Pub 6 2021 Issue 1

20 The Sad, Lazy Myth of the “Middleman” M any first-year MBA students learn a marketing concept called the “Iron Law of Distribution.” The idea is that when you bring a product to market, you can change who owns the distribution channel for that product — but changing who distributes the product doesn’t change the cost structure associated with distributing the product. That is, you can change whether a factory or an independent company owns the retail outlet — but that by itself doesn’t change or make retailing costs disappear. This is a stumbling block for lots of factories that are looking for ways to reinvent themselves. It’s also a huge source of misunderstanding for business reporters who cover companies seeking to “sell direct.” If factories own their own stores, the narrative goes, then there will be no “middleman,” their costs and profits will go away, and the savings will get passed along to customers. Except for the Iron Law. Changing retail ownership 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 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. The Myth of the Middleman The fact is that when a factory decides to sell its products directly to customers, they incur costs of selling those products to customers — in the exact 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. They would incur the costs of buildings, land, equipment, inventory, insurance policies, utility bills, and all the human capital needed to run the operation. And the auto dealership business is complex. Longtime auto industry analyst Glenn Mercer calls the dealership business “the most complex retail business in America today.” That’s because local dealerships don’t just sell new cars. They service them. They arrange financing for them. They handle registrations and titles. They take trade-ins. They advertise and collect sales data and customer lists. They often also sell used cars. This is another reality that gets completely lost in the “direct sales” debate: Dealerships take care of their customers for the entire lifetime of the automobile across the entire automotive ecosystem, not just the point of sale. Manufacturers that experiment with selling directly always eventually run into that reality. They always find that auto retail is complex, that factories are not all that good at retailing, that having local dealers buy those cars off the factory line, and selling and servicing them in their local communities makes a lot more sense business model. Dealerships take care of thei r customers for the enti re l i fetime of the automobi le across the enti re automotive ecosystem, not just the point of sale. B y Jonathan Collegio, NADA Senior Vice President of Public Affairs