Auto Distribution: Current Issues and Future Trends Federal Trade Commission Workshop

Dear Commissioners: 

The Federal Trade Commission's (FTC's) workshop examining the effects of state regulations on competition in motor vehicle distribution is timely and relevant. As deputy director of the FTC's Office of Policy Planning, I helped plan the FTC's 2002 workshop on anticompetitive barriers to electronic commerce, which included a panel on automobile distribution that examined some of the same state regulations the FTC is considering in the current workshop.¹ A great deal of the FTC staff's research was subsequently published in the Journal of Law, Economics & Policy.² More recently, a colleague at the Mercatus Center at George Mason University and I published a short research summary, attached to this letter, that revisited the state regulatory issues.³ In brief, we found that state regulation of automobile distribution continues to protect established dealers at the expense of consumers by preventing manufacturers from experimenting with new distribution models. 

Virtually all states require auto manufacturers to sell new vehicles through local franchised dealers, protect dealers from competition in Relevant Market Areas, and terminate franchises with existing dealers only after proving they have a “good cause” to do so. In 1979, fewer than half of all states regulated all three of these aspects of the manufacturer-dealer relationship. By 2014, all but one state regulated every single one of these aspects. These state laws harm consumers by insulating dealers from competition and forestalling experimentation with new business models for auto retailing in the twenty-first century. 

The state-mandated restrictions in new car markets are part of a larger class of business arrangements between producers and retailers known as “vertical restraints.” Economic research finds that voluntarily adopted vertical restraints often benefit consumers, but state-mandated vertical restraints virtually always harm consumers. 

New competitors, such as Tesla Motors, seek to sell motor vehicles directly to the public instead of establishing franchised dealer networks. The FTC’s workshop announcement also raises the possibility that new developments, such as vehicle sharing and connected vehicles, could alter incentives for vehicle ownership in ways that might spur changes in existing distribution arrangements. Disruptive, dynamic competition can sometimes allow firms to overcome entry barriers that would otherwise protect incumbent firms, since dynamic competitors by their very nature possess cost or quality advantages. However, the one type of entry barrier that dynamic competition cannot easily overcome is a government-imposed mandate. When regulation prohibits entry or raises rivals’ costs, superior efficiency alone does not allow a new competitor to enter a market. This point is explained in greater detail in my recent submission to the EU Internal Market Subcommittee of the House of Lords’ Select Committee on the European Union, which is also attached.⁴  

A pro-consumer policy would make franchising, exclusive territories, and termination protections voluntary rather than mandatory. Under voluntary contracting, these business practices could still survive when their benefits to consumers exceed the costs. 

I do not claim to know the optimal way of organizing auto distribution and retailing for the industry as a whole or any individual automaker. The auto dealers’ trade association argues strenuously that the current system of franchised dealers will always out-compete a system of manufacturer-owned dealerships. If this is true, the current franchise system should not need the legal protection it enjoys in every state. 

Please let me know if I can furnish additional information or otherwise be of help to the commission or its staff. 

Sincerely,  

Jerry Ellig 
Senior Research Fellow 

Attachments: 
Jerry Ellig and Jesse Martinez, “State Franchise Law Carjacks Car Buyers.” 
Jerry Ellig, “Dynamic Competition, Online Platforms, and Regulatory Policy.”