Saturday, May 16, 2009

How Does Closing Dealers Help the Auto Companies?

Can someone explain this one to me? The dealers are independent, and buy cars from the manufacturers at a wholesale price. Yes, there are some volume-based rebates and so on, but nothing that would seem to change my basic view of things.

For any given wholesale price, the manufacturers want to sell as many cars as possible. Or, to put it differently, for any wholesale price, the manufacturers want the final retail price to the customer as low as possible.

This calls for as much competition among the dealers as possible.

Closing dealers reduces competition among dealers and for a given wholesale price causes a larger wedge between that wholesale price and the final retail price.

If there were things that the dealers were doing such as providing information or extra services, then there is a valid reason for the manufacturer to want to limit price competition -- to avoid some dealers from free-riding on other dealers' provision of services.

But in the modern auto world, I don't know what services are being free-ridden on. Consumers can find most information online. All that dealers need to do is to have some cars on the lot for people to drive. The manufacturers can easily require that and even pay for the cost.

Many people get the basic economics here wrong, even people who are pretty smart. They somehow think that competition between dealers on price reduces the price that the manufacturer gets. This is clearly wrong. Or they think that the manufacturers are paying for the dealers' costs. That also is not right.

I cannot believe that the manufacturers and their consultants are getting this wrong. There must be some other contractual obligation that I am unaware of, or there is some freeriding issue that is not obvious to me.

1 comment:

Ivan Png said...

I wondered the same. I recall that state laws provide considerable protection to franchisees (such as auto dealers). These may include heavy exit penalties for the franchisor (eg, GM). GM may make payments to dealers -- I can think of cooperative advertising and perhaps subsidies to provide maintenance and repair service (which a dealer might independently prefer not to provide). Going through the bankruptcy process might allow GM to circumvent the state franchise laws.