Are Car Dealers and Politicians Colluding To Bilk Consumers?

January 17, 2013, 2:59 PM

Friday’s black-tie Auto Show Gala is arguably Detroit’s biggest social event. It’s also a major fundraiser for local charities. The party, and the entire North American Auto Show, is also a showcase for car dealers who, according to consumer advocates, bilk consumers to the tune of $20 billion a year.

Members of the Detroit Auto Dealers Association, which organizes and hosts the auto show, like auto dealers across the country, are protected by a myriad of regulations that both consumer advocates and free-market economists claim stifle competition and limit consumer choice. Laws in Michigan and most other states prevent automakers from selling their product online or in corporate dealerships. Laws also limit automakers’ ability to issue and revoke franchises for dealers.

The Consumer Federation of America calculated the consumer cost of dealer protection at $20 billion annually in 2001, or about $1,500 per new car. According to CFA Director of Public Affairs Jack Gillis, the CFA hasn’t updated the numbers since ’01 but the same rules governing new car sales remain in place.

“All we are calling for is a much freer and more open marketplace,” said Gillis.

“We suggest that if national organizations were allowed to sell those vehicles or the manufacturers were able to sell those vehicles two things would happen. There would be more price competition and that would drive prices down. Secondly, there would be more efficiencies in the manufacturing and distribution of the vehicle.”

Dealers don’t see it the same way. Robert Shuman, vice-chair of the North American International Auto Show and owner of Shuman Chrysler Dodge Jeep Ram in Walled Lake, says laws governing the relationship between manufacturer and dealers trace their roots to a time when automakers ran roughshod over dealers.

“If you go back to the early days of the manufacturer, as we were changing from horses to cars, they would sign-up dealers and the dealers would buy product, invest in facilities, and the manufacturers would decide: ‘thanks a lot, we’re going to go with the dealer on the other side of the street’ and leave dealers hanging,” said Shuman. “There were a lot dealers who lost a great deal of money.”

Protecting dealers from unscrupulous manufacturers, he says, ultimately protects consumers from fly-by-night sales operations and from automakers forcing reputable dealers out of business.

“Over a long period of time, over decades, laws eventually arose to try to equalize the balance of power between manufacturers and dealers,” said Shuman.

Gillis concedes the regulations were once necessary to equalize dealers-automaker relations, but he says the regulatory structure currently protects existing dealers profits at the expense of consumer choice.

“They have carved out extraordinarily strong state franchise laws which are purportedly to protect them from abuse by manufacturer,” said Gillis. “There is no doubt some of those laws are necessary. However, they’ve morphed into somewhat of a restraint of trade which provides dealers with the unique ability to control the sale.”

All Politics Is Local

New car sales regulations aren’t dusty rules left on the books from some bygone era. Michigan’s new car sales law was overhauled in 1981 and revised several times since.

Public Act 139 of 2010 expanded dealers’ territorial rights. Under the law, existing dealers can challenge another dealer offering the same vehicle line from entering their “relevant market area.” However, there is no guarantee the challenge will be successful.

Prior to P.A. 139, relevant market area was defined as a six-mile radius in counties of 150,000 or more residents and a ten-mile radius in less-populated counties. The new law expands the zone of protection to a nine-mile radius in high-population counties and a 15-mile radius in smaller counties.

“Maybe it depends where the freeways are or maybe there is a big state park between me and the other dealership,” explains Shuman. “There could be all kinds of situations as to whether it is fair or unfair. All that nine-mile rule does is give the dealer a chance to get to a judge, on an expedited basis, and just say this is right, this isn’t right.”

P.A. 139 had a bipartisan roster of co-sponsors, including current Senate Republican and Democratic leaders Randy Richardville and Gretchen Whitmer. It passed the state Senate unanimously, won House approval with just two dissenting votes, and was signed into law by then-Governor Jennifer Granholm.

While new car dealers have territorial protections written into state laws, Michigan’s franchise law does not spell out territorial rights for other types of franchisees. It’s a question of contract law to be negotiated by private parties. 

Of course, car dealerships are more complex operations than sandwich shops. Dealers must invest heavily in their businesses to meet manufacturer standards, says Shuman.  He argues it’s in everyone’s best interest to ensure automakers cannot undercut or compete with their dealers.

“The dealer can only get cars from the manufacturer,” said Shuman. “No dealer can build their own car. It’s too complex. We just want to sell the car, but we need some protection because there is unequal bargaining power.

“We are investing millions of dollars in these facilities and if GM, Ford, Chrysler, can on a whim—because they don’t like the color of your tie one day—say you’re no longer our dealer, you can lose millions of dollars. And you haven’t done anything wrong.”

Rules protecting new car dealers may have broad support inside the corridors of power, but they are opposed by an equally broad spectrum of economists and consumer activists.

The Consumer Federation of America was founded in the 1960s at the suggestion of the Johnson Administration. The late Sen. Howard Metzenbaum, a liberal Democrat from Ohio, served as CFA’s honorary chair after leaving Washington. Equally critical of new car sale rules are free-market champions like Michigan’s Mackinac Center for Public Policy.

“We’ve got an area where honest liberals and free marketers and tea partiers should be all on the same page against the massive growth of crony capitalism in this country,” said Jack McHugh, the Mackinac Center’s Senior Legislative Analyst.

McHugh says the nature of auto dealers as an industry gives them a unique position to win support for favorable rules for state legislatures: “They are in every legislative district. They are an employer in every legislative district. They have the financial depth and geographic breadth.”

According to documents from the Michigan Campaign Finance Network, the Auto Dealers of Michigan PAC raised $350,073 during the 2009-10 campaign cycle and $225,669 during the 2011-12 cycle. It is among Michigan’s 50 largest PACs. 

Tesla breaks the mold

The California-based carmaker Tesla hasn’t yet delivered an electric car at a mass-market price point, but if they do, they may offer new car consumers a vastly different buying experience than other carmakers.

Tesla ruffled dealer feathers by selling directly to customers through corporate showrooms. Dealers associations in New York, Massachusetts, Illinois, and Oregon are suing Tesla. They claim direct sales violate state laws. A judge dismissed the Massachusetts case, ruling the state’s dealer association had no standing to bring the case.

John O’Dell, senior editor of the automotive trade publication Edmunds.com, says the dismissal likely doesn’t end the case, but it could mean that carmakers without an existing dealer network may not have to create one.

“In Telsa’s case, their argument is: there are no Telsa dealers, there are no Telsa franchise holders, we aren’t competing with anyone,” explains O’Dell. “They may compete with XYZ out there but that’s different from the factory competing with a factory-authorized independent dealership.”

Many dealers don’t agree. All dealers are affected if even one automaker is allowed to sell directly to customers. Robert O'Koniewski, executive vice-president of the Massachusetts State Automobile Dealers Association, told National Public Radio that traditional dealers often carry multiple brands, each with their own dealer standards and training. They would be at a disadvantage if Tesla can operate single-line corporate stores.

"Those dealers are investing millions of dollars in their franchises to make sure they comply with their franchise agreements with the manufacturers," he told NPR in November. "Tesla is choosing to ignore the law and then is choosing to play outside that system."

But even if Tesla is ultimately successful in their fight to sell their product directly to customers, O’Dell says it’s unlikely that it will affect existing carmakers or their dealer networks. Ford or Chrysler, for example, couldn’t launch a new brand that operated without an independent dealer network.

“I think that would be seen as disingenuous by court,” he said. “Obviously, I’m not a lawyer, but I think a court would see that as disingenuity by an existing corporation.”

A market unlike any other

There is no getting around the fact that new cars are sold in a regulated, limited marketplace compared to other major consumer products, for instance power tools, televisions, or computers.

Both Home Depot and Lowe’s can sell you the same power tool brands, often in stores sharing a parking lot.

Target, Wal Mart, and Best Buy can carry the same television brands. All three carry Apple computer products, which are also available at Apple’s corporate stores.

Consumers can bypass the big chain stores and purchase many of these goods at locally owned independent retailers. Or skip brick-and-mortar retail completely by ordering directly from manufacturers online.

In contrast, the digital store for new cars exists strictly for browsing. You can “build” the Ford Focus of your dreams on the carmaker’s website, but Ford can’t legally sell it to you. I know. I tried.

The best you can do is search nearby dealer inventories for a vehicle that matches the one you want. There simply isn’t another legal way to purchase a new car.

“There is good competition between brands,” said Gillis about the new car market. “But within a brand, there isn’t much competition.”

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