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Entrepreneurship - BLOG

Car Dealerships Are a Bad Deal for Customers

Karan Girotra, INSEAD Professor of Technology and Operations Management |

The car dealership model no longer provides the value it once did. Letting market forces prevail is what’s best for customers.

Last week New Jersey started enforcing a ban on direct sales by Tesla Motors of its path-breaking model S. Tesla’s direct sales have also run into hot water in a number of other states: Ohio lawmakers are debating a ban on Tesla’s direct sales and Texas, Arizona, and Virginia are also opposed.   Proponents of a ban on direct sales claim that they are acting in the interest of customers. But is it the interests of customers they’re following or rather the bidding of the powerful car dealership lobby?

Car dealers and more generally intermediaries represent an extra layer of companies in the supply chain that clearly increases costs to customers. But in many cases they also serve important functions in a supply chain and can create more value than the inefficiencies they cause.  Let’s look at whether these functions are needed in the car market:

  1. Search and discovery: In the same way eBay helps turn one person’s junk into another person’s collectible or AirBnb makes your empty guest room a hotel room, intermediaries can help buyers find sellers. Beyond finding the right seller, an intermediary might help match the buyer to the best product for her, providing important guidance and product information. In disaggregated markets with many sellers and buyers and where search costs are high, intermediaries provide considerable value.  But the car market is no longer like this.  With product information widely available on the Internet, numerous knowledgeable automobile blogs, websites, most customers can investigate different cars themselves. Further, the test drive can be done via a few product galleries (as is the case with Tesla). The rest of the dealership infrastructure is, basically, redundant from a search and discovery perspective.
  2. Relationship management and trust: In markets with many small unknown sellers and buyers intermediaries can create trust between the buyer and seller and help facilitate transactions where none would have happened otherwise. The Hong-Kong based intermediary Li and Fung’s entire business model is based on orchestrating trust based relationships between garment factories in Asia and other low cost locations and established clothing brands. Again this is not the case with the auto-industry. Most sellers are very established companies with strong reputations and do not need local dealerships to help establish trust with the customer.
  3. Local inventories: Intermediaries can hold inventory in order to provide instant delivery to customers. This was a major role of car dealerships when cars were made to a few limited standard specifications. Today, cars can be increasingly customized. In most European markets a majority of cars are made to order: a customer places the order and the car is then manufactured to exact specifications and shipped directly. This is increasingly happening in the US with higher-end cars and also with cars popular with the younger generation that prefers an individualized product rather than a cookie-cutter vehicle.
  4. After-sales service: Historically, car dealerships and intermediaries have been an important interface for maintenance of cars. But cars have become much more reliable than they were when most of the dealership network was set up. A new well-engineered car rarely needs any special maintenance in the first 7-8 years of its life. And with a large established certified network of repair shops, a car dealership is not necessary to provide the limited maintenance a car might require.

To sum up, our assessment of the ways in which you would expect dealerships to add value suggests that there no pressing case to be made for protecting car dealerships from market forces. In the same way as when travel agents were disintermediated by websites and direct sales, the quintessential auto dealership may now be counting its last days, only creating more inefficiencies in the supply chain than the value it provides.

The process of intermediation and disintermediation in different industries is an essential part of innovating business models. It is these innovative business models that have created industries where none existed before and created immense value for customers. State governments in Texas, New Jersey and Virginia by intervening in the process are not only retarding the innovative processes at the heart of new business creation, but may also be harming their constituents.

 

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Comments
Chris,

Points 1 and 3 are somewhat accurate and valid however 2 and 4 are rather large leaps to make. Sellers are generally not well trusted, and it's easy to see this reflected by the warranty defects, concerns and recalls that have occurred in recent years on makes such as Toyota and GM. The automotive vertical is also exceptionally competitive with low margins. The customer has never had so many options, so the rooftop salesman is still providing a considerable advantage driving interest to their brand vehicles.

Finally, while vehicles are indeed becoming increasingly more reliable, this reliability is really an trend from the last 3 years. The average vehicle in the US market is now older than it has been in quite some time and fixed ops (service, parts) business is booming. While the vehicles that are 3 years of age and under may be more reliable, they still have not been tested for 12+ years to scale in the US market. Cars may be becoming more reliable, but there will always be a need for service and this is a large leap to make.

While it is true that ecommerce is becoming a larger focus of the industry dealerships will be evolving their sales focus to narrow in on up-selling and diversifying their inventory to promote profit. Dealerships still (typically) cover all expenses through fixed ops absorption rate and focus on sales for profit already, so while overhead may decrease and margins may drop this is a fundamental process they are familiar with. This was first experienced in the industry when average vehicle markup plummeted following the emergence of Digital Marketing and increased transparent pricing

David Ford,

Let's see . . Karan Girotra says car buyers need a "product gallery" for the test drive, then "local inventory" for timely delivery of the car, and then a "certified repair shop" after the sale. Well, given the relative high cost of the "land, brick & mortar" businesses necessary to offer these three services in a market; a smart business person would combine all three into one location. Wait a minute . . . wouldn't that essentially BE A CAR DEALERSHIP?

ruggles,

Absolutely! OEMs needed access to dealer capital and local connections. They still do. Interesting how these people writing this ridiculous stuff have NO experience in the retail auto business. They think they understand consumers. They think the business is simple.

David Ruggles,

YES!

Philip,

Each year in the US, consumers purchase about 16M new cars. These are, by definition, commodity goods. Every green Toyota RAV4 rolling off the assembly line should be just like every other green Toyota RAV4. Your logic applies to new cars.

Each year in the US, consumers purchase 40M used cars. Those used cars are all different and no right-minded consumer is going pay thousands of dollars sight unseen on a used car. Used car dealerships aren't going away, regardless of what happens with state franchise laws.

Ratchet,

New car dealers are not going away . They take trade ins to get new cars sold , they help with financing , they give the buyer a place to go for warranty work which could be days or months after vehicle is plated even yes a new car . Dream on

David Ruggles,

Interesting how people who write these articles and make many of these comments have never had any experience actually operating a retail auto dealership.

Even new vehicles are not commodity goods. But if someone wants to try to sell them as commodity goods within the confines of the franchise system, I'm happy to see them try. I'm happy to see TESLA try to own all of its own dealerships. That's what they are. TESLA dealerships. When they start selling 500K units per year with their current model, we can call it successful. But at 500K they are no longer a niche product that has cachet. At 500K they aren't mainstream either and lack the economy of scale to compete with other brands. Their competitors won't be sitting on their hands if it looks like TESLA has something the market wants.

Car fan,

Amazon and other online sellers of new/used goods can establish a relationship, and buy back assurances as well, in fact better than car dealerships. There would be a consistency to their approach. As far as used / trade - ins; I suspect you would see a huge jump in organizations like CarMax and new competitors jumping in to cover that gap. And as far as repair goes, some of the good dealers might remain, but I think dealer repair would give way to a much better model where independent and focused repair facilities would prevail. I think the dealer model could be ditched with no pain and a lot of gain.

David Ruggles,

I don't think so. Independents make heavy use of low wage labor. Training to do repair on today's complex vehicles isn't a job for independents, but they are welcome to try. An example: Ford did some research in the 1990s to find out why so many HVAC blower motors were burning out in their vehicles, many under warranty. It turns out that owners of Fords with the new pollen cabin filters were taking their vehicles to the Jiffy Lubes of the world for routine maintenance. The pollen filters weren't being changed before they clogged. Two guesses what was causing the burned out blower motors.

The list of these kinds of issues has grown exponentially as vehicles have become more complex.

Trade ins? How would Car Max solve that issue? Most trade ins involve a payoff larger than the vehicle is worth. A consumer goes to CarMax, gets an offer for $10K but the payoff is $15K. What happens next? What happens to the lost sales tax credit when the trade in isn't traded in on the next vehicle?

People with no experience in auto retail tend to come up with these kinds of crazy ideas because they don't understand the most basic elements of the business.

Taylored,

Purchasing habits are changing quickly with the next generation of tech savvy buyers. No longer can the fast talking salesman do well with an inferior product and I see little value to the dealerships anymore. Not that they had the best intentions before, but they where the only credible source for information before the masses had the power to review their products. I stand behind Tesla and beleive that they can provide a better service and control quality better by keeping everything in house.

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