Traffic Jam

Auto dealers use government to build Internet roadblocks.

America's automotive giants have not always been quick to jump on the next big thing. But they are heeding the call of the Internet revolution. At General Motors, for example, worldwide purchasing chief Harold Kutner promises that by 2003, 80 percent of new car buyers will be able to custom- order its vehicles online.

Kutner's team, and others like it throughout the auto industry, have been scrutinizing the business models of Dell, Gateway, and other made-to-order PC retailers. The goal: to remake their outdated and inefficient vehicle-distribution scheme for the online market. It is a grand ambition that is gaining converts fast. Nearly 7 million Americans--more than 40 percent of all new car buyers last year--electronically kicked tires via the Internet before finalizing a vehicle purchase. The Web is awash with information on vehicle performance and options, as well as availability and price.

But as in all revolutions, the old guard refuses to go quietly. In recent months, at the behest of conventional dealers, at least nine states, including Texas and Wisconsin, have restricted online auto sales. Similar measures are currently pending in several more. As if car salesmen weren't already sufficiently suspect, they are pulling every string to maintain their monopoly of the $360 billion new car market--highlighting how regulatory power is being marshaled against the free market just as the Internet empowers consumers like never before.

More than 16 million new cars were sold in the United States last year, representing vast e-commerce opportunities. A slew of online brokers has emerged, and manufacturers have teamed with high-tech giants such as Netscape, Microsoft, and Dell to create their own online presence. Consumers now can access a wealth of information about vehicle prices and performance that used to be much more difficult to come by.

But what consumers don't enjoy is actual choice of whom they buy their new car from--a choice that for other product lines yields lower prices and better service. The sole barrier to exercising this economic muscle is franchise law, which grants a licensed elite exclusive control over virtually every new car sale.

Forty-eight states tightly regulate who can sell a new car and where they can sell it. Michigan, the heart of the U.S. auto industry, provides perhaps the worst-case scenario of overambitious franchise law, with the statutory fine print running 19 pages long. But it is indicative of the anti- competitive restrictions built into most states' franchise laws.

Michigan's dealership laws cover everything you can think of, ranging from allowable sales territory (in counties with more than 25,000 people, there can only be one dealer per six-mile radius) to which family members can inherit a franchise ("the spouse, child, grandchild, parent, brother or sister of a deceased new motor vehicle dealer"). Back in the 1950s, dealers secured franchise laws after convincing legislators they needed protection against bullying manufacturers, who otherwise might impose costly dictates on dealers and demand sales and service concessions in return for advantageous inventory. Some states also banned automakers from directly competing in sales to ensure that distribution was "fair."

With millions of dollars invested in facilities and inventory, the dealers' protectionist impulse is understandable. But such matters are more typically the province of contract law, not legislation. The practical effect of franchise laws has been to inhibit competition. Through territorial monopolies sanctioned by the state, dealers effectively limit the ability of consumers to comparison shop. And dealers need not worry overly much about customer satisfaction when there's nowhere else to go. (The dealers' refusal to open on weekends--the most convenient time to shop --has frustrated Detroiters for decades.)

In a 1997 study, Hillsdale College's Gary Wolfram and Michigan State's Lynn Jondahl pegged the cost of franchise regulation at $800 million annually in Michigan alone--a huge transfer of wealth from consumers to dealers. Supply restrictions increase vehicle price and search costs. And Wolfram and Jondahl's calculations included the cost to consumers of dealers using their market power to restrict product choices to mostly option-rich vehicles.

The Internet promises to free consumers from dealer captivity. Unconstrained by franchise law, services such as Autobytel.com or Priceline.com could locate a precise make and model in a given price range, and arrange delivery straight to your driveway. Or a customized order could be filled within days rather than weeks if sent online to the nearest factory and purchased directly from the manufacturer. This competitive potential has converted some traditionally pro-regulation consumer advocates to free markets. For example, the Consumer Federation of America, a Naderite consumer advocacy group that has long championed franchise law, now acknowledges that such statutes are anti-consumer.

"The Internet has changed everything," says Federation spokesman Jack Gillis. He sees the enormous consumer benefits that online booksellers have brought to the traditionally bricks-and-mortar book trade and believes that the Amazon.com model would liberate the car shopper as well. "Anyone who can sell a car should be able to," he adds. "It would put a lot of price competition in the marketplace because you would eliminate the immediate problem, which is the inability of the manufacturer to sell directly to the consumer."

Smart dealers are embracing the Internet, either by hosting their own Web sites or by cooperating with online brokers who act as intermediaries between buyer and dealer. But they remain a minority. In a recent test of online auto brokers, Consumer Reports found that only 35 percent of shoppers received a quote within 48 hours, and 22 percent were told they would have to visit the dealership to get a firm price.

Their worst fears notwithstanding, dealers wouldn't just disappear in the absence of franchise law. There are plenty of people who would prefer to actually sit behind the wheel rather than take a virtual test drive. And the demand for service--for which dealers earn their biggest return --would undoubtedly continue.

But consumers clearly want an online option. A recent survey by consumer-research firm J.D. Power and Associates found nearly half of respondents would prefer to buy factory-direct even if there were no cost advantage. And when surveyed about potential savings through direct purchase, nearly 70 percent indicated they would buy from the manufacturer. Aside from cost savings, most respondents said they simply want more freedom to customize a vehicle and to avoid the often laborious haggling over price.

"Dealers need to take a long, hard look at the frustration causing consumers to vocalize their desire for factory-direct sales," said Chris Denove, director of automotive retail/distribution analysis for J.D. Power. "Although dealers are likely to stay, the franchise system as we know it is ripe for fundamental restructuring."

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