American University Kogod School of Business Tesla’s Direct-To-Consumer Sales Model: A Perfect Fit? Margaret Moore University Honors Program Capstone Professor Parthiban David Spring 2014 Moore 1 Abstract In the United States, the ubiquitous method by which automotive companies sell cars and light trucks to consumers is via a franchise sales model. Recently, Tesla Motors bucked this trend by offering its electric-powered automobiles through manufacturer- owned retail stores, which elicited a substantial amount of legal pushback from some states. This study investigates Tesla Motors’ business model through the framework of a situational analysis to better understand the maverick. The report facet of the capstone seeks to determine and explain that while Tesla is currently best suited to engage in a direct-to-consumer sales model, as the company reaches the middle market and establishes a strong consumer following it would do best to transition to a more traditional franchise sales model. Moore 2 I. Introduction Tesla Motors is well known for a variety of reasons, ranging from its luxury electric automobiles to its founder and CEO, Elon Musk. While these famous attributes of the company to most people frame their perception of Tesla positively, the recent press surrounding Tesla’s legal battles regarding their direct-to-consumer sales model has been explosive. With states blocking the sale of Tesla automobiles within its borders, Tesla needs to find a way to operate and successfully ensure that consumers can easily purchase a Tesla automobile should they desire to do so. This paper seeks to answer whether Tesla Motors is right to engage in a direct-to-consumer sales model in the United States, and if so, should the automobile manufacturer continue engaging in the aforementioned sales model in the future or instead transition to the traditional franchise sales model? This report seeks to answer this research question by first looking at the current automotive sales environment in the United States. Next, the history of direct-to consumer sales models in the United States is highlighted, touching upon Ford’s attempt through the Ford Retail Network to sell directly to consumers as well as Fisker Automotive’s failure in this space when using a franchise model. To determine why these companies did not find the direct-to-consumer sales model successful and why Tesla is facing opposition, the current legal landscape that protects the franchise model is evaluated. After, the benefits of the direct-to-consumer sales model are examined in an effort to convey why Tesla seeks to defend its current sales practices. Then the benefits of the franchise model are evaluated to identify if this model would benefit Tesla now or in the future. Finally strategic recommendations are made before the conclusion of the report. Moore 3 II. Current Automotive Sales Environment In 2012, the United States had 17,635 new-car franchised dealerships, up 95 franchised dealerships from the year prior (NADA). As can be seen in Figure 1, this number has declined over the decades. The number of new cars being sold by each automotive dealer has declined, on average, in recent years, even amidst the decline in the total number of dealerships (Figure 2). Any automobiles sold directly from the manufacturer, such as in Tesla’s sales model, would not be factored into this analysis; however, after extensive research, Tesla appears to be the only well-publicized automobile manufacturer engaging in direct sales in the United States in April 2014. Figure 1 Number'of'Automotive'Dealerships'in'the'US' 60,000" 50,000" 40,000" 30,000" 20,000" 10,000" Number'of'Franchised'New3Car'Dealerships' 0" 1947" 1949" 1951" 1953" 1955" 1957" 1959" 1961" 1963" 1965" 1967" 1969" 1971" 1973" 1975" 1977" 1979" 1981" 1983" 1985" 1987" 1989" 1991" 1993" 1995" 1997" 1999" 2001" 2003" 2005" 2007" 2009" 2011" Source:'NADA'Industry'Analysis' Moore 4 Figure 2 Important to note are the expenses incurred by new-car dealerships, as these are expenses that Tesla Motors must incur when they establish and run their direct-to- consumer sales operation. New-car dealerships in the United States had an average annual payroll of $2.9 million, with the total payroll totaling $51.6 billion (NADA). The new-car dealerships held substantial inventory in 2012 as compared to recent years, totaling almost 3.8 million vehicles (Figure 3). Tesla would be able to avoid holding much of the inventory that dealerships are required to hold, as Tesla employs a just-in- time manufacturing model. This manufacturing model for Tesla means that the company only produces vehicles after consumers have already purchased them, requiring virtually no inventory. Now that the current automotive sales environment has been explored, Moore 5 automotive manufacturers’ attempts to engage in direct-to-consumer sales are next discussed. Figure 3 III. History of Direct-To-Consumer Sales Model Tesla is not the first company to attempt to use a vertically integrated direct sales model to sell to consumers. From 1997 until 2002 Ford implemented the Ford Retail Network, in which the automotive manufacturer sold vehicles directly to consumers by acquiring dealerships in Salt Lake City; Oklahoma City and Tulsa, Oklahoma; San Moore 6 Diego; and Rochester, New York (Klayman). Ford said they wanted to engage in the retail business to learn more about it and potentially make the sale of their vehicles more efficient (Box). Also, Ford wanted to block the larger automotive dealer networks from further growing in size and obtaining too much leverage over the franchisor (Box). Ford’s dealers, however, despised Ford’s approach and were concerned that Ford may favor their factory-owned stores over their dealer-owned counterparts (Box). By September 1999, the results were reported by CNW Marketing Research to be disappointing (Mobile Register). Art Spinella, an analyst of the marketing research firm, reported that, “There has never been an auto dealership owned by the factory that has ever made a dime,” because automakers do not know how to sell cars (Mobile Register). These poor results led the automaker in 1999 to begin to slow down the pace at which it consolidated regional markets (Klayman). By 2000, many states established laws that barred automobile manufacturers in response to Ford’s experiment (Harris). In 2002 Ford ultimately had to give up on the Ford Retail Network (Klayman). However, more Ford incurred more costs with their experiment than the $200 million financial toll of selling their retail stores (Bloomberg). The company lost an enormous amount of goodwill with regards to its dealers (Harris). General Motors has attempted in the past to engage in direct-to-consumer sales buy running its own dealerships through its independent subsidiary, General Motors Retail Holdings (Associated Press). When GM publicized the plan in 1999, the company projected that General Motors Retail holdings would purchase or partner with dealerships in their largest US markets, with the goal of controlling 5-10 percent (or up to 800) of GM’s dealerships in 10 years (Mobile Register). General Motors, like Ford, claimed to Moore 7 engage in the direct-to-consumer sales model, “…(to) improve market performance where we lag, enhance our revenues, understand our customers better and look for ways to reduce distribution costs and improve the customer’s buying experience,” according to Roy Roberts, group VP of GM North American Vehicle Sales, Service, and Marketing (Beran). General Motors ultimately eliminated General Motors Retail Holdings after facing legal barriers to widespread implementation (Hyde). Interesting to note, however, was that unlike its other Big 3 counterparts, Chrysler never attempted to branch into direct-to-consumer sales. Chrysler’s president at the time when Ford and GM started their forays into retail stores, James P. Holden, called the direct-to-consumer sales model one of “those fad diets” and expressed his confidence in private dealers (PRNewswire). Next, another electric vehicle (EV) manufacturer is assessed, one that engages in a franchise model. IV. Evaluation of EV Manufacturer Using Franchise Sales Model In terms of smaller automobile manufacturers who only make electrically powered automobiles, some of their failures may be attributed to unsold inventory, or not properly exploiting the benefits of the direct-to-consumer sales model rather than their demise being caused by using the aforementioned model in the first place. At Fisker Automotive for instance, battery issues coupled with unsold automobiles are the factors attributed to Fisker applying for Chapter 11 bankruptcy on November 23, 2013 (Keane). These unsold automobiles are a result of the large inventory levels required when employing the franchise sales model. Thus, once a wider consumer base exists for electric automobiles and the general public accepts the safety and reliability of said Moore 8 vehicles, then economies of scale can be employed as opposed to the conservative practice of engaging in just-in-time manufacturing because the risks to Tesla of becoming the next Fisker Automotive drastically subside. Next, the legal landscape surrounding the direct-to-consumer sales model is explored. V. Legal Landscape of Direct-to-Consumer Sales Model Since Tesla’s inception, the company has been required to defend its direct-to- consumer sales model. As seen in Figure 4, Tesla Motors has faced direct opposition from Arizona, New Jersey, Maryland, Virginia, and Texas under the guise of protecting consumers. In those states, Tesla Motors cannot sell or discuss their pricing and terms with potential customers in their retail showrooms (Farnham). Instead, interested customers have to purchase their Tesla automobiles out of state, which is incredibly burdensome (Wilhelm). Tesla is seeing some success in states such as Ohio, where they were granted the right to directly sell their automobiles to consumers so long as each retail location has a state-issued license (Kaiser).