The introduction of Tesla’s Model 3 has rekindled the debate about whether the company will succeed in executing Elon Musk’s master plan to disrupt the auto industry and change the world.
Brent Goldfarb argues in Vox that Tesla is overhyped and overvalued. Goldfarb notes that in every area in which Tesla is operating – electric vehicles, connected vehicles, autonomous vehicles, batteries – there are numerous other competitors, including firms with vastly more resources and comparable technology. Broken down into its constituent pieces, Tesla isn’t really doing much that is truly out of the box, and certainly not enough to justify its sky-high valuation.
But what Goldfarb misses – as do most other analyses of Tesla that focus on technology – is that the place where Tesla is likely to wreak the most disruptive havoc isn’t with automobile manufacturers, but with automobile dealers.
It’s a strange oversight, given the experience of another company inspired by Elon Musk, SolarCity, which helped popularize solar power through an innovative business model based on no-money-down solar leases. Founded by two of Musk’s cousins based on a concept he developed, SolarCity didn’t attain prominence by making solar power better; it did so by making putting solar panels on your house easy.
It’s also strange since Musk has had the traditional franchised dealer model in his sights from Day One, insisting on selling his vehicles directly to the consumer.
Musk’s challenge to the automobile dealership model is profound and has far-reaching implications – both economic and environmental. To understand why, one first needs to understand the role dealers play in car sales and the motivations they face.
How Car Dealers Make Money
If you have ever purchased a new car in the United States, it is almost certain that you bought it at an independently owned, franchised auto dealer. In much of the country, you wouldn’t have had any other choice – nearly every state has laws on the books that constrain or even outright ban auto manufacturers from selling vehicles directly to consumers.
Auto dealers face economic motivations that have historically been aligned with, but are fundamentally different from, those of car manufacturers. If there is one thing you remember from this blog post, it should be this: Car dealers do not make most of their money selling new cars. The profit centers for new car dealers are: financing, high-margin add-on products (service plans, alarm systems, etc.), used car sales, and – most of all – parts and service. According to the National Auto Dealers Association, cited in a 2013 story from Edmunds.com, parts and service provide 44 percent of dealer profits, with financing and service contracts accounting for another 37 percent.
Selling a new car, therefore, is mainly an opportunity for dealers to sell other products and services that are profitable, and to enter into a long-term service relationship with a customer that keeps the service bays humming. “Moving metal” – generating sales volume – becomes ever more important to securing those revenue streams.
Electric and connected vehicles undercut the traditional auto dealer business model in several ways. First, electric vehicles require less maintenance than gasoline-powered vehicles. No oil changes. No tune-ups. No exhaust systems. Whatever chance a car dealer has of engaging a consumer in a lucrative ongoing service relationship is likely reduced every time they get a customer to sign on the bottom line to buy an EV.
Second, connected vehicles create new opportunities to sell add-on products after the initial sale – without visiting a dealer. Tesla’s “autopilot” feature, for example, can be unlocked after sale if consumers pay an additional fee. Tesla has also pioneered over-the-air updates that improve the functionality of the vehicle. It is not hard to imagine a near future in which the main way that consumers are “upsold” on additional capabilities is not at the dealership at the initial point of sale, but rather through continuing marketing pitches over the lifetime of the vehicle.
Tesla has another potential ace up its sleeve in the long run in that it stands to profit not just from selling a consumer a car or a software upgrade, but also from selling solar panels and batteries to provide a complete home energy solution. Tesla’s technology in those areas may or may not be unique, but its ability to extend the customer relationship from a car to these other products is. It is also another area of business from which most traditional car dealers will be shut out – who is ever going to go to their local Buick dealer for solar panels?
A Constituency for the Status Quo
It is no surprise, then, that, with a few exceptions, dealers tend not to be all that excited about electric vehicles. Moving lots of cars out the door fast does not lend itself to spending time to educate consumers about a new and exotic type of vehicle they may never have driven before – especially when that car is unlikely to come into the shop very often for service in the years to come. (A 2016 report by the Sierra Club documented the absurd hurdles faced by many would-be EV buyers in dealerships.)
It is also no surprise that auto dealers have been among the most vociferous and effective opponents of higher fuel economy standards and rules such as those in California and a number of other states that require the sale of a certain percentage of electric and other high-tech cars. During the 2000s, when we at Frontier Group were documenting the benefits of the Clean Cars Program, auto dealers were generally among the biggest obstacles to its adoption in the states. Because there are auto dealers in every community – sponsoring Little League teams and community events, taking part in the Chamber of Commerce, supporting local elected officials – they carry an unusual amount of political clout.
Lastly, it should also be no surprise that an entrepreneur of Musk’s savvy would recognize all these tensions early on and seek to go around the traditional dealership model. Tesla only sells cars directly to consumers, showcasing them in retail “stores” and “galleries” in places like shopping malls. The company is in the midst of a legal war with auto dealers in a number of states (and in the federal courts) to secure the ability to sell cars directly to consumers. As the Union of Concerned Scientists’ Daniel Gatti lays out in this excellent overview of the situation, you cannot buy a Tesla in Connecticut … or Michigan, or Texas, or Utah, and opportunities to do so in other states are limited.
Analysts who see the challenge posed by Tesla as strictly about technology – and not about warring business models – miss the fact that dealership model is, in many ways, an albatross that keeps conventional automakers from innovating in the electric and connected vehicle space with the speed, vigor and agility of their far smaller and unencumbered competitor. Automakers may be able to develop technology every bit as good as Tesla’s, but their ability to sell that technology to consumers with gusto is constrained in a way that Tesla’s is not.
Here's The Twist
The temptation is strong, given the history of resistance by legacy automakers and dealers to measures that reduce the environmental and public health impacts of cars, to engage in a bit of schadenfreude at the difficult spot in which the auto industry currently finds itself. But I think that is a mistake.
The automobile manufacturer/franchised dealer system has proven to be a remarkably effective and resilient system for putting lots of cars in lots of people’s hands very quickly. If you see electric vehicles as a necessary (but by no means sufficient) part of a strategy to eliminate transportation carbon pollution, auto dealers and legacy manufacturers are people you really want to have on your side. Moreover, Tesla's ability to actually deliver on the promise of the Model 3 is still very much in question.
The strategic dilemma is not much different from that facing electric utilities in relation to distributed solar power. Utilities that lobby states to clamp down on distributed solar may win the battle by preserving a revenue stream in the short run, but risk losing the war by positioning themselves for mass defections from the grid as solar power, energy storage and microgrids become cheaper and better developed. Advocates for clean energy often oppose utilities’ efforts to limit solar power, but they also generally recognize that the transition to a clean energy future will be far easier, cheaper and more efficient if the strengths that utilities bring to the table can be harnessed, rather than tossed aside.
There is simply no way to appreciate the challenge Tesla poses to the auto industry without understanding how cars currently get into the hands of consumers – and how electric and connected vehicles in general and Tesla’s in particular propose to change that. Tesla’s success is vital to the rapid electrification of the vehicle fleet. So too, though, is the ability of automakers and dealers to resolve the strategic tensions that hamper their ability to champion electric vehicles … before it’s too late.
 EVs will, of course, require tires and body work, and likely some maintenance of electrical systems and mechanical elements, but eliminating complex and fickle internal combustion engines removes a lot of headaches.