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 The goal: to remake their outdated and inefficient vehicle-distribution scheme for the online market.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."

Automakers are fully aware of customer frustration, but still shy from publicly advocating repeal of franchise laws in the face of fierce dealer opposition. No manufacturer wants to antagonize the customer's most direct link to the company. And this is particularly true of dealers who sell more than one vehicle brand, and who therefore could play favorites. An experiment in manufacturer-owned dealerships initiated two years ago was quickly abandoned in the face of bitter opposition from the National Automobile Dealers Association (NADA). Ford instead is testing factory-direct sales in Belgium. And GM has formed an advisory council to incorporate the Internet into the franchise model.

Online brokers, too, are reluctant to challenge franchise law for fear of vexing the source of their product—the dealers. Yet as long as companies like CarsDirect. com are forced to buy vehicles through the franchise monopoly—effectively guaranteeing a double mark-up—savings to consumers will be slim.

NADA, meanwhile, is preparing to launch a Web site in June featuring price data and dealer links. Sales referrals will be offered free of charge—in direct competition with the online services that typically collect brokerage fees from either the dealer or customer. (NADA evidently embraces some forms of competition.)

But the group adamantly refuses to cede control of sales, insisting that all online orders be delivered through a dealership. And its members are furiously lobbying for even tighter restrictions in state legislatures.

Texas, for example, recently outlawed brokering altogether, instituting a fine of $10,000 per violation. The state also ordered Austin-based CarsDirect.com to cease offering services in its home state. Regulators even denied a dealer's license to GM, and prohibited Ford from selling used cars online—a move the number two automaker has challenged in court.

A bill pending in Washington state would flatly prohibit manufacturers from owning dealerships. Arizona is considering legislation to prohibit automakers from selling directly or even owning part of a dealership. A pending bill in Nebraska, meanwhile, would require that all car purchases be delivered through a dealer.

While clearly irrational from a consumer perspective, the legislative backlash is hardly a mystery. "Our dealers have a lot of influence," said Mark Hogan, president of e-GM, General Motors' Internet Commerce Division. "They are among the most important businesses in the community. They have a lot of influence in the political process, and the outgrowth of franchise laws is certainly part of that whole tapestry."

States also find it a whole lot easier to collect taxes from local dealers than dot.coms. But history won't stand still. Just as fundamental changes in the electric and telecommunications marketplace are forcing utility monopolies—even with their legislative clout—to adapt to a new economic order, so will dealer monopolies have to adapt to the fast-changing digital landscape.

At a new $550 million facility in Brazil, GM is testing operation "Blue Macaw." That's the code name for a new manufacturing system that houses parts suppliers adjacent to the vehicle assembly line. The concept anticipates the quick production so vital to GM's e-commerce plans. Inside the factory, 15 suppliers feed the line complete "modular" component systems, rather than hundreds of individual parts, as the chassis moves by. The result? The time required to install an instrument panel, for example, drops from 22.5 minutes to just 3.3 minutes.

And in a huge expansion of electronic commerce, the major automakers last month announced they are moving the entire automotive supply chain online—some $250 billion worth of parts and supplies for Ford, GM, and DaimlerChrysler. Because orders for parts can be relayed in real time, the new system will reduce the wait for a custom-ordered vehicle to just days. Like Blue Macaw, it is a critical step toward factory-direct purchase. When it's fully operational, consumers won't have to settle for inflexible option packages.

There also are important efficiencies for dealers. More customized purchases would eliminate the large inventories that weigh heavy on a dealers' bottom line. No longer would dealers and manufacturers be guessing what models and options customers most want and left to cross their collective fingers that a mistaken forecast will not leave thousands or even millions of cars sitting unsold on lots nationwide.

While acknowledging that the Internet can accelerate customization and improve efficiency, Mike Savoy, president of the Detroit Auto Dealers Association, insists that the franchise-dealer system remains necessary. "There are 50 different state laws. How's GM going to address 50 different franchise laws, 50 different title laws, 50 different sales taxes, and a litany of other things that need to be signed?" he asks.

And if there were no franchise laws?

Dealer Savoy refuses to speculate. Franchise laws are necessary, he says, to protect dealers' investment. But in a veiled warning to such entrenched attitudes, GM's Hogan notes that no business can long ignore consumer demands and survive. "The efficiency of the Internet is driving people to behave differently as consumers," he says. "The customer will ultimately decide, and we have to be prepared to adapt to meet what the new model ends up being."

State legislatures would do well to heed the call.

Diane Katz ([e-mail]) is an editorial writer for The Detroit News. Henry Payne ([e-mail]) is a cartoonist for The Detroit News and REASON.