Why restricting Tesla sales in New York is bad for Innovation

Tesla is having itself a pretty nice year so far. Not only were sales of its first mid-priced sedan, the Model S, 20% higher than anticipated (helping land Tesla a nod on our Most Innovative Companies list), but Consumer Reports recently gave it top honors in its annual rankings of the best cars available for 2014.

It has had its share of hurdles, too–as is to be expected of an up-and-coming company looking to carve out a place for itself alongside existing auto giants and the retail industry they have spent the last century building. This week, a Capital New Yorkreported that a bill is currently making its way through the New York State Legislature that would explicitly prohibit the direct sale of vehicles from automobile manufacturers to consumers. If passed, it would present a major blow to Elon Musk and Co., since direct sales are how Tesla moves the vast majority of its vehicles. Writes Scott Waldman (emphasis added):

Deborah Dorman, president of the Eastern New York Coalition of Auto Dealers, was at that meeting and said Tuesday Cuomo aides told the group the governor would sign the bill if it passes… She said the bill was designed to protect consumers because it required companies to create a storefront in the state and was not directed at Tesla because it sold electric vehicles. Some environmentalists have claimed the bill unfairly targets electric car manufacturers.

The spirit of innovation seeps into everything Tesla does, from the staff it employs to its battery swapping technology to its not-all-that special business model that relies on the Internet.

The Eastern New York Coalition of Auto Dealers, which has not responded to a request for comment, is a trade organization that works in the interests of car dealerships sprinkled throughout the state; Tesla is notoriously opposed to selling its vehicles in auto dealerships, preferring special “Tesla Stores,” or showrooms where consumers can test drive vehicles before purchasing them online. Indeed, the state of New York has tried to prevent Tesla from opening new stores within its borders before.

In this case, the coalition’s main argument is that direct sales give manufacturers like Tesla a competitive advantage that, according to Dorman, is unfair. Slate’s economics writer Matt Yglesias agrees, in a manner: There is a clear competitive advantage. But that’s kind of the point:

One of the great things about the journalism industry is that thanks to the First Amendment, it’s very challenging for incumbents to try to use this kind of business strategy. Owners of print magazines can’t complain that it’s “unfair” for Slate to enter the marketplace with its low-overhead web-first strategy.

Other critics weren’t quite as delicate. As Seth Weintraub, who founded 9to5 Mac and 9to5 Google, writes at Electrek, the decision is “a fantastic litmus test to see if your state government represents the people or corporate interests. 90+% of voters want to be able to buy cars outside of the dealership monopoly. If your state even votes on something so lopsided, they should be voted out.”

Comparatively speaking, dealerships are not the most efficient way to sell vehicles. Maintaining an inventory is expensive, especially after the 90-day mark, when car dealerships have to begin paying the manufacturers for unsold cars and trucks. Other overhead costs like property taxes and sales staff salaries eat into your bottom line, too.

In fact, a 2009 competition advocacy paper put together by the Economic Analysis Group, or EAG (which provides economic analysis on civil disputes for the Department of Justice’s antitrust division), found that state franchise laws prohibiting auto makers from “making sales directly to consumers” are–unequivocally–bad for business. Why? Part of the answer is that built-to-order, direct from the manufacturer sales have shown to be far more competitive and profitable wherever the practice is legal. “As a matter of economics,” wrote EAG, “arguments for state bans on manufacturer direct sales of autos based on holdup and free-rider problems are not persuasive because competition among auto manufacturers gives each manufacturer the incentive to refrain from opportunistic behavior and to work with its dealers to resolve any [issues].”

Even GM–a company which, let’s remember, not too long ago required the saving graces of a $10 billion government bailout–has implemented programs to sell factory direct to consumers in Brazil, where one of its major plants is located. Indeed, EAG concluded its analysis with an appropriate analogy for what Tesla is trying to do: “Just as Dell has altered its distribution model in the personal computer industry to better meet evolving consumer preferences, car customers would benefit from elimination of state bans on auto manufacturers’ making direct sales to consumers.”

If, as the Eastern New York Coalition of Auto Dealers claims, requiring brick-and-mortar stores to sell electric vehicles is anti-competitive and not in the best interests of consumers, perhaps we should let the market decide for itself.