Don’t Bet on Direct-to-Consumer Automotive Retail…..Just Yet.

During my professional career, including management positions at eBay Motors, AOL Autos, Ford Motor Company, and startups CarWoo! and now Roadster, I have seen a lot of change in the auto industry. Twenty years ago, the Internet changed things forever by giving buyers access to information they had never had before, but over the past 5 years, the pace of change has increased dramatically. Much of that change has been forged by the ambitious Elon Musk and his anything-is-possible approach to business. Tesla Motors has challenged the status quo in so many ways, including the incumbent franchise dealer sales model.

In fact, Tesla’s recent success has many industry observers and consumers concluding that the direct-to-consumer model represents the imminent future of automotive retail and the franchise model is on its last legs. I have witnessed first-hand widespread consumer frustration with today’s car buying process, but the practical implications of a major retail model change are extremely complicated. Let’s take a deeper look at the pros and cons of the direct-to-consumer model vs. the current franchise dealer model and examine what the future may hold.

It should be noted that each manufacturer’s franchise arrangements with its dealers are unique, making it difficult to predict changes for the industry as a whole. For example, Lexus and Land Rover do not allow their dealerships to market to consumers outside of pre-defined geographic territories, also known as their primary market areas. Honda does not allow its dealerships to publicly advertise prices below invoice price. In addition, most states dictate their own rules, some more draconian than others, that define how all franchise and independent dealerships can and cannot sell cars. There is no one-size-fits-all rule that applies nationally or across all brands.

How did we get here? Because it worked.

Franchise dealerships have been around for more than 100 years and were created to bolster the once-fledgling automotive industry. Manufacturers moved to a franchise-model when they realized that a third-party sales entity was more effective than manufacturers doing sales themselves, and they wanted to offset the financial burden of carrying inventory. With tens of thousands of franchise dealerships conducting business today, the advantages of this longstanding system can be debated at length, but here are a few of them:

• Competitive pricing on vehicles based on supply and demand dynamics in local markets
• Geographically efficient allocation of vehicle inventory
• Taxes remain in local municipalities
• Dealerships own the burden of inventory risk through their investment in vehicles, allowing manufacturers to focus capital on vehicle technology, infrastructure and processes
• Dealerships apply for all required licenses and permits to operate in their respective regions
• Dealerships pay for all equipment and training as well as take on all liabilities outside of the manufacturing of the vehicle itself

But as consumers have become used to a more immediate and transparent way of conducting their lives online from buying books to their daily banking, there has been a bigger push for the auto industry to follow suit.

Here are the cons of the franchise model:

• Overall lack of consistency in vehicle pricing, financing, trade-ins and other product offerings, which vary dealer-to-dealer as well as consumer-to-consumer
• A typically uncomfortable sales process (sometimes described as worse than going to the dentist’s office), including bait and switch and unnecessary upsell practices
• In more rural areas, monopolistic behavior of local dealerships that enjoy a geographically captive audience
• An uneven sales and customer service experience, even within a brand

Does The Direct-to-Consumer Model Fix These Problems?

The answer would depend on how manufacturers decide to implement direct-to-consumer models in the future. Tesla has done it with a very formulaic pricing approach, which turns out to be consistent and simple because it is standard across the entire country. That approach even applies to how they sell certified pre-owned vehicles. Assuming other OEMs take a similar course, the direct-to-consumer model will also have its share of pros and cons. Here are some of them.

Pros of the direct-to-consumer model:

• Simplified, stress-free sales processes
• Consistent and fair pricing of vehicles (consumers feel confident that they are receiving the same price relative to other buyers)
• Manufacturers have more brand control of how their product is presented
• Potentially more cost efficient since there is one less profit center involved
• Vertical integration allows for improved information sharing from manufacturer to consumer; as cars become increasingly Internet enabled, software updates and service reminders can be pushed to vehicles by the manufacturer

Cons of the direct-to-consumer model:

• Less competition and potentially higher prices since there would not be multiple dealerships competing for buyers
• Consumers may not be able to see and touch the exact product they want to buy
• Vehicles may need to be custom ordered if inventory is tight or not available on lots (as Tesla operates today)
• OEM showrooms would be branches rather than deeply vested, small businesses in the community
• Manufacturers become spread too thin, reducing focus on product development, technology, and safety

Tred CEO Grant Feek does a nice job breaking down the potential shortcomings of the Tesla direct-to-consumer model in a post from August 19, 2013:

While manufacturers want to keep car factories cranking as often as possible, consumer demand for cars can be lumpy and difficult to predict. As a result, car makers depend on franchise dealerships to offer a steady sales channel and inventory buffer between their uniform supply and the end consumer’s erratic demand. If Tesla wants to sell 100,000 cars annually (or one million), it will need to transition from a “pull” a la carte retailer to a “push” wholesaler, and to leverage the inventory buffer that franchises provide.

I’m not sure I agree that Tesla will be forced to make this change, but I understand the logic. Even Elon Musk conceded in an October 2014 interview with Autoline Daily that Tesla may have to consider moving to a modified franchise dealership model in order to scale volume and service those vehicles. He stated, “We may need a hybrid system, with a combination of our own stores and some dealer franchises.”

If Tesla is able to accurately predict demand, cost effectively modulate production to optimize supply, and remain differentiated enough such that consumers are willing to wait for their custom orders, they’ll be fine with their current sales model. This will get more and more difficult as the Tesla product lineup broadens and the vagaries of consumer tastes ebb and flow. Another key factor to consider is that direct-to-consumer sales are currently prohibited or highly regulated in almost every state. California law prohibits automakers from owning dealerships within 10 miles of their franchised dealers, whereas other states require that new cars be sold only by licensed, independently owned dealerships. Tesla has been able to get special “electric car only” exceptions in 25 states (now including Maryland).

What Will Happen Over the Next Decade?

How will we buy new cars in the next 5, 10 or 20 years? The eventual outcome, which is likely many years from now, may be somewhat of a hybrid between the current franchise model and the pure, manufacturer direct-to-consumer model. It is not hard to imagine a world in which manufacturers utilize current franchise dealerships as product specialists for the retail process, similar to the associates working at the genius bar in Apple stores. Manufacturers will provide each dealership with a representative cross-section of showroom and test drive vehicles for hands-on merchandising. In rural areas, the franchise dealerships may hold (but not own) inventory on their lots, whereas in major metropolitan areas, manufacturers are likely to keep inventory in one centralized location for delivery at the time of sale. Vehicle pricing will be determined by the manufacturer and inventory will be shifted geographically as needed to meet regional demand fluctuations and to adjust for inevitable forecasting mistakes. The franchise will be compensated with a fixed bounty or a percentage of the sale price as a commission for each facilitated vehicle sale.

There will be a role for the franchise dealership for many years to come, but it may ultimately look significantly different from what we see today. Of course, in addition to the new car product specialist function, franchise dealerships will still provide service, repair, finance, aftermarket products, and last but not least, used car offerings.

Consumers will get the experience they want: a fast, consistent, and stress-free buying process not unlike the one they enjoy with online retail experiences. While a customer will likely test drive vehicles at one or more dealerships, all other aspects of the purchase process, including financing, leasing, warranty agreements, insurance, and trade-ins, will occur online. Your new car will be delivered to your house and your trade-in will be picked up at the same time.