0:36 Intro. [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.

4:20 Franchisees 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.

11:00 American 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.

19:27 Nobody 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.

28:42 Seems 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.

31:23 Political 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.

40:10 Back 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.