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Tesla’s Business Model: Threat, or Free Market Triumph?

Cutting out dealerships—and their powerful lobby—is market-based innovation.

by
Tsvetelin Tsonevski

Bio

April 12, 2014 - 11:00 pm
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Over the past several weeks Tesla Motors has received a lot of publicity, though not for the quality of its cars or the rise of its stock price. Tesla has been in the news because of its unique business model: the company offers a completely new car-buying experience by selling their luxury cars directly through their website.

This direct method of reaching to consumers does not sit well with independent auto dealers, who see this as a threat to their business. Their fear is not that the high-priced electric cars will undercut their car sales, though it may for some dealers selling luxury vehicles; their fear is that this business model may inspire other automakers to do the same thing.

Under the current system, car making is separated from car selling. The reason for this separation is to eliminate the “monopoly power” of automakers. They can only sign franchise contracts with independent companies and authorize them to carry on their car sales. Contracts include a clause for exclusivity, which effectively bans the automaker from signing another franchisee within a certain radius.

It is believed that through this business model, the middleman provides the highest value to customers by offering a better price, and better customer and maintenance service. If the consumer is not happy, he or she still has the option to go to another auto dealer, even if further away.

In reality, a car dealer maintains a relatively small inventory — which limits the consumer choice. If a customer wants more customized options, the car dealer would have to place an order for the desired car to the automaker.

Tesla Motors operates differently. A customer goes online, and with several clicks he or she builds a car based on personal choice. Much like going to a grocery store, the price is set — there is no room for negotiations. The car gets delivered to the local shop, where a technician explains how to operate the vehicle to the new owner.

In essence, Tesla Motors is practicing vertical integration; the company combines car making with retailing. Antitrust laws look suspiciously on this practice — but antitrust laws look suspiciously when products are priced above, below, or even equal to production costs.

To detractors, vertical integration “forecloses” the market by eliminating competition at the retail level and allowing companies to charge “monopoly” price twice: once at production and once at retail. This is nonsense. In his book Antitrust Paradox, Robert Bork argues that vertical integrations are means of creating efficiency, not of injuring competition:

Vertical mergers may cut sales and distribution costs, facilitate the flow of information between levels of the industry (for example, marketing possibilities may be transmitted more effectively from retail to the manufacturing level, new product possibilities may be transmitted in the other direction, better inventory control may be attained, and better planning of production runs may be achieved), create economies of scale in management and so on.

In this battle with Tesla Motors, independent car dealers fear that if direct car sales are allowed, then other automakers may adopt the same strategy. This model has been tried and failed in the past, but internet commerce has opened new opportunities.

Car dealers want to put barriers before all car makers — not just Tesla Motors. They are determined to fight, claiming that they are needed because they provide consistent quality service, employ locals, and contribute to local economies. Of course, automakers would do the same if they decide to open their own stores.

While this may look like a battle between the small guys and the big corporations, this is not the case. It’s quite the opposite, actually.

Comments are closed.

All Comments   (20)
All Comments   (20)
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Much ado about nothing. Tesla is a flash in the pan.

At most, they will subsist as a novelty manufacturer of rich people's toys.


Electric cars solve no problems. They do relocate some, but at a huge cost.

15 weeks ago
15 weeks ago Link To Comment
Agreed.
15 weeks ago
15 weeks ago Link To Comment
Poor Tesla. He was a brilliant man but he lost the race with Edison although his name continues in "scientific" circles. Only the rich can afford the car named after him. I heard O"Reilly extolling its virtues...forgetting that the energy required to run it will be produced by coal burning plants. I am sick of hearing about energy! Now some washers must be "washed" to remove the stench...probably due to the dirt collected in the high performance machines. I know little about science but people believing this garbage must be really stupid....during the last energy crisis (in the Carter Administration) a cousin tried to convert me to exchanging my furnace to a wood burning stove..and something about pellets...like returning to another century. I refused and I have noted that idea rapidly faded. As I get older, with physical problems commensurate with my age, I want things made easier. I don't want the physical effort required to live in past centuries. For any of these "breakthroughs", I demand those instigating the changes DO IT THEMSELVES. No servants carrying in the wood or scrubbing the smelly washer, hand washing the clothes in the bath tub. IF you advocate it...proof that you do it yourself.
15 weeks ago
15 weeks ago Link To Comment
Gimme a break. Tesla is the exact OPPOSITE of a free market success story. They ONLY reason they're in the black, and not facing bankruptcy is because real car companies are FORCED by the CA government to pay freaking "carbon offsets" to Tesla. Tesla is the model of government cronyism - the pinko hippies in Sacramento are picking winners and losers.

http://www.marketplace.org/topics/sustainability/teslas-secret-success-selling-emissions-credits.

http://www.ibtimes.com/teslas-first-ever-profit-came-thanks-selling-zero-emission-credits-competitors-it-insists-its-not
15 weeks ago
15 weeks ago Link To Comment
Don't forget about the $12,500 taxpayers are footing for each Tesla sold in CA ($15k in WV).
http://www.examiner.com/article/the-truth-about-tesla

Even PJ Media is starting to take on a socialist slant. Is there no fiscally conservative news outlet left?
15 weeks ago
15 weeks ago Link To Comment
"Even PJ Media is starting to take on a socialist slant. Is there no fiscally conservative news outlet left?"
Don't be silly. The article is about selling to consumers, nothing more.
15 weeks ago
15 weeks ago Link To Comment
PJM is apparently run by "reformed" red diaper babies who inhabit the left coast. They're only conservative compared to the unrepentant marxists who surround them at every turn. They're not from Free America.
15 weeks ago
15 weeks ago Link To Comment
"PJM is apparently run by "reformed" red diaper babies who inhabit the left coast."
You are even sillier then the poster before you.
15 weeks ago
15 weeks ago Link To Comment
Apparently you don't know much about PJM's history.

15 weeks ago
15 weeks ago Link To Comment
Give us a break. Those carbon offsets are available to any car maker who qualifies, they are not crony capitalism. And they certainly won't be the source of their last profits.

The "family" sedan comes out, and they are going to clean up.
15 weeks ago
15 weeks ago Link To Comment
Expect Tesla to win. In the days when newspapers ruled, auto dealers ruled newspapers. Nobody reads newspapers anymore hence the auto dealers have lost their trump card in stopping this.
15 weeks ago
15 weeks ago Link To Comment
For them to win, they will have to have a marketable product. All they have is a novelty item, and the novelty will not carry them forever.

15 weeks ago
15 weeks ago Link To Comment

Never underestimate the power of the dark side.
15 weeks ago
15 weeks ago Link To Comment
In terms of cronyism, auto dealership will be a damn hard dragon to slay. The wealthiest people in most cities are the big car dealers. In San Antonio for example, one dealer is a billionaire, as well as being a notable philanthropist.

For the most part these are people who participated in a model they did not create and thrived, however, they may be expected to defend it relentlessly.
15 weeks ago
15 weeks ago Link To Comment
This brings to mind 2 like biz stories. 1) Currently that idiot old fossil Sheldon Adelson (owner of The Venetian Resort) is dead set against internet gaming, while a number of his competitors (Caesar's World & MGM International for example) are smartly jumping on this fast moving bandwagon. Adelson is "lobbying" his elected officials for "protection". 2) In the early 1990's, Dell Computer burst onto the scene with the radical concept of selling direct to consumers, thus bypassing the "established practice" of computer hardware manufacturers selling to Distributers, who in turn, sold to Resellers, who sold to the Consumer in what was referred to as "Channel Sales". Dell was successful & now "The Channel" is a shadow of it's former self existing only as "Value Added Resellers" in an exclusively "B 2 B" model. Even Apple, (once a Channel only champion) opened the "Apple Store" to sell direct. FACTOID: Adelson made his money by owning the once mighty COMDEX show. When be sold it to "SoftBank" he took the money & built the Venetian, as a gift to his wife...inspired by the Taj Mahal. Clearly, his ego knows no bounds!!
15 weeks ago
15 weeks ago Link To Comment
It looks like the auto dealerships are the bad guys here. So far, I'm still agnostic.

How about washers. Just order directly through Whirlpool and have sent to house. It does seem it would be cheaper.

Speaking of washers, I just can't figure out how they cost so much and live a shorter life than appliances of years past. I work on the Whrilpool dryer from 30 years ago and I could easily keep it working another 30.

With materials science, products should last a lot longer.
15 weeks ago
15 weeks ago Link To Comment
Washers are an evolving technology. Same with dryers. My mothers dryer from 40 years ago would be seen as injurious to clothing today, and washers are required to "wash" with less water, making them suck. The technology to improve these appliances advances and they get materially better every five years or so. This prompts upgrades. Manufacturers know what the life cycle of their products are and make them strong enough to survive beyond the point where the vast majority of people will either discard them, or use them far less as a secondary appliance. Why spend more to make a washer that lasts 30 years if everyone cycles their washers in seven? It's forcing the majority of consumers to pay the freight for the thrifty. Under these circumstances you reduce the price by building for 10.

Which is the long way of saying, they last exactly the duration the market told them to last. Guys like you and me who fix rather than buy or drive the wheels off cars (I quit using my 87 Nissan Truck in 2004 when it simply died past revival) are statistical outliers.
15 weeks ago
15 weeks ago Link To Comment
"I work on the Whrilpool dryer from 30 years ago and I could easily keep it working another 30."

But buy a new one, and rots a ruck getting it to last 1 year past the warranty. And also, with Whirlpool, rots a ruck getting them to honor the warranty.

Oh, that old one that has lasted 30 years? You won't get another 30 years out of it because there won't be parts available.

15 weeks ago
15 weeks ago Link To Comment
Yes, they should, but wouldn't that lead to lower profits?
15 weeks ago
15 weeks ago Link To Comment
It would lead to higher prices as people would be buying overbuilt appliances and throwing them away to obtain new features after only a third of their operational life.
15 weeks ago
15 weeks ago Link To Comment
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