Electric-car maker Tesla bucks traditional dealership network

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When electric-car company Tesla Motors Inc. started selling its flagship Model S luxury hatchback earlier this year, it eschewed the traditional dealership network to open its own stores.

But that’s not sitting well with U.S. auto dealers, who have controlled new-vehicle sales for nearly a century.

The nation’s roughly 18,000 new-car dealers got a cut of every one of the 12.8 million new cars and trucks sold in the U.S. last year, from the biggest domestic sport-utility vehicle to the tiniest Japanese import. It’s an exclusive arrangement that has made many of them very rich — and one that they’re not about to cede to some tiny Palo Alto automaker.


Some individual auto dealers and regional associations have already filed lawsuits attempting to block Tesla, which now operates 16 stores in 12 states. A La Jolla store opens today.

The upstart automaker’s battle with dealers is shedding light on a little-known practice that it contends amounts to legalized restriction on trade. The franchised new-car dealership system dates back to the start of the U.S. auto industry, when hundreds of manufacturers were fighting for market share. Setting up showrooms was expensive and time-consuming. So automakers sold other entrepreneurs the right to market their cars in specific cities.

Over time, car dealerships became crucial sources of employment and tax revenue for local communities. To prevent manufacturers from opening their own stores and undercutting neighborhood dealers, states developed laws governing the franchise relationship. Bottom line: Carmakers had to leave their retail sales to someone else.

Tesla isn’t buying it. The company wants to sell directly to consumers. That way it gets to keep the profit that dealers make on new-car sales. It’s also the only way an electric car will get a fair shake, co-founder and Chief Executive Elon Musk said.

“Existing franchise dealers have a fundamental conflict of interest between selling gasoline cars,” Musk said. “It is impossible for them to explain the advantages of going electric without simultaneously undermining their traditional business.”

A South African-born serial entrepreneur, who co-founded an Internet payment company that eventually become PayPal, Musk thrives on disrupting established industries.


His Hawthorne rocket maker SpaceX is breaking the historic monopoly that governments have long held on spaceflight. In May, his Dragon spaceship became the first private spacecraft to supply the International Space Station, a test of a $1.6-billion contract to carry out 12 cargo missions.

If Musk can beat back the auto dealer associations, other fledgling automakers as well as foreign brands launching for the first time in the U.S. could follow his lead and cut dealers out of the loop.

Elaine S. Kwei, an analyst at Jefferies & Co., said Musk’s strategy makes sense. It would enable Tesla to keep control of the sales experience and educate consumers about its electric car, an automotive technology that most shoppers know little about.

Tesla “is at a disadvantage compared to the vast existing networks of dealerships and marketing budgets of the major automakers,” Kwei said. “As a brand-new manufacturer with a new vehicle technology, they have to try something different.”

Dealers are nervous that other, larger manufacturers might adopt Tesla’s sales model, said Aaron Jacoby, a Los Angeles attorney who heads the automotive industry group at the Arent Fox law firm. On average, dealers make about $1,300 on a typical new-car sale before expenses.

According to the National Automobile Dealers Assn., 48 states either prohibit or in some way restrict automakers from owning sales facilities. For example, in California a manufacturer can’t have a store within 10 miles of a franchised dealership of the same brand.


Still, laws in most states do allow automakers to open their own stores if they don’t have an existing dealer network. That’s why “Tesla is more likely than not to prevail,” Jacoby said.

Dealers aren’t conceding. Last week, the Greater New York Automobile Dealers Assn. and a dealer in the region sued Tesla and the New York Department of Motor Vehicles, alleging that they violated state franchise laws when Tesla opened a store in Westchester, N.Y., in late May.

Additionally, the Massachusetts State Automobile Dealers Assn. is seeking a preliminary injunction to close Tesla’s store in suburban Boston. The legal actions were first reported by the trade journal Automotive News.

Musk said the lawsuits, “are starkly contrary to the spirit and the letter of the law,” adding that the plaintiffs “will have considerable difficulty explaining to the court why Tesla opening a store in Boston is somehow contrary to the best interests of fair commerce or the public.”

Tesla has no existing dealers who have risked their own money building showrooms and marketing the brand. Therefore, Musk said, there are no franchisees “anywhere in the world that will be harmed by us opening stores.”

The U.S.-style dealership system is the way most cars are sold around the globe. That model has enabled carmakers to focus on product development and manufacturing, leaving retailing to dealers, who have the specialized sales skills to move cars.


Still, outside the U.S., some carmakers operate their own retail outlets. BMW, for example, has 18 company stores in Germany, and it also owns stores in most European capitals as well as in Tokyo and Sydney, Australia. In South Korea, Hyundai both operates its own stores and uses franchises to sell cars.

But U.S. dealers don’t want a hybrid system taking root in the United States.

The National Automobile Dealers Assn., which has 16,000 members in the U.S., said it has “serious concerns about Tesla’s intentions” and is seeking a meeting with Musk.

“NADA supports the franchised new-car dealer system, and will provide legal support to state dealer associations if necessary,” said Bill Underriner, chairman of the National Automobile Dealers Assn.

Although the dealership system has allowed manufacturers to get their cars to far-flung locations, automakers have discovered it also has its share of flaws.

It’s hard to get thousands of individual dealers to adhere to consistent sales and customer service standards. That has hurt the industry’s image. Moreover, studies by market research firm J.D. Power and Associates and other organizations have repeatedly found that most car buyers dislike haggling with high-pressure salespeople.

Tesla sells its cars for a set price and Musk said his sales staff does not work on commission. The company is also steering clear of traditional auto rows and opening stores in upscale shopping areas. Its Santa Monica facility is on the Third Street Promenade, flanked by an Adidas store and Club Monaco, an apparel retailer. Parking is a block away in a public garage.


“We are deliberately positioning our store and gallery locations in high-foot-traffic, high-visibility retail venues, like malls and shopping streets that people regularly visit in a relatively open-minded buying mood,” Musk said.

So far Tesla has not presented much a threat to car dealers or the industry. It has produced fewer than 400 of the Model S and is slowly ramping up production of the vehicle at the Tesla factory in Fremont, Calif.

The car offers seating for five adults and sells for about $50,000 to more than $100,000 depending on trim level and options. It is fast, boasting a zero-to-60 miles per hour acceleration of less than six seconds. The car has received rave reviews from the automotive press.

“It is designed with the aspiration of not simply being the best electric car, but being the best car of any kind,” Musk said. “Despite being purely electric, it is faster zero to 100 than BMW’s top-of-the-range M5.”