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