Sean Chandler

Tesla's Sales Moat

TSLA

Summary

  • Tesla dodged a bullet by avoiding the dealer sales model.
  • Dealerships add thousands to the cost of each sale, and this now gives Tesla a cost advantage.
  • Any automaker that has sold franchises (dealerships) could not replicate Tesla's sales model due to strong laws backed by dealerships that are collectively worth more than individual automakers.

During Tesla’s (TSLA) most recent call, otherwise known as the secret conference call, Elon Musk commented on its shift to an online sales model. He was right on the money with the following statement:

“This will be a long-term competitive advantage of Tesla that only a start-up could replicate. No one who has sold franchises (dealerships) could replicate this and I think this was an extremely important strategic decision.”

The size of the service and sales operation is enormous. I knew it was big, but I was surprised by how much after some simple digging. I go into further details below using Honda (NYSE:HMC) as an example. In short, Honda’s US automotive dealerships are collectively worth at least 27% of Honda’s entire valuation. That’s dealerships from one country vs. a global company that sells more than just cars. In terms of sales, the US accounts for just 30% of Honda’s global auto sales, and furthermore, nearly a third of Honda’s business comes from outside of cars.

That would be as if just Apple's (AAPL) US retail stores were collectively worth $230B, or just 19% less than Walmart's (WMT) total valuation. Fortunately, with no franchise laws, Apple can sell its products online, with its stores, and to third-party retailers. Unfortunately for Honda or any auto manufacturer with the exception of Tesla, there's no such freedom. For Tesla, this is a huge cost and customer experience advantage. Ultimately, it’s a sales moat that, in my opinion, is one reason that allowed Tesla to exist.

Tesla needs a great marketer

Before I go into auto sales I want to touch base with this secretive conference call. Everyone who wasn’t a part of it, including strong supporters, were disappointed. This has only added to the lack of finesse that Tesla has had lately. With $1.6B in lease obligations due through 2023, the sudden closure of its stores has been put on hold, making Tesla look like an amateur (again). I think a lot of it has to do with a lack of a great marketing director, if there's one at all. Instead of creating a video or event of Tesla handing out the first $35,000 Model 3s, it instead gave the steering wheel to the press.

Musk should stop participating in conference calls

During the conference call, Musk presented the news in five minutes and allowed the press 30 minutes of Q&A. The questions started with CNBC reporter Phil LeBeau asking Musk if his Model 3 sales projections were based on hand razors. It’s the job of reporters to be critical, but it almost appeared as if he was intentionally hoping to upset Musk. Probably not, but from that point onward you could tell that Musk wasn’t happy.

The next reporter asked a series of back-to-back questions and Musk interrupted him and told him to pick one question, to which he then answered with “Nope. Next.” I’m not sure why Musk does this to himself - perhaps he should follow Steve Jobs, who almost never attended public conference calls including those that followed earnings. I think investors would be very happy with this.

The value of the sales operation

According to the NADA, there are nearly 16,800 franchised auto dealerships in the US and not a single one is owned by a car manufacturer. How much each dealership is worth is difficult to gauge, but if we look at some publicly-traded corporations we can get a general idea. Lithia Motors (LAD), which owns about 190 dealerships, has a valuation of $2 billion, and AutoNation (AN), which owns about 300 stores, is worth $3B. To put it simply, that’s an average of $10M per store.

Dealerships are no small operation. In 2018, Honda sold 1.6 million vehicles across 1,320 dealerships. Given that a Honda dealership is probably more desirable to own I think that on average each is worth over $10M. Either way however, at $10M a piece that’s a value of $13.2B or roughly 30% of Honda’s $48B valuation. That’s just US automobile dealerships. Honda lists that its total US retail network consists of 12,300 dealerships employing 158,000 people (Honda sells more than just cars). That’s five times more than the 31,000 people that Honda employs in the US (same source as above).

I don’t know what fulfills the requirement of these other 11,000 dealerships since Honda sells engines for just about everything that moves, but it’s safe to say that the sales and service operation from just the US has a very high value on it. Unfortunately, due to its high value as well as the franchise laws that protect it, Honda will likely never be a part of this operation.

A game of pennies

Every penny counts and Musk coined the $35,000 Model 3 a “game of pennies” during the conference call. The last few pennies for Tesla came from the retail operation, which again is a luxury no other automaker can afford to alter. Tesla’s direct-to-consumer sales model is lean in comparison to dealerships. In my honest opinion, Tesla wouldn’t exist today if it weren’t for the inefficiencies of the dealer model. The numerous costs passed on to the customer prevent cars from being more affordable. The insane economies of scale that automakers like Honda and Toyota (NYSE:TM) would acquire with its own sales operation could allow them to price its cars so effectively that considering a Tesla would be too costly.

Leaching off a bad sales operation

The automotive industry directly or indirectly employs millions of people in the US, most of which are not associated with the manufacturer. In a sense, they are all leaching on what's a terribly inefficient sales and service operation. It’s easy money for those not making the cars.

Since dealerships compete with each other, they each have hundreds of cars in inventory likely costing thousands in interest payments to local banks each day. AutoNation and its 300 stores reported “Other interest expense” of $119 million in 2018, which includes inventory financing. Tesla does this, too – its cars are shipped to the customer after they’re made rather than sitting on storage lots for what could be months.

Additionally, each dealership has its own unique website and CRM, which is typically run by a third party such as dealer.com. Dealer.com was purchased by Dealertrack Technologies for $1 billion, a company that managed a gross margin of nearly 60% by providing dealerships with a sales platform. Dealertrack was later acquired by Cox Automotive for $4B. That’s nearly the value of Lithia Motors and Autonation combined.

Dealerships also are big spenders on unique services that you don’t find at a Tesla store. Ever walk into a dealership and wonder what prevents every salesperson from running up to you for attention? Likely an up system such as NextUp, which puts salespeople through a rotating sales queue. Ever been to a dealership with salespeople using iPads? Intellacar might be why. It’s an iPad app that helps educate salespeople on-the-go and provide customers with videos to watch while they do nothing but wait for the finance manager salesperson.

Dealerships also independently manage DMV operations, advertising, and customer documents (doc fees can cost over $400). They also must have their own HR department and employee insurance plans, among other benefits. The list of inefficiencies goes on and on. Under a large corporation this would be outright unacceptable, but franchise laws protect them from manufacturers impacting almost everything that goes on at a store.

Despite this lax system that many corporations find a way to leach on, dealerships can be very profitable and its associates are paid quite well. In its 2018 annual report, Autonation reported an average gross profit of $1,660 per new vehicle sold, with an additional average of nearly $1,800 from the back end - those are markups on resold products like warranties, insurance, rust protection, alarms, etc. Ultimately, this is an expense that hurts the customer and manufacturer. To go back to salaries, here’s how dealer employee’s compare to a Tesla’s:

Role (Dealership)

Average Salary

Role (Tesla)

Average Salary

Dealer salesperson

$48,000

Product Specialist

$32,000

Dealer Sales Manager

$108,000

Owner Advisor

$39,000

Dealer General Manager

$119,000

Store Manager

$70,000

Dealership owner

Up to 7 figures?

Owner

N/A

Sources: Ziprecruiter (Dealers: I, II, III) & Glassdoor (Tesla)

The dealership sales and service operation is far from lean. I can’t begin to imagine how cheaply Honda or Toyota could sell a quality, mass-produced car like the Accord, Camry, Rav4 or CR-V if it weren’t for these inefficiencies. Given the attention to detail that they’ve reached in manufacturing, I could only imagine that the sales operation would also be lean. So lean in fact that I don’t think Tesla could ever exist, especially with all of the costly mistakes it has made in the last 12 months.

Automakers would love to copy Tesla’s sales model

The NADA argues that the dealer franchise system adds value to the consumer and uses an example where cars were $500 more in places where dealer competition didn’t exist. If car manufacturers owned the sales operation, I strongly believe prices would be equal across the country with the exception of areas like Hawaii. Competition? Other brands.

Many argue that automakers wouldn’t want to delve into the expenses of owning stores, but this is not true. Adam Jones from Morgan Stanley in an interview with CNBC stated the following:

From our discussions with (traditional automakers) over many years, most auto companies would love to sell vehicles the way Tesla does. There’s just one catch. They can’t. It’s against the law

Franchise laws protect dealerships

In short, franchise laws protect manufacturers from opening stores that would compete and take business from the existing dealerships. As covered above, dealerships are collectively very large, and since they happen, collect the sales tax from the consumer, they become one of the largest tax payers in a given state. This has given them tremendous influence over Congress, and with the power of dozens of dealer associations across the country any manufacturer attempts to start a sales operation has been shut down.

Tesla dodged a bullet

Without knowing, I think Tesla dodged a bullet with its direct-to-consumer sales operation. Tesla initially sold cars directly to consumers so that it would have a chance of actually selling its cars. As a small carmaker at first, Tesla would unlikely find anyone willing to open a store dedicated to Tesla. Selling a single electric car alongside dozens of gas models is difficult since it’s a numbers game.

If you’re a car salesperson or sales manager and have prospects looking for cars, in order to sell the benefits of an electric car you need to undermine the rest of your ICE inventory. I believe the Chevy Bolt suffers from this. It’s a great car and with a tax incentive and 250-mile-plus range, sales should have been very, very good. However, if a new customer walks into your store trying to sell a Bolt would be pouring all your eggs in one basket. It would also invite them to take a look at Tesla.

With an EV-only lineup, Tesla didn’t want to expose itself to this fallback and that's apparent in this blog post. I’m not sure if Tesla was thinking about the inefficiencies of dealerships because it wasn’t until later did it actually find out how strong the dealer associations are through its many legal battles.

Conclusion

If you go to Tesla’s website, you can order a Model 3 in one minute. With a phone call from Tesla and some electronically signed documents, your new car can be on its way to your door step. That’s what car buying should be like. Not only is it a better experience, it’s a lean operation that saves thousands per sale. That's just from the sale, and dealerships make most of their profits from service.

Unfortunately, Honda, Toyota, Ford (F), General Motors (GM) or any other automaker could never replicate this model even though it's apparent and obvious that they would want to in today’s Internet-based society. Franchise laws prevent this and its backing by dealer associations and dealerships that are collectively more valuable than the manufacturers are independently there’s no way they can win.

Tesla’s current retail operation avoids most of these inefficiencies and stated that moving to an online-only sales model would save it 6% on the cost of the $35,000 Model 3. As mentioned, this plan did not go so smoothly and the latest news shows that it will raise the price of its premium vehicles by 3% to make up for this. I can’t imagine how much competitive automakers could save by adopting a similar sales model. If they did adopt a similar sales model, especially while Model 3s started at more than $50,000 I could never see Tesla having anything near the success it is today as its cars would be immensely more expensive than what Honda or Toyota could sell affordable vehicles. In that sense, they lucked out, and going forward it’s just one big moat.

Here’s a similar video I made on 5 reasons why Tesla doesn’t use dealerships:

Disclosure: I am/we are long TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.