2 Numbers That Show Why Tesla Motors Can't Use Dealers

By Markets Fool.com

Image source: Tesla.

Continue Reading Below

Tesla's war on the dealer model rages on.

Just this week, the Indiana state legislature debated a new bill (HB1254) that would ban Tesla from the state unless it transitions distribution to third-party franchise dealers. Under existing law, Tesla is able to sell in the state through its one retail location. Sadly, some of the lawmakers quite literally didn't understand the pertinent laws or how the bill would affect them.

Tesla has laid out numerous times before why the dealer model simply would not work for the company, and it reiterated many of those reasons at the hearing. As is often the case, the economic argument always makes the most sense, since traditional dealers have strong disincentives when it comes to electric cars.

Service is king
Beyond the fact that dealer salespeople are compensated primarily based on volume, and electric cars take a lot longer to sell due to a long educational process, Tesla's model is dramatically different when it comes to how it approaches sales and service and where its profit motives lie.

Traditional manufacturers make most of their profit off the vehicle itself, when they sell inventory into the dealer channel at wholesale prices. They often also have financing arms that are quite profitable. Dealers make very little money on the markup of new vehicles -- service is the primary cash cow in this segment of the value chain.

Continue Reading Below

But since electric vehicles have significantly fewer moving parts (gas-powered cars have approximately three times as many components), they require less service over time. Not only that, but Tesla's corporate philosophy is that it doesn't want to make money on service. The electric automaker believes that it's wrong to profit so much on servicing a vehicle. It would rather make a little bit more up front (Tesla has a higher gross margin than the traditional manufacturers) and sell you a car that's more reliable and requires less maintenance over time.

One of these is not like the other
Most dealers are small, locally owned businesses, but there are a few publicly traded auto retailers. Owning or operating 342 new vehicle franchises nationwide, AutoNation is the largest. Here is how AutoNation's "Parts and service" segment compared to Tesla's "Service and other" in 2015.

AutoNation

Tesla Motors

Revenue

$3.1 billion

$305 million

Gross Profit

$1.3 billion

$5.8 million

Gross Margin

43.4%

1.9%

Data source: SEC filings. Tesla's certified pre-owned vehicle sales are also included in its "Service and other" segment.

These two gross margin figures show you why the franchised dealer model simply can't work for Tesla, because it underscores the fundamental difference with how Tesla operates. Most dealers need a profit source as well beyond vehicle sales, and they simply can not build profitable services businesses off electric vehicles.

It's worth noting that AutoNation gets 41% of its total gross profit from parts and service. The retailer generated nearly 21% of gross profit from new vehicles, but this is largely a function of volume. AutoNation sold 339,000 new vehicles last year at a 5.6% gross margin. Most local dealers don't have this national scale, so they very much rely on service to pay the bills.

The only way for Tesla's model to work viably is by selling directly to consumers.

The article 2 Numbers That Show Why Tesla Motors Can't Use Dealers originally appeared on Fool.com.

Evan Niu, CFA owns shares of Tesla Motors. The Motley Fool owns shares of and recommends Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.