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Why Chrysler is Closing Dealers

May 15, 2009, 9:24 am

I had a question the other day:  Why is closing dealerships a cost savings for Chrysler?  My understanding is that dealers were independently-owned businesses that bought inventory from the manufacturer, and then sold and serviced the cars.

I came up with only two answers:

  1. Auto makers finance dealer inventory in some way (either as financing or putting the inventory on consignment) such that cutting back on dealers cuts back on financing needs.  Yes, with fewer dealers, the others are likely to need more inventory, but basic inventory theory says the total in the system will still be less with fewer outlets.  Also, they might preferentially cut weaker dealers more likely to need financing in favor of larger dealers who can self-finance
  2. Having too many dealers competing against each other with the same product undermines pricing in the market.  Dealers cut pricing to the bone in order to get the servicing income stream after the sale.  While this should not directly affect the pricing to the manufacturer, it might be argued that retail discounting is a negative for the brand over time  (electronics manufacturers have debated this point for years, and there is certainly no consensus on this).

Megan McArdle provides her own answers to this question, some similar and some different:

A number of readers have asked a simple, obvious question:  why do the dealers cost Chrysler so much money that they want to shut them down?  I don't have a complete answer to it, but here's what I understand:

  • Inventory:  Chrysler often has to take back unsold inventory.  A lot of dealers selling a little inventory is costly, because you have to ship a minimum number of cars to each dealer
  • Financing:  Chrysler helps many dealers float their purchases (though to be fair, those dealers also tap their own credit for things like advertising, expanding the company's effective spending)
  • Brand costs:  Shabby, run-down dealerships don't improve the image of the firm, and if they are the only game in town, drive users to other cars.

She follows with a good analysis of why independent dealers exist in the first place.

It will be interesting to see how this goes down.  Frequent readers will know that I often have said that the power base of many small-medium size towns is made up of 1) the auto dealers, 2) the beverage wholesalers and 3) the owners of the local TV stations and newspapers.  Auto dealers wield a lot of local political power - they are often the largest single financial supporter of local politicians and even some Congressional reps.  They also wield power as typically the largest single advertiser in local media, so they get sympathetic coverage.  Over the years, they have translated this into a lot of legislative help (such as limitations on Internet competition).

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Category: General Business
  • Ian Random

    According to my dad, the dealerships weren't powerful enough in my old home town. The city wouldn't let them expand, so they went over the hill to San Jose. I visited a few years back and seem to remember that downtown was dominated by thrift shops.

  • Jess

    Well, it's not the number of dealers per se, rather, the number of low volume dealers that is the issue.
    Dealers don't actually buy the goods (autos & parts), and rarely own outright other "factory" materials (specialized tools & equipment) - everything runs on a type of credit called "floorplan", in which the dealer pays a %/month until the goods are sold, and then the funds are transferred from the finance arm to the factory (ok, that's a very incomplete description, but this isn't my blog).

    It's inventory that chews up a great deal of $. I could go into detail (again, not my blog), so I'll just point out that it's far cheaper to do business w/one point in a market than say, 1/2 dozen. Megan is on the right track, but the answer is even more complex...

    J

  • http://blog.jackalopepursuivant.com/ Dan

    "...the power base of many small-medium size towns is made up of 1) the auto dealers, 2) the beverage wholesalers and 3) the owners of the local TV stations and newspapers"

    A very astute observation. I think you're dead-on, Warren. I couldn't figure out why none of the restaurants in Astoria, Oregon served Coke until I learned that the mayor also owns the Pepsi distributorship.

    Should we expect a shift in small-town governance, due to the current decline of domestic auto dealerships and newspapers? There's a question with long-term political significance...

  • beck

    Just food for thought: Dealership loses franchise (Chrysler) but still has other franchises. Here is what will happen. 1. Office and Accounting staff is either cut or takes a salary cut. 2. Fixed operations (Parts & Service) Must cut techs, car cleaners, porters and parts drivers. 3. Service and Parts advisors take a cut in thier commisions and/or salary.
    Now Here is the outcome:
    1. The gas station across from dealership just lost 20% of his business (all those new cars get full tanks), so he lays off an attendent.
    2. The local resturants see less patrons because of the salary cuts and they don’t hire any new wait staff.
    3. That trip to Disney that one of the Service Advisors planed on is cancelled. Now disney has to do a hire freeze.
    4. The new house that the Parts Mgr just bought, well he has to go into forclosure. Now your house 2 doors down is worth much less.
    Can you see where I’m going with this?
    Even if you are not in the auto industury, you will be affected

  • http://e-gad-fly.blogspot.cpm/ gadfly

    Having done some accounting work for a small-town Jeep dealer, I can attest that Chrysler does not provide floor-plan financing to its dealers. The dealers contract with local banks to finance the inventory. Therefore Chrysler is being paid immediately for shipments. Further, Chrysler limits "free floor-planning" to a specific time period, let us use 90 days. This means that Chrysler reimburses up to three month's of interest charges or x% of the "dealer's cost." All business majors recognize that this cost is supposed to be built into the manufacturer's wholesale selling price.

    Dealers also build there own buildings, buy there own equipment and pay wholesale for parts when shipped. The business belongs to them, for good times and bad. If sales fall too far, capitalism will rid us of the weak dealers. Neither the car company nor Obama and his Car Czar need interfere.

    As a business owners would you rather have 10 salesmen or 199,000 if we assume rightfully that the selling cost per unit is the same? It is indeed obvious that non-business oriented Obamaphobes are making life or death business decisions. Where is the bankruptcy judge in all this?

  • Tom

    Given that the O administration is involved, has anyone done an analysis of the racial/political profiles of disenfranchised dealers?

    There was a dealer interviewed on a talk show here who was positively stunned that he was being closed down given his performance and recent investments in the dealership. I wonder if maybe there aren't some "affirmative action" cases that have kept low performing dealerships open while stronger ones are closed. When business decisions are politicized, these issues come up.

  • Allen

    Does anyone have more details on what sort of state and federal laws may have been involved in all of these dealerships being open? I've heard it elluded to in the news but nothing concrete. Technically the comments I've heard could be nothing more than laws that enforce contracts between the dealers and Chrysler. But I'd suspect there's something more.

  • markm

    Allen: As I understand it, most states have laws forbidding the manufacturers from selling cars directly. There are reasons for that, but they aren't strong ones:

    1) Dealers provide warranty and non-warranty repair services. But manufacturers could just as easily contract with local garages to provide these services without having a sales force attached, or they could just re-imburse you for warranty service at the garage of your choice - and at the price dealer garages often charge, I suspect it's the service department subsidizing the sales, rather than the other way around.

    2) "Dealer prep" of the new car. That is, you can find the car you want right on the lot, but they want a couple more days with it before you can drive it away, and they charge for whatever they're doing. Surely the car companies could ship the cars out with ready to drive away?

    3) I think you'd be nuts to buy a car by internet without a test drive. How my butt feels in the seat is as important as a ream of specifications. But dealers don't do a good job of meeting that need. They'll have 15 cars on the lot in different colors but otherwise identical, and none with the manual tranny I'm going to order. And they'll have sales people talk your ear off for an hour when all you want is to get in THAT ONE right there and take it around the block.

  • http://www.gazzersgabfest.com Gazzer

    I think another aspect is that when you have too many dealers it drives down the price as the dealers have to compete with each other, as well as other manufacturers. If memory serves, back when the top selling cars was either a Taurus or the Accord, the Rord dealer network was 4 times the size of that of Honda. The dealership model of 1000s of cars on a 10 acre lot with all the attendant infrastructure and employees is surely out-moded in this day and age.

  • Noumenon

    I think I am a longtime reader and I have never heard this theory about "the power base of many small-medium size towns is made up of 1) the auto dealers, 2) the beverage wholesalers and 3) the owners of the local TV stations and newspapers" before. Would you mind linking to a post about the beverage wholesalers, and maybe explaining why owners of a nice industrial foundry or plastics factory wouldn't be in the top three? My town is pop. 10,000, so this is interesting to me.

  • spiro

    Noumenon,

    I haven't read the original "power base" article either, but I agree with the premise completely.
    The reason why the beverage wholesaler has power is similar to the car dealerships - Branding. Nobody (outside the geekery) knows who manufactures the containers their consumables come in, but everybody knows Coca-Cola and Ford. Plus, every restaurant, convenience store, campus, hotel, etc...needs to be supplied with soft drinks. so as the beverage czar, you have a presence in a large chunk of the local economy.
    This is REALLY noticeable on state-funded college campuses -- where beverage suppliers contract with the school to sell their brand exclusively. When I was there (4 years ago) you couldn't find a Coke product on the campus of the University of Arizona. Everywhere on campus it was Pepsi products, vending machines, cafeterias, sports venues, even in the medical center.

  • John

    I live in a small town, where the dealership is closing down. The closest dealership, is now 110 miles away. We always bought from this dearship, so we could get local service. Now I will be looking at imported cars, as I can be as close as the big three dealerships.
    And if this is how they treat the people selling their products. I acan not believe that they will treat the customers any better than the low support we are gettin now.
    Is this just another grasp for give away money?

  • marco

    Tom,
    Another website, "the truth about cars", posted a PDF list of all the affected Chrysler dealers. It is an address list with a lot of D/B/A and legal but not physical addresses of many of the dealerships. But the very first name on the list, Vern Buchanan, is a Republican congressman from the Sarasota area of Florida. Just sayin'

  • Tim

    Chrysler provides floorplan via Cerberus's finance arm -- GMAC; but the dealership can also obtain their own line of credit. Dealers may buy their own equipment; but OEMs provide at least some equipment to their dealer's service departments.

    Your second point is on, too -- the competition among dealers drives down the transaction price, which is the final out the door pricing.

    One other thing that wasn't mentioned is that the more dealers in the network; the number of vehicles that need to be built to fill the floorplan. GM and Ford, which are also cutting their dealer network; try to match factory output to orders -- but a lot of vehicles are ordered to fill floorplan. Having a lot of dealers means that the manufacturer is building a lot of stock to fill dealer lots. This contributes to days supply; and the days supply of built cars can only really be shrunk by offering discounts. Ideally, you want ~60-90 days in the middle of a model year; but you want it shrunk to 0 before a model year changeover.

    Having fewer dealers, and less unsold inventory in the overall dealer chain; makes the manufacturing-to-buyer channel less elastic. This allows for more accurate production planning. It costs money to run overtime to make up for demand greater than planned output; and it costs money to be idle when output is greater than demand. A less elastic retail channel allows for more accurate forecasting, cutting costs. This is one way where the domestic manufacturers got into trouble. A long time ago, they used to build based on forecast -- without adjusting to orders. This was called the 'sales bank'; and these vehicles were pushed to dealers with steep discounts, which were passed on to buyers. The justification was that it was cheaper to sell them at lower transaction costs than pay extra to idle the plant. This lowered transaction cost hurt the resale value of the vehicle, and diluted the brand. GM and Ford ended this practice a long time ago; but even as late as 2007; Chrysler was still building a sales bank.

  • DrTorch

    Another possibility in why some dealerships are closing

    http://directorblue.blogspot.com/2009/05/red-alert-did-campaign-contributions.html

  • Hal

    My uncle owns 2 dealerships that have been profitable since 1956. He has been a 5 star dealership. it doesn't make any sense to fire your sales crew when you need sales!

  • Mr. Natural

    Followed DrTorch's link. His thesus about the reverse racism in this Chrysler think is both unbelievable and unsustainable. True, it IS a sad day in America, but the truth of the matter is that Chrysler has been making JUNK for many many years, AND flooding the market with it. The auto manufacturers, like so many others, have been working with a very flawed business plan. The workers didn't do it, and the dealers didn't do it, but, of course, they are the ones to suffer. It has always been thus.