Dealership Competition In The U.S. Automobile Industry

American Economist, Spring, 2001 by Lall B. Ramrattan

Lall B. Ramrattan [*]

Abstract

This paper develops a model of dealership rivalry for the U.S. auto industry in line with the research program of Joe Bain. In Bain's research, the literature depicts the auto. industry as a differentiated oligopoly with non-price competition and price collusion. It has established advertising and R&D rivalry successfully, but has focused little attention to dealership competition. Because Bain has given a dominant role to dealership competition, this paper addresses the dealership rivalry problem. We found that a competitive model allowing a firm to react to a rival's past levels of advertising, R&D outlays, and the number of dealers, represents the firms' non-price competitive behavior well for the 1970-1996 period. The hypotheses we used have captured the joint effects of advertising, R&D, and dealerships, when explicit specifications for the financial constraints facing the firms are accounted for. We are able to statistically validate the hypothesis that U.S. firms do compete in dealership systems, as J oe Bain has predicted, within the differentiated oligopoly market structure. The results also allow some inferences regarding the sequential nature of non-price competition among the firms.

1. Introduction

This paper is a sequel to several articles in this journal (Ramrattan [1991]; Ramrattan [1994]; Ramrattan [1998]) that apply Joe Bain's hypothesis to the U.S. auto industry. According to Bain, auto firms engage in dealership rivalry partly to maintain the product preferences of buyers, partly to sell a substantial part of their products through retail dealerships, and partly to promote sales, specialized maintenance, repair service, and easy access to replacement parts (Bain [1956], p. 300). This study analyzes and statistically explains how auto firms compete in their levels of dealerships. Such competition can take place over exclusive or dual franchises, with the special case of the latter entitled intercorporate duals. The method of dual dealership suggests that dealer rivalry among firms may not fall under the traditional leader-follower model found with advertising and R&D rivalry. Broadly speaking, we find that the proliferation of products has encouraged nonexclusive dealerships, (Dhebar, Neslin, and Quelch [1987], p. 338) while intercorporate duals are located mostly in rural areas where dealers tend to spread their overhead. (Bresnahan and Reiss [1985])

The domestic auto firms let their dealers carry practically all their inventory, except cars in transit, (Blanchard [1983], p. 368). An early policy of General Motors, aimed at smoothing out seasonal variations, related dealers' inventory holdings to a sales index (Kashyap and Wilcox [1993]). Today, marketing and efficiency are emphasized over sales targeting, yet stay within Bain's paradigm. To demonstrate marketing and efficiency advantages, a GM report points to the widespread use of dealers by both domestic and foreign firms (General Motors Corporation [1968], p. 9). We find that both small and large firms have symmetric power in increasing the number of their dealers (General Motors Corporation [1968], p. 82, and General Motors Corporation [1974], pp. 84-85). For example, foreign firms, such as Toyota and Volkswagen, have been known to capitalize on the dual nature of franchises, selling their brands through domestic dealers that have been established over the years.

Comparable time-series data for the foreign firms are not available to allow the study of non-price rivalry between domestic and foreign firms. In the case of price collusion among domestic firms, one study was able to source disruptive price behavior to the influence of foreign competition (Ramrattan [1991], pp. 63-65). However, the influence of foreign firms in that study was limited to three specific situations, viz., a cross-section point of view, anomalous behavior over only two years--1983 and 1986, and the disruptive influence of foreign competition on the collusive price behavior of domestic firms. The non-price dealership environment in this study does not display such anomalous behavior among the domestic firms. This might be because a sub-market of American buyers remains loyal to domestic brands, while foreign competition continues to disrupt the pricing policies of domestic firms.

The logical structure of dealership competition has taken the form of many "if-then" statements. If a firm's cashflow and pricing strategies are successful, then it may want to strengthen competition in the areas of R&D, Advertising, and Dealership rivalry. If its pricing strategy yields an optimal outcome or even prevents price wars, then it may seek to maximize the return from its R&D endeavor in the areas of basic research, new model year design, or the diffusion of innovation. If its sequence of price and R&D strategies are working successfully, then it will look to Advertising outlays and dealership systems to sell its product. The final outcome will be optimal because a firm will most likely follow optimal policies at each stage regarding decisions on price collusion, reaction functions for advertising, research and development, and dealership franchise. In such a dynamic scenario, a firm will not only follow a stabilizing policy by varying its stock of dealers in a smooth fashion, or a destabilizing p olicy by synchronizing desired and actual stock of dealers, but can react to its rivals' past level of franchise holdings, as well. The empirical section below specifies a single equation model to explain such a dealership reaction. We will also examine that equation within a system of equations model, which was validated in the literature.