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A manufacturer is any business that produces finished goods from raw materials. They sell these goods to consumers, wholesalers, distributors, retailers, and other manufacturers wanting to create more complex items.
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EAG Competition Advocacy Papers are a vehicle for disseminating analysis from economists in the Economic Analysis Group (EAG) of the Antitrust Division concerning public policy options for the promotion of competition. These papers are intended to stimulate discussion and criticism of economic issues related to industries and activities in which the creation and promotion of competition may replace either monopoly or government regulation or both. The Antitrust Division encourages independent research by its economists. The views expressed herein are entirely those of the author and are not purported to reflect those of the United States Department of Justice.
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State franchise laws prohibit auto manufacturers from making sales directly to consumers. This paper advocates eliminating state bans on direct manufacturer sales in order to provide automakers with an opportunity to reduce inventories and distribution costs by better matching production with consumer preferences.
Automakers General Motors Corporation (GM) and Chrysler LLC have received $17.4 billion in loans under the Troubled Asset Relief Program (TARP) and have indicated that they may need up to an additional $21.6 billion in federal assistance to restructure their operations.(1) As a condition of the loans, the companies are required to develop plans to achieve profitability. Much attention in the plans has centered on getting labor costs under control. Among other measures addressed are ways to cut distribution costs. As part of its cost-cutting effort, GM has announced that it will reduce its dealership network from over 6,200 dealers today to 4,100. The cost of the auto distribution system in the United States has been estimated as averaging up to 30 percent of vehicle price.(2)
With dealer networks being rationalized as part of cost-cutting initiatives, direct manufacturer sales to car buyers may present an additional opportunity to lower distribution costs. Such sales might range from consumers' simply ordering assembled vehicles of their choice directly from automakers to a scenario along the lines of the "Dell Direct" build-to-order model that revolutionized the personal computer production and sale process. GM initiated a build-to-order sales model in Brazil for its Chevrolet Celta economy car over eight years ago. In 2008, the Celta was among the sales leaders in Brazil.(3) At the time of the Celta's introduction, an auto analyst said that build-to-order could result in "spectacular improvements in the company's competitiveness and profitability."(4)
The next section offers a brief overview of the auto dealer franchise system. Then the essential features of the direct manufacturer distribution model are described and compared with the traditional method of selling autos. Discussion of the benefits of a direct distribution model to auto consumers and manufacturers follows, along with economic analysis of some of the concerns of dealers. A conclusion addresses the question of federal involvement in this issue.
Early in the evolution of the auto industry direct manufacturer sales to consumers were not uncommon. At that time, production processes had not yet been standardized and industry sales volumes were low. Introduction by Ford of the assembly line technique early in the twentieth century enabled high-volume production and ushered in the era of mass-market sales in the United States. Ever since then manufacturers have sold cars through franchised dealerships.
Selling through dealerships has offered several benefits to manufacturers historically. Auto production is a capital-intensive business and a franchise system allowed manufacturers to concentrate their resources upstream while accessing capital through franchise fees from independent entrepreneurs at the retail level. Economies of scale in auto production also required having relatively few, large manufacturing operations located near essential supplies like steel. This contrasted with the nationwide distribution network needed to reach consumers, who could be more effectively served through local dealerships in a better position to assess demand in particular markets and to provide service and repairs.
With the advent of the internet, some of the mutually beneficial nature of the franchise system for manufacturers and dealers has diminished, as information and access to services historically provided primarily by dealers has become more readily available. Online buying services are an obvious example. In addition, a variety of auto information, including pricing data and reviews, can be found online from sites like Edmunds and Consumer Reports. This raises the prospect of disintermediation, broadly defined as direct-to-consumer sales through reduction or elimination of the role of retailers. With respect to autos, unlike the situation with books and CDs, most customers probably will continue to want some hands-on contact with the product before purchasing, likely implying a continuing, though possibly changed, role for dealers. Since the internet can potentially provide manufacturers with better information on consumer preferences than the traditional local franchised dealer, direct manufacturer sales may be one way through which that changed dynamic occurs.
There are substantial differences between the auto industry and the personal computer (PC) industry in which Dell pioneered the direct manufacturer distribution model.(7) These differences have implications for the extent to which a direct manufacturer sales model is adaptable to the auto industry. Auto production is currently characterized by integral and closed product architecture where product design is critical. There is much more product variety in autos than in PCs and the myriad auto components tend to be non-standardized without a common interface across models or companies. By contrast, the manufacture of PCs involves a modular structure with a smaller number of standardized components or modules having a common interface. Build-to-order personal computer products can be readily assembled using the common interface by matching modules to customer preferences.
Despite the differences in the design and production processes of PCs and autos, the computer industry's Dell Direct model can provide some insight into potential cost reductions, particularly with respect to inventories, from direct manufacturer sales of autos. The defining characteristic of the Dell Direct model is the virtual elimination of inventories. Although Dell modified its distribution system a few years ago, historically Dell had sold only directly to final consumers based on customized orders shipped to end users.(8) In the process Dell avoided the cost of carrying finished inventories. Unlike the build-to-order PC model, auto distribution is "make-to-stock," with cars sold through extensive franchised dealer networks. Dealer inventories can range from sixty to ninety days, a consequence of which are substantial carrying costs and negotiation of prices with consumers in order to keep inventory stocks manageable. 041b061a72