Why automakers sell through dealers

If you want to buy a new Ford, Chevrolet or Nissan in the United States, you almost always buy it from a local dealer. The dealer is usually a separate company from the automaker. That can seem like an extra step. Why not buy straight from the company that built the car? The answer comes from how the business is set up, and from the laws that protect that setup.

This article explains the franchise dealer model in plain terms. It is general education about how the auto retail industry works, which matters to anyone trying to understand dealerships as businesses.

The franchise agreement is the foundation

A franchised dealer sells new vehicles under a franchise agreement with an automaker or its authorized distributor. Economists describe the dealer as the franchisee and the automaker as the franchisor.

AutoNation, one of the largest dealer groups in the country, describes this in its annual report filed with the U.S. Securities and Exchange Commission. Each of its new vehicle stores operates under a franchise agreement that grants the right to sell the manufacturer's or distributor's brand within a specified market area. The same agreements set requirements for inventory, the sales process, branding and facilities.

Terms differ from one agreement to the next. AutoNation reports that some run for as short as one year and others have no expiration date.

What dealers do for the automaker

Selling cars to the public takes real money and real space. A dealer pays for the showroom, the service and body repair facilities, and the lots where vehicles are stored. The automaker does not carry those costs in every town it sells in.

Dealers also bring local relationships. A person who buys a car locally often returns to the same place for service, and the dealer is the face the customer knows. Economists describe the arrangement as one that can benefit both sides: the automaker relies on dealers to bear downstream costs and to use local ties to sell more vehicles.

What the automaker keeps control of

The dealer does not run the store with a free hand. According to AutoNation's report, manufacturers can set performance standards, and they can decline to renew a franchise for performance reasons such as sales volume and customer satisfaction. They influence store naming, digital channels and advertising, and they set minimum facility requirements. AutoNation also states that it relies exclusively on manufacturers for its new vehicle inventory.

So the relationship runs both ways. The dealer depends on the automaker for the product, and the automaker depends on the dealer to sell it and to meet its standards in the local market.

Wikipedia notes that this can create tension. Each side has made large investments that cannot easily be moved, and each can try to take advantage of the other. An automaker might push for low vehicle prices and low pay for service work, while a dealer with a strong local position might overcharge or provide poor service.

State law keeps the model in place

Franchise agreements are not only private contracts. State laws shape them. AutoNation's report says it is unlawful for a manufacturer to terminate or not renew a franchise unless good cause exists, and that it is generally difficult, outside of bankruptcy, for a manufacturer to do so. Manufacturers do keep the right to establish new franchises or relocate existing ones, subject to state franchise law.

Other rules go further. Wikipedia reports that by 2010 all 50 states and the District of Columbia had laws restricting direct sales from manufacturers to consumers. Franchise laws also limit termination of dealers, forbid forcing a dealer to buy vehicles it did not order, and often require the manufacturer to buy back inventory when a dealership ends.

The details differ by state, and the rules continue to be argued over. Economists describe these laws as raising costs for consumers and raising dealer profits. Anyone reading about the industry should know that the laws are debated.

Where dealers actually earn money

Many people assume a dealer earns most of its income from selling new cars. Wikipedia reports that in the United States, dealer profits come mainly from servicing, some from used cars, and little from new cars.

Wikipedia also notes that many dealers provide servicing, financing, insurance and parts alongside vehicle sales. For anyone studying the industry, that spread matters. A dealership is a retail store, a service shop and a finance office in one business.

Competitors and change

The model is not without pressure. AutoNation lists manufacturers that sell directly to customers, including electric vehicle makers, among its competitors. Outside the United States, Volvo has announced plans to sell all of its vehicles directly to customers by 2030, according to Wikipedia.

Within the United States, state law makes a quick shift away from dealers difficult, which is why Tesla's galleries are built around the rule that orders go through the website.

What to take from this

The franchise dealer model exists because it splits the cost and risk of selling cars between two kinds of companies, and because state law protects it. Dealers carry the facilities, the inventory and the local customer relationships. Automakers keep control through standards and agreements. The result is that a dealership is a business with several revenue lines, with its brand rights set by a franchise agreement.

This article is general information about how the auto retail industry works. It is not investment advice, and it is not an offer to sell securities.