By Morgan Smith
It has been four years since Georgia legislators enacted broad changes to the state laws that regulate the relationship between auto dealers and car manufacturers. The changes have created significant benefits for auto dealers by insulating them from new forms of competition – such as direct sales to consumers from car manufacturers and online retailers. The new rules also expanded some existing protections that restrict how car manufacturers can interact with dealers in key aspects of their business.
Georgia’s 1999 regulations have created a less competitive market environment, which imposes excess costs on consumers, car manufacturers and online retail competitors. The expanded restraints – such as the prohibition on non-dealer sales and strict relevant market area (RMA) rules – deter new retailers from entering the market and create unfair advantages for existing dealers. The net effect is to encourage fewer dealerships than would result from a more open policy. This can lead to higher prices for both new cars and repair services, makes comparison shopping and service visits less convenient for consumers and imposes unnecessary restrictions on emerging retail alternatives.
These generous regulatory protections are based on the historical premise that auto dealers are structurally vulnerable to economic abuse from larger manufacturers. However, this imbalance in bargaining power has shifted considerably, and in reality is less pronounced than ever before. Today, the average dealer is no longer exclusively bound to one brand, and is not likely to be either the small or locally rooted business that once prevailed. Given these significant and ongoing structural changes, there is little rationale for laws that strengthen auto dealers’ economic advantages.
In advocating for increased regulation, auto dealers claimed that new forms of competition threatened to eliminate traditional dealers, raising concerns about local employment and economic impact. But as a matter of good public policy, the state should not be in the business of creating protectionist laws simply to maintain the status quo, particularly in an industry that is undergoing broad economic changes. The automotive sales industry is not sufficiently “special” to warrant such aggressive regulatory intervention, given that these benefits must come at the expense of other groups.
In addition, the traditional franchise dealership system is in little danger of disappearing. This system has not only stood the test of time, but dealers have recently undertaken initiatives (such as the widespread adoption of online services) that confirm dealers are more than capable of defending themselves from industry changes. In fact, the franchise system has been proven to work well for both dealers and manufacturers, and there is little justification for expanded state intervention on behalf of either side. Evidence shows that franchise dealers provide consumers with some valuable services – like hands-on “tire-kicking” access to inventories – that are not replicable by emerging online entrants. Thus, the franchise system’s long-term survival is fairly assured, as is indicated by measures such as rising consumer satisfaction and dealers’ record profit levels.
Given these facts, the state should revisit the generous rules enacted in 1999. State regulation should not be used to shield one group from economic changes at the expense of consumers and other businesses. The excessive provisions should be critically examined in light of the economic costs being imposed and the overwhelming evidence that today’s dealers have less need than ever for protection from manufacturer “abuse.”
By undertaking these revisions, state regulators can increase competition and efficiency in Georgia’s retail auto market. Regulatory changes could reduce prices and improve service levels for consumers, regardless of whether they continue to use traditional dealers or online competitors. Such reforms would also help to promote continued innovation in the market and new channels for future auto sales. Most importantly, a more open regulatory policy would better balance the combined welfare of Georgia’s consumers, manufacturers and other retailers against the relatively narrow interests of traditional franchise dealers.
II. How Dealers and Manufacturers Interact
New car sales represent a key segment of the U.S. economy, with tremendous financial interests at stake. More than 17 million vehicles are sold annually, generating almost $700 billion in revenue. To satisfy this vast market, auto dealers and manufacturers must depend on one another in some ways, while essentially competing in others. As a result, the need for both groups to work together to satisfy customers is offset to some degree by their internal competition for profits.
Manufacturers, for their part, rely on dealers to act as their local presence. Dealers function as the all-important “front door” of the auto industry, giving consumers an entity that is more accessible and theoretically more locally responsive than the large, multinational supplier. In this role, dealers are expected to provide a range of services to promote the manufacturer’s brand. These include local and regional marketing efforts, maintenance of inventories for customers to browse and warranty or repair services. Manufacturers need dealers to perform these tasks well, in order to generate ground-level interest in their brands and to maintain customer satisfaction over the life of thevehicle.
Dealers, in turn, are at the mercy of auto manufacturers in several respects. Individual dealers must depend on the manufacturer for a good mix of products (i.e. a favorable share of “hot” brands or styles) in order to stay competitive. Inventories must be distributed by the manufacturer in a timely fashion, otherwise the dealer faces the added pressure of too many or too few vehicles in stock. Dealers also rely on manufacturers for effective corporate-level marketing and rebates to generate overall brand goodwill and create sales incentives. Finally, dealers need access to the manufacturer’s warranty repair accounts, since these represent an important share of the average dealership’s operating profit.
To accommodate these competing needs, the auto industry has adopted a franchise system as the framework for dealer-manufacturer relations. This allows auto manufacturers to maintain a high level of control over the distribution of their cars, while assuring that dealers receive significant assistance with their retail and service business. Even so, there is a natural tension between the need to work together and each group’s economic self-interest. The net result is a complex relationship, within which state intervention can have significant and unintended consequences.
III. The State’s Regulatory Role
Historically, the business relationship between auto dealers and manufacturers has been subject to a level of regulatory scrutiny not found in other industries. This is due to both the economic magnitude of the auto industry and the unique role automobiles play in American society. States have traditionally asserted that the smooth operation of the retail auto industry has such broad economic implications that it is a matter of public interest, and thus deserving of a distinct set of laws and controls.
Most of the rules governing an auto dealership are captured in the private contract with the manufacturer called the dealer’s “franchise agreement.” From the 1930sonward, federal and state policymakers have concluded that dealer franchise agreements are “between parties of very unequal economic strength and bargaining power,”and thus contain some inequities that justify further protections on behalf of auto dealers. Toward this end, many important aspects of dealer operations are monitored and enforced by the public sector. These regulatory interventions attempt to create a system of checks and balances that extends beyond the more detailed provisions of the franchise agreement.
At the state level, the main instrument for regulating auto dealers’ operations is the state’s motor vehicle franchise law. In Georgia, this law – comprises a series of separate acts. These franchise laws create unique rules for auto dealers – as opposed to franchisees in other industries – and place certain obligations on how car manufacturers must interact with their dealers. For example, the state’s auto franchise laws set conditions on whether a franchise can be terminated, how dispute arbitration will occur, and on a variety of ownership issues.
Georgia’s auto franchise laws are intended to correct the perceived imbalance between the large, economically powerful manufacturer and the smaller, local dealer. But changing market conditions – discussed in more detail below – raise the question of whether auto dealers today are truly disadvantaged relative to auto manufacturers. In addition, the usefulness of state protections must be balanced against the effect on other groups. Given that regulatory intervention can create significant costs throughout the industry, Georgia’s current laws – particularly new provisions passed in 1999 – deserve critical analysis and review.
IV. Problems with Georgia’s Current Regulations
Georgia’s auto franchise laws are derived from two key assumptions: that the auto industry is sufficiently special to state regulation, and that auto dealers are inherently vulnerable to exploitation from manufacturers. These assumptions have led to a set of regulations that provide significant protections for auto dealers. It is important to recognize that these benefits come at the explicit expense of manufacturers, consumers and other groups. For this reason, the burden of proof should be placed on auto dealers to demonstrate that state intervention on their behalf is justified from the perspective of good policy.
Of particular concern are recent changes that significantly expanded the state’s intervention in the retail auto market. In 1999, auto dealers in Georgia initiated a campaign to increase the legal restrictions that protect dealers from certain types of competition. This effort mirrored similar movements in other states, such as North Carolina, Floridaand Arizona.
The 1999 legislation (H.B. 356) proposed major changes to the state’s motor vehicle franchise laws, including several new protections for auto dealers. The legislation was passed despite broad criticism from auto manufacturers, a coalition of diverse Georgia business groups and consumer advocates. Opponents of the proposed provisions argued that the new rules created “a black spot in an otherwise pro-business state.” Auto dealers, on the other hand, claimed that their businesses “couldn’t survive” the effect of new forms of competition.
The revised franchise rules were signed by Gov. Roy Barnes and became effective on May 3, 1999. As a concession to critics, portions of the new rules were subject to a sunset clause and scheduled to expire after three years. Shortly the bill was passed, however, the original sunset clause was repealed and the revisions became permanent.
In general, the changes enacted in 1999 were intended to head off the threat of competition from new forms of sales outlets such as Internet brokers, manufacturer-owned sales centers and other emerging entrants in the retail auto market. While it is to be expected that current stakeholders (i.e. franchise dealers) would take steps to defend their market power, state intervention to protect the status quo was both inappropriate and shortsighted.
In Georgia, as elsewhere, dealers used local lobbying efforts to win significant expansions of existing regulatory protections. In this respect, local dealers had a practical advantage over the large car manufacturers, who are located out-of-state and typically have little local political clout. Once enacted, the new regulations have contributed to a less-competitive market that favors auto dealers at the expense of other retailers, car manufacturers and Georgia’s consumers.
Since portions of the expanded protections were originally conceived as temporary measures to ease dealers’ adjustment to new market conditions, the time has come to re-examine the need for these new, more restrictive rules. In particular, two aspects of Georgia’s current regulations deserve review:
- the mandate that only franchised auto dealers may sell new cars, and
- the codification of Relevant Market Area (RMA) rules.
The Dealer as the Only Source for New Cars
Under Georgia’s rules, consumers may effectively purchase new cars from only one source: a franchised auto dealer. This restriction is enforced by the state’s Motor Vehicle Fair Practices Act through specific provisions added in 1999. The current law states that no business other than a franchised dealer “shall sell or offer to sell, directly or indirectly, any new motor vehicle to a consumer in this state.”
The main intent in creating this restriction was to prevent auto manufacturers from establishing their own dealerships, which might compete with existing franchised dealers. Dealers have argued that manufacturer-owned sales outlets would place traditional dealers at a disadvantage in terms of pricing and access to inventories. As one dealer stated,“We feel it’s possible for the manufacturer … to sell parts or merchandise for less to their [own] outlets – to the detriment of independent dealers.”
The 1999 legislation went beyond creating explicit prohibitions against manufacturer-owned dealerships; it also made other emerging outlets for auto sales illegal.Georgia’s new rules prevent consumers from buying new cars through online direct purchase services such as CarsDirect.com. Instead, the law requires that online auto retailers and referral services use a franchised dealer to complete the transaction. This essentially forces online companies to act merely as a broker. Looking ahead,Georgia’s revised franchise laws also prohibit manufacturer-direct sales or build-to-order programs, which industry experts predict may become important elements of the future marketplace.
The emergence of these new, more direct mechanisms for auto sales reflects a broader trend seen in many other industries. “Disintermediation” – the movement towards fewer and fewer layers between the supplier and the consumer – is a phenomenon that has affected a wide range of retail markets, particularly those with emerging online outlets. Technology has made it feasible for consumers to interact more closely with suppliers and to directly purchase goods that were traditionally controlled by a middleman (books, airline tickets, mortgages, etc.). In such cases, disintermediation has the potential to create significant savings for consumers and to dramatically reshape some aspects of the retail marketplace.
By setting up franchise dealers as the only legitimate source for new cars, Georgia’s regulations have effectively locked consumers into a single venue for new car purchases. This comes at a time that new, potentially revolutionary mechanisms for auto sales are just beginning to evolve. To the extent that these rules eliminate competition from new entrants, the prohibition against alternative forms of retailing creates significant economic benefits for auto dealers.
Without this regulatory roadblock, Georgia’s consumers would be free to investigate other options for new car purchases. For example, direct car sales via the Internet – although currently prohibited – have the potential to be an important segment of the new car market. Many consumers appear intrigued by the possibility of shopping for a car online, as a complement to visiting a local dealer if not a perfect substitute. In fact, most car buyers already use the Internet as a source for information about pricing, model comparisons and available options. The ability to complete the sales process online seems a natural next step.
In addition, using online services to sidestep the traditional dealer as a middleman has the potential to create savings for consumers. Attempts to quantify the economic benefits to consumers from non-dealer direct purchases have been controversial. Some estimates predict that online retailers could cut as much as 10 percent from the purchase price of a new car. Competing studies, often sponsored by dealers’ associations, argue that the potential savings from an online, non-dealer structure would be much lower, and perhaps negligible.
Critics point to the failure of most well-known online auto retailers to achieve profitability (for example, CarsDirect.com) as evidence that the online model is not a viable alternative to traditional dealerships. But conclusions about the feasibility of new entrants in the auto market are premature. A major factor cited in recent online business failures is the fact that most state’s regulations prevent online retailers from completing direct sales to consumers. If this is true, then the problem with online retailing may be less about economics and more about the regulatory barriers raised by existing car dealers.
Despite the potential benefits offered by an online auto market, the evidence suggests that the majority of car buyers still prefer to test a new car in person. The ability to see, touch and drive a prospective car matters to consumers, and these options are currently only available at a traditional dealership. So while consumers are increasingly using online services to research car purchases, the large majority – roughly 95 percent – still chose to close the sale in person via a dealer. Evidently, only a very few consumers are willing to use an online purchase mechanism that eliminates the dealer.
For these reasons, among others, it is clear that traditional dealers will continue to play a central role in the purchasing process. But there is no good rationale for regulatory prohibitions against emerging forms of competition. If traditional dealers are truly adding value to the transaction, then consumers will continue to use them for most auto purchases. Indeed, this seems to be the case. But it is inappropriate to use state laws simply to protect existing dealers from new entrants and the possibility of increased competition in the market.
Relevant Market Area (RMA) Laws
Another controversial feature of Georgia’s auto franchise laws are the restrictions on where new dealerships can be established. Before H.B. 356, the placement of new or relocated dealerships was negotiated privately, according to rules outlined in each dealer’s franchise agreement. Georgia’s new auto franchise rules elevated this internal business dialogue to a matter of public interest, by including a provision that codified the concept of “relevant market area.”
The designation of a relevant market area attempts to define the geographic area within which a new car dealer is presumed to be directly competing with existing dealerships. Under the revised Georgia law, the RMA for auto dealers is set at an eight-mile radius, regardless of the population of the area. Whenever a manufacturer intends to add or relocate a dealership, state law now requires an in-depth evaluation of the prospective dealer’s impact within the RMA.
RMA constraints are designed to protect existing dealers from losing their investment in their business in the event that the manufacturer wishes to insert a new dealership in a nearby location. In principle, these rules help determine to what degree a potential new entrant will compete against an existing dealer, and consequently erode the economic value of the existing dealer’s business. The intent is to level the playing field between dealers with sunk investment costs and large manufacturers who want to increase the number of sales outlets. But if inappropriately applied, overly restrictive RMA laws can create disproportionate economic advantages for established dealers.
The provisions enacted in 1999 specified 11 factors that courts must consider in weighing potential harm from new dealerships. Manufacturers now face a daunting burden of proof that – in many cases – significantly inhibits the creation of new dealerships within the eight-mile boundary. Under this system, the burden is now placed on the manufacturer to prove the need for a new dealership based on a range of criteria, some of which are only marginally related to the market demand for new cars.
Although many other states have also adopted RMA restrictions, some have looser RMA regulations or none at all. Several states – for example, New York andIowa –do not stipulate territorial limits on new auto dealerships, preferring to let the issue be resolved through the private negotiation of dealers’ franchise agreements. A number of other states have more liberal RMA laws that use a “tiered” system, in which the restrictive boundaries are much smaller for more populated, urban areas. In comparison, the rules imposed by H.B. 356 mandate a one-size-fits-all restriction, and give Georgia’s auto dealers a more favorable advantage than exists in some other markets.
Consumers face tangible consequences from overly conservative RMA protections, particularly in more densely populated communities. Assuming that the regulatory controls imposed within the eight-mile RMA represent a substantial barrier to new dealer entrants, this restriction has a disproportionate impact on the auto market in larger cities. In more populated areas, or locations that experience rapid growth, RMA restraints can have an especially restrictive effect on competition, and can result in far fewer dealerships than would exist in a more open market.
To the degree that strict RMA laws artificially limit the number of dealers, these rules inflate existing dealers’ market power and create a range of costs for consumers. Most directly, dealers who are protected from intra-brand competition are able to charge higher prices for both sales and service than would be possible in a more competitive market. Consumers must invest more effort if they wish to comparison-shop between dealerships, which are now located farther apart. This creates costs in terms of the excess time needed to travel to competing dealers, the tendency for consumers to collect less comparison information, and the subsequent disadvantage from negotiating with reduced bargaining power. After the purchase, customers in restricted markets face additional travel costs each time they return to the dealership for warranty service or repairs. All of these effects have both explicit and implicit consequences that combine to increase dealer market power and the potential for excess pricing.
In addition to the effect on consumers, overly conservative RMA restrictions have important consequences for how the auto manufacturer can manage its relationship with its dealers. With stricter RMA standards, the manufacturer has little or no recourse for punishing non-performing dealers. Manufacturers are also constrained in their ability to respond efficiently to changing market conditions, such as shifts in population or consumer preferences. These restraints result in less balance in the dealer-manufacturer relationship, greater inefficiency in the allocation of dealerships and a more protected retail market for existing dealers.
The concept of RMA restrictions is applied in a variety of industries, although usually through agreements reached via private contract and not under the imposition of state law. Even within private agreements, these types of territorial constraints have a long history of legal and economic controversy, based on the potential for such rules to create anti-competitive obstacles within a market.
In the auto industry, the use of RMA laws has been scrutinized repeatedly. Several economic studies have tried to quantify the dollar effect of RMA regulations on auto sales. One study, which is frequently cited, concluded that states with RMA laws experience average new car prices that are more than 6 percent higher than prices in states without such restraints. However the data used in this study is quite dated, and its applicability to the current auto market is questionable. More recent attempts to estimate the cost of RMA rules have, as noted by auto dealers’ groups, also been vulnerable to criticism.
The exact economic impact of RMA laws may be debatable, but it is clear that overly restrictive RMA rules have the potential to increase costs for consumers:
“[S]tate regulation has served effectively to entrench existing automobile dealers. They appear to be protected from entry of new dealerships, from discipline by the manufacturer, and from involuntary termination. The net effect is fewer dealerships and increased market power resulting in higher prices.”
Excessive RMA laws can create unequal market share for dealers by raising legal barriers against new entrants. Georgia’s 1999 changes unnecessarily elevated RMA issues from the private domain of the dealers’ franchise agreement to a matter of state law. As a result, the balance of power between dealers and manufacturers has been artificially skewed. The state’s strict new RMA laws now protect existing dealers from a more competitive environment, while placing undue constraints on auto manufacturers, and creating added costs for consumers.
VI. The Effect of Industry Changes
An underlying weakness in Georgia’s auto franchise laws is that current regulations are derived from historical industry assumptions that may no longer be accurate or relevant. In many respects, the dealer protections adopted by the state are based on decades-old perceptions about dealers’ economic vulnerability. Such assumptions fail to recognize important recent changes in the industry. As a result, Georgia’s regulatory policy creates benefits for dealers that are overly generous and places restraints on manufacturers that are overly harsh.
When the auto industry first developed, dealers were typically small, local enterprises that were perceived as particularly vulnerable to the market power of large manufacturers. Local dealers were concerned that manufacturers had the ability to disrupt their business through punitive control of inventories or the creation of new, competing dealerships. This vulnerability was a main impetus for the initial passage of motor vehicle franchise laws in Georgia and elsewhere.
Today, there are over 21,000 dealerships in the United States with average sales per dealership of over $30 million annually. As the auto industry has matured, the economic nature of dealerships has changed significantly. To begin with, there has been significant consolidation among dealers in recent years, with almost 20 percent fewer dealers today than in 1980. At the same time, smaller dealerships (those selling fewer than 150 units per year) are rapidly disappearing while the number of large volume dealers (750-plus vehicles per year) has almost doubled. One result of this consolidation is that the average dealership has evolved to become a very large business, with over 50 employees and an annual payroll of $2 million.
The success and growing scale of new car dealers has mirrored the exceptionally strong performance of the auto industry overall. In recent years, the sector as a whole has enjoyed unprecedented sales and revenue figures. Dealerships have posted record profit levels repeatedly in the last decade, most recently in 2001, with an average profit across all dealers – large and small – of more than $600,000. These statistics are not mentioned in order to disparage profit-making, but rather to help evaluate whether this industry should receive special economic protections based on dealers’ economic vulnerability.
Compared with other states, Georgia has a fairly typical retail auto industry. The state currently counts more than 600 new car dealerships. Average annual sales for Georgia dealers are roughly $35 million. This figure is just above the national average and somewhat higher than dealers in neighboring states.
Another significant change to consider is that most car dealers now represent more than one brand, with the average dealership holding at least three franchises.This reflects a key shift in the structure of the industry. A multi-brand dealer is inherently different from the historic, single-brand dealer because his economic investment is no longer dependent on an exclusive connection to one manufacturer. Indeed, a dealer’s ability to add or drop manufacturers, or to carry a portfolio of brands, has dramatically altered the traditional business arrangement between dealers and manufacturers. Federal regulators have noted that the presence of fewer single-brand dealerships “means that there is a great deal more competition at the manufacturer level to sign up particular dealers and establish a franchise relationship.” Other industry observers assert, “[T]here is little question that in today’s automotive market, more brands, more franchises, and more locations mean lower dealer risk.”
In general, the traditional image of local dealerships as economically vulnerable small businesses is no longer accurate. And as dealerships move towards larger-scale operations, their growing economic power affects other aspects of the marketplace. The modern dealership is not merely bigger, it is an entirely new type of enterprise. Today’s large dealers – with business interests across a wider territory, and increased opportunities to drop or change brands – have sufficient negotiating power to counter the threat of manufacturer abuse. These factors have created a new dynamic within the dealer-manufacturer relationship, and have shifted the balance of power more favorably towards auto dealers.
Manufacturers, for their part, have also experienced important changes. Today’s manufacturers face increased competitive pressures and a subsequent reduction in their market power, relative to earlier industry conditions. The most important development has been the impact of greater inter-brand competition, particularly from the introduction of foreign imports. Manufacturers have also had to accommodate such ongoing trends as decreasing consumer brand loyalty, demand for a wider range of models and better consumer access to vehicle pricing information. The net effect has been a narrower profit margin at the supplier level and increased pressure to streamline distribution costs.
Clearly, the economic environment for both auto dealers and car manufacturers has evolved significantly as the auto industry has matured. The net effect appears to be that manufacturers face greater competitive pressures, while dealers have largely benefited from industry changes. As a result, there has been a shift in the relative bargaining strength of each group. Auto dealerships are not the same kind of businesses they once were, and are no longer as vulnerable to manufacturers’ control. In some respects – for example, their ability to carry multiple brands – dealers may even be judged to have the upper hand over manufacturers.
In this context, auto franchise regulations that perpetuate strong dealer protections are no longer appropriate. There is good evidence that dealer protections are less necessary than when originally conceived. Thus, there is even less justification for the broad expansions such as those enacted by H.B. 356. The strong bias in favor of franchise dealers puts Georgia’s laws increasingly out of step with the widespread changes in the automotive industry as a whole. If special benefits are to be provided to auto dealers, they should be designed to more accurately reflect the realities of today’s marketplace rather than outdated historical assumptions.
Current auto franchise regulations in Georgia and other states are predicated on the assumption that the auto industry is sufficiently “special” in its operations that outside intervention in the industry is justified. However, it is not clear that this should be the case. Many industries use exclusive territories and distributorships to manage their retail sales, and do so without substantial state intervention. While there is no good parallel for the vast automotive retail market, it is useful to make some comparisons. Soft drink distribution, for example, shares a similar industry structure in that local distributors are territorially based, relatively small and often exclusively bound to the national supplier’s brand. Computer retailers handle technically complex products with similar after-market warranty and repair issues. In these and other cases, franchise distributors in a variety of industries successfully operate without the benefit of special regulatory protections.
To ensure a level playing field for the state’s consumers and other businesses, Georgia’s auto franchise regulations should be revisited and revised. Some regulatory protections for auto dealers may be appropriate. However, any interventions should provide clear benefits to the state’s economy and consumers, without placing undue burdens on the groups being restrained. Unfortunately, Georgia’s current laws are now overly protective of auto dealers, and insulate dealers from competition while obstructing other groups and innovation in the market.
With the passage of the 1999 legislation, Georgia joined a growing group of states that have been persuaded to expand the regulatory protections they provide to auto dealers. It is important to recognize that these state-level initiatives are part of a very recent trend that is closely linked to dealers’ concerns about new forms of competition. According to the Small Business Association, only two states had laws restricting new franchise licenses in 1970; today such rules exist in more than 40 states.
The fact that such initiatives have been successful in Georgia and elsewhere does not mean that they should not continue to be scrutinized. Since 1999, franchise dealers in the United States. have enjoyed record profits, increasing sales and accelerated consolidation. These results call into question the appropriateness of stronger dealer protections and suggest that the regulatory pendulum has swung too far in favor of franchise dealers. Indeed, other states have faced subsequent legal challenges to regulations similar to H.B. 356, and the Federal Trade Commission has recently sponsored a public workshop to examine the “anticompetitive” effects of such laws.
New forms of business always create challenges for existing participants. But regulatory protectionism for one group is both shortsighted and inefficient, because it creates entrenched biases in the system and stifles innovation. In this case, excessive franchise protections increase the costs of doing businesses for a range of groups, including new car buyers, owners seeking repair service, competing retailers and auto manufacturers. Ultimately, Georgia’s current regulations cause these groups to pay more than necessary to subsidize the guaranteed market share and reduced competition that franchise auto dealers have come to enjoy.
Georgia’s policymakers should take steps to correct the imbalance caused by the state’s current regulatory laws. The stronger provisions enacted in 1999 should be critically examined in light of the economic costs being imposed. Regulators should also take note of the overwhelming evidence that today’s dealers have less need than ever for protection from manufacturer abuse.
In addition to a general review of the state’s regulations, some specific changes should be considered:
Auto dealers have themselves disproved some of the key arguments in favor of H.B. 356. Since 1999, dealers across the country have quickly learned to mimic the technology interface and accessibility that online retailers introduced. Today, almost every dealer has an online presence and more than 6 percent of all dealer sales are conducted online.
On the one hand, this acceleration in dealer modernization is a good example of the benefits that can follow from exposure to competitive pressures. Dealers as well as consumers gain from investments in better technology and improved access to information. On the other hand, the fact that traditional dealers are trying to more closely resemble online retailers further underscores the arbitrary nature of the state’s new franchise laws. Dealers have responded to the threat of online competitors by adding their own Web-based services, while at the same time arguing for laws to preserve their monopoly over the actual transaction.
Given dealers’ own expanding use of online sales channels, regulatory prohibitions against alternative forms of car buying create an unfair and unjustified advantage for traditional franchise dealers. New entrants in the online market have the potential to generate significant benefits for consumers in terms of both pricing and transaction costs. To encourage these alternatives, state rules governing who can sell a new car to consumers should be revised to permit direct-to-consumer online sales, particularly since franchise dealers are themselves making good use of this channel.
Manufacturer Direct Sales
In the same respect, regulators should review the state’s laws with an eye towards the emergence of manufacturer-direct sales and build-to-order programs. Many industry observers see these programs as a foregone conclusion, and an important next step in the evolution of the retail auto industry. While auto dealers may have legitimate concerns about the effects of direct competition with their suppliers, consumers and other businesses have the potential to gain from this latest form of “disintermediation.”
State regulators should seek to anticipate – rather than obstruct – such wholesale changes in the economic environment. Protectionist laws that prohibit new forms of auto retailers, like those passed in 1999, create a less competitive marketplace and prevent the evolution of new business channels. If the state’s regulations continue to explicitly prohibit new forms of retailing, Georgia is essentially mandating the insertion of a middleman between the consumer and the auto manufacturer.
At this point, it is unclear whether manufacturers’ direct sales or any of the other emerging retail alternatives will supplement the traditional dealer, change his way of doing business, or replace the dealer entirely. But these are matters that should be left to the market to determine. Whenever possible, state regulations should be revised to permit and encourage such innovations, under the same level of scrutiny and enforcement that applies to traditional retail channels.
Relevant Market Area Rules
The state should reverse the 1999 change that elevated RMA considerations to a matter of state law. There is no evidence that the previous system – in which such issues were governed solely by the franchise agreement – was not effective. Where no compelling reason exists for the state’s intervention in free enterprise activities, all parties are best served by a minimalist regulatory approach.
In the event that state regulation of the RMA persists, the current limitations should be loosened. Georgia’s current eight-mile rule creates a regulatory standard that is stricter – and therefore more favorable towards dealers – than policies used by several other states. The state should also adopt a more sophisticated “tiered” set of criteria, so that the special needs of more populated markets can be appropriately differentiated.
By undertaking these and similar revisions, state regulators can increase competition and efficiency in the state’s retail auto market. These regulatory changes could reduce prices and improve service levels for consumers, regardless of whether they continue to use traditional dealers or online competitors. Such reforms would also help to promote continued innovation in the market and new channels for future auto sales. Most importantly, a more open regulatory policy would better balance the combined welfare of Georgia’s consumers, manufacturers and other retailers against the relatively narrow interests of traditional franchise dealers.
 2002 NADA Data Report.
 For example, manufacturer discounts are roughly 6 percent of a vehicle’s MSRP. By comparison, dealer discounts are typically much smaller (approximately 3 percent of MSRP). Source: Singleton, Solveig, “Will the Net Turn Car Dealers Into Dinosaurs?” Cato Institute (7/25/00) at p. 31.
 According to the National Automobile Dealers Association (NADA), sale of parts and services accounts for only 11 percent of the average dealership’s revenue, yet these activities generate 48 percent of the business’ operating profits. Source: 2002 NADA Data Report.
 For example, Georgia’s Motor Vehicle Franchise Practices Act begins with the statement, “The distribution and sale of motor vehicles within this state are vital to the general economy of this state and to the public welfare.” O.C.G.A. 10-1-621. With the exception of Alaska, every state has passed a comprehensive motor vehicle franchise law that singles out the automotive industry for specific state regulation.
 The franchise agreement stipulates how the dealership will be managed and certain details regarding dealer performance, such as annual sales quotas, revenue targets for repair services, etc.
 Smith, Richard L., “Franchise Regulation: An Economic Analysis of State Restrictions on Automobile Distribution,” Journal of Law & Economics, vol. XXV (4/82) at p. 131.
 O.C.G.A. 10-1-620 to 664.
 “Vehicle Dealership Bill’s Fate in Barnes’ Hands,”Atlanta Journal-Constitution (4/30/99).
 Ball, Jeffrey, “Auto Dealers, Fearing That Detroit Will Hog the Web, Fight Back,” Wall Street Journal (5/10/00) at p. A1.
 “Car Dealers Sell Senators on Their Pet Legislation,” Atlanta Journal-Constitution (3/23/99).
 Georgia H.B. 356 (1999).
 Georgia H.B. 415 (2000).
 Georgia H.B. 356 Section 11 subsection (c).
 O.C.G.A. 10-1-664.1 (c).
 “Atlanta Dealers Seek to Limit Factory-Owned Dealerships,” Milwaukee Journal Sentinel (2/26/99).
 Since 1999, CarsDirect.com has changed its business model and now either incorporates a dealer as the point of sale or refers consumers directly to a dealership. Source: www.CarsDirect.com
 Currently, direct sales to consumers by manufacturers and online auto retailers are prohibited in each of the 50 states. Source: Atkinson, Robert and Thomas Wilhelm, “The Best States for E-Commerce,”Progressive Policy Institute (3/02) at p. 19.
 Interestingly, Georgia’s law exempts small manufacturers with build-to-order programs that sell fewer than 150 vehicles per year. O.C.G.A. 10-1-664.1 (1) (7).
 See “Getting Into Gear: Car Companies Have Big Plans for E-Commerce,” Wall Street Journal (4/17/00). See also Greenberg, Paul, “Automakers to Test Web-Direct Sales in Canada,” E-Commerce Times (6/30/00).
 Atkinson, Robert D., “The Revenge of the Disintermediated: How the Middleman is Fighting E-Commerce and Hurting Consumers,” Progressive Policy Institute (1/30/01) at p. 1.
 Ibid at p. 2-4.
 The revised Georgia law does permit manufacturer interest in dealerships in some narrow circumstances, such as for a temporary period between a change in ownership, or in cases where no existing dealership is located within a 15-mile radius. In practice, these rules effectively prevent the introduction of new manufacturer-owned sales outlets and dramatically restrict the opportunities for manufacturer-control of existing dealerships. O.C.G.A. 10-1-664.1
 According to a 2001 J.D. Power and Associates study, 62 percent of all consumers shopping for a new car used the Internet in conjunction with their purchase. “Internet Usage Among New-Vehicle Buyers Continues to Increase,” J.D. Power and Associates Reports (11/26/01).
 Cooper, Mark, “A Roadblock on the Information Superhighway: Anticompetitive Restrictions on Automotive Markets,” Consumer Federation of America (2/01) at i.
 See Shaffer, Brian, “An Assessment of Franchise Laws and Internet Auto Sales,” NADA Public Affairs, (8/01) at p. 4.
 Keller, Maryann and Kenneth Elias, “Stuck in Reverse: Two Seasoned Veterans Tell Why Selling Cars Online Just Doesn’t Work,” Barron’s (12/11/00).
 Ibid. See also Katz, Diane and Henry Payne “Traffic Jam: Auto Dealers Use Government to Build Internet Roadblocks,” Reason (7/00) at 48.
 According to research from one industry observer, “75 percent of consumers prefer to visit a dealership before purchasing a new vehicle.” Source: Hyatt, David, “Franchise Laws in the Age of the Internet.” NADA Public Affairs (1/01). Given that only 6 percent of new cars are purchased online (source: J.D. Power & Assoc. 2001), it can be inferred that an even higher percentage of consumers continue to chose on-site purchases at a dealership.
 O.C.G.A. 10-1-622 paragraph 13.1.
 O.C.G.A. 10-1-664.
 For example, some of the criteria include the size of the investment the existing dealer has made, whether the existing dealer is in compliance with his franchise agreement, and whether the franchisor has made any attempts to coerce the existing dealer into consenting to the new dealership. O.C.G.A. 10-1-664.
 Currently, least 40 states have some form of territorial restrictions. (See Cooper, 2001, at p. 19).
 See New York State Vehicle and Traffic Law, Title 4, Article 17-A, Sec. 462-3, and Iowa State Code Chapter 322A.1.
 For an example of tiered RMA rules, see New Mexico’s statute, N.M.S.A. 57-16-13.Q.
 Smith at p. 150.
 Eckard, E. W., “The Effects of State Automobile Dealer Entry Regulation on New Car Prices,” Economic Inquiry, vol. XXIV (4/85) at p. 228.
 Smith at p. 136-141, 150.
 In addition to automobile sales, RMA considerations are commonly applied in other franchised retail settings such as fast-food restaurants, gas stations, oil-change service centers and others.
 For example, Eckard at p. 223 and Smith at p. 125.
 Rogers, Robert P., “The Effect of State Entry Regulation on Retail Automobile Markets,” Federal Trade Commission (1/86) at p. 8.
 Shaffer at p. 2-4.
 Smith at p. 150.
 Smith at p. 130-3.
 2002 NADA Data Report.
 Since 1982, the number of small volume dealers has dropped from 10,180 to 3,488 while the number of large volume dealers has grown from 3,160 to 6,518. Source: 2002NADA Data Report.
 2002 NADA Data Report.
 Ibid. See also the Georgia Auto Dealers Association, which represents “over 600 members.” http://www.gada.com
 2002 NADA Data Report.
 Across all U.S. dealers, the average sales revenue in 2001 was roughly $31 million. Average annual sales for dealers in Alabama,South Carolina and North Carolina were approximately $25 million or less. The figure for Tennessee dealers was $31 million. (Source: 2002 NADA Data Report)
 2002 NADA Data Report.
 From a speech by Thomas B. Leary, Commissioner, Federal Trade Commission, “State Auto Dealer Regulation: One Man’s Preliminary View,” to the International Franchise Association (5/8/01). Commissioner Leary is also a former executive with General Motors Corporation.
 Flynn, Michael S. et al, “The Economy, Competition and the Retail Auto Dealer,” University of Michigan Transportation Research Institute (2001) at p. 115.
 Muller, Joann, “Autos: A New Industry,” Business Week (7/15/02).
 “U.S. Auto Industry Under Siege,” Detroit Free Press Special Report (1/7/01).
 According to some estimates, distribution costs may account for as much as 25 percent of a car’s costs. (Ball, “Auto Dealers …” WSJ (5/10/00)).
 Jack Faucett Associates, “The Impact of E-Commerce on Auto Dealers,”U.S. Small Business Administration Research Report No. 212 (11/29/01) at p. 54.
 See, for example, Alliance of Auto Manufacturers v. Hull in Arizona and Ford Motor Company v. Texas Department of Transportation.
 “Possible Anticompetitive Efforts to Restrict Competition on the Internet,” a Public Workshop held by the Federal Trade Commission, Oct. 8–10, 2002, Washington,D.C. (http://www.ftc.gov/os/2002/07/ecomfrn.htm)
 Jack Faucett Associates at p. 41.
Morgan Smith is a freelance public policy analyst and an adjunct scholar with the Georgia Public Policy Foundation. The Foundation is an independent think tank that proposes practical, market-oriented approaches to public policy to improve the lives of Georgians. Nothing written here is to be construed as necessarily reflecting the views of the Georgia Public Policy Foundation or as an attempt to aid or hinder the passage of any bill before the U.S. Congress or the Georgia Legislature.
© Georgia Public Policy Foundation (April 11, 2003). Permission to reprint in whole or in part is hereby granted, provided the author and her affiliations are cited.
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