When Tesla came to the market and violated many states’ consumer protection laws, which require a car manufacturer to sell only through a franchised dealership, Elon Musk’s fight to overturn those laws stirred many individuals and political organizations to vocal outrage. It also demonstrated the stunningly widespread lack of basic knowledge of how large-scale industrial consumer manufacturing entities operate and earn their profits.Manufacturing automobiles entails enduring periods of serious negative cash flow; you need so much money in the bank to attempt to design and manufacture cars, it’s amazing that anyone ever wants to do it at all. The fact is that an auto manufacturer can have hundreds of millions of dollars tied up in just one car, long before the first one is ever built and shipped out for retail. It is highly doubtful that any manufacturer in his or her right mind would make such an investment if they didn’t know that they could force their retail dealers to purchase most of production for any make and model.If a new car is a flop it’s the dealers that protect much of the manufacturers investment. Basically, no sane auto manufacturer would spend that much money to design and build a car and then just hope that the public will buy all of a year’s production of the vehicle, as fast as it can be produced. Dealers as Piggy BanksMaxing out factory production on any given vehicle, or hitting the highest plant utilization rate, is the only way to ensure the lowest cost per vehicle built — and that’s the only way manufacturers make their money. In order to do that, they chose 100 years ago to put together the franchised dealer system we have today. The manufacturer’s zone office personnel ensure that all of the cars built are sold to dealers. Zone reps are some of the most ferocious car salespeople in America, often forcing dealers to take vehicles that they already have too many of. One of the biggest secrets in the auto industry is how this works, but more on that in just a minute. The basic thrust of this system can be explained this way: It’s the 18,000 new car dealers who keep the manufacturers’ factories operating consistently, month in and month out, in great and bad months of sales and hopefully with high factory utilization rates. Because the moment there aren’t enough orders to keep any given plant open for a week, the cost per vehicle goes through the roof. This I learned in the RV business back in the late 70s. At the time my company, Neonex Leisure, built the 55-foot-long fifth-wheel trailer, the Arctic Sun. And on Monday morning, if all we had was one sale to put through the factory, the cost per unit was a little over $250,000. But with 100 orders that same vehicle only cost us $39,500 each to build. That’s how mass production works. More important to auto manufacturers, because they have franchised dealers, the second that vehicle ships from the factory it is paid for in full. If they sold direct to the public, they would continue to tie up their own money until the retail consumer finally paid for the vehicle. So in a world where we are on our way to selling 16.2 million vehicles this year, manufacturers might actually build more than that, but the collective improved cash flow that manufacturers make by selling cars to franchised dealers comes to $486,000,000,000 this year (16.2 million sales x $30,000 average cost per car). That’s right, car dealers cover that much in cash flow for automakers each year, just in this country.The Big SecretStill, even under this system there is no guarantee that any car will be such a hit that retail demand forces the factories to run full out, year round. Some weeks, or even months, there are far fewer dealer orders because retail demand on a certain vehicle is slow. Here comes the great secret of the car business; this is an example, not to be construed as fact. Let’s say you have a Ford dealer who does an exceptional job selling the Focus compact car. Both the dealer and the sales staff love the product, as do their customers. In this example that dealer sells 20 – 25 Focus a month but already has 100 of them in stock. Because this dealer has a four- to five-month supply on his lot, for the past couple of weeks he hasn’t asked the factory for more vehicles. So far, it hasn’t mattered. Only now Ford realizes that dealer orders on hand will force its Focus factory to operate at only 70 percent utilization this coming week. So, to keep the factory utilization rate high, the local zone distributor now has to get on the phone and find enough dealers to take another 1,442 Focus compacts right now. He calls our dealer, who explains that he loves the Focus, as do his salespeople and their customers, but he does have plenty of them in inventory and doesn’t need any more right now. He’ll be glad to reorder more once his supply of unsold cars hits around a 60 days supply.Great business decision, but it’s not going to work on this day. The zone rep will tell the dealer he has to take so many of these 1,442 unsold and un-built cars, no matter what. The dealer continues to resist this pitch but knows he’s going to have to buy some of them to make Ford happy. Somewhere in the conversation the factory rep might say, “I’ll tell you what, take an extra 25 cars now and, when the all-new Mustang comes out this fall, I’ll give you 10 more over your allocation.” With that carrot being dangled in front of him, offering more of a model that will be super hot when it arrives, the dealer finally agrees to take those 25 Focus compacts that he really doesn’t need at the moment. It gets worse. Both the dealer and the zone rep know he’s been pencil-whipped; he really knows he’s never going to get those 10 extra Mustangs. It’s just part of the game that goes on every day in the auto industry and by every manufacturer to maximize their production, thereby maximizing their profits off the dealer’s back. Now it’s the dealer’s problem to find a way to sell those extra Focus compacts because now he owns them, not the factory. And What about Warranty Work?Again, this was just an example that’s easy to understand. In my career I’ve played the same game with Honda, Oldsmobile, Pontiac, Acura, Chevrolet, Buick and others. You take cars you don’t need for a promise of something really hot that you can’t get enough of it, all the time knowing it’s probably a false promise. But it keeps peace in the family and a good relationship with the factory.And that’s why selling cars direct to the public will never work. You can’t twist a customer’s arm to buy two Focus units when they only want one, just to keep the factory humming. You can’t plan long-term and consistent production at all if you wait for customers to come in and buy a car first. And high-volume car companies would go broke trying to sell direct to the public. Car dealers are the $486,000,000,000 buffer that makes the entire system work. That’s why the other auto manufacturers aren’t jumping on the bandwagon and telling the public and legislators they want to sell direct to the public, only Tesla. And if sales of its Model S cool to where there’s more production than buyers, guess what happens next?
© Ed Wallace 2014 Ed Wallace is a recipient of the Gerald R. Loeb Award for business journalism. He hosts Wheels, 8:00 to 1:00 Saturdays on 570 KLIF AM. E-mail: email@example.com; read all of Ed’s work at www.insideautomotive.com