The Moderation Conversation, Email Edition: Tesla Motors vs. Auto Dealers

This is the first installment of “The Moderation Conversation, Email Edition”, a spin-off of RM’s “Moderation Conversation” feature wherein Matt and Chris get together to record a discussion and then heavily edit the resulting transcript. The exchange took place in cyberspace this time, meaning a lot of their typical malapropisms never even made it into the text in the first place! The topic of the thread was Tesla Motors’ plan to shake up the world of car retailing, and the obstacles that have been put in its path as it attempts to launch its new model around the country.

Matt

I wanted to get your thoughts on an issue that I’ve been hearing about on and off for a while, but that’s recently become the subject of controversy in our own home state [of New Jersey]. The electric vehicle manufacturer Tesla Motors has been attacked by several state governments and by organizations representing auto dealerships over their efforts to sell their cars directly to consumers in their own company-owned showrooms rather than through dealer franchises.

Tesla is essentially trying to sell cars the way Apple sells computers: by managing a network of proprietary retailers where the corporation can more tightly manage the entire consumer experience. My understanding is that they’ve also been trying to give customers the option to order cars online and have them delivered Amazon-style (!).

Now, Tesla argues that they’re bringing efficiency to the whole car-buying experience by cutting out the middleman, and I’m inclined to agree. The arguments I’ve seen for why states should require autos to be sold through dealerships seem pretty weak; I read an article a while back that talked about how they play an important role in their communities by sponsoring things like Little League. Now, I consider myself a communitarian and all, but I don’t think restricting the market share of auto dealerships is what’s going to destroy civic life in America!

One potentially more serious concern I’ve heard is that diluting competition among dealers will increase auto prices, but I wonder about this one too. Isn’t it competition among brands that keeps prices low? I would think that the cost of a Toyota is kept reasonable because there are guys selling Hondas down the street, not because there’s another Toyota dealership in the area. Or like, isn’t the price of a Chipotle burrito held in check by the fact that Taco Bell also sells burritos, not by the presence of other Chipotle locations in the vicinity? (Actually, we could just make this a discussion about Mexican food if you want. Apparently climate change is threatening Chipotle’s supply of guac inputs, which, not good.)

I certainly worry about large corporations engaging in monopolistic/oligopolistic behavior, and I’m all for trying to limit the power of any one firm or handful of firms to distort the market. But I think people are fixating on a red herring here. It seems to me that this is mostly a matter of auto dealers trying to protect themselves against disruptive innovations.

I’m eager to hear your thoughts. The Christie administration has taken regulatory action to keep Tesla from selling direct-to-consumer, but evidently there’s going to be a legislative debate about this in the near future. How do you think that might go down? (Feel free to also comment on [Tesla CEO] Elon Musk, and/or his ideas for using magnets to shoot humans through tubes at several hundred miles an hour.)

 

Chris

Thanks for sending your thoughts about this.  I’m inclined to agree that the crux of this debate is about how the current auto dealership lobby is trying to protect its livelihood in the automotive market.

A little context might be helpful in showing why this issue is important, especially because the facts indicate it should be a nonstarter.  Tesla offers only one model – the Model S sedan – and sells around 7,000 vehicles or so per quarter.  The Model S has a base price of $70,000 and climbs to over $100,000 with larger batteries and additional equipment.  Tesla’s production quantities are increasing monthly, but its total number of cars sold, and the market to which it’s catering, is miniscule compared to all other auto brands sold through dealerships.

On the surface, it seems like an undue amount of outrage is being expended over the slight increase in difficulty for a few really wealthy people to purchase a car.  But this matter is important for two main reasons:

1) Tesla is the most innovative carmaker around that actually has a chance to redefine how we drive.  It’s currently working on a $30,000 entry level electric car that, with federal tax credits, might dip to below $23,000.  A base price at that level would be a viable option for quite a few middle class or upper-middle class consumers.  Not only will consumers save money from the model, but the demand for gasoline will also drop.  Restricting its sales opportunities now makes it more difficult for these positive outcomes to be achieved in the near-term, if at all.

2) Tesla is working to revolutionize the maintenance and car care experience.  This speaks to your point above- it seems like car dealers are opposed to Tesla’s sales model because it totally eliminates the middleman.  Tesla’s model cuts out about $1500 per car sale that are directly related to dealer expenses, and its all-electric technology makes most dealer maintenance services irrelevant.  (All electric means zero repairs for the engine or transmission and no costs associated with oil changes and other maintenance fees.)  Making it tougher for Tesla to initiate this model means the benefits will take longer to be realized.

That said, this entire debate is getting a little out of hand because New Jersey residents can still purchase Teslas.  It’s not like this is an injunction against the ability to buy a car; the law only prohibits the transaction from taking place in one of Tesla’s New Jersey showrooms.  From Elon Musk’s own blog post:

Our stores will transition to being galleries, where you can see the car and ask questions of our staff, but we will not be able to discuss price or complete a sale in the store. However, that can still be done at our Manhattan store just over the river in Chelsea or our King of Prussia store near Philadelphia.

Most importantly, even after April 1, you will still be able to order vehicles from New Jersey for delivery in New Jersey on our TeslaMotors.com website.

What do you think?  It seems we agree that Musk should be able to sell his cars in NJ, but is the issue being unnecessarily blown out of proportion?  And how do you think any sort of legislative amendment process will go down, if at all?

(To answer your last thought- the Hyperloop looks simultaneously amazing and terrifying.  Suffice to say that I would not want to be one of its first test subjects.)

 

Matt

I think we’re in basic agreement about why this has become such a contentious debate. I also agree with you that stymieing Tesla in its efforts to upend the market is shortsighted, given its potential to steer the auto industry (pun certainly intended) in a more sustainable direction. The seriousness of the Christie Administration’s position here is also called into question by the fact that the Republican Party, at least at the national level, is always insisting that the government should refrain from “picking winners and losers” in the realm of alternative energy through subsidies, tax credits, etc. Christie’s stance is somewhat of a political aberration.

Recall that the Solyndra “scandal” was based on the GOP’s belief that extending subsidized federal loans to clean energy corporations is a form of cronyism that can lead to significant losses for taxpayers when those corporations go belly-up. But doesn’t this mean that putting up roadblocks to selling electric vehicles is an equally unwarranted form of market intervention? The opposite of picking winners and losers is not using state power to protect the status quo. Creative destruction sometimes entails destruction.

You’re right to point out that the immediate impact of this rule will be attenuated by the fact that you can still easily buy Teslas in New York or Pennsylvania, and of course by the fact that there are very few people buying Teslas in the first case. (I was surprised to hear that you can still order them online and have them delivered to New Jersey, though. A regulation requiring auto sales to be routed through dealerships seems to lose all of its bite if there’s a loophole so big you can drive a Tesla through it.)

But I think you’re overlooking the fact that this is not just an argument we’re having here in New Jersey. Restrictions on Tesla’s ability to sell its product directly to consumers in its own showrooms have already been enacted in states like Texas, Virginia, Arizona, Colorado, and Georgia as well, and limits have been proposed in North Carolina, Minnesota, New York, Massachusetts, and Ohio. This really is a nationwide battle. If Tesla were somehow backed into the same corner in Pennsylvania, potential Garden State customers would have even fewer options. This might be something Tesla could easily ignore if it were only coming up in one state, but if its hands are tied across the country the ramifications could be significant.

You asked about how I think the legislative debate might play out. I won’t pretend to know what the final result will be, but I can say that I don’t think this is going to split down party lines like you might expect. When similar restrictions came up for debate in the legislature in Washington state, they were defeated by an unlikely coalition of environmentalist Democrats and free-market purists on the Republican side.

Business Insider notes that the New Jersey Coalition of Automotive Retailers gave almost $700,000 between 2003 and 2009 to politicians of both parties, so opposition to Tesla is likely to be bipartisan in any fight that might break out in the State Assembly and/or Senate. This is not to suggest that money is the only thing driving support for dealerships – I mentioned last time around that skepticism of monopoly power and a desire to empower small businesses could be legitimate grounds for wariness about Tesla’s plans – but it does indicate that this likely won’t be your typical conservative-liberal skirmish.

 

Chris

Great find on that NJ Coalition of Automotive Retailers statistic.  Given that both parties are on the receiving end of its coffers, it does seem improbable that Tesla will have much support should an amendment battle occur going forward.

You question the Christie Administration’s seriousness on the issue and I second your skepticism.  My initial thought was that this decision was a logical reading of the law; the eight members of the Motor Vehicle Commission (all Christie appointees) voted unanimously to prohibit Tesla’s sales model, suggesting a consensus that Tesla’s current model is not compliant.  My amateur reading of the relevant parts of the law in question, N.J.A.C. 13:21, also suggested some seemingly obvious instances where Tesla’s sales practices are of questionable legality.  For example: I’ve visited the Paramus Garden State Plaza showroom and only one vehicle is on display.  N.J.A.C. 13:21-15.4 states that at least two vehicles must be present in any automobile sales establishment.

But the details of the proposed amendment suggest that Tesla was directly, and unfairly, targeted in this attempt to clarify the law.  The same law cited above currently mandates that showrooms have at a minimum of 72 square feet of office space, whereas the new regulations require 1,000 square feet – clearly a constriction against Tesla’s mall outlets.  Moreover, one can’t help but feel the amendment was unnecessarily harsh in redefining dealer requirements and imposing restrictions against Tesla’s selling ability.  It should be equally easy to redefine the established dealer requirements such that Tesla is simply allowed to operate independent of third party sellers.

Jim Appleton, President of the NJ Coalition of Automotive Retailers, told MSNBC’s Chris Hayes that “No one wants to see Tesla close their stores in New Jersey.”  He buttressed his claim with an argument for the consumer protection benefits of dealerships:

You have no choice when you buy from Tesla. You buy from a factory store, period, end of discussion. You buy from a new car dealership, you have the choice of buying from several. This is really a consumer protection argument. It`s not consumer choice argument.

Interestingly enough, the law cited above actually falls under “Law and Public Safety,” which suggests that there is some legitimacy to the argument that car dealerships were, at one point, important in helping consumers purchase a car fairly.  Clearly that’s not the case now, or at least it’s not categorically the case, as Josh Barro contends in the Hayes segment.  (Price and amenity competition among different car brands will still exist regardless of whether different car dealerships are around.)  That this is fast becoming a national issue, as you point out, suggests that NJ citizens should lobby for a new amendment that would maintain consumer safety standards but eliminate the mandate of having a dealership involved.

 

Matt

I thought it would be helpful to see if any hard research has been done on market structure in car retailing, and a quick Google Scholar search turned up an illuminating Journal of Economic Perspectives article from 2010 entitled “State Franchise Laws, Dealer Terminations, and the Auto Crisis.” The authors, Francine Lafontaine of the Ross School of Business at the University of Michigan and Fiona Scott Morton of the Yale School of Management, argue that

[t]he laws favoring car dealerships were put in place, according to a representative statement by the Florida state legislature, to “protect the public health, safety, and welfare of the citizens of the state by regulating the licensing of motor vehicle dealers and manufacturers, maintaining competition, providing consumer protection and fair trade” (Florida Law, §320.605). In our view, the current regulations tend too much toward protecting auto dealers from market forces and raising their profits; we argue that consumers would benefit if manufacturers could have much more leeway in experimenting with alternative distribution models than the web of franchise laws currently in place allow them to do.

The paper lists a number of examples of regulations that states have enacted regarding auto dealerships and car manufacturers beyond the one’s we’ve discussed so far, including some really galling ones. There are laws protecting dealers against “encroachment” (where a manufacturer opens another dealership close to an existing one without demonstrating “need”), laws mandating that manufacturers compensate dealers for repair costs, laws penalizing manufacturers when a franchise agreement is terminated even if the dealer terminates it, and laws forcing manufacturers who offer incentives to dealers for facility improvements to pay at least a portion of those incentives even to dealers who decline to improve their facilities.

What’s more, Lafontaine and Morton explicitly address the Little League argument! This must be a popular one:

As an article in an auto industry newsletter comments: “Even if it’s healthy for the auto industry long-term, Chrysler and General Motors closing thousands of dealerships will create a huge amount of collateral damage to Main Street institutions like Little League Baseball and local newspapers. Love them or hate them, car dealers are the go-to donors for local causes and local sports teams, not to mention keeping newspaper advertising in business almost singlehandedly.” Economists will recognize this argument as being overbroad. It could be applied just as well to restaurants and any other local business, and therefore does not provide a convincing economic justification for high profits for auto dealerships in particular. Moreover, if additional subsidies to Little League and local newspapers are desirable, artificially high profits for auto dealers would be a peculiarly inefficient way to provide such subsidies.

All of this feels a bit counterintuitive. How can it be that dealerships, which are – as they are quite eager to remind us – small businesses, have more pull with state lawmakers than the big automakers? How can they convince the politicians to enact so many laws that seem to benefit them at the expense of the automakers? Granted, the auto industry has taken a beating in recent years, but it still seems strange that some of the largest corporations in the world are in fact politically weaker than mom-and-pop car dealers. The authors actually offer a compelling explanation for this apparent incongruity:

States earn about 20 percent of all state sales taxes from auto dealers, and auto dealerships easily can account for 7–8 percent of all retail employment… The net result of all these laws is to raise profits for car dealers. State legislatures may be willing to do this because dealers represent an identifiable source of state employment and tax revenue, while even large manufacturers can site manufacturing plants only in a limited number of states. The result is that new car dealers have an advantage over auto manufacturers when it comes to political leverage in state legislatures, and thus states enact laws that extract rent from manufacturers and redistribute it to franchise dealers.

Aha! So while any individual dealership is economically miniscule, the fact there are a heck of a lot of them means that, collectively speaking, they tend to have a great deal of clout.

The remaining question is whether these regulations are actually bad. It may be the case that the interests of dealerships and consumers are aligned to a greater extent than we might think, and that our own skepticism about their motives (or at least about whether their actions will benefit the public) has been unwarranted. Or maybe not. After considering existing scholarly work on the subject – which they admit is sparse – Lafontaine and Morton conclude that these laws do not serve the common good:

In their review of the limited empirical literature on vertical restraints across different industries—namely exclusive territories, dealer licensing (protection from entry), and termination restrictions—Lafontaine and Slade (2008) find that that while privately imposed restraints seem to benefit manufacturers and consumers alike, when restraints such as these are mandated by the government, as they are in the case of car distribution state legislation, they lead to higher prices, higher costs, shorter hours of operation, lower consumption—and thus declines in consumer welfare…

The economic evidence thus suggests that the end result of the laws is a wealth transfer that benefits dealers at the expense of consumers (and post-bailout, at the expense of taxpayers as well). Moreover, as the European experience shows, the type of contractual restraints contained in state laws affecting car dealerships, if they were imposed privately, would likely be subject to antitrust scrutiny, and might well be prohibited. After all, these restraints limit entry and can be used, and in fact have been shown, to soften competition among existing dealers.

In economics, “common sense” can often be quite wrong. The notion that the government should have to balance its budget during hard times because middle-class families have to do the same is a fallacy that has a lot of intuitive appeal, but it’s a fallacy nonetheless. In this case, however, the limited amount of research that has been done in this area seems to support our initial reaction. The public will not necessarily suffer if Tesla is allowed to sell its cars directly to consumers – though we might not be able to go watch as many Little League games.

Unreasonably Immoderate: Commuting in New Jersey

In the nine months since we launched RM, we have tried to provide fair and holistic commentary on a variety of political, religious, and cultural topics. Today, however, is April Fools’ Day, a holiday wherein absurdity rules the roost and things are… a little different from the norm. On that note, we’re happy to present a somewhat unreasonable and immoderate take on a subject near and dear to our hearts: driving and commuting in our home state of New Jersey.

Chris

The drive to my office is about two hours round trip without traffic, which means at least three hours in reality. In the course of commuting for about a year and a half, I’ve compiled a few scattershot observations about traveling in NJ.

  • New Jersey: where doing 80 MPH in the right lane will earn you looks of disgust from other drivers who, as they fly past your car, wonder what led you to such a torpid, stuporous existence.
  • I’m convinced that Purgatory will probably look like a traffic jam in the tri-state area, except that in Purgatory you have a better chance of actually getting to your destination.
  • If my soul had a face, this would be its reaction whenever I see anyone with truck nuts affixed to their car.
  • Saw a dude pass another car on the shoulder of the highway a couple months back. Because when there are two other lanes open for use, the best option is to make your own.
  • NJ Transit reports that 79% of customers would recommend its services to a friend or relative. NJ Transit is a PUBLIC TRANSIT SYSTEM. In many cases, people have no other choice to get to their destination. Of course there’s a high recommendation rate!
  • Here’s a handy map of Route 3 for you to consult when stuck in traffic.
  • I can think of a few thousand better ways you could have spent your money instead of souping up your Toyota Camry with a spoiler and gold rims.

To non-New Jersey residents: despite what’s listed above, I encourage you to come visit our state. Contrary to its reputation, there are actually (I’m not kidding) some beautiful areas that warrant your time and patronage. But for the love of God, DO NOT attempt to travel here from 7-9am or 4-6pm on weekdays. You will be eaten alive.

Matt

I would also like to take advantage of this brief suspension of the rules to offer some of my own thoughts on commuting in New Jersey. RM will be back to its regularly scheduled programming of reasonableness and moderation and refuting stereotypes about the personality traits of Garden State residents before long, but sometimes you just need to get something off your chest. (Have you ever seen The Purge? Me neither, but it’s kind of like that.)

Unlike Chris, my commute involves fighting my way across Manhattan as well as New Jersey. But like Chris’ commute, mine can also take about two hours… one way. In fact, I spent about that long on a veritable expedition to work yesterday morning, when my bus was rerouted to the train station in Newark on account of a pothole at the Lincoln Tunnel (sorry, “roadway depression”) that was in need of emergency repair.

That odyssey gave me some time to daydream, and I decided that if I had absolute power over NJ Transit and the Port Authority, there are at least seven things I would do to improve the daily commute of millions of road-weary souls:

(0. Use my power to punish my political enemies with traffic jams. I’m not even counting this as one of the seven things because, like, it goes without saying.)

1. Before taking any specific actions, do a traffic study to figure out which are the most urgent problems facing the transit system in the metropolitan area. No, not a “traffic study.” A traffic study.

2. Befriend New York Mayor Bill de Blasio, and use some of the proceeds from his planned expropriation of all private businesses in the city to fund the construction of a new tunnel under the Hudson River (NJ taxpayers won’t be on the hook!).

3. Cut the cost of bus rides by handing over management of NJ Transit’s bus system to experienced independent contractor Fung Wah.

4. Make sure that all announcements over the loudspeakers in the Port Authority Bus Terminal clearly state the reason for delays in service. People know that “police activity” is not a real reason. Police engage in activity because something else has happened. They don’t just decide to go play bocce in the Lincoln Tunnel.

5. Bring back the Cinnabon in Port Authority, which closed earlier this year. The sublime aroma of “the goo” has been proven to inhibit the release of stress hormones in the bodies of harried travelers. This obviously won’t improve anyone’s commute in an objective sense, but it will make the ordeal more tolerable.

6. Change the bus schedule so that every arrival is forty-five minutes later, but don’t tell the drivers to do anything differently. All buses will be on time, guaranteed! Some may even be early!

7. Have Cory Booker part the Hudson River, thereby facilitating travel for those who wish to walk, bike, or ride donkeys to or from Manhattan.

Feel free to write with additional suggestions. And don’t worry about your idea not being up to snuff – all of the bad ones have already been implemented, so you can’t go wrong!