When automobiles first reached the mass market more than a century ago, manufacturers quickly settled on dealership franchises as the best distribution model. The contractual arrangements between dealerships and manufacturers meant that both parties relied on the success of the other to be profitable, and both industries flourished.
But after the automobile manufacturing industry had consolidated into a handful of major producers by the 1920s, some dealership franchises became concerned that large carmakers might use their market power to exert unfair leverage over small dealerships.
In response, states began passing laws to protect local franchises from alleged abuses by automobile manufacturers. Today, all states have dealership-friendly franchise regulations, including laws that give automobile dealerships territorial exclusivity and encroachment protections from competition. These laws limit market entry and reduce price competition between dealers selling the same brands and models, leading to higher consumer prices. A study in 2015 quantified the effects of the geographic distribution of dealerships and found that the price of a Honda Accord increased by $500 when dealers were 30 miles apart.
Along with exclusive territories and market entry barriers, many states have laws constraining dealership termination. Under many of these statutes, even gross inefficiency and poor financial condition are not legitimate grounds for termination. Even when good cause can be found, laws give dealers time to remedy shortfalls, making termination a costly and drawn-out process. Moreover, termination usually requires manufacturers to buy back unsold cars, parts, accessories, and equipment, which adds to manufacturers’ costs and translates into higher prices for car buyers. Laws also permit dealers to impose excessive markups on warranty repairs and parts, which carmakers pay and must recoup by charging consumers higher vehicle prices.
These regulatory mandates ignore the interdependence inherent in private contractual arrangements between manufacturers and dealerships. Manufacturers have no natural incentive to squeeze dealerships, because that would cause dealers to exit the market, reducing car sales and manufacturers’ profits.
Although car dealerships try to justify these protections by portraying themselves as struggling small businesses, the reality is that the industry as a whole averages about a 30 percent return on equity for domestic vehicles. By contrast, the automobile manufacturing industry, where competition is thriving, has not managed to reach 8 percent in profits in any year during the last decade. Because state laws make little distinction between large and small dealers or between wealthy or struggling ones, the focus of these laws is not to help the “little guy.”
Public policies that impose regulations on businesses do not spare consumers the cost. The American Consumer Institute estimates that the removal of these regulations, which enable dealers to inflate their prices over cost, would lower prices by 8 percent and bring 2 million more vehicles to the U.S. market. This would produce an improvement in consumer welfare of $47.5 billion per year, all from the elimination of territorial exclusivity regulations. Considering the many other dealer-friendly regulations and the continued expansion of protectionist legislation, the real cost of these rules is likely much higher than estimated.
It is not the role of regulators to prop up poorly-performing businesses or tilt the playing field in favor of any industry or interfere with private business contracts. Dealerships have benefited from this corporate welfare for decades, costing Americans consumers billions of dollars. It needs to stop.
Liam Sigaud works on economic policy and research for the American Consumer Institute, a nonprofit educational and research organization. For more information about the Institute, visit www.TheAmericanConsumer.Org.
