a theoretical note on the dealer-manufacturer relationship in the automobile industry.pdf

8/10/2019 A Theoretical Note on the Dealer-Manufacturer Relationship in the Automobile Industry.pdf

1/11

A Theoretical Note on the Dealer-Manufacturer Relationship in the Automobile IndustryAuthor(s): Anthony Y. C. KooSource: The Quarterly Journal of Economics, Vol. 73, No. 2 (May, 1959), pp. 316-325Published by: Oxford University PressStable URL: http://www.jstor.org/stable/1883728.

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2/11

A

THEORETICAL

NOTE ON

THE

DEALER-MANUFACTURER RELATIONSHIP IN THE

AUTOMOBILE INDUSTRY*

By

ANTHONY

.

C.

Koo

I. Introduction: some terms

n

automobile

pricing,

316.

-

II. The theoreti-

cal

basis

for conflictof interest

no

unique

invoice

price,

318.

-

III.

Sliding

scale

vs.

flat

bonus,

321.

-

IV.

Conclusions,

324.

I. INTRODUCTION: SOME TERMS IN AUTOMOBILE PRICING

The

cyclical

natureof automobile

demand

and

its

impact

on the

general

economy

have

attracted

much

attention from

economists.

However,

during

the course of

cyclical

movementsof automobile

demand,

the

relationship

between dealers and manufacturers as

been

subjected

to

severe

tress nd

strain,

s

witness

he

voluminous

literature f

dealers' and

trade

ournals,

reports

n

financial

ages

and

testimonies

f

both

dealers

and

manufacturers

uring

Congressional

hearings. Economists eemto have stoodaloof n thiscontroversy,

and

have shown

ittle

nterest

n

this

aspect

of

the

problem

of

the

automobile

ndustry.

Their

attitude s

understandable,

ecause the

dealer-manufacturer

elationship

s viewed as a

problem

of business

practice,

with no theoretical ssues

involved.

In

the midst of

the

controversy,

mail

survey

of

the dealer-

manufacturer

elationship

was undertaken o ascertain

the bases of

conflict f

interest.

The

survey

covers

such

topics

as duration

and

securityof dealers' franchise, ontrol over inventories nd sales

quotas,

practicesregarding

markups

and

dealers'

contribution

o

advertising

osts

and

freight harges.'

One issue

that

dominates

the

dealers'

mind

is the

forcing

of

cars,

.e.,

according

o

dealers'

replies,

hey

have

been

forced

o

buy

more

cars

than

they

would

like

to

take,

with

consequent

prevalence

of

bootlegging.

On

the other

hand,

manufacturers

iew

the

com-

plaints

as excuses

for

nefficiency

r

nonagressiveness

f

dealers

in

pushing heir ales. This note, althoughmotivatedby theproblem,

*

I

wish to thank Professors

M.

Bronfenbrenner,

.

Child,

B.

Kemp

and

T.

Mayer

for

helpful

comments.

1. The

results

will

appear

as a

separate study.

Professor

Donald

A.

Moore

of

Los

Angeles

State

College

initiated

and was

mainly responsible

for the

survey.

He contributed a

great

deal

to

crystallizing

he

issues

involved

in

designing

the

survey.

316

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3/11

RELATIONSHIP

IN THE

AUTOMOBILE

INDUSTRY

317

is not intended

o resolve

the issue. It is an

attempt

to

show

that

there

exists a

theoreticalbasis for

dealer-manufacturer

onflict

f

interest,

nd

to

incorporate

his

problem

nto

the

usual

simplified

model

consisting

f

only

consumers nd

producers.

To

understand

he

problem,

t is

important

o

explain

a

few

terms sed

in automobile

pricing.

(1)

The

price

of

cars

which

dealers

pay

to manufacturerss known as

price

to

dealers

or

invoice

price.

This

price

is uniform

hroughout

he

year

except

in

the

closing

weeksor months

f model

year,

t

which

ime

manufacturers

sometimes

ive

dealers

special

discounts nd bonuses for

cars

sold

in

excess of

normal

volume. For

purpose

of

illustration,

et

us

assume

thatthe

price

o dealersofa

low-priced

ar is

$1,730.2

(2)

The manu-

facturer

generally

suggests

(he

cannot

legally

enforce)

a

dealer

markup

of

31.6

per

cent of the

invoice

price.

This

increase s

also

expressed

s

24

per

cent

of the

factory uggested

ist

price.

In

our

present

xample,

t

amounts

to

$546.

In

actual

practice

n

the

low-

priced

field,

ealers seldom

can

make

that much

except

n

periods

of

extreme

carcity.

To

meet

competition,

hey

have

to sacrifice

part

of

the

markup.

According

o the National AutomobileDealers

Asso-

ciation, hemarkup n sucha model s close to$330. (3) Not counted

in

the

markup

s another

tem

to

be

added

to

the invoice

price

which

is labeled

by

various names. General

Motors

calls

it

E.O.H.

(excise,

overhead

and

handling).

It

is

mostly

he 10

per

cent

federalexcise

tax.

To

the

sample

car

price,

we

add

another

$180.

(4)

Another

factory-suggested

harge

is called the make

ready

or

dealer

handling harge,

which

s

supposed

to

cover

the

time

normally pent

by

the dealer

preparing

he car for

delivery.

This

amounts

to

$50

forthe sample car. (5) There are state and local taxes including

licensing

ees.

In

Detroit

thesetaxes

add

up

to

$80.

The

list

of tems

to be added

to

the dealer's

price

to arrive t

factory uggested

rice

is as

follows:

2. The

figure

s

broken own nto the

following

omponents:

1.

Materials,

outside and

inside

$1,100

2. Productive labor 75

3. Overhead 1254. Return on investment 180

5.

Freight

S5

6.

Tooling

and

engineering

50

7. Sales

and

advertising

50

8. Administration 65

Price

to

dealer

$1,730

The

example

was

taken

from

Car

Pricing

How Auto

Firms

Figure

Their

Costs to

Reckon

he Price Dealers

Pay,

Wall

Street

ournal,

ec.

10,

1957.



4/11

QUARTERLY

JOURNAL

OF

ECONOMICS

1.

Priceto the

dealers

$1,730

2.

Markup

546

3.

E.O.H.

180

4. Make ready 50

5.

Federal

nd state

taxes

80

Factory uggested rice

$2,586

On

the

basis of

the

foregoing

actual

background,

we shall

solate

the

central ssue of the divisionof

profit

etween

the

dealer

and the

manufacturer.

II. THE

THEORETICAL

BASIS

FOR CONFLICT OF

INTEREST

-

No UNIQUE INVOICE PRICE

It is

obvious that

the

dealer's total

profitdepends

upon

the

volume and the

difference etween

what the

buyer

pays

and

the

invoice

price;

and the

manufacturer's

otal

profit epends

upon

the

volume

and the

difference etween nvoice

price

and

the

unit cost.

The

issue

on

which

conomic

heory

an

contribute

o

our

understand-

ing

of the

problem

s

that of

whether

r

not

there

exists

a

unique

invoice

price

that

will

maximize he

profits

f

both the

dealer

and the

manufacturer t the same time. If, theoretically,ne can demon-

strate its

existence,

hen

there

may

be a

price

relationship

which

eliminates

any

conflictof

interestbetween them.

Unfortunately

there s

generally

o

unique price

relationship

which

will simultane-

ously

maximize

the

profits

f

both

dealer

and

manufacturer.

This

can

be seen fromthe

following

nalysis

which

demonstrates

hat,

assuming

one obtains

simultaneous

maxima,

no

unique

invoice

price

can be derived.3

Let

cu

= unit

production

ost

Cd

=

unit

sales

cost incurred

y

the dealer

q

=

output

pl

=

invoice

price

p2

=

sales

price

ul

=

total

profit

f

the

producer

U2

=

total

profit

of

the dealer

c,

=

fi(q)

....................

(1)

Cd

=

f2(q)

....................

(2)

p2=

f3(q)

....................

(3).

3.

The

general

case

of

simultaneous

maxima is considered

y

Emilio

Zaccagnini

in

Massimi

Simultanei

in

Economia

Pura,

Giornale

degli

Economisti

e

Annali di

Economia,

No.

5/8,

1947,

translated

nd

reprinted

n International

Economic

apers,

No. 1

(1951),

pp.

208-44. Our

model s

based

on

his

special

case of

simultaneousmaxima

or

wo

equations,

which

s

reproduced

ith

light

change

f

notation

nd some

other

modifications.

318



5/11

RELATIONSHIP

IN THE

A

UTOMOBILE INDUSTRY

In

order to

exclude

negative

profit

o

either

participant,

we

impose

the additional condition

hat

CU,

pi ................... (4)

pI

+

Cd

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