« "Historical Aspects of U.S. Trade Policy" | Main | FOMC Meeting Minutes »

Tuesday, August 29, 2006

Franchises and Sluggish Adjustment

Why GM cannot simply drop brands like Buick and Pontiac even if it is in GM's best interest to do so:

Dealer'sChoice, by James Surowiecki, The New Yorker: When General Motors was the biggest and most profitable auto manufacturer in the world, its strategy was to provide “a car for every purse and purpose.” G.M. offered a panoply of distinctive brands, each targeted at a particular category of buyer—Buick for the successful but conservative driver, Cadillac for the wealthier and more flamboyant, and so on. This was a tremendously successful strategy in the days when G.M.’s domination was unchallenged. But now, with G.M. losing billions of dollars a year and struggling to restructure, ...[w]hen analysts talk about how to turn G.M. around, most start with the need to slim down the company and get rid of less popular brands. (Buick and Pontiac are perennial nominees.) It’s an eminently sensible approach, but it’s unlikely to happen anytime soon, because it would challenge the interests of some of the most powerful players in today’s auto industry—car dealers.

Car dealers ... seem like the archetypal small businessmen, and it’s hard to believe that they could sway the decisions of global corporations like G.M. and Ford. But, collectively, they have enormous leverage. Dealers are not employees of the car companies—they own local franchises, which, in every state, are protected by so-called “franchise laws.” These laws do things like restrict G.M.’s freedom to open a new Cadillac dealership a few miles away from an old one. More important, they also make it nearly impossible for an auto manufacturer to simply shut down a dealership. If G.M. decided to get rid of Pontiac and Buick, it ... would have to get them to agree to close up shop, which in practice would mean buying them out. When, a few years ago, G.M. actually did eliminate one of its brands, Oldsmobile, it had to shell out around a billion dollars to pay dealers off—and it still ended up defending itself in court against myriad lawsuits. As a result, dropping a brand may very well cost more than it saves, since it’s the dealers who end up with a hefty chunk of the intended savings.

You’d think that what’s bad for G.M. would also be bad for the people who sell its cars. But G.M. makes money (when it does) on new cars and on the financing of loans. Dealers, by contrast, make most of their money on servicing old cars and selling used ones. So dealers can thrive even when the automaker languishes. And at the state level they often have more political influence than automakers do. In the late nineties, for instance, local dealers were challenged by companies that wanted to sell cars over the Internet. In response, some states, including Texas, actually passed laws making it illegal to have a business selling cars online (unless you already owned a local dealership)... When Ford itself started experimenting with online sales, dealers’ vigorous objections (along with legal challenges) caused the manufacturers to quickly retreat. ...

Ford and G.M. always sold their cars through independent dealers... They could have owned the dealerships themselves... Instead, they preferred to give dealers franchises, and work with them as partners. And, historically, the automakers were not good partners. In 1920, for instance, the U.S. economy went into a deep recession. But Henry Ford kept his factories running at full tilt, and forced thousands of Ford dealers around the country to buy new cars that they had little chance of selling. The dealers knew that if they said no they’d never see a Model T again, so they ate the inventory. A decade later, when the Great Depression hit, Ford and G.M. used the same strategy to help keep the production lines going. They turned their dealers into a cushion against hard times.

In the long term, this was a disastrous tactic, because it inspired mistrustful dealers to look to the government for help. (The first franchise law was passed in 1937.) Dealers recognized that much about their businesses was always going to be out of their control—automakers not only decide what cars get made but also dictate sales strategies and incentive plans. So they decided to protect what they could, using laws to insulate themselves from competition and from the risk of being dropped by the manufacturer. And that’s what has made life so hard for the automakers today.

The irony in all this is that G.M. and Ford adopted the dealer system because they thought it would make their lives easier. A dealer who owned his own business would work harder than a mere employee, the thinking went, and would not require a lot of outside monitoring. But the benefits that the car companies reaped from franchising cost them a lot in terms of control and flexibility. There are now many things that G.M. can’t do (like shut down Buick) that it could do easily if it owned its own dealers. Car companies might like to change this—in the late nineties, both G.M. and Ford tried to start buying up dealerships. But, at this point, the system is self-protecting; dealers revolted, state regulators started nosing about, and the automakers gave up. They made a devil’s bargain some eighty years ago, and now they’re stuck with it...

    Posted by on Tuesday, August 29, 2006 at 11:12 AM in Economics, Regulation | Permalink  TrackBack (0)  Comments (5)


    TrackBack URL for this entry:

    Listed below are links to weblogs that reference Franchises and Sluggish Adjustment:


    Feed You can follow this conversation by subscribing to the comment feed for this post.