The Myth of the “Middleman”
Updated: Jan 14, 2022
Dealerships aren’t middlemen any more than Amazon or Walmart are.
Often in the automotive media or on blogs, you’ll find dealerships referred to as “expensive middlemen.” Middlemen, because they exist between the factory and the customer, and expensive, because they don’t usually sell cars at a loss.
But the reality is that dealerships are not middlemen any more than Amazon or Walmart are. Some entity—either owned by factories or locally by businesspeople—must retail vehicles. And shifting ownership of the retail channel from local dealership to factory store doesn’t create any savings in and of itself, because the factory store becomes the new “middleman.”
The factory will need to make its own profits in retailing. And worst of all, customers are usually hurt when factories vertically integrate sales with manufacturing because it raises prices by reducing retail price competition.
When factories decide to sell products “directly” to customers, they incur costs of selling those products to customers—in the same way that an independent distributor would incur costs.
In the automobile business, that means factories “selling direct” would incur the costs of running a dealership—costs of buildings, land, equipment, inventory, insurance policies, utilities, and all the human capital needed to operate.
Eventually, manufacturers that experiment with selling directly always run into this reality. They always find that auto retail is complex and that having local dealers buying those cars off the factory line, and selling and servicing them in their local communities makes a lot more sense as a business model.
“But what about the profits?” one might ask. “Can’t selling direct eliminate dealership profits?”
Not really. The fact is that because of the fierce competition, dealerships make very little money selling new cars. Local dealerships are only profitable when they take into account the entire ecosystem of the vehicle—sales, service, used-vehicle sales, reconditioning contracts, fleet maintenance, and on and on.
Local dealerships are capital-intensive businesses—that is, it costs a lot in land, buildings and equipment to run them. American dealerships have invested a total of more than $200 billion in land and buildings alone. Any factory wishing to sell directly would incur those same costs of capital—and its shareholders would certainly expect to get a return on those expenditures. Why sink money into a retailing operation when there’s no return on it?
For consumers, it could be worse. When factories own retail outlets, there is no direct competition to keep prices down. Factories have the ability to set prices and hold any potential excess profits for themselves. When independent retailers compete, it may result in price pressure. That’s why no supermarket can sell Campbell’s Soup for 10% or 20% more than another supermarket— they’ll eventually go out of business. Same thing with car dealerships. When car dealers compete, prices have the potential to go down. One peer-reviewed academic study has shown that when dealerships compete in proximity to each other, the average price of a vehicle drops by about $500.
And price competition affects not only sales but service and repairs as well. Customers at one factory-owned retail chain have had to wait literally three weeks or longer for a service appointment. Can you imagine waiting three weeks to get your vehicle fixed? Nowhere in America today would a customer have to wait that long to get service on a Chevrolet, Jeep or Toyota. If one local dealership can’t get you in for a service appointment this afternoon, the dealership down the street most certainly can. Consumers win when dealerships compete.
In the end, the “middleman” myth is a really lazy and simplistic way of thinking about business. If local dealerships are middlemen, then Walmart is a middleman. So is Amazon. But Walmart and Amazon aren’t expected to service or repair the products they sell, like dealerships do.
Local dealerships do a lot more than sell cars. They help their customers over the life cycle of the car—from sales, to financing, to registration, to service, to trade-ins. They compete for customers at every stage of the ownership cycle, providing choices and competitive pricing for customers.
That’s why locally owned dealerships are good for consumers and for the communities where they operate. It’s been that way for a hundred years, and it will be good for customers for the next hundred years.