Some 70 auto dealers recently rallied in the Connecticut Capitol to protest proposed legislation that would allow car maker Tesla Motors to sell its luxury electric cars directly to consumers. Currently, state law requires car manufacturers to sell their vehicles through franchised dealerships. But Tesla’s CEO Elon Musk maintains the company has a huge stake in maintaining control over “the customer experience,” claiming advanced batteries and in-car electronics used in producing electric cars make the Tesla showrooms education venues as much as retail venues.
UConn Today asked Timothy B. Folta, professor of management and the Thomas John and Bette Wolff Family Chair of Strategic Entrepreneurship at UConn’s School of Business, for his views on Tesla’s bid to bypass dealerships. His research examines both entrepreneurship and corporate strategy, considering why and how firms evolve over time.
Why is Tesla Motors fighting for direct sales to consumers when it could just cooperate with existing franchise owners to sell its cars?
There may be several reasons. One is because it will allow them to increase demand for their product by lowering the price of their vehicles for customers. By selling directly to consumers, they avoid double marginalization. Laws requiring manufacturers to sell through independent dealers include two profit margins: the dealer’s margin and the manufacturer’s margin.
The decision to sell directly to customers makes sense for Tesla if the demand for their product is high, and there are strong reasons to believe that they will be. Society will likely benefit as we replace gasoline powered vehicles with electric. Moreover, there are also likely to be indirect benefits, meaning customers extract more value from their Tesla when more people purchase a Tesla because electric vehicle infrastructure such as charging stations become more available.
Another key reason is control over building the Tesla brand. Tesla is investing quite a bit not only in their own manufacturing capability, but in establishing infrastructure around the world for electric vehicle use. It may be that Tesla is concerned that local dealers will be unsophisticated about their technology, and the accompanying infrastructure they are building, and the costs of training and monitoring is easier if retail distribution is in-house
Why does Connecticut have a law that forces car manufacturers to sell their vehicles through franchised dealerships? Does the law provide protections to consumers?
It is difficult to understand why such a law exists. One potential argument is that it helps foster competition in retail distribution of cars, which keeps manufacturers from gouging customers on price. But this does not make any sense because retail distribution is a cost of doing business. If anything, outsourcing the retail distribution function could lead to increased prices for customers because of double marginalization.
A second argument is that local dealers have strong incentives to take care of an area’s customers, or else lose their reputation. But given that manufacturers expend considerable capital on the creation of their products—and considerably more than dealers spend—there are reasons to believe manufacturers have stronger incentives than dealers to maintain their reputation for good service.
A third argument is that dealers play an important role in complying with local laws and safety inspection. But there is little reason to believe that manufacturer-owned dealerships would be any less capable of performing these functions.
A final argument is that manufacture-owned dealerships might undercut independent dealers on price. This does not hold for Tesla as they do not sell through independent dealers. This raises the question of whether the law should be exempt for Tesla, or other new automobile manufacturers, while maintained for all existing manufacturers. If exemption occurs, Tesla might indeed be able to lower prices and obtain a competitive advantage. So, this argument is basically an admission that dealer laws are unnecessarily raising car prices.
In the early days of the U.S. auto industry, manufacturers couldn’t afford to both make and sell cars across the country so they relied on having their new cars retailed through dealerships. Why?
A key reason is that they avoid the investment in establishing the dealer network, and allow the firm to focus on its core competence in research and development and manufacturing. Another reason is that it shifts sales decisions to managers with local market knowledge. Finally, independent dealers can gain economies of scope by sharing costs while selling several different brands under a single roof. It is worth noting that Elon Musk, the founder of Tesla, it quite wealthy and so his company may not be financially constrained by the challenge of selling directly. It is important to point out that compared to Tesla, other manufacturers may not likely benefit as much by selling direct to customers, and so will be less inclined to do it.
If Tesla prevails in maintaining control over its brand while seeking entry into markets, will that change the shape of the entire U.S. auto industry?
It is possible that allowing Tesla to sell directly to consumers may start a cascade of manufacturers trying to benefit the same way, or avoid being put at a competitive disadvantage relative to those that sell directly. I believe this is unlikely because other manufacturers will not have the same incentive to sell directly for several reasons. First, they already have dealer networks established, so attempts to go directly to consumers may be met by backlash from existing dealers, who cannot sell at the same low prices. Second, Tesla has new and exciting technology and is making substantial investment in electric vehicle infrastructure, and so the preservation of the brand is probably much more important for them. Moreover, the importance of sales training is more critical for Tesla, given their unique technology, and training may be more effectively delivered if the sales function is internal.
