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Dealers, long protected, face days of reckoning

Amid the myriad problems facing the Big Three automakers, one is often overlooked — a costly, inefficient network of dealers, protected by a byzantine web of state laws.
Image: Car Dealership
A new Chevrolet is topped with a bow in an optimistic display at a San Francisco dealership. Thousands of dealers are threatened by the auto industry's steep downturn.Justin Sullivan / Getty Images file

Amid the myriad problems facing the Big Three automakers, one is often overlooked — a costly, inefficient network of dealers.

But while thousands of dealers are likely to disappear in coming years, there is little the auto industry can do to make its distribution more efficient, because dealers are well-protected by a byzantine network of state franchise laws.

The laws prevent automakers from owning dealers or selling directly to members of the public, ensuring that vehicle prices get a minimum markup before they reach consumers.

“They can’t take an order over the Internet for a made-to-order car like Dell because the states have made it illegal,” said Peter Morici, professor of business at the University of Maryland. If automakers could sell over the Web they could probably reduce inventory costs and “lop something like $1,000 off the cost of making one of their cars," he said.

Consumer advocates long have criticized state laws that protect the dealers, saying they are anti-competitive and should be abolished.

“We’d like to see them go away, and that would immediately open up online sales of automobiles,” said Mark Cooper, director of research at the non-profit Consumer Federation of America. “Right now you have a bloated distribution network, and so squeezing that network down would lower costs, and from an environmental point of view when people buy online instead of in the showroom they won’t have their arms twisted to buy more horsepower.”

But don't look for that to happen anytime soon.

For one thing, auto dealerships are among the most powerful business groups in each state. They are politically well-connected and have been diligent in protecting the franchisee system or any attempt to cut them out of the car selling process, Morici said.

Dealers defend the system, including laws that prohibit manufacturers from unfairly canceling or refusing to renew a dealer’s franchise.

“Car dealerships are massively credit-intensive enterprises, and they are seen by lenders as more of a risk without state laws to protect them from being closed down,” said Bailey Wood, a spokesman for the National Auto Dealers Association.

He said the average individual dealership typically invests $11 million into a business over its life.

“That money goes into inventory, buildings, tools and personnel,” Wood said. “So if you suspended state franchise laws in general it would threaten the nation’s economic stability.”

In any case, the economy and the dire prospects of the industry ensure that many dealers will go out of business in the near future.

NADA predicts that this year alone will see the demise of 900 of the nation’s 20,700 dealerships. A report from consulting firm Grant Thornton LLP says 3,800 dealers, or one in five, will need to close by the end of 2009 as weak sales, increased operational costs and the credit crunch continue to take their toll.

In the survival plans GM and Ford submitted to Congress this month, the nation’s two largest automobile manufacturers said a fundamental part of their bid to stay in business is a reduction in their dealer networks.

GM said it will focus its U.S. resources around a smaller, more profitable set of nameplates, cutting the number from 48 to 40 by 2012, and consolidate its dealer network to 4,700 locations by 2012, compared with 6,450 currently and 8,138 less than a decade ago.

GM also said it plans to focus substantially all of its product development and marketing resources in support of four core brands — Chevrolet, Cadillac, Buick and GMC.

GM hasn’t said exactly what will happen to the four remaining brands — Pontiac, Saturn, Hummer and Saab — but they undoubtedly face a difficult future, making prospects uncertain for those dealer networks.

For its part, Ford said it will have reduced its U.S. dealer network 14 percent from 4,396 locations at the end of 2005 to 3,790 by the end of this year. Chrysler made no mention of its planned dealer cuts in its report to Congress last week, but the automaker already has an ongoing project designed to cut models and consolidate dealerships.

State dealership laws make it difficult and costly for automakers to eliminate brands, as GM discovered when the automaker dissolved its 106-year-old Oldsmobile brand in April 2004. By discontinuing the Oldsmobile brand, GM had effectively broken is agreement with dealerships, and had to pay severance to each of its dealerships.

“It cost GM between $1 billion and $2 billion to close down the Oldsmobile brand for the whole country, and the most expensive part of that was placating the dealers,” said Aaron Bragman, an automotive analyst at consultancy Global Insight.

This year, with the U.S. automobile market on the skids — a very different place today compared with 2004 when Oldsmobile was suspended — automakers may find money-losing dealers much easier to deal with when it comes to close down brands, Bragman noted.

“Back in the Oldsmobile days the market was good, but today many of these dealers are facing bankruptcy simply because no one is buying cars, so they’re more likely to sit down and discuss their options with GM,” he said.

NADA’s Bailey Wood said his members recognize the economic challenges they face and are willing to work with automakers to close brands or shrink dealer networks. He said he hopes that any decisions to close brands or dealerships will be done fairly and with the best interests of dealers in mind.

“For example, when Oldsmobile closed, one dealer in Florida became a Saturn dealership instead, and there are other avenues that can be pursued,” he said. “I know a Ford dealer in central Pennsylvania that was approached by Ford. The company told him there were too many Ford dealers in the area, so they gave him some money and he closed, and everyone walked away happy.”