Reforming Michigan Vehicle Direct Sales Laws: Thanks to Tesla, the home of the U.S. auto industry could embrace a 21st century business model.

• Author: Crane, Daniel A.

Most Americans would be surprised to learn that there is an important sector of the economy in which some states' laws prohibit a company from selling its products directly to consumers or providing after-market service for those products. We are used to buying iPhones from Apple, basketball shoes from Nike, cable services from Comcast, and houses from the builders who make them. But, for many decades, car manufacturers have been prohibited from selling their cars directly to consumers or servicing those cars in the aftermarket. Instead, many states' laws require manufacturers to sell and service through independent franchised dealers.

How did this come about? In the early years of internal combustion vehicles, car manufacturers used a variety of distribution methods, including dealer franchising, traveling salesmen, consignment, direct sales through company-owned stores, and sales through general retailers. Historically, there is nothing inevitable about dealer distribution as the exclusive means of getting cars to customers.

The present dealer-franchise system arose over the period 1930-1950. At that time, the Big Three automakers--General Motors, Ford, and Chrysler--dominated car sales and dealers were mostly "mom-and-pop" local businesses. The dealers complained that the Big Three took unfair advantage of their unequal bargaining power to impose draconian contractual terms on the dealers. For example, Henry Ford allegedly forced dealers to buy Model Ts that they could not sell under threat of not getting any more inventory. The dealers also argued that the Big Three unfairly competed against their own franchised dealers by offering lower prices at company-owned stores than what independent dealers could match.

The dealers ultimately persuaded most state legislatures to pass laws regulating the automobile dealership relationship to protect the dealers, not consumers. Among the provisions of most of these laws was a prohibition on manufacturers opening their own showrooms and service centers and thereby competing against their franchised dealers. Those direct distribution prohibitions have mostly carried over until the last decade, when some states began to loosen them in light of the changing economic, technological, and social landscape.

Even before coming to the novel distribution issues raised by electric vehicles (EVs), it had become clear in recent decades that the original dealer protection rationales for the direct distribution prohibitions were waning. As noted, the dealers' original arguments for protection from the manufacturers were based on two economic facts creating grossly unequal bargaining power:

* Car manufacturing was a three-firm oligopoly with little competition among the Big Three on franchising terms.

* Car dealers were local, family-owned, mom-and-pop combinations.

The world is radically different today. First, there has been considerable new entry from foreign competitors, making the car market much, much more competitive than it was in the mid-20th century. Car dealerships can now negotiate with around 15 to 20 different car manufacturers over potential dealership opportunities. Second, many car dealerships are no longer mom-andpops, but part of multi-billion-dollar dealer groups. The top 10 dealership groups in America have annual revenues around $100 billion--more chan any car company. To put things in perspective, that's about one-fifth of Michigan's gross domestic product. Many of these large dealer groups operate in Michigan. For example, the Suburban Collection, based in Troy, operates 47 dealerships in Michigan and reported $2.6 billion in revenue in 2019. Based on these economic changes, it would be hard to argue that the inequality of bargaining power between manufacturers and dealers is anything like what it was in the mid-20th century.

TESLA'S ENTRY, NATIONWIDE RESPONSES

When Tesla entered the market in 2013, it announced that it would be selling and servicing its vehicles directly and not employing franchised dealers at all. A customer buying a Tesla buys the car directly from Tesla and has the vehicle serviced by Tesla.

In testimony before the Federal Trade Commission, Tesla explained that seven factors supported its rationale:

* Dealership locations: Dealerships are usually found in out-of-the way locations. Tesla feels it's important to "bring the new technology to the consumer" in places like shopping malls.

* Inventory differences: Large inventory is the lifeblood of traditional dealerships, but Tesla works on a built-to-order model.

* Longer sales cycles: The franchised dealer model is based on a high volume of fast-paced sales. EV buyers take longer to educate themselves on EV sales and therefore need to work with salespeople who are working on a commission model.

* Different profit models: Traditional dealerships earn low profit margins on new car sales and make it up on service. EVs have a much smaller service com ponent because they don't have service needs like oil changes or engine tune-ups. Traditional dealerships therefore lack much of an incentive to sell EVs.

* No advertising: Traditional dealerships rely on manufacturers to fund their advertising in TV, radio, and print media. Tesla does not advertise.

* Dealer price mark-ups: Franchised dealers could not make money selling Teslas because they would have to sell them at a higher price than they bought them from the manufacturers, and therefore could not compete with Teslas sold directly from the company.

* Conflict of interest: EV sales cannibalize internal combustion sales, which are the dealers' lifeblood. Dealers therefore lack the motivation to sell EVs.

Tesla's decision to sell direct and bypass dealers was not well-received by the car dealers. Beginning in 2014, the dealers launched a state-by-state battle to block Tesla's entry, arguing that direct sales and service were prohibited by existing law. Over the course of the next several years, these battles played out in state courts, motor vehicle commissions, and legislatures. In some cases, they are still ongoing.

Today, almost half of the states have eased their direct sales restrictions for EVs. This has come about in several ways. Some states have held their existing dealer laws inapplicable to EV companies that do not want to use franchised dealers at all. For example, in holding that the dealers lack standing to challenge Tesla's entry, the Massachusetts Supreme Court held that the state's dealer franchise law was intended to protect dealers in franchise relationships with manufacturers, a circumstance inapplicable to Tesla because it doesn't want to use franchised dealers. Similar interpretations have occurred in Arizona, Minnesota, Missouri, and Rhode Island. Other states, like Colorado, New Hampshire, Utah, and Wyoming, have passed new statutes opening the door to EV direct sales. Other states have allowed direct EV sales on a limited basis. For example, in Ohio in 2014, the dealers and Tesla reached a compromise that allowed Tesla to open three stores in the state. Georgia, Maryland, New Jersey, New York, North Carolina, Pennsylvania, and Virginia similarly allow some direct EV sales. Finally, technologically important states like California have never blocked direct EV sales at all.

Even states that prohibit direct EV sales and service cannot stop their residents from buying EVs directly. Thus, in...