Is the control of discounts by car manufacturers justifiable?
A recent judgment by the Indian Competition Commission (ICC), penalizing Maruti Suzuki India Ltd for engaging in what is considered anti-competitive behavior, by practicing resale price maintenance (RPM), warrants further investigation in-depth on the economic rationale for the original actions of equipment manufacturers (OEMs). A similar case had occurred with Hyundai Motors, where the company’s discount control policy was believed to harm intra-brand and inter-brand competition and harm consumers. A heavy sentence was imposed.
While any form of vertical restraint can limit competition, RPM, i.e. fixing the retail price by imposing a ceiling or floor price, is often criticized and viewed as unethical because this practice is seen as harming competition and limiting consumer welfare by limiting entry and increasing prices for consumers in three possible ways. One, if it results from a cartelization by a sub-group of dealers or equipment manufacturers themselves. Second, price caps can hamper intra-brand competition by restricting entry into dealer markets. Third, price floors can increase the retail prices faced by consumers.
The case of Maruti Suzuki, or Hyundai, are not cases of cartelization by the dealers to keep a high price, but rather the automakers have a policy of controlling discounts, i.e. setting a retail price. uniform to be offered by all dealers. Commercial wisdom suggests not to do this by companies, as keeping the price high will deter consumers and they could look to other brands, in a very competitive and elastic passenger vehicle market. In fact, allowing discounts is in the OEM’s best interest to increase sales.
Uncertainty of demand
What drives companies to resort to discount control policies should then be the focal point of any assessment. One plausible explanation is the uncertainty of demand in the business-cycle sensitive passenger vehicle segment, resulting in high inventory costs for dealers who are unable to properly capture demand. Such costs are much more important in times of low demand, as it is during these times that dealers with high inventories have to accept a reduction in their margins, while those with better foresight may have low inventories. and will be able to offer a reduced price. in the absence of additional costs of keeping stocks.
Auto dealerships are often exclusive, require heavy investment, and offer low margins, creating foreclosure for dealerships. In a survey of automobile dealers across the country, conducted by the Federation of Automobile Dealers Associations (FADA), the main concern of dealers was the viability of the business.
For the manufacturer, the problem is that some dealers are deterred from holding large stocks by the ability of others (dealers) who hold lower stocks to undercut the price in times of low demand. Large equity traders will only get adequate returns in times of high demand. And they would tend to charge higher markups during times of high demand to recoup the loss from times of low demand. This could mean less consumer demand and less overall business for the manufacturer.
It therefore encourages the manufacturer to impose a constraint in the form of a retail selling price which avoids the overall loss of demand and induces the holding of stocks so that states with high demand can be served more efficiently. Uniform prices therefore, in a way, promote the widest possible distribution of the product in both directions, over periods of varying demand, and spatially, across locations with varying demand. Competition from dealers may otherwise cause inventory to decrease, limiting consumers’ access to the product.
Another often-cited reason for car manufacturers to eventually resort to such policies is to limit the problem of “Free Ridership” by some dealers, as there are strong positive externalities associated with the promotional activities they undertake to differentiate themselves on the market. intra-brand market. For automobiles, with the specific impact of pre-sale information sharing on final sales, it is possible for consumers to collect the brand information from one dealership and then purchase the products from another. offering a discount on the price.
In the long term, such practices will drive dealers who offer better quality of service and a better experience away from the market. This has a negative externality for the brand in the longer term and causes the manufacturer to set the dealer mark-up on the manufacturing price. While this is plausible, in the automotive industry it is the manufacturers who do the promotion and advertising campaigns for cars and the dealerships invest tiny amounts in pre-sales service to improve sales.
Contrary to the ICC assertion, we postulate that a possible reason for RPM is that the manufacturer tries to preserve demand which is deterred by dealerships with unsold inventory which increases margins in high demand states. Regulatory principles should be aligned with the realities of business where manufacturers prevent sharply reduced retail prices to improve welfare enhancing inventories. Care must be taken in defining anti-competitive practices so that regulatory teeth bite in the right direction.
D’Souza is Professor of Economics and Director at IIM Ahmedabad, and Agarwalla is Associate Professor at the Adani Institute of Infrastructure Management. Thanks to the founding of The Billion Press