DIVORCEMENT IN GASOLINE RETAILING
(Ghostwritten by Richard Bellikoff)
California motorists who wish to purchase name brand gasoline can choose from thousands of retail service stations. These stations, owned by major oil refining companies, are either leased to independent dealers (lessee-dealers), or operated by the companies’ own employees (company-operated). Few consumers are aware of this distinction — and of proposed legislation which would eliminate it, and by doing so, have an adverse financial effect on the consumers themselves.
Under the provisions of this legislation, known as divorcement, oil refining companies would be prohibited from operating their own service stations. Company-operated service stations would cease to exist; the oil companies would be forced to close them or hire lessee-dealers to operate them.
The lessee-dealers who support divorcement legislation claim that it is necessary in order to protect them from what they characterize as unfair competition by the oil companies. The dealers maintain that company-operated stations sell gasoline at predatory prices which are calculated to drive them out of business. According to the dealers, once they are out of business, the oil companies — with a virtual monopoly in gasoline retailing — will raise prices and gouge the consumer. Divorcement, the dealers contend, is necessary to preserve market competition and thus protect the consumer.
Like many conspiracy theories about “Big Oil,” the lessee-dealers contention is based on a series of oversimplifications and misrepresentations. Foremost among these is a fundamental confusion about what constitutes free competition in an open market. What the dealers attribute to unfair behavior on the part of the oil companies is in reality simply aggressive marketing in response to radical changes in consumer demand.
The actual results of divorcement legislation are likely to be quite the opposite of its intent. A probable scenario is that, with competition from company-operated service stations eliminated, it is the lessee-dealers themselves who will raise prices. In the final analysis, consumer interests will have been sacrificed to protect a single segment of the retail gasoline market from having to compete in the marketplace. In effect, motorists, by paying higher prices at the pump, will be subsidizing the dealers for their inefficiency and unwillingness to innovate.
To fully understand why divorcement legislation is not in the public interest, it is necessary to be aware of the dramatic changes in the gasoline retailing industry in the last twenty years.
In the 1950s and 60s, the typical gasoline service station was a four-pump, “Mom-and-Pop” operation owned by a major refiner and run by a lessee-dealer. It was usually open from 7 A.M. to 7 P.M., and often closed on Sundays and holidays. The station’s competition was likely to be at the very same intersection where it was located; it was not unusual for all four corners to be occupied by service stations. Each station would have its own group of loyal customers, attracted not only by preference for one particular brand of gasoline, but also by familiarity with the dealer and the service he offered. A customer driving up would be greeted by an attendant — often the dealer himself — who filled up the customer’s tank, cleaned the windshield, checked the oil, coolant and battery fluid, and often handed the motorist a premium, such as drinking glasses or trading stamps. When the customer paid the dealer, an oil company credit card was frequently used. Repair work, should the motorist require it, was as easy as pulling the car into the nearest service bay and entrusting it to the care of the station’s resident mechanic. Just as consumers turned to the neighborhood general practitioner for all their health care needs, so they relied on their local dealer for the care and feeding of their automobile.
Today’s typical service venue is in marked contrast to the Norman Rockwellesque ambience of that old familiar neighborhood dealer. Motorists now drive into a 16-pump self-service or dual-service operation that handles perhaps ten times the gasoline volume of the lessee-dealer and never closes. Rather than paying several cents extra per gallon for full service, most motorists prefer to check their own oil and water and pump their own gas. For auto repair work, the motorist will visit a specialist; there are no service bays to be seen here. Payment for gasoline is often handled in bank teller fashion, by an attendant in a booth. Frequently cash or a bank credit card is used, rather than one issued by the refiner. Before driving off, many motorists stop to buy merchandise in an on-site convenience store.
The key event that led to these profound changes in gasoline marketing methods was the 1973 OPEC oil embargo. Most consumers reacted to the gasoline shortage by filling their tanks whenever and wherever gas was available. In the process, they discovered that their cars ran reasonably well on brands other than their customary one — and even on lower priced unbranded gasoline. With prices skyrocketing in the wake of the embargo, brand loyalty quickly eroded as drivers became less willing to pay higher prices. Before the Energy Crisis, there had been in effect a two-tiered system of gasoline pricing, with consumers paying a premium for branded gasoline. But now, it was clear that the marketplace would no longer allow such a system to continue. As consumers increasingly made gasoline buying decisions on price alone, the major oil refiners realized that they were going to have to compete on that basis or fall by the wayside. Full service, once built into the price of gas, soon became an option, offered for an extra charge. Similarly, discounts were offered for payment by cash rather than credit card. Some major oil companies cut costs even further by eliminating their credit cards completely at company-operated stations. Motorists signaled their acceptance of these features by taking advantage of them. “No-frills” gasoline marketing was born.
Even before the 1973 oil embargo, the steady drop in motor oil sales had signaled a growing trend toward “do-it-yourself,” routine auto maintenance and minor repair work — formerly the province of the service station mechanic. After the embargo, the mechanic’s position eroded further, as stringent fuel economy and air quality standards, the growing sophistication of automotive design and engineering, and the penetration of the American market by foreign auto manufacturers all combined to make vehicles far more technically complex. The net result is that today’s motorist relies increasingly on specialized retail outlets that offer such goods and services as tires, tune-ups, transmission work, batteries, mufflers and lubes. The neighborhood auto mechanic is rapidly going the way of the general medical practitioner who made house calls. According to the Southern California Service Station Association, the number of service stations offering repair service has dropped by nearly two-thirds since 1971, in response to declining consumer demand.
With motorists less reliant on gasoline service stations for automotive service, a greater burden has been placed on station operators to make gasoline retailing profitable. But with consumer brand loyalty eroding and price competition becoming more intense, gross profit margins on gasoline sales have shrunk. To compensate for these market shifts, company-owned stations have been forced to adopt lower-cost operating modes — including higher gasoline throughput, self-service dispensing and discounts for cash purchases.
In light of this market upheaval, it is entirely understandable that dealers who persist in running high-margin, low-volume gasoline retailing operations and rely on automobile service to cover some of their overhead would find themselves at a competitive disadvantage. Some lessee-dealers have successfully pursued the marketing strategy of the company-owned stations. Others, however, have sought legislative intervention rather than adapt to the changing marketplace. Crying foul, they accuse the major oil refining companies of predatory pricing designed to force them out of business and secure a monopoly position for the majors themselves.
The dealers’ accusations are based on an erroneous and misleading assumption: that low pricing, designed to meet the competition, is synonymous with unfair or predatory pricing. To support their contentions, the lessee-dealers claim that the major oil companies are charging them higher wholesale prices for gasoline than the retail price at company-owned stations. In a recent in-depth study of retail and wholesale gasoline prices, the Attorney General of the state of Washington found that there was no factual basis for this allegation.
The Washington study goes on to examine a second dealer assertion: that the lessee-dealers’ shrinking profit margins are too low to cover their overhead costs. The Attorney General concluded that slim profit margins are evidence of increased competition in the industry, rather than intent by the majors to drive out their lessee-dealers. What is causing a significant number of dealers to go out of business, the Attorney General concludes, is failure to adapt quickly enough to changing competitive factors in the gasoline retailing market.
The major oil refining companies sympathize with the dealers’ predicament, but feel in no way responsible for it. The lowering of profit margins is a fact of life in an increasingly competitive market, not a Machiavellian plot by “Big Oil.” The chief characteristic of the contemporary marketplace continues to be relentless and often unpredictable change. Those who adapt stand a good chance of survival and even prosperity; those who refuse face an uncertain future. The major oil refiners, in fact, encourage their lessee-dealers to run high-volume, low-margin operations, generating income through efficiency, volume and ancillary businesses such as convenience stores, car washes, and specialty service centers.
Dealers are, of course, free to operate their service stations in any way they choose. Yet they seek to legislatively deny consumers that same freedom of choice in making their gasoline purchases, by removing company-owned service stations from the marketplace. To discover the probable results of this reduction in competition, one need look no further than a study of gasoline retailing in Maryland following the passage of divorcement legislation. Prof. John R. Umbeck of Purdue University found that, far than promoting competition, the law actually led to fewer stations open for shorter hours and charging higher prices. The dealers had no competitive incentive to change their antiquated marketing methods, and the consumer was the one who suffered. Similarly, if oil refiners are prohibited from operating service stations in California, consumers can expect to pay several cents per gallon — or dollars per tankful — more for gasoline. Motorists would also bear the burden of intangible costs associated with the inconvenience of reduced service station hours and fewer conveniently located stations. In effect, consumers would be rewarding dealers for their inefficiency. Rather than promoting competition, divorcement legislation protects a specific class of competitor from competition — and entirely at the consumer’s expense.
Proposals for protectionist legislation in the U.S. are of course nothing new. Throughout American history, special interest groups have clamored for legislative refuge from what they deemed to be unfair competition. Whenever such legislation removes an active class of competitors — such as company-operated service stations — from the marketplace, the competitive process suffers, and along with it the consumer. Motorists deserve the chance to decide which types of gasoline retailing they prefer, and thereby to determine what portion of the market the lessee-dealers should retain. The effects of divorcement legislation would be preemptive. In denying refiners the opportunity to market gasoline in what they consider to be the most profitable manner, consumer preferences are also denied, and future innovations in marketing are foreclosed. What the lessee-dealers want, in short, is not protection from unfair competition, but from the competitive process itself.