Russ Roberts

Munger on Franchising, Vertical Integration, and the Auto Industry

EconTalk Episode with Mike Munger
Hosted by Russ Roberts
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Michael Munger, of Duke University, talks with EconTalk host Russ Roberts about franchising, particularly car dealerships. Munger highlights how the dealers used state regulations to protect their profits and how bankruptcy appears to be unraveling that strategy. The main themes of the conversation are the incentives in the franchising relationship and the evolution of the auto industry in the United States over the last forty years.

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0:36Intro. [Recording date: June 5, 2009.] Strange world of franchising and dealerships, retailing. Chrysler and GM are closing down a lot of dealerships. Apple has an Apple store; but GM cars are sold through a privately owned dealerships--franchising. Why does it exist? People speculated that capital markets were imperfect when autos first started to be sold; during the 1930s, hard to raise money. Selling franchises that had a particular type of car would pay for that privilege, raising money for the company. By "raise capital," which player? Argument was that in addition to selling stock and bonds, General Motors could raise money to invest in larger plants by having a guaranteed place where it could sell its cars. Makes lender more comfortable? No, the franchise fee. Local dealers could borrow locally for their franchises. Plausible story, but not true. Why would we continue to do that when well-capitalized.
4:20Franchisees tended to be pretty wealthy people, chambers of commerce; got laws passed prohibiting car makers from owning their retail outlets directly--prohibiting vertical integration. Against the law--possible threat GM could use with a dealer. Claim is that GM and Chrysler have too many dealerships that compete with each other, bid down the profit margin, and don't do enough volume. Threat would be reasonable, keeping franchise fees higher than they otherwise would be. Written into the contract that you have regionally exclusive areas. Politically designed; in addition, auto corporations not allowed to close the dealership unless they paid back the entire franchise fee. GM can't close a line that is not doing well--Plymouth, Pontiac--because it would have to pay off all the franchised dealers. Weird law: can't close a franchise--presumably the reason they can do it now is that they are in bankruptcy--even if you realize you've made a mistake. Can't stop making the car because of contract provision that the main company would have to pay back the franchised dealers of that make of car. Also main company has to advertise the line of cars. McDonald's ads benefit each franchisee. Mostly a problem for GM, which had a huge variety of different lines which didn't compete against each other directly, but side by side on same street. Two profitable lines are Chevrolet and Cadillac; others go from a little loss to an enormous loss. Couldn't close them because of these state laws and contract provision. Is there a term for the franchise? Provision is that only the franchisee can close the contract, unless you can show cause. If franchisee didn't have enough little colored triangular flags. Local clout, particularly in the House of Representatives; set of laws. Backwards from big corporation with lots of small parts; all of the power lies with the franchisees. Bankruptcy is the only way out.
11:00American auto industry digression. Go back to 1940s, 1950s, even 1950s, three large firms: Chrysler, Ford, and GM, some smaller firms now gone. Compete with each other, but their competition mitigated by the unions. Because there are rents, because the three firms generating profit, unions try and are sometimes able to extract some of that profit in the form of higher benefits. Suddenly in 1970s something happens that on the surface has nothing to do with the auto industry--big jump in the price of gasoline. Changes the attractiveness of certain kinds of cars--historically small cars not made in the United States, with lots of land and low gas taxes. Rest of the world has different model, huge gas tax; suddenly that makes foreign cars much more attractive. Industry should have responded dramatically, but they are not used to responding, something of a cartel, partly because of unions. What they meant by design was different shapes of sheet metal. Neil Young, album At the Beach, Cadillac fin stuck in the ground. Behemoths of the big three suddenly have to compete with more nimble companies; legacy costs. Handicapped by the past negotiations with the unions--think true--retirees' health care plans. Also environmental regulation, mileage restriction, CAFE standards; if they don't get more nimble they'll be eaten. Honda--two cars. Accord, Civic; focused on same car. Get around regulations by having different sheet metal around them. Difference in margins, GM became more cynical; relied on the brand name; but people shifted to Hondas. Book, The Decline and Fall of the American Automobile Industry, psychology. Drove large station wagons, meetings, not paying attention. Automobile companies put heads in the sand. Corporate culture, bureaucratic and not nimble if not competitive environment. Why should every newspaper have its own movie critic? Nashville, TN movie critic; economies of scale not taken advantage of. The auto companies didn't know how to become competitive.
19:27Nobody likes the haggling process; wear old clothes. Salesman is trying to elicit the maximum price you will pay. What is "the price"--many margins. Only marginal buyer and marginal seller are the ones who are indifferent about buying at that price. Money left on the table by one or the other, competitive market. Malls, shopping area in Asia, no "the price"--all negotiated. In used cars, some companies like CarMax have taken haggle out; others still have price discrimination. Seller has minimum amount at which he will part with the merchandise; buyer has maximum amount that he will pay. Difference is gap; usually knowing that there is a gap is irrelevant. Pile of apples in supermarket at $.30 per pound, even if I love apples and am willing to pay $4/pound, is irrelevant. Market price, may differ across stores, those who choose to buy get consumer surplus; sellers forced to lower price, still making some money. Honda Accord buying podcast. Can spend a few hundred and be happy; Russ angry because lied to about car price to get him into the dealership. The price--p*--differences are small, but with car price large. Why sometimes there is a "the price" and sometimes not? Has to be that sometimes the transactions costs of negotiating separate prices for each buyer are so big that it would swamp the profits you would get by being able to discriminate across different elasticities, different amounts you'd want to buy. Another answer: competition from elsewhere forces one price, no-haggle price. Appliances, shirts, apples, no-haggle price. Grad student: Could contract out the haggling function. Priceline sounds like advantage for the buyer, but suppose I am the seller. What would help the most would be if you announced the maximum you would pay. On Priceline, consumer announces the maximum he will pay; documented instances of people paying more than the maximum amount that a hotel would charge. StubHub, also. What usually keeps the information from exploiting is competition. Haggling allows for the possibility of price discrimination, but given how many car dealers there are, in competition one might try just a single price. Saturn tried this; the internet is forcing this on some dealers. Just one price--why doesn't competition push the price down to the competitive price? One answer is that it's not that competitive. Another answer is that there advantages that accrue to the customer that aren't obvious. Average price with haggling is lower than it would otherwise be, say, inventory costs. Might be lower than you'd pay in a no-haggling world.
28:42Seems mysterious; people out there laughing. Answer: choosing the one that will help them make more profits. Over the long run, drive down the average willingness to buy more cars. Back to the 1980s, if you wanted a Honda, no-haggle--you paid above the sticker price, dealers didn't get as many as they wanted; voluntary import restraints; here's the price, take it or leave it. Alien world to what we're now accustomed to. Should have put a scare into American carmakers. Voluntary restraint agreement benefited American carmakers because there weren't enough to compete away the advantage, and benefited Honda. Other Japanese sellers had same restraints; Japanese government decided who got the shares. If private company had done it it would have violated the Sherman Act, but since the government did it, it was all okay.
31:23Political power in hands of dealers created a restraint on GM and Ford that limited their ability to reduce the number of lines they had. McDonalds, the Arch Deluxe, worst sandwich in history, less ketchup and more mustard, rolled it out, nobody bought it; stopped selling it. If you had opened up an Arch Deluxe dealership, they couldn't have stopped, and would even have to advertise it. Statistic: average Chrysler and GM dealer sells a little over one car a day; average Toyota or Honda dealer sells three or four. That's the average, some doing well, some doing worse. If you are selling a car a day, huge staff, what are the side-payments going on? Dealer in podcast, profit of the dealer is ambiguous. Price he pays for the car is not precisely known. Changed business model; instead of focus on flow, focus on the stock. A lot of Chevrolets out there, start to focus on services; make money on warranties. Dealership like dealing with pirates. Go there because it's "free." Dealership service contracts only option, eating their seed corn, monopolistic practices, local dealer. Principal-agent problem--the principal, the car owner, Detroit, want their dealers to offer really good service--and to sell cars. Distribution system for movies, movies have incentive to make money on concessions, popcorn; McKenzie podcast. If local dealer does gruesome job on service of car or makes me angry by luring me into buying things I later realize I didn't want, sours me not just on the dealer but on GM. How does GM maintain the service? Gulliver tied down by Lilliputians, but by the time he realizes it it's too late. GM can't solve the principal-agent problem because they are bound by the ropes of the franchisee problem. By the time they realized it, it was too late. Original idea of the Saturn line was to make a more foreign-car-like company within GM. Hope was that the Saturn corporate culture would influence the GM corporate culture; went the other way. Metastasized. Saturn, tried starting from scratch; couldn't change the corporate culture they were locked into in their other lines. Was a mild success for a while; no-haggle was attractive. GM knew what they needed to do.
40:10Back to service question; three parts, lumped together in the dealership: service, selling of the car, and financing of the car. Could be separate, but bundled together under same roof. Suspect in early days of franchises, better incentive system. You'd think you'd want to contract out service. For years most profitable part of GM was GMAC--GM Acceptance Corporation--financing arm. They made money; the manufacturing portion broke even; franchises made money on service. Bizarre industry, only way people made money was on financing and service. Would say that the manufacturing part was competitive. Warranty, manufacturer's--buy a GM car, six months in a noise under the hood. Why will they make money on that? Two things covered on warranty, but something else found as additional problem; why not also take care of that? Not sure that's how they made their money, but service and financing was where all the profits were made. "Just following up your speculation, pumpkin." Other way to think about it: two ways to make money on service. One is charge nothing to the customer during the warranty period, but assume the dealer is being compensated by GM. Then GM was not making money, had to take that out of the purchase price. Maybe the warranties were overpriced, but think they were pretty competitive. Or they could have made their money after the warranty expired; or the complexity of the parts. Interesting point: state laws that constrain the companies. Didn't fight them state by state. As competition arises from overseas, the division of the pie is harder. Interesting point: state laws that constrain the companies. Didn't fight them state by state. As competition arises from overseas, the division of the pie is harder. Franchises limited ability to react. That's why GM has had to go into bankruptcy.
45:47Why so profitable before, making so many cars. In the 1960s, advertising the image created the downward sloping demand for each of these cars. People loved Mustangs, Cadillac with the big fins, 1957 Chevrolet. Comment in comment section. Why in the good days was there franchising at all? Was more viable model when industry was less competitive. Ford seems to be doing better. Ford selling in Germany, Europe, more successful. Why no vertical integration extending down into dealerships? Questions for commenters: Why the franchisee program to begin with? Capital market explanation just false. Why does haggling persist--Russ's explanation because people get a lower average price, Mike's explanation because they get a higher average price that benefits the company? On first part, might be Hayekian explanation. Charles Platt podcast, week working at Wal-Mart, autonomy at low levels of employees; local knowledge, no way corporate can successfully understand what's going on at the local level, hard to watch costs and monitor things. Corporate GM could run its own retail outlet, but maybe it can't easily figure out local market conditions. Want to put potential profit--give away money--in hands of the franchisee because you want to incentivize the dealer. Car rental business example: local manager can be the highest paid person in the chain, not the Vice President or executives. Bonus tied to success of the local office. If local office thrives, local manager does great. Some of thriving is watching costs, monitoring. Want to see effort correlated with outcomes in these margins to see this argument work. Paper in JLE by Richard Smith. Local residual claimant. Makes argument and looks at different profit rates. Paper by Peter Pashigian, analysis of different kinds of incentives and contract forms used for different kinds of franchisees. More claimants creates more profit opportunities. Only way to always make a lot of money is to always create a lot of value. Though some of that is created by protections by the state. Challenge to these kinds of arguments: the reason you want to have a franchise is to give local office an enormous incentive to do a good job because you can make more money yourself that way. Yet, there are other models that thrive. Wal-Mart example: an in-between. Doesn't have a franchise, but to keep the incentives for local production, their bonuses and incentives and returns to local employees are tied to their work at the store; employees can make a lot more money than their salaries through bonuses. The Gap example. All sounds very reasonable, but Just-So story--so that's why the monkey has a tail. Monkey with webbed feet. Nothing wrong with ex-post story-telling, and a lot of times you learn a great deal. Probably twelve other things we don't know about. Look forward to the comments. Saving Mike's cultural observations about Germany while at Friedrich-Alexander University at Erlangen-Nurnberg. for some future time.

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COMMENTS (48 to date)
Steve F writes:

Haggling is rapidly being replaced by reverse auctions. I personally know several people who have simply picked a make and model by doing research on the Internet, then sent e-mail to 5 or 6 local dealers saying, "I'm buying this car today. Send me your best offer and if you are lowest, I'll buy it from you."

There are several new web sites that will run this reverse auction for you.

I'm sure car dealers are not happy about this trend.

bluhawkk writes:

Can the bankruptcy process undo/eliminate the morass of state laws restricting competitiveness?

US auto industry outlook appears bleak with China emerging as the global leader in production.

JOP writes:

I wonder if the original reason for franchising car dealerships had to do with the financing component of a car sale. Debt collection over many years in multiple different locations from thousands of people might have seemed like an unpalatable business to GM in addition to manufacturing.

The franchise system could have been a way of not having to make thousands of credit worthiness decisions for GM and instead give that role to a local businessman who might be better attuned to local knowledge. Perhaps there's evidence of differing interest rates between local markets?

Anybody knows when car dealerships payed for cars, when the franchise system was first established ?

If car dealerships payed upon sale to the consumer, or within X months of delivery, the money payed for franchise "license" could work as guarantee for payment. That is, if the car dealership did not pay the auto manufacture for purchased cars, the manufacture could just revoke the franchise and sell it to somebody else.

Of cause, one could argue that it would be a lot easier for car manufactures to just require payment upon delivery. But there might have been some issues with that. First, their might have been some law (properly not) or strong custom against payment on delivery. Second, by charging a fixed amount for the franchise, but only charging for delivery when the final sell to the customer is made, they encourage car dealerships to have a big inventory, and let customers have access to all the different models.

Steve Hemingway writes:

I have no connection with the car trade other than as a customer. However, it seems to me that the reason that manufacturers offer multi-year warranties is so that cars will come back to the dealership to be serviced profitably. As I understand it, if you get your car serviced by an independent car servicing company you void the warranty. Modern cars are pretty cheap to service, so this dealer servicing can be very lucrative, and is not subject to haggling since you can go elsewhere only if you are prepared to sacrifice your warranty, something which the customer is very reluctant to do as he finds it very difficult to value, although now insurance companies will offer these fairly cheaply.

Walter K writes:

By way of explaining variable pricing and haggling when buying a car:

An automotive retailer has more than three businesses under his roof, Russ, and they vary from retailer to retailer. There is new car sales, parts sales, service sales, and F&I (financing and insurance.) Some have another channel (profit center) in used car sales, some retailers dump trades as if they were poison. Some retailers have parts departments that do a big wholesale and over-the-parts-counter business. For some retailers, and in my experience they tend to be foreign car franchise holders, there is a major profit center in service, and in fact in a recession, the ones that keep going have good service departments and repeat customers that return long after the warranty has expired. All of this makes for uncertainty when a new car customer comes in the front door (in sales lingo that person is an "up") -- the price of the car depends on whether or not there is a trade, and if there is if the sales department will recondition and re-sell the trade, or if it will wholesale the trade. In the auto business, used car sales can be the real profit center (if the retailer is good at it, that is) because each new car has lots of other places that the car can be bought, but each used car is unique. In deciding on a price, a sales department may lower the retail price of the car if the sales department will be making some profit on financing, or on accessories, or if the car to be purchased is in stock rather than is one that must be ordered (the one in stock is probably costing interest payments -- floor plan). If the retailer has a service department with a stellar reputation, he may figure to make good profit on the servicing and parts sales, and thus that may influence price for a new car.
Remember, most car transactions are not like buying a gallon of milk, which is to say, the customer doesn't walk in with a wallet full of money and buy on the spot with no trade, no financing,the car off the lot. Most car sales are a combination of new car sale, used car trade, financing or lease, and more.

And that's just some of it!

Gary Rogers writes:

One of the main reasons for franchises is to finance the local car inventory and keep cash flowing to the manufacturer. The marketers knew that they were much more likely to make a sale if the customer could sit in a shiney new car and imagine it as his rather than have to wait for his dream car to be delivered from the factory. At the same time, the manufacturers could not afford to tie their money up in inventory all over the world. The floor planning programs initiated by the car companies allowed the dealer to receive an inventory of cars on credit while the manufacturer was paid on delivery. One of the sales incentives was that the manufacturers knew that once they pushed cars out to the dealers, the dealer would find a way to move it, so there were all kinds of quotas and incentives to encourage dealers to take more cars than they otherwise would.

I also want to compliment Mike Munger on being one of my favorite interviews on EconTalk. He has a way of making a subject interesting and adding new perspective to a subject. Keep up the good work.

James Harrigan writes:

I haven't dealt with automobile dealerships, but have purchased from, and have service done by, motorcycle dealers. Where I live there are two good higher-end motorcycle dealers, one in San Jose and the other in Palo Alto, both of which have been in business for well over two decades. What they have in common is that they are staffed by people who live and breathe the product. I didn't hear either you or Mr Munger mention that esprit in any of your transactions. The transactions seemed to be more impersonal.

It does instill customer satisfaction and repeat business as you get the impression that you are not just a source of income but a fellow enthusiast. And then there's Harley fanaticism...

Matt writes:

Great podcast. I have one thought regarding the dealership closings...why are they necessary?

I have heard no evidence that dealers pose incremental costs onto GM. Presumably their competition with each other kept retail markup to a minimum vs. imports, which lowered effective pricing.

But most curiously, if they were so unprofitable, why did they not exit the market on their own or rapidly consolidate to a more advantageous scale?

If scale mattered, why did it not win out? It is clear that many profitable franchises are being forced to shutter themselves, and this strikes me as potential suicide. Perhaps the only advantage that GM had was a denser distribution network, which improved availability and shopper convenience.

Bigger dealerships should have proved a better model, and I only see evidence that this did not happen.

GM's woes had little, if anything, to do with it's dealer network. I think there is correlation without causality when you look at the decline of the Big 3 and their more distributed dealer network.

Scale should have proved out long ago. Yet even amid declining share, GM dealers remained profitable. I take Munger's point about service, but that does not explain why we did not see more consolidation via free market activity.

The more profitable dealers should have bought out the little guys easily...they did not.

My Nissan dealer tries the same tricks every other dealer does with regard to service.

Closing all these profitable dealers means lost distribution reach, less competition and higher retail dealer margins with higher effective pricing. My sense is that it gives away the only asset that could prevent permanent share losses.

Is Ford consolidating it's dealer network? I do not see evidence of that.

Keep in mind that they are closing GM dealers that are parts of auto groups that have foreign nameplates as well.

Talk about stupidly giving shelf space to the competition!

I have seen no proof that a profitable dealer imposes any negative cost to GM. Firing people who only want to sell your product is not a growth strategy.

I understand the political dynamics, but the market did not rid the world of these dealers who had plenty of ways to invest their money elsewhere.

...but an auto task force did what the market refused to do. I smell a BIG mistake in the offing...

Michael Brady writes:

I am a former automotive technician (mechanic) and I am currently an economics student. My experience working in the automotive service industry is as a dealership technician. The dealership I worked for was high volume and specialized in premium foreign brands (mostly European).

Warranty repairs provide a substantial amount of the gross revenue for dealer service arms, but that is a matter of sheer volume rather than high margins. Each repair/service has a "book" time that is determined by the automaker. However, there are two separate rates - warranty/manufacturer extended warranty and cash/outside extended warranty. So, a warranty replacement of transmission may pay 5.1 hours, but a cash replacement of a transmission may pay 5.8 hours. Mechanics often work "flat rate" and their wages are determined by the book time multiplied by their rate of pay(e.g. $10/hr * 5.1 hours = $51.00 net, or $10/hr * 5.8 hours = $58.00 net). However, especially concerning warranty repairs, experience pays off. If the repair pays 5.1 hours for warranty, but you finish in 3.5 hours, you are still paid 5.1 hours. Mechanics prefer cash jobs because they pay more time for the same work (i.e. like doctors usually prefer private insurance or cash to Medicare/Medicaid). This works for dealers as well. Dealers are reimbursed by the warranty arm of the automaker.

The money comes from service (which is more common than repairs and usually not included in the warranty). These jobs are called "gravy work" because they are easily completed in well under the time paid and so volume works to the service department's advantage. This would include brakes, oil changes, transmission fluids changes, etc. After doing a "service" (often includes multiple services - inspection, oil change, tire rotation, air filter, and so on) a hundred or so time they can be done, many times, in less than half of the time stated in the "book" - now computerized. Luxury foreign automakers have an easier time keeping customers after the warranty has expired because they can require special training/equipment/experience to repair, dealer-only replacement parts, parts are kept in stock for the product line and do not usually have to be ordered, and owners are typically wealthier and less likely to shop around. This advantage is less so for popular makes like Honda, Ford, or Volkswagen because they are more commonplace and so is knowledge about their repair. Additionally, there is often more proprietary system diagnostic equipment (see computer software) for premium foreign makes.

So, basically, service departments make money through service, not repair. They also have higher margins on non-manufacturer warranty work. Warranty work is a necessary evil for service departments because they ensure steady work and high volume, but cash-paid service/repair provides much higher returns.

BTW - Warranty repairs/service often come with special requirements (e.g. given parameters in which a part can be replaced - such as a particularly measurement - or time interval). Some automakers (e.g. VW) provide "free services" like oil changes for during the warranty period, but that is wrapped into higher MSRPs.

I hope I've provided some insight. I'm sure I left a few things out. Feel free to ask me more.

Walter K writes:

Just a comment on whether dealerships impose a cost on a manufacturer -- such as GM, or Ford, or Chrysler. I regularly heard commentary on the radio and TV that dealers are all benefit and no cost, but that certainly is not the case. Manufacturers and the wholesale divisions in the US of foreign manufacturers provide training, a field force of sales, parts and service personnel, technical expertise, dealership financial oversight, parts inventory, and so forth. My experience working at both the dealership level and at the wholesale (manufacturer's) level is that some retailers are a net benefit, and some are a net liability. Since reputation is important, a dealership that is a poor servicing dealership, or one that has a hard time fixing cars under warranty correctly is a liability, no matter how many cars are sold by the dealership. All manufacturers continually try to weed out the weak franchise holders, but it is difficult under many state laws to do that. Ford has slowly, over the last several years, shed dealerships, as have most companies that have been in business for a long time.
A dealership can be profitable from its own point of view but be a net liability to a manufacturer, because of the many channels for profit within each dealership. A manufacturer makes money from a dealership that sells new cars and parts and doesn't require lots of extra assistance from the manufacturer, whereas a dealership that services cars and sells and reconditions used cars, and buys parts from independent sources but sells few new cars can be very profitable internally but not a good deal for the factory.

Sam Severinson writes:

Just wanted to share an observation I had regarding haggle / no-haggle pricing while traveling in Africa.

Virtually no shop had prices for anything, so as an outsider with no idea of what things were "worth" (p*), I'm sure I paid way more than I could have gotten something for. And haggling really took all the energy out of me. So I was extremely happy one day to see a shop with actual prices, and a strict no-haggle policy. But then I didn't end up buying anything from them. I just made a mental note of their prices, and went to a "pro-haggle" shop and tried (and succeeded) to get the item I wanted for a lower price.

Relating back to cars, I can imagine that there's very little incentive to be the first dealership to move to a no-haggle, fixed-price model if all competitors use the haggling model (although maybe this will change now that people can relatively easily access a sort of p* for cars through the internet).

Matt writes:

Walter K. -

I think we can all agree that a dealer who damages the brand can do harm. Despite that, this is not the rationale for mass dealer closings.

The rationale is that they are uneconomical and lack competitive scale. I don't think there is evidence of it. Dealerships do not drive substantial incremental operating costs for the manufacturer. There is virtually no
risk capital at work on the manufacturer side. They may finance the inventory for a few weeks, but this is a net benefit allowing them to maximize all-important availability.

Though I am sure the cost is not zero for the manufacturer, it appears to be negligible. In fact GM makes a lot in franchise fees.

I am sure that a few franchises deserve to close on the basis on poor service, but this is true at any given franchising system at any point in time.

Weaker distribution, poorer availability, higher dealer pricing, and lost franchise fees does not strike me as a way to grow. The "too many dealers" argument has never persuaded me. If it were true, they would have been swept away by market forces. State laws may have prevented vertical integration, but they cannot make profit where none can be had and they did not preclude greater horizontal integration.

Floccina writes:

I think about GM, Ford and Chrysler what I thought about the investment bankers and that is: If let fail it is hard to imagine that they would not be replaced by something better. I look at a situation like this as a chance to big old dislodge entrenched interests creative destruction style. Too bad that the federal government did not see it that way. They talk about the suffering that such creative destruction would cause but is that not what we have welfare unemployment insurance, food stamps subsidized housing etc. for? We gave them all those programs and they still are unwilling to allow creative destruction.

Trevor writes:

I have the same question as Matt.

I keep hearing on news shows that they don't cost the car company anything. If this is true, what advantage is there for closing them down?

The only thing I can see is the ability to close down a product line, such as Pontiac or Saturn.

Great Podcast as always. I have enjoyed all of the conversations with Russ and Mike. Just picked up your books (as well as Adam Smith, Friedman and Hayek)

Don writes:

Regarding the issue of why auto manufacturers have dealerships/franchises, I took at look at the book "The American Car Dealership" by Robert Genat. It states that originally cars were made to order, but manufacturers soon determined that there had to be a better way to make vehicles available for ready purchase without tying up the manufacturers' capital in the inventory.

I know Munger belives that the capital argument is false, but I think we have to remember that in the infancy of automobile manufacturing in the early 1900s, there were many more manufacturers than exists today, and there was a race for sales and to gain acceptance. Pushing inventory through the pipeline with the sales lag was just too expensive. By the time the surviving manufacturers had capital to support the distribution network by themselves, the dealers had built up political capital to assure their survival, as Munger goes on to discuss.

Thanks for this very enlightening podcast, and I really appreciate the rapport that Munger and Pumpkin have.

Walter K writes:

Matt and others,

You are just dead wrong that that costs of supporting franchises is minimal. The cost of Field Operations for each an every manufacturer, support for dealers, is substantial. In addition, all of the big three have a dealer body that was developed 50 or more years ago, and is no longer viable. Just look at the number of GM franchise holders vs Toyota, Nissan,Honda, Subaru, Volvo,Kia. There is, of course, the corrosive effect of bad dealers, but there is also the cost of maintaining the support for a too-large dealer body, one that sprung up when GM's market penetration was maybe twice what it is today.

On scale: Matt, you are correct that if all things were equal, a successful dealership expanding - growing - should be able to buy out nearby less successful dealers. But, franchise laws effectively prevent that from happening. The less successful dealer can muddle along, refuse to be bought out, make enough to stay profitable. Remember, there are many ways to make money in the auto business, it ain't all new car sales.

I'm in New England; if I were to look at the region in 1950 or so, and were deciding where to locate retail outlets, the number and the placement would be vastly different from what I would do today -- populations have changed, people have moved, commuting patterns are different, a town that looked like a good prospect in 1950 might turn out to be the wrong location for a dealership. Each dealership is assigned an "AOR" - an area of responsibility for car sales. After 60 years, that AOR will have changed through development, so that the best place for the retailer in the AOR may not be where the dealer is located, or maybe there is no longer a need for the AOR because of changes in the area. But state laws being what they are, a retailer can't just move, or the manufacturer can't just reorganize the areas. In Massachusetts, for example, dealers surrounding an Area of Responsibility of a dealer that wants to move to a new location in his own AOR can prevent that move.
What has happened over many years is that one of the legacies that manufacturers have -- especially the big 3 --- is the legacy costs of many more dealerships than are needed: it was just too hard to shed unnecessary dealerships, so they accumulated. They should have been eliminated years ago, little by little with not much disruption, but that did not happen, the unseen consequence of lots of things including state franchise laws protecting car dealerships.
The "seen" and the "unseen" -- probably worth a chapter or two in an introductory Economics text!

Paul Ingrassia has written extensively in the Wall Street Journal about the legacy costs of the big Three, and that they are more than just the costs for health care; he adds the extensive work rules that govern the relationship between the manufacturer and unions. Add the legacy costs of too many dealerships, some in the wrong places, to the list.
And, again, Ford has been paring down it dealer network, it is just that it is being done over a longer time period, so it is less noticeable.

Mike Munger writes:

Wow! What great comments. You people are the best. Someone could learn a LOT here, just by reading the comments.

I do want to say this: I don't think the capital argument is false, on its face. It is probably a good explanation for INITIAL franchising. But the auto industry is not expanding, and there aren't many new franchises. So I don't think it is the CURRENT explanation.

keep up the good work, folks!

Mike

Doug Ransom writes:

Interesting use of crowdsourcing to try and understand the econmics of franchising, by soliciting solutions in the podcast.

With enough creative destruction, we might see economists go the way of encyclopedia editors — an army of unpaid volunteers. Some irony in that.

Schepp writes:

Thank you gentlemen,

Let me take a shot at why haggling still exists in the car market. Let's say Dr. Munger goes to Smith's 'mer'can car dealership that offers "One" simple price. Dr. Munger looks at the price and says to himself, I bet that all prices are negotiable and tests the dealer to see if the dealer will budge.

The dealer mean while now sees 20% of the customers have Munger negotiating tendencies and sets his one simple price a little higher than than Russ's P* so he can make Dr. M feel good by giving him a special deal, and profit from those that don't negotiate.

The dealer also puts his popcorn pricing on his warrantees and other elements where the marketing cost is low since the customer is already there. He also does the lovely dance of finacing the warrantee with the car (note the warrantee owner is paying interest on services that he has not even recieved yet.) You can bet your bottom dollar your still negotiating 20% of the cost after the nominal price is agreed to and they send you to "Jimmy to work out the paper work."

The larger the price of a good the more likely the transransaction cost of haggling will be less than profit(or less loss depending upon your view and skill) from haggling for both the buyer and the dealer. Both negotiators contribute the the haggle.

Orn Gudmundsson, Jr. writes:

Excellent podcast, very interesting subject.

On Quality, Common Parts and Redundant Brands

There was a comment about Detroit (used here as the American Auto Industry) being too hard on suppliers and Russ found it strange that this is a source of criticism. The problem was not that they were focused on cost, the problem was they were focused on cost above all else, including the long-term perception and actual quality of their product. It really wasn't rational behavior to beat up suppliers, after all, they are needed for long-term business (if your suppliers can't make money, that is not a good strategy). Furthermore, if you use identical light grey plastic knobs (because it is a fraction of a cent cheaper than black) in the Caprice as you do in the 60k Suburban (echoing the comment in the podcast that Detroit became cynical about their brand separations) you will fool some people for a while, but, eventually, the public will figure out that the Lexus truck provides a better value. If you use all the same parts, your brands loose their independent identity. Actually, the brands did not have to be redundant, Detroit made them so by common parts and common platforms -they killed their own differentiation.


Dealer Network, Small Cars, and Other Red Herrings

Assuming that it was not a foregone conclusion that the brands were made with no differentiation, I see no reason why the dealer network is at fault. Very interesting about the state by state protectionism, but, a GM dealership's smarmy sales tactics are no different than Honda's or Toyota's dealers, most of the dealerships act in much the same way (as Russ proved with his own minivan purchase).

On small cars, I find it ironic that GM is essentially selling its small car division (Saturn), yet the Obama administration (and everyone else) thinks that Detroit is in trouble because they did not build small cars, when the problem is they did not build small cars anyone wanted. Yes, they depended on large cars for a significant portion of their "profits" for a while, but the real rot was already there. Designing cars by committee and focus group, led to things like the Aztec. Focus groups garner the lower-middle class and below (i.e., not the ideal customer). Who has time to sit in a focus group? Certainly, no one I know. Other manufacturers are guilty of this too, I think I could fit 10 Colt-45s in my 7-passenger Sienna, but the residual damage of focus-group feedback seems to be mitigated at Toyota and other foreign companies.

Where the money is made, is to me, the least interesting point of discussion. Bundling products confuses not just the customer but also the seller. The more variables, the more chance for pricing errors on all sides. While in car sales, bundling would seem to benefit the dealer (e.g., when the dealer wraps financing and the purchase together), it can also penalize the seller (e.g., when the financing arm of the auto-maker gets the residual value of the car in a lease wrong). When the typical buyer gets a car, he/she is buying a basket of products: car, service (through warranty), financing and delivery. When bundled like this, it is hard for the consumer to figure out (perhaps, impossible, is more accurate) how much of the price is allocated to each part (I am not even sure how much it matters or if the buyer cares), but it is not that much easier for the manufacturer. In fact, I think that is where so many have gone wrong, incorrect allocations on internal pricing, they did not really know where they were making/loosing money.


Saturn, the "x-way out"

The Saturn story is interesting, and I think the podcast hit it square on. I interviewed several people at the Spring Hill plant when I was in graduate school, and I think you hit it right on what some people in GM and the union were trying to do. It did become infected with the culture from the rest of the company and lost its way.

Conclusion

Small cars, changes in the dealer network, sales tactics, all of these are distractions from the real issue. Building better cars, designed well, that appeal to real customers is the only answer. Yes, Detroit had some unnatural handicaps and burdens to carry. The real issue still has not been solved: when are they going to build something I want?

Nethy writes:

On Franchises in General

Franchises are a fascinating field in themselves. The podcast seemed to suggest that this kind of arrangement is a consequence of legal restrictions, but who knows. Franchising is a model that thrives in many unrestricted applications.

The reasons for this are , I think, difficult to capture in the most common terms for economic stories. Sure, incentive is important. Sales is an area that tends towards a high level of direct incentives, so it must be even more important here. But it's a bit more then that. Business ownership attracts different people to a similar position for a similar compensation structure. It affects corporate culture. A locally owned franchise can be as different from a competing subsidiary as an embassy is from a travel agent.

I think franchising is an area to further explore.

eKENomic writes:

If you want to learn a lot about this business the best blog in my opinion is www.thetruthaboutcars.com Many of the questions I've seen hear have good answers there and with credibility and economic logic. I read it every few hours because it is erudite, funny and most important "confirms my priors" (HA!)
They predicted the entire auto manufacturing conflagration with frightening accuracy. Check out a few of their archived posts.

Love the show! Maybe I shouldn't declare that I would be willing to pay a good deal of money for this service but it seems like there is a lot of consumer and producer surplus going around in the market for EconTalk

Adam writes:

A question for the two professors, and any commentor who is more knowledgeable about such things than I am:

My understanding is that the whole "dealers don't cost manufacturers anything" is bogus, not just for the reasons that Walter K mentioned above, but because forcing GM to produce more cars than consumers will buy forces the market price of those cars down. I'm not sure how that works in practice however, as the whole relationship between manufacturer and dealer is mystifying to me. Am I onto something here?

JOP writes:

I think the haggling issue is explained simply by opportunity cost on the part of the purchaser.

The larger the sticker price the more it likely it is in your favor to haggle, because the reduction in price of the car or house is worth more than the value you place on your own time.

Russ had it right, you only haggle for the two largest consumer purchases you make in your life. Your car and your house. The reason you engage in haggling is because you feel the activity, even with its bad aftertaste, is more valuable to you than the time you spend doing it.

Consider that if you were incredibly wealthy if you would then be willing to pay sticker price on a car... my guess is that you be much more likely.

The reason I don't haggle at Walmart is because the gain of the few dollars I might get is no match for either what I can produce during the same time, or the enjoyment I might have if left to my own devices.

Thoughts?

Russ Roberts writes:

Lauren Landsburg, EconLib editor, notes that our story about the evolution of the US car industry is missing something:

"In the simple version of the auto story you and Mike told, the 1974 oil price crisis was a great divide. Before that, U.S. carmakers were insufficiently pressured to have to compete. After that, there was the Honda.

"While it doesn't completely obviate your story, there are two cars that complicate it a lot."

The two cars she has in mind are the Volkswagen Beetle and the Dodge Dart. Both got fantastic mileage. Why didn't they thrive in the oil crisis? Why did Japan dominate in the post-oil crisis era? Why wasn't the Dart America's answer to Honda.

I think Lauren is right that our story is missing something. My guess is that the missing piece is the increase in federal safety regulations that began in the late 1960s and surged in the 1970s. My guess is that the Dart and the Beetle (and other small high-mileage cars of that era--the Hillman, the Morris Minor, the Valiant) couldn't pass the crash test standards. That still leaves the question of why Detroit didn't re-engineer the Dart. And why Honda could pull it off--keeping decent mileage and meeting the safety standards.

My guess is a mix of hubris and a failure to anticipate the demographic changes of the 1970s--the increase in the number of singles that also increased the demand for small cars. Detroit didn't appreciate the profit potential.

Reactions appreciated.

Roger writes:

What wasn't mentioned is if the franchise state laws applied to all car manufacturers or only those based in the US. I'd assume they applied to all, so the commentary didn't really explain why the GM dealers were such a problem but the Honda ones operating under the same laws were not a problem.

Also is the franchise fee a one time thing or an annual payment?

Scott writes:

I think I would have appreciated the conversation more if you had a car authority participate in the preparation of the show or perhaps as a 3rd voice to chime in with expertise of the larger picture, to help with some of the inaccuracies or misconceptions of the industry in general. Someone such as John McElroy of http://www.autolinedetroit.tv/ has been around the industry for a very long time and could have easily helped with historical perspectives (and I don't think people would consider him biased, or at least would be perceived as less biased than others).

I'm sure Mr. Munger knows the franchising material well, but I noticed some struggling when either of you wandered from the economic sphere and I know the whole industry was driven and is still driven by a combination of leaders, politics, policies, legal pushes, customer expectations, economics, and of course armchair generals.

Gary Rogers writes:

The difference between the VW Beetle, the Dodge Dart and other small cars and the Japanese imports was quality. W. Edwards Demming had been preaching statistical quality control over in Japan since the end of WWII and by the 1970s their quality surpassed even the Germans.

Matt writes:

Walter K -

I have heard your point about "substantial" costs of supporting too many dealers. I have not heard you articulate what those are. Keep in mind that from a cost basis, GM was bigger than the economy of whole countries. This is a cost basis of several hundred billion a year.

Now, if the personnel costs of supporting 5,000 dealers with reps and dealer support totals anything close to a billion dollars a year, I would be shocked. For a company that recently had 200,000 US employees, this would be negligible and more than likely covered by annual franchise fees. Does it cost money to support them? Yes. Does it cost more than what dealers pay for these franchise services? I doubt it.

Parts and even the vehicles are often delivered by contracted third parties, all of which is cost covered by dealers.

Dealers pay destInation charges and other sundry support charges. Nobody has made a persuasive case that these dealers did not pay for services rendered. The reason that GM did not "buy" them out in solvency was precisely for that reason. They paid huge sums for the mere right to distribute the product.

This is the equivalent of Sony wanting to close down mom and pop electronics stores...why would they? To create greater buyer power on the other side of the transaction? To the extent they care, they want more competition on the retail end to keep service competitive, prices low and to give customers as many points of access to the product as possible. Consumer goods manufacturer margins have suffered at the hands of Wal-Mart (goods for us) and general retail consolidation.

My sense is that the distributed dealer network was more of an advantage for GM than a hindrance. Foreign automakers did not succeed because of bigger dealership and local cartels, they succeeded because the cars were that much better that poor guys like Russ had to wait a month to pay a markup over sticker.

Lucky for GM that you had to pass 5 of it's dealers to get to a Honda dealer. I doubt Honda wanted it that way. They had bigger dealers because they had fewer than they might otherwise want.

How many extra lot visits did GM get because it's dealer was 5 minutes away and not 25?

I fear we are soon to know the answer. A lot.

If shuttering 1,500 dealers saves GM any money at all after lost sales and franchise fees I would be shocked.

Shuttering profitable dealers that the market would not kill off, and who are not damaging the brand is suicide.

Justin P writes:

Haggling is like poker. Most people just aren't good at it until they practice it a lot. To haggle effectively you need to know how the game is played and you need to have a good poker face. Of course, you have to know when to fold.
One of the most important thing to do is get as much information as you can before hand. The asymmetrical nature of buying a car, is to the advantage of the dealer initially. Thanks to the glorious internets, it's easier for the layman to get the information needed to know what a "fair" price is. Even then "fair" is highly subjective and regional.

This was a great podcast. I really love how Prof. Roberts and Munger make the information easily digestible to the economical amateur. I really would like to see Prof. Roberts moderate a Keynesian (Reis) vs Austrian (Selerno) on some current topics like inflation, the Fed, The housing bubble, Stimulus, etc...

Miles Mullin writes:

Russ et. al.,

I just listened to this podast this morning. Another great one. Thanks. Here's my personal experience:

After graduating college in the mid 1990s, I sold cars for a Chevy-Geo-Hyundai dealer for a while. Aside from some isolated incidents and particular individuals, and some of the usuall silliness (i.e. "a processing fee") we had a pretty honest dealership. My experience affirms your contention about service. We made a lot of money in service, but that was because we had an awesome service department that was consistently rated at the highest level by customers. Even customers who did not buy their cars from us or did not own our GM brand brought their cars to us because of our service department's reputation.

I cannot speak to things as they stand today with any certainty, but when I was selling, the studies showed that on average, people paid more at "no haggle" dealerships than in more traditional dealerships. If I remember right, the average profit margin (per vehicle) for no haggle places were somewhere in the 1500-1800 range while the average profit in a traditional store was somewhere between 1000-1200. In reality, consumers could always and without exception negotiate a better price at our store than they could get at a "no haggle" dealership. (This is even more true with all the pricing information that is available now.) At the same time, this points out a fundamental fact that I think is often missed in economic discussions of price and that is this: price is not the only thing that matters to consumers. For whatever reasons, haggling really bothers some consumers, so they are willing to pay more in order not to have to haggle. In fact, when we explained that they could negotiate a better "deal" at our dealership, some would say, "Yes, but I hate the haggling. I'm going to buy it at XYZ Chevrolet because they have not haggle pricing."

In the opposite way, a similar thing applies the concept of "reverse auctions," something that went on well before the internet was available as a tool. (Customers would buy a pricing guide, figure out the cost and then shop 3-4 dealerships in person or on the phone.) People's decision to buy at X or Y dealership rarely included only the price. People are concerned with how they are treated, how will they be "taken care of" if there is a problem, if you are their cousin, will their car get equal treatment (in terms of que position, etc.) in your stellar service department if they buy somewhere, etc. . Some people will ignore all other factors and purchase simply on the fact that they saved $50 on the price, but they are the rare exception. The same thing could be said of other venues at well. For example, David Platt's Wal-mart might be great, but having lived in 3 large cities over the past 10 years, our Wal-mart has always been awful: out of stock or shelved wrong, prices mis-labeled, service terrible, both in terms of salesperson's knowledge and interest in helping, products (esp. fruit and vegetables) are cheaper but inferior in quality, etc. This may be different in small towns, but I suspect that many who live in large urban areas might have similar experiences. As a result, my wife and I avoid Wal-mart as much as possible. Service, quality, having what we want/need matters to us, not just the dollar price. Incidentally, the same goes for the "big box" hardware stores. Although the service is usually good in terms of friendliness, the knowledge is often lacking. If you want someone who can help you figure out how to retool your router in order to make a particular edge for an old table you are re-working, the tool guy at HD can sell you the bit, and he's probably nice, but he's not going to give you much insight on the project--often because he's simply filling in as a "loaner" from the paint department. For help, you have to go to a "Mom & Pop" store, or at least to a franchise store like Ace or True Value.

Interestingly enough, I did not sell cars too long. Although I loved working with people and selling "the product," (showing them the benefits, finding the right car, etc.) I did not like "haggling" with customers. Ironically, I probably would have enjoyed working at a "no haggle" dealership (and likely made more money as well!). But that says more about me than about the process.

Third to last thought: One thing that always amazed me was that often customers who were very savvy about pricing and haggling did a poor job of comparing apples to apples. Often, they wanted to buy an S-10 with power locks and windows from me at the same price another dealer offered them on one without power locks and windows. They weren't being brutal negotiators, but they legitimately thought that they were "the same truck except for the color"

Second to last thought: why do people not mind haggling over house prices but hate it when it comes to vehicles? Lots and lots of deception goes on in both cases (both seller and buyer) and so that is a constant, so what is it? I think that is a curious thing.

One more thing: when the Chevy Tahoe/GM Yukon came out, we could not "get enough." Always good at manufacturing trucks, GM had a real winner. We sold over sticker price on pre-order and GM raised the price several times. It was a hot vehicle. Believe it or not, the Chevy Cavalier was the same at first. Although we made no money on those and they (rightfully) have not endured as a popular vehicle whereas the Tahoe has...

Thanks again for a great podcast,

Miles

Alvin writes:

Russ,

Always great to have Mike Munger back on the show.

One request: I hope you will bring back Mike to discuss his cultural observations from Germany or wherever. I think that would make for a lively and interesting discussion.

Alvin

Trevor writes:

Walter.
I wouldn't expect that you would know what the actual values but if you know of the kind of costs I'd be interested in knowing as well.

There is definitely conflicting information from the dealership owners and corporate GM. The burden of proof would lie with GM since the dealers claim there are no costs.

Proving what doesn't exist would be a bit tougher in this case.

jldugger writes:

I recently purchased a Subaru; this talk and pointer to a dealer interview came a bit too late. Probably, this comic is easily adaptable to car sales.

Anyways, I recently got a request to fill out a survey about the experience. It seems that Subaru considers 4 out of ten "average". This leaves an lot of wiggle room on the high end, and not much on the low; it seems awful optimistic to think you need greater accuracy there.

MikeD writes:

Russ,

I'm Never Disappointed when I hear the First Thing Out of Your Mouth is to BASH the auto unions or the worker in almost every topic you bring up. Do you realize your own distorted bias?

I've never had a problem with the union work of the Cars I've bought from American Manufacturer's.

Here's my car list:
- Dad's Chevy Malibu 67, Dad bought the more affordable 6 cylinder, with a 1 Barrel Carb, and a 2 speed auto. My uncle bought the 68 with a V8 and a 4 on the floor. Even back then, GM sold two types of vehicles: The Guzzler, and the low end, you could not get a High MPG 6, what at least a 2 barrel carb and a 3 spped auto. Which would have shown a much greater difference in fuel economy vs. the V8.
Car was well built and reliable, and handled well, lasted 20 years. Notice the poor value of the 6? This is what ticked me off about GM.

- My Ford Mustang: 6, a Tractor motor. Lasted 15 years. Again a terribly inefficient 6, vs. a lot of money V8. No problems.
Notice the poor engineering of this motor?

- Mercury Merkur XR4Ti, well built, beautiful ride, great performance, excellent handling, good economy ( vs. a V8 ). The, only a V8 wlll do, auto reporters Panned this car. This was the best car I ever owned. Problem: Stalling issue at year 7. Ford did not address this issue until forced to by a lawsuit, 15 years later.
Dealership could not fix the Electrically Heated seats after 3 try's!
Notice the Poor dealer support? And Poor Manufacturer support?

- Ford Probe: Well built, excellent performance for 170 hp v6, east coast too crowded for this type of car. After 3 years the ride was too harsh.

- Subaru Outback: Ford and GM Refused to build a 4 wheel drive CAR. Dealership expected Me to pay half the cost for a broken axle, while in the warranty period. Subaru has lost their repeat business.
Notice GM and Ford didn't have any 4 wheel drive cars available?
Notice the Poor Dealer support?

- Now, I'm looking for a Hybrid. Ford and GM are pricing their hybrids into the Unaffordable Range. They see Green Customers as customers to fleece.
Notice the PRICING?

So, my issues are with Management. Did not back up and fix a stalling issue. Did not support the product.
Did not build the car I wanted to buy.

MikeD writes:

Why don't you do a story of "Free Trade", where we let China impose a 30% tariff on imported cars, and we impose a 3%? tariff?

This is a Suckers Bet. I thought that in Game Theory the best strategy is to mimic your opponent's moves. Why is the US Not Imposing a 30% tariff on Chinese cars?

Who is Funding our Politicians to allow Chinese goods to flood the US market with Low Tariffs? WalMart?
Why during your WalMart post, didn't you bring up Health Care Costs? Is it your position that the CEO is the only one entitled to Health Care? And what about Displacement?

WalMart Displaces mom and pop stores, who pay themselves maybe 50,000 to 100,000 in salary and have Full Health Care benefits on a Family Plan.

By the way, in Philadelphia, there are Good Mom and Pop Stores that bend over Backwards to get you what you need. And have their floors stocked Floor to Cieling with good High Quality items.

I also notice you didn't cover the POOR Quality of the WalMart Junk from China? That's not an issue for you? It is for me. I don't like having to buy a NEW RAKE Every Year, for example and a New Lawn Mower every 3.

John Henry writes:

Great Podcast. I think you and Munger always go well together on any topic. A suggestion and a couple comments:

Suggestion: Roger Penske bought the Saturn brand from GM last month. It is too soon just now but I think you should follow this story and see what happens in 6 months or so. Penske seems to have a magic touch, turning loser or so-so businesses into gold. It will be intereting to see what happens.

Someone mentioned Deming and SPC as the reason for Japanese success. The real reason for Japanese success was that Toyota read Henry Rord's 1923 autobiography that explains how to manufacture high quality cars cheaply. They then implemented the book pretty much word for word. The book was out of print in English for 80 years. It has never been out of print in Japanese. That might tell you something. Download it here
http://www.gutenberg.org/etext/7213 or buy a copy here
https://www2.xlibris.com/bookstore/bookdisplay.asp?bookid=32476

Best book on manufacturing in general and lean manufacturing in particular ever written. Lean manufacturing is my field and I've read over 100 books on the subject. No other one is even close.

You can also read the chapter on measurement and quality from his 1933 book "Moving Forward" on my website at http://changeover.com/metro.html (I am in the process of scanning the whole book and will eventually make it available on Gutenberg. I thought this was the key chapter.)

I agree with the person who took umbrage at criticism of the unions. They did not cause the problems of GM. It was management and giving in to union demands. Blaming the unions for GM's demise is like blaming a kid for eating too much ice cream. It is the parent's job to say no. As Gompers said, what the workers want is "more" and it is the union's job to try to get it for them. It is not the union's job to decline if management gives more than it should. It is management's job to say "enough".

And, without getting into the whole free trade issue, I would just ask the commenter why the 30% Chinese tarriff is a problem for the US? Seems to me that this tariff is being paid by the CHinese buyers and would be a problem for them. Now kf we started charging a 30% tariff on Chinese imports to the US, THAT would be a problem for us.

Finally, the last American car I had was a 1982 Malibu, bought new by my company for my exclusive use. What a piece of crap. I've owned nothing but Mitsubishis and Nissans and one 1985 Subaru since. All have been excellent cars with no maintenance other than fluids, brakes and alignments prior to 125-150,000 miles. I almost bought a Ford Explorer 4 years ago but wound up buying a Mistubishi Outlander. It was just a lot more car for the money.

Now of course, I would not take a GM or Chrysler if it were given to me. I do not want to drive a govt car.

I look forward to every Monday.

John R Henry
www.changeover.com

Mike Munger writes:

For Mike D: Sir, we may just disagree. China is taxing its own consumers heavily, with those tariffs. I agree that they are making a mistake.

But why will it help if we make the SAME mistake? The jobs we save will cost US consumers up to twice, or even more, the total salaries and other benefits of the jobs saved. This has been demonstrated over and over, in a variety of studies. I know of no game theory result that suggests that if you opponent does something stupid you should do something stupid also. If China wants to subsidize US consumers, why not let them?

You make two other points. One is about the rake. I agree. I buy high quality tools, and power equipment. Some of it is made in the US. Much of it is made in Japan, however. The power tools they make (eg, Honda power tools) are expensive, but they are really first rate. There are many outlets that sell these high quality tools and equipment, available for you in your community. I'd say you should spend the money.

The other point is about health care. This is a win for you, and we SHOULD do a pod cast about it. Other nations substantially subsidize their exports by providing for health care out of general tax revenues, while we "cover" health care in a patchwork way, through labor contracts.

However, as my analysis of US auto employment (for example) contracts shows, the problem is that US autoworkers get benefits 30-40% BETTER than their German or Japanese competitors. If US autoworkers got only the world average level of health care, our auto industry would have been competitive. Still, you are right that the GENERAL level of public subsidy, for most industries, is quite high when it comes to health care.

Mike

Phil Niswonger writes:

Mr. Roberts and Mr. Munger,

Please refrain from referring to Ford, GM, and Chrysler as "American" and all others as "foreign". Toyota has plants all over America and is traded on the NYSE. Ford has plants in Mexico and has many non-Americans as owners. Calling Toyota foreign is inaccurate and is a term that people latch onto to re-enforce protectionist thinking.

Mike Munger writes:

Phil Niswonger raises an interesting point: what is the "nationality" of an auto company?

It is true that here in Germany I see MANY Fords, all of them assembled entirely in Germany.

Still, there is the question of nationality, and I would answer it this way: If the company goes belly up, whose taxpayers are going to have to pony up for the bad decisions?

By that standard, Chrysler, GM and Ford are American. The others are not. If Skoda goes bankrupt, American taxpayers won't have to pay. Same is true of Toyota, no matter how many plants they have in the US.

Still, your point is a good one, Phil. Making the discussion hinge on nation state is really quite beside the point, and even misleading, UNLESS the discussion comes to center on protectionism. Then national focus is unavoidable.

Phil Niswonger writes:

Mr. MikeD:

1.) Your idea of game theory and mimicking is false. If you and I were dueling and I shot myself in the foot, is your best response to shoot yourself in the foot?

2.) You ask " Is it your position that the CEO is the only one entitled to Health Care?" I will not speak for Mr. Roberts or Mr. Munger, but I believe no one, including CEO's, are entitled to health care. It is to be earned like anything else in life.


marko writes:

One thing that you are ignoring is that other companies in other countries also have independent dealer networks.

I do not know why that is the case, but there are no crazy regulations like in US, so I guess there has to be some other explanation...

Lukus C. writes:

Interesting podcast. I'm a big fan of the show.

I recently read a forthcoming paper by Tom Woods that I think could have some points relevant to the subject of the auto industry.

In the paper, Tom points out how the astronomical amounts of defense and military spending in the US have drained a huge amount of manufacturing, engineering, and R&D resources out of the private, civilian economy. Particularly, pages 13-15 detail how tax-funded defense research robs many of the brightest minds, who would otherwise be doing work that would benefit the civilian population. It's not hard to imagine that the American auto companies were to some degree victims of that brain-drain.

The paper also details the decline in American-made machine tools due to defense-related influence, which then led to declines in manufacturing developments. Much machine tool manufacturing shifted to foreign producers whose militaries weren't sucking so many resources out of the civilian economy. The shift in car manufacturing wasn't far behind.

The paper is great on its own, but it really intrigued me as to how it might apply to this subject after I listened to the podcast. Here's a link to the paper:

http://mises.org/journals/scholar/woods2.pdf

I'd be interested to hear what you think.

Gary Froehlich writes:

Your question "Why the car companies went with the dealer model instead of direct selling."
It seems you also know the answer but want one of us to reply. You said the dealers used state laws to tie the hands of the car companies. Which is the answer to why they went with the dealer model. Car dealers have connections to state & local politicians and even to the national politicians that represent their area. The car companies could use those connections. The car companies did not think about those same connections being used against them.

Charu writes:

This is my first comment at EconTalk, and I have to say that these podcasts really make my commute a breeze. Regarding vertical integration: it would be interesting to compare this across other industries. For example, I work in a software company that primary sells back-office software for making IT more efficient. Software is probably the opposite of cars in terms of creation, inventory, etc., and yet we still have distributors and resellers (in addition to our own sales force). I suspect that flexibility and the cost of doing business is the main reasons that manufacturers rely on others to sell their product. I cannot imagine how overweight our company would become if we suddenly included all the partners currently selling our product. Just the thought of having that many employees... So I think it's a lot more complicated than just local politics or legacy business models.

mjh writes:

Part of the reason that I don't buy cars at Saturn or Carmax is that I think the cars are overpriced compared to what I can get haggling elsewhere. With Carmax, this is really easy to test. Go there armed with data from edmunds.com (or other sites) and see if the prices match up. In my experience, they don't.

Of course, another part of the reason, is that I really enjoy the haggling process. It reminds me who is in control of the money and that we must come to a mutually beneficial *agreement* before a trade is made. My favorite thing to do is to start walking off the lot when the dealer says it's his best deal. If they let you, it's true. And then you can come back later and say, "Hey I reconsidered." If they say, instead, "Well, let me see what we can do" then you know that your offer is acceptable to them, they just want to see if they can pry out any more from you. Before we had kids, my wife & I would go to car dealers to haggle for 3 hours as a date. It was fun. (Although it's clearly not that fun of a date since, now with fewer dates, we choose other things to do.)

I like the strategy suggested by the 1st post. I may have to try that one. Although, if it becomes widespread, information sharing between dealers might reduce it's effectiveness.

paul roscelli writes:

With respect to the cars designs in the 50's being more "iconic" as compared to the 70s and 80s and how that affected manufacturers with multiple lines of cars, I have a thought.
It seems to me that as the government got more and more involved in dictating safety, materials and MPG the designs of all car makers converged. Yet another "tether" on the car companies ability to individualize cars were these government policies. As car design became ever more constrained, the look of cars became ever more similar. This works against car companies with multiple lines (and hence multiple product differentiation opportunities) and works to the advantage of car companies with fewer lines ( Honda, Toyota, BMW). I think at some point consumers noted the convergence of design and didn't see much difference between all GM's lines--thank couldn't have helped its sales

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