Ed Wallace

Law and the Balance of Power

In America laws protect people and entities that invest in their future. It’s even true in the radio industry; the government assigns the airwaves so stations don’t have competitors broadcasting on their wavelength. Zoning laws keep trailer parks from being opened across the street from the mini-mansions in Rockwall, which could destroy the value of the homeowners’ properties.

I actually had to explain that to a radio listener. He suggested laws protecting new car dealers and their investments in franchises “anti-capitalistic” because, he said, he couldn’t buy a Tesla direct from the factory. Yet he also said he was about to buy his second Tesla. Had I been thinking quicker, I simply would have told Mr. It’s All About Me that his opening line disproved the very statement he was making. Obviously he could buy direct from Tesla, since he had already done so once. Just as thousands of other Texans have in the past.

Not National Car Warehouse

By and large, America’s franchise system is misunderstood by most. As law professor Stewart Macauley wrote in his 1966 book, Law and the Balance of Power, automobile franchises are completely different from owning a furniture store.

First, furniture store owners can buy from any wholesaler, dropping one brand and adding another at their discretion. But a car dealer has to make a massive investment to carry typically only one manufacturer’s line of products. In fact, the dealer will be forced to carry, represent, and sell not only the hottest vehicles their manufacturer makes, but also vehicles that no one believes should ever have been made. Moreover, new car dealers have to pay for those vehicles, wanted or not, shortly after they come off the manufacturer’s assembly line.

Consider this. In March Auto Dealer Today magazine reported the unsold inventories of new vehicles on dealers’ lots had hit a 78-day supply, or 4.1 million unsold vehicles. As the average window sticker price is now close to $37,000, new car dealers across the country have paid manufacturers $151.7 billion to have the pleasure of keeping lots of cars for you to choose from. That means they have paid the manufacturers their profits up front, plus the cost of their labor and parts to build those vehicles. And put the manufacturers $151 billion in working capital back in the bank for them.

And that’s not counting the normal expenses of operating a large new car dealership. Worse, some dealerships in the Metroplex today have physical facilities that cost $40 million and up.

Yet the manufacturers often speak of their franchise dealers as if they are the problem in the industry. They’re not: Today factories are producing far more new vehicles than we have buyers; according to the raw data, North American light vehicle excess capacity is 2.5 million vehicles. Meaning, local zone offices are begging dealers every Monday morning to buy more product, even if they have a four-month supply sitting on the ground.

Then, to add insult to injury, because it’s the modern era of rebates, incentives, and subvented interest rates, often the car buyer can purchase the vehicle they want for less money than the dealer paid for it. Think about that one. The dealer may have a $20 million store, more money than that tied up in the 600 unsold vehicles there, plus the cost of operations, and hundreds employed to sell and service those cars; yet a person who hasn’t bought a car in a decade can walk in and pay less money to buy their one car than the dealer paid the manufacturer for each of hundreds of that particular vehicle. Oh, and then the buyer gets to complain that somehow they paid too much.

But we’ve seen this before, twice in a major way in the history of the auto industry.

It’s Always the Dealers’ Fault

It started in the years just after the Great War. Henry Ford had bought out his partners and opened the River Rouge Factory, then the world’s largest, for production of his Model T. And, while car sales skyrocketed in 1919, a serious recession slammed the nation in 1920. By 1921 Ford owed his banks $30 million and the Federal government $40 million; and because of the recession orders for his vehicles were desperately low. Bankers demanded representation in his company to lend him the financial aid he needed, but instead Ford made the decision to open up production of his Model T and ship them to Ford dealers nationwide, even though nobody had ordered them.

The instructions were that if a Ford dealer complained or refused to accept those products, his franchise would be canceled. Additionally, Ford had 8,300 dealers at the time and decided to increase that number to 10,000. The word was, Ford wanted a dealer at every crossroads — and that’s what they named the program.

Oh, and Ford cut the dealers’ profit margin in cars from 20 to 17.5 percent. Basically, Ford took his $70 million problem and transferred it to his dealer body. But that was the mindset of the time. Ford, (and other manufacturers) sincerely believed there was nothing wrong with his car, or with any of his company’s policies; therefore, anything that wasn’t right was caused by the failings of his dealers.

Ford did the same thing at the start of the Great Depression, only that time his dealers fought back and won that shallow victory. His company would probably have survived had Ford not done this, but the Ford family’s control of it might have been diminished. But that decade set up the ongoing battle between most if not all manufacturers and their dealer bodies. Automobile production is incredibly cash intensive, with ridiculously low margins; one marvels that you can put 20– 30,000 parts you designed and engineered into a reasonably priced automobile that sells affordably to the public — and both manufacturer and dealer find away to profit from that business.

New car sales bottomed out in 1931 at just 1.78 million. But two years later, despite the Great Depression’s lasting effects, sales doubled to 3.4 million, then peaked at 4.66 million on the eve of the attack on Pearl Harbor in 1941. Two months later, automobile production for the public ended to free up Detroit’s manufacturing capability for war material.

Contrary to popular belief, Ford actually started building its 1946 model in July of 1945, even before the Japanese surrendered. GM and Chrysler were still working on war goods and slowly getting their factories retooled for civilian production; they would reopen their lines in October of 1945. Obviously, things went slowly at first.

Too Much of a Seller’s Market

That may have been the Golden Era for automobile sales. Just not for the public. There were massive shortages of products thanks to ongoing strikes through the late Forties; American workers wanted wages that reflected the expanding economy. The demand was due to the car-buying public still driving vehicles purchased in the Depression, held together by baling wire.

Demand was such that customers who ordered cars found out later that their car had arrived, but someone else on the showroom floor had offered hundreds of dollars more if they could take it home immediately. The most popular cars were never made in enough volume to satisfy the demands of millions; people were often forced to buy the least desirable vehicles, simply because they were the only ones left on dealers’ lots.

But every year improved the American automakers’ production capability, and by the early Fifties the serious lack of product compared to potential buyers reversed. Now, every dealer had the most popular vehicles in stock — but so did their nearest competitor. More important, the manufacturers were pushing those same dealers to take ever more product, regardless of demand. New car dealers hoped to maintain the profits they had earned after the war, and manufacturers wanted to net even more.

How lucrative were those days? Forty years ago I worked with an older Buick salesman; he was a great guy, but wasn’t selling that many cars or making much money. He’d started in the business in the years after the Second World War, and we asked him why he kept at it. Finally one day he brought in his tax return for one year in the early Fifties, working at Town North Buick in Dallas. It showed he had earned in excess of $100,000, about the same as a million-dollar income this year. He told us, “I only did this once, but I stay in the business hoping I could do it once more in my lifetime.”

The early Fifties gave dealers the reputation they still have today, even though few practice the sales techniques used back then: Throwing customers’ keys on the roof, putting hidden microphones in offices so you could hear your customers’ comments while you were out of the office, hiding trade-ins, and so on. Like the early 1920s, when production capabilities were far in excess of customer demand, the early Fifties put that scenario on steroids. If dealers didn’t take the cars the factory demanded they take, their franchise could be ripped away for any or no reason.

The public blamed the car dealers for these new aggressive sales tactics; Congress would see it another way. That story next week.

Ed Wallace is a recipient of the Gerald R. Loeb Award for business journalism, bestowed by the Anderson School of Business at UCLA, and hosts the top-rated talk show, Wheels, 8:00 to 1:00 Saturdays on 570 KLIF AM. Email: edwallace570@gmail.com