Friday, May 25, 2018
Business

Tesla upsets status quo of traditional U.S. auto sales rules

When electric-car company Tesla Motors started selling its flagship Model S luxury hatchback this year, it eschewed the traditional dealership network to open its own stores.

But that's not sitting well with U.S. auto dealers, who have controlled new-vehicle sales for nearly a century.

The nation's roughly 18,000 new-car dealers got a cut of every one of the 12.8 million new cars and trucks sold in the U.S. last year, from the biggest domestic sport utility vehicle to the tiniest Japanese import. It's an exclusive arrangement that has made many of them very rich — and one that they're not about to cede to some tiny Palo Alto, Calif., automaker.

Some individual auto dealers and regional associations have already filed lawsuits attempting to block Tesla, which now operates more than 15 stores in 12 states.

The upstart automaker's battle with dealers is shedding light on a little-known practice that it contends amounts to legalized restriction on trade. The franchised new-car dealership system dates back to the start of the U.S. auto industry, when hundreds of manufacturers were fighting for market share. Setting up showrooms was expensive and time-consuming. So automakers sold other entrepreneurs the right to market their cars in specific cities.

Over time, car dealerships became crucial sources of employment and tax revenue for local communities. To prevent manufacturers from opening their own stores and undercutting neighborhood dealers, states developed laws governing the franchise relationship. Bottom line: Carmakers had to leave their retail sales to someone else.

Tesla isn't buying it. The company wants to sell directly to consumers. That way it gets to keep the profit that dealers make on new-car sales. It's also the only way an electric car will get a fair shake, co-founder and chief executive Elon Musk said.

"Existing franchise dealers have a fundamental conflict of interest between selling gasoline cars," Musk said. "It is impossible for them to explain the advantages of going electric without simultaneously undermining their traditional business."

A South African-born serial entrepreneur, who co-founded an Internet payment company that eventually become PayPal, Musk thrives on disrupting established industries.

His Hawthorne, Calif., rocket maker SpaceX is breaking the historic monopoly that governments have long held on spaceflight. In May, his Dragon spaceship became the first private spacecraft to supply the International Space Station, a test of a $1.6 billion contract to carry out 12 cargo missions.

If Musk can beat back the auto dealer associations, other fledgling automakers as well as foreign brands launching for the first time in the U.S. could follow his lead and cut dealers out of the loop.

Elaine S. Kwei, an analyst at Jefferies & Co., said Musk's strategy makes sense. It would enable Tesla to keep control of the sales experience and educate consumers about its electric car, an automotive technology that most shoppers know little about.

Tesla "is at a disadvantage compared to the vast existing networks of dealerships and marketing budgets of the major automakers," Kwei said. "As a brand new manufacturer with a new vehicle technology, they have to try something different."

Dealers are nervous that other, larger manufacturers might adopt Tesla's sales model, said Aaron Jacoby, a Los Angeles lawyer who heads the automotive industry group at the Arent Fox law firm. On average, dealers make about $1,300 on a typical new-car sale before expenses.

According to the National Automobile Dealers Association, 48 states either prohibit or in some way restrict automakers from owning sales facilities. For example, in California, a manufacturer can't have a store within 10 miles of a franchised dealership of the same brand.

Still, laws in most states do allow automakers to open their own stores if they don't have an existing dealer network. That's why "Tesla is more likely than not to prevail," Jacoby said.

Dealers aren't conceding. Last month, the Greater New York Automobile Dealers Association and a dealer in the region sued Tesla and the New York Department of Motor Vehicles, alleging that they violated state franchise laws when Tesla opened a store in Westchester, N.Y., in late May. Similar litigation is taking place in Massachusetts.

Musk said the lawsuits "are starkly contrary to the spirit and the letter of the law," adding that the plaintiffs "will have considerable difficulty explaining to the court why Tesla opening a store in Boston is somehow contrary to the best interests of fair commerce or the public."

Tesla has no existing dealers who have risked their own money building showrooms and marketing the brand. Therefore, Musk said, there are no franchisees "anywhere in the world that will be harmed by us opening stores."

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