Day in Court Act garnered legislative support because the manufacturers routinely abused their dealers in ways which were fundamentally unfair. While I wouldn't defend every aspect of the current system, simply abolishing the protections would wipe out local businessmen who have large sums of money invested. I can't see how that's in anyone's interest.
2.5.2009 1:20pm
Dan Weber (www):
If GM sells 1,000,000 cars in a year why does it matter to GM whether 10,000 dealers sell 100 cars each or 5,000 dealers sell 200 cars each?
To a first approximation, 100% of the costs to operate those stores comes out of the pockets of GM customers. And the customers cannot avoid those costs.

(Yes, dealers can make money on used cars that aren't GM. And lots of the money in dealerships is on financing.)
2.5.2009 1:31pm
David M. Nieporent (www):
I don't understand what is meant by "legislative fiat". All laws are "legislative fiat".
I think it's clear that he was contrasting "legislative fiat" to market-based negotiations.

That aside, statutory frameworks such as the CA New Motor Vehicle Board or the Dealer's Day in Court Act garnered legislative support because the manufacturers routinely abused their dealers in ways which were fundamentally unfair.
Even assuming that a free market transaction can ever be "fundamentally unfair," those were enacted at a time when the auto makers had far more power (and less competition) than they do now.
2.5.2009 1:42pm
Oren:

That aside, statutory frameworks such as the CA New Motor Vehicle Board or the Dealer's Day in Court Act garnered legislative support because the manufacturers routinely abused their dealers in ways which were fundamentally unfair.

So the dealers were free to walk away and the manufacturers would sell less cars for lack of exposure.
2.5.2009 2:04pm
Houston Lawyer:
This issue does matter to people outside of urban areas. Last month, my mother bought a Hyundai from a large dealership about 15 miles from her home. Yesterday, that dealership, which was associated with one of the largest Chevy dealerships in the country, closed their doors for financial reasons. This dealership previously sold 9,000 vehicles a year.

There isn't another Hyundai dealership within an hour's drive, so getting her car serviced is going to be a pain.
In my mother's home town, we used to have Ford, Chevy and Dodge dealerships, and for a while Toyota. Right now, there are no dealerships. While not defending the featherbedding done by dealerships and their cronies, you can see why its a win for state legislators to protect them.
2.5.2009 2:13pm
Avatar (mail):
More to the point, price competition on new cars is ruthless; the incentive structure is such that quite a few cars are moved with no (dealer) profit, and a lot of the dealer profit even under normal circumstances is on add-on extras and financing (and repairs, which are the preponderance of a dealer's profits anyway).

If the dealers were all owned by the manufacturer, there wouldn't be the same kind of price competition. GM wouldn't care so much whether you bought the same car from one dealer or the other; the managers running the dealers would, obviously, but not to the point where they were willing to let a car go for cost to prevent the customer from going across town.

The extra administrative cost of dealing with more dealerships is present, to be sure, but not nearly as large as the price competition problem. (Unless, of course, you're a consumer!)
2.5.2009 2:15pm
Tatil:

GM wouldn't care so much whether you bought the same car from one dealer or the other

But GM would care if you buy a car from another company. I doubt the prices would change a whole lot.


Accordingly, he sponsored the first Sunset law in the nation, requiring that professional licensing boards automatically expire after a period of years, unless they are renewed by an affirmative act of the legislature.

Well, you can also look at that as an opportunity for legislators to obtain favors and donations from lobbyists every so many years instead of only once. :)
2.5.2009 2:27pm
David Walser:
The problem is not too many dealers, the problem is too many ineffective dealers. While manufacturers spend a ton on marketing, it's up to the local dealers to sell the cars. The current laws prevent the manufacturers from weeding out weaker dealers and giving their territory to more capable dealers.

For example, many years ago my parents moved to a rural area. Visiting them while on break from college, I noticed that the local Ford dealer had several new cars from a prior year on its lot. I thought this was a chance to pick up a new car for a used car price. The dealer insisted on full sticker price. (IIRC, he wanted full sticker price for '84 Escorts in 1986!) Any wonder most of the town drove Chevy's? If they wanted a Ford, most in town choose to drive 2 hours to the next closest Ford dealership. Ford did not become competitive in that area until the dealership was sold to a man who'd run a very successful used-car lot in town.
2.5.2009 2:31pm
ShelbyC:

I don't understand what is meant by "legislative fiat". All laws are "legislative fiat".




So you do understand what is meant by "legislative fiat"
2.5.2009 2:35pm
Abdul Abulbul Amir (mail):

A question. Would someone explain why too many dealers is a problem? If GM sells 1,000,000 cars in a year why does it matter to GM whether 10,000 dealers sell 100 cars each or 5,000 dealers sell 200 cars each?



There is a cost of maintaining those dealerships. GM has 5 times the number of dealers for about the same volume. Just for starters, that means five times as many credit checks. With one dealer in town he is competing solely against Ford, Toyota and the like. With 5 dealers they are competing to some extent against each other.

Keeping a trained service staff is easier at one large dealer than 5 small dealers. Arranging joint advertising is easier for Toyota since they need to deal with fewer dealers for a given market. There is more of course.
2.5.2009 2:56pm
MarkField (mail):

So the dealers were free to walk away and the manufacturers would sell less cars for lack of exposure.


Not at all "free" to walk away. Operating a car dealership is a very capital intensive business. There are leases, flooring, showroom costs, etc. In most cases, the dealer signs a personal guarantee for these expenses.

What all too often happened was that the manufacturers would encourage someone to open a new dealership during high sales periods and then arbitrarily close them when sales declined. In addition, the manufacturers used their control over product to favor some dealers over others for irrational or even corrupt reasons (see, e.g., the Honda bribery scandal). Because of the dealer's large capital exposure, he was very vulnerable to imposition by the much more powerful manufacturer.

I do agree that conditions have changed. I'm not saying there should be no changes in the law. I am saying that it's important to understand how and why those laws came to exist, and that abolishing them would have significant consequences.


I think it's clear that he was contrasting "legislative fiat" to market-based negotiations.


Sure, but in that sense the UCC is "legislative fiat". That hardly means we should repeal it today.
2.5.2009 3:45pm
Bruce Hayden (mail):
My father served 22 years in the Colorado House of Representatives, representing northeast Denver....Accordingly, he sponsored the first Sunset law in the nation, requiring that professional licensing boards automatically expire after a period of years, unless they are renewed by an affirmative act of the legislature.
I have mentioned this before, but my mother knew David's father then, when she was the state Legislative Chair of the League of Women Voters and their head lobbyist. His father's liberal reputation was part of why my parents always thought it interesting that David was the "conservative" on the Colorado Inside Out.

That said, the Sunset law on professional licensing was unique at the time, and I do think it was in the consumers' best interests. In the end, most of the licensed professions lost their monopolies. Of course, law, medicine, insurance, and real estate remained regulated. We couldn't have unregulated attorneys running around, could we?

I do find it interesting that David's father is mentioning agency capture. That is one of the reasons that some of us on the right question big government.

The Colorado laws are bad here, and it appears that they may be getting worse. The Sunday closing laws are silly, esp. now when everything else, except for liquor stores are open on Sunday. On the other hand, it does provide a time when you can window shop without being high pressured by a car salesman.
2.5.2009 3:49pm
David Warner:
Interesting that personal computers were once sold via the dealer model, but outfits like Dell and Gateway made that obsolete. It's entirely possible that the whole dealer system is likewise extraneous. It should at least be legal for a company to try it to see.

My uncle is a car dealer, and I worked for him for three years. He would strenuously disagree, but he was never able to make a strong economic case for commensurability between the value he added and the money the business made (other than "employing seventy people"). BTW, that money's been hard to come by lately.
2.5.2009 6:00pm
ohwilleke:
A good part of the cost of having many dealers is how it impacts the market rate compensation (mostly commission) for people who sell cars.

People who sell cars spend large parts of every week sitting around the dealership waiting for someone to come and buy a car, although there are, of course, busy times (Colorado forbids car sales on Sunday, so Saturday is when the bulk of car sales take place) and busy seasons. Commission rates are set in a way that allows someone who is reasonably competent at selling cars to make a living.

But, the more dealers you have, the more car salespeople you need to have, and some combination of advertising, service quality and geography apportions the pool of people who want to buy the kind of car that the dealer sales amongst them. Within a given car market, which roughly corresponds to a metropolitan area, the fewer dealers there are, the more people who want to buy the kind of cars that the dealer sells will come to that dealer.

When dealer's have more customers each, each salesperson at those dealers can sell more cars, and car salespeople can get smaller commissions per car and still make a good enough living to keep them from doing something else. Hence, the customer pays less (assuming that there is still some competition in the market to prevent monopoly conditions from arising, and for multiple dealers of the same brand in the same metropolitan area one comes very close to classic perfect competition).

Dealers don't have a monopoly on maintaining the cars that they sell any more, so the need for a robust network of rural dealers isn't nearly as great as it used to be. A very small operation can competently and efficiently maintain many different brands of cars (Toyota, Lexus, Honda, Acura, Hyundai and Kia are a common combination at a single independent repair shop, for example). The reality of rural life is that most rural people go to their local metropolitan area for most major purchases in any case, because they can usually get better deals and more selection. Most farmers have off season jobs (often in construction and often in the city) at any rate.
2.5.2009 6:28pm
Sean O'Hara (mail) (www):
Can't someone bring suit on the grounds that this is an anti-trust violation? The situation seems identical to when movie studios owned theaters, which the Supreme Court held was unconstitutional.
2.5.2009 6:42pm
ohwilleke:
If federal law expressly permits it, and indeed commands it, it isn't an anti-trust violation. Anti-trust law are strictly a creature of staute.

There is absolutely nothing unconstitutional about movie studios owning theaters. It may have violated anti-trust laws, but with rare exceptions, the United States Constitution governs the powers of government, not the legality of conduct by private parties not acting under color of law. The only exceptions that come to mind right off are the slavery ban and the limitations on issuing currency.
2.5.2009 7:29pm
ohwilleke:
"The Colorado laws are bad here, and it appears that they may be getting worse. The Sunday closing laws are silly, esp. now when everything else, except for liquor stores are open on Sunday. On the other hand, it does provide a time when you can window shop without being high pressured by a car salesman."

Liquor stores have been open on Sundays in Colorado since July 2008. The only Sunday closing laws of any moment in the state right now are those that apply to car dealers.
2.5.2009 7:31pm
Andy Freeman (mail):
> In most cases, the dealer signs a personal guarantee for these expenses.

What stops car dealers from incorporating like almost every other biz does?
2.6.2009 10:21am
MarkField (mail):

What stops car dealers from incorporating like almost every other biz does?


They can and do incorporate. But the banks and the manufacturers routinely demand personal guarantees from the owners.
2.6.2009 1:22pm

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