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Thursday, May 23, 2013

Tesla's Distribution Challenge

...the issue isn't whether Tesla's distribution approach is legal, it's whether it's sensible...
Tesla is distributing its battery electric cars directly, rather than through franchised dealers. That's raised a hulabaloo from NADA and dealers about legality. Texas is one large market in which Tesla may be stymied for several years; its attempt to get legislation that would permit direct sales is dead this legislative season, and the next session isn't for two years, until 2015. Barring judicial support, that's a long wait in a large market. There may be room to do so, since the firm has no franchised dealers in any state, hence the idea that it is undermining dealers protected by franchise agreements has no merit. Be that as it may, taking the issue to the courts takes time, and Tesla would like to become a volume manufacturer sooner rather than much later. Time will tell, but time is not in their favor.
The real issue, however, isn't whether Tesla's distribution approach is legal, it's whether it's sensible. In his visit to Lexington to speak to my Economics 244 students, David Ruggles posited that it's ultimately unworkable. Let me make a few points in that direction; interested readers might find the Dicke chapter cited below of interest, and hopefully David will add his thoughts.
    1. For a firm seeking to expand, dealerships are the cheapest available source of finance. We can ignore the up-front fees to purchase franchise rights (at issue in the failed attempt of Mahindra & Mahindra – or maybe primarily the serial entrepreneur Malcolm Bricklin – to set up a dealerships to sell trucks imported from India). That's really small stuff, from the perspective of the financial needs of a car assembler. Much more important is that a dealership pays for new vehicle inventory, signage and replacement parts inventory and provides the necessary real estate. That is a crucial source of working capital for a manufacturer, because the factory is paid cash when a car rolls off the assembly line, whereas parts suppliers are paid a month or three (and workers a week or two) in arrears. Remember, too, that dealerships frequently hold two month's of inventory. Under its current structure Tesla will need to fund that directly.
    2. It may not be a big issue when they restrict themselves to a low volume of hand-assembled cars. It won't be trivial when they want to run a proper assembly operation.
    1. Moving to volume business will also require making provision for repairs. That may not be a big issue when its market is limited to a handful of states and is of high-end cars. They and their cars' owners can wait for a technician to be dispatched, or the car transported. That won't work if they want to move away from the supercar end of the market, because their vehicles will be means of transport, not playthings. Would-be purchasers won't want to wait a week or more to get a problem looked at. I think Tesla underestimates the challenge (cost!) of directly developing a dense network of repair facilities.
    2. In the old days, the local mechanic could do the actual work. But as Kevin Borg (a historian of the independent service station at James Madison University in Virginia) emphasizes in recent work, even the most skilled of independent service technicians lacks the training and equipment for working with the computers and high-voltage electrical systems of a vehicle such as a Tesla. To put it simply, they are fundamentally mechanics, experts in traditional mechanical systems, and a Tesla lacks much of the appurtances of an internal combustion engine powered vehicle.
    1. Historically the "factory" has been abyssmal at controlling inventory and even worse at handling tradeins. Think of Ford's disastrous attempt [1998-2001] under Jacques Nasser at Ford to buy up independent dealers and run their stores directly in several markets where state franchise law allowed direct sales (eg, Oklahoma City). Dicke's history of the early days of automotive distribution tells the same story. The bottom line is that the factory bleeds, and the longer it tries, the more money it loses.
    2. Now the rise of multistore dealership groups suggests that at least some people have figured out how to run stores under hired general managers rather than owner-operators. So maybe there is more know-how available. However, such dealership groups – the AutoNation and Penske's of the world – still account for but a small share of total US vehicle sales. I remain skeptical.
Ford in its early days had time to experiment; it wasn't until the early 1920s, after DuPont took over GM, that Ford faced a serious rival. They had time to recover from mis-steps. Tesla won't have that luxury.
...mike smitka...
Dicke, Thomas S. (1992). “From Agent to Dealer: The Ford Motor Company, 1903-1956.” In: Franchising in America: The Development of a Business method, 1840-1980. Chapel Hill: University of North Carolina Press, Chapter 2, pp. 48-84.