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The Australian Automobile Dealers’ Association

‘Charter of Fairness’

Discussion Document

July 5 2002

Case Managers:Mark Wainwright MBIM. MBA. FIMI.

Frank Dennis LLB.

Level 10, 300 Flinders Street Tel: +61 (0) 418990919Melbourne Victoria 3001 Australia [email protected]

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Contents

Executive Summary 3

1.0 Background discussion of ‘The Charter of Fairness’ 4

1.1 The Global Automotive Industry - Overview 4

1.2 The Consumer

1.3 Evidence of Regional Collaborative Behaviour

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1.4 The Australian Automotive Industry – Overview 27

1.5 Competition in the Australian Automotive Industry 30

2.0 Legal Discussion of the Charter of Fairness

2.1 Background

2.2 Legal Issues

2.3 Applicable Law & Inadequacies in Law

2.4 Recommendations

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Executive Summary

The Australian Automobile Dealers’ Association (AADA) has developed a ‘Charter of Fairness’as a considered response to the changing competitive dynamics of both the global and Australianautomotive industries. These changing dynamics are implicitly and explicitly increasing theconcentration of market power of the global automotive companies and have already beenobserved to be substantially lessening both inter and intra brand competition in the Australianmarkets for new and used vehicles.

There are now only six major global manufacturers all of whose profitability is being diminishedby global productive overcapacity. This is largely due to their new investment in regions wherethe cost factors of production can be minimised without sufficient closure of old capacity in aglobally static market. The automotive value chain has been radically restructured and now someof the global automotive companies are pursuing strategies of downstream continuousdiversification and forward integration including, in those jurisdictions that have not prohibited iton anti-competitive grounds, the disintermediation of their franchised networks.

This discussion paper utilises two recent, large-scale, independent European consumer surveysand other evidence to discern that the retail automotive industry is highly competitive at both interbrand and intra brand levels and that intra brand competitive issues are involved in eighty per centof consumers’ major concerns and over fifty per cent of their buying decision process. Thesurveys demonstrate that any significant diminution of intra brand competition would lead to asubstantial lessening of total competition in the markets for new and late model vehicles, service,parts and employment for skilled staff associated with that brand. The paper finds that Australianlegislators and regulators have neither fully understood the role of intra brand competition in theretail automotive market nor its importance to consumers.

Despite finding that inter brand competition is globally intensive the paper presents evidence oflarge scale regional pricing collaboration between the remaining big six vehicle manufacturers.

Utilising Professor Michael Porter’s ‘Five Forces Model’, the competitive dynamics of theAustralian retail automotive industry are analysed and the overwhelming dominance of the brandowning franchisors established. The paper demonstrates that inadequacies in relevant legislationand regulation have led to the franchisors exploiting this position of dominance via inequitablefranchise agreements and in some cases a total absence of good faith in dealing with theirfranchisees. It is in this environment that the Australian Automobile Dealers Association hasproduced its ‘Charter of Fairness’, a document setting out key industry issues that must beaddressed by legislators and regulators if intra-brand competition is to survive in the Australianmarket for new vehicles. The Charter does not seek protection for incompetent or genuinely underperforming businesses but a fair go for entrepreneurial Australian businesses often confrontedwith the prospect of untimely, ineffectual or prohibitively expensive means of resolving disputeswith global corporations.

This report seeks to explain the reasoning behind each of The Charter’s articles, identify thefederal and state laws and policies associated with each and advise the AADA as to ways toproceed in having them adopted as policy or law by the relevant authority, organisation orgovernment.

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1.0 Background Discussion of The Charter of Fairness

1.1 The Global Automotive Industry (Overview)

“Any colour, so long as it’s black” Henry Ford (1863-1947)

Over the past decade the global automotive industry has, through merger and acquisition activity,contracted to six major, multi-national brand owning vehicle manufacturers, who compete inmost markets and most market segments. There is also a number of mid-range and relativelysmall, niche vehicle manufacturers, most with some common ownership or strategic alliance withthe ‘Big Six’ (Fig.1). The ‘Big Six’ now effectively control over 82% of global light vehicleproduction – the top nine producers over 95%. The major driver of this consolidation has been thepursuit of low cost competitive advantage through economies of scale, scope and experience. Theconsolidation process was aided by:

1. An historically strong U.S. dollar2. The Asian economic crisis (including Japanese recession)3. The expansion of The European Community (EC)

Fig.1. The Major Players

The global automotive market is therefore an imperfect oligopoly, a market where there are fewplayers with slightly differentiated offerings and where extreme competition can and should exist.

Over the same period the structure and nature of the manufacturing industry has radicallychanged. The motor vehicle manufacturers, or brand owners, have increasingly:

1. Adopted ‘lean production’ systems (first developed by Toyota) which incorporate:

o Waste eliminationo Inventory minimisation (through ‘just in time’ delivery)o Flow maximisation

FordVolvoJaguarMazdaLand Rover

ToyotaDaihatsuLexus

GMDaewooSaabIsuzu

VWAudiSkodaSeatBentley

DaimlerChrysler

RenaultNissan

MitsubushiFiatPSA HondaHyundaiKia

Subaru Suzuki BMWRR

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o Demand driven productiono Meeting customer requirementso Doing it right the first timeo Worker empowermento Design for rapid changeovero Partner with supplierso Create a culture of continuous improvement

2. Improved supply chain efficiency through:

o Outsourcing design and production of components and, increasingly,component modules to specialist external ‘tier one’ suppliers. Thetier one suppliers have become strategic partners of the brand ownersand in turn partner with tier two (sub-componentry) and tier three(raw materials) elements of the supply chain. In the globalenvironment each of the tier one suppliers need to partner with thebrand owners wherever they produce vehicles. The capitalrequirements to roll out globally have led to unprecedented andongoing rationalisation of the supply chain. Industry experts predict a75% decline in the number of tier-one suppliers, and a 90% reductionof tier-two suppliers by 20101. Creating collaborative tradingnetworks that leverage industry-wide resources is an imperative.

o Adopting web based exchanges to manage procurement transactionse.g. in 2001 the Covisint joint venture between GM, Ford andDaimler Chrysler managed more than $129 billion in transactions--nearly 53% of the estimated $240 billion spent last year by itsfounders. GM has pushed $96 billion worth of procurement forcurrent and future auto models through the exchange, via ‘QuoteManager’, Covisint's online negotiating tool2.

3. Adopted platform rationalisation

The competitive imperative to lower design and manufacturing costs is driving platformrationalisation. It’s been predicted that by 2005 there will be at least 20 one-million-unitplatforms. Two of these platforms exist today, and each one serves as the building blockfor multiple brands and models. As a result, nearly 70-80% of content is shared acrosseach model (current world best practice is exhibited by the Volkswagen Group whichmarkets 54 model variants based upon just four platforms). As there is alreadyconvergence between brands, of quality, performance and complexity, the challenge forthe brand owners is to create a differentiated product with the remaining 20-30% ofcontent — which in turn requires suppliers to respond faster and more effectively in acollaborative environment in order to remain competitive.

1. ‘A2C: The Second Automotive Century’ Ferron, PWC 2000; 2. www.covisint.com

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The major driving force of the global automotive industry has been globalisation itself. Themigration of productive capacity to regions that minimise the cost of the factors of production hasnot been matched by sufficient closure of old capacity in higher cost regions. In a contractingtotal market this has led to a global excess capacity of some 35%, (Exhibit 1) a massiveinefficiency that has depressed industry profitability.

Exhibit 1. Global light vehicle sales and assembly capacity. Source: Autopolis Autofacts

Net investment in capacity in Eastern Europe, Mexico, S.E. Asia and particularly China, isforecast to continue outstripping market growth through to at least 2005.

The secondary capital market’s recognition of this inefficiency and the low industry growthprospects (after accounting for cyclicality the average long–term volume growth perspective isbetween two and three percent) has the shares of the major players trading at a price earningsmultiple average of 9.2 against a market average P/E of 22 (Exhibit 2). The pressure is clearly onvehicle manufacturing management to improve total shareholder returns (dividend stream pluscapital appreciation of stock).

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Exhibit 2. Source: McKinsey & Co, Ealey & Troyano-Bermudez 2001- Automotive OEMs refers to the vehicle manufacturers.

Exhibit 3. Source: McKinsey & Co, Ealey & Troyano-Bermudez 2001

Exhibit 3 illustrates the total vehicle life value chain profitability. More than 50 percent of theindustry’s value added, and more than 60 percent of its total profitability, is generated‘downstream’ of the vehicle manufacturer. To address the secondary capital market’sperceptions and improve total shareholder returns the vehicle manufacturers, to differingextents, are pursuing a value chain strategy of:

o Upstream outsourcing – transferring large capital investment, research and development,technological risk and logistics costs to their supply chain.

o Internal competence rationalisation and re-alignment.

o Downstream related - diversification into consumer finance, insurance, telematics, quick-fit accessory / service centres (Exhibit 25 p.43).

(Total Life of CarUSA, EC & Asia)

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o Forward integration. In markets where the legislators allow they are disintermediatingtheir traditional distribution channels. In most significant markets the large players havealready taken, or are in the process of taking, control of their regional distributors. Nowtheir attention is turning to their retail channels, in most markets, their franchisenetworks.

Fig.2 The Automotive Industry Value Delivery Chain

The franchise network is the retail distribution mechanism by which the manufacturers havehistorically transacted the localised: stocking, display, demonstration, sale, pre-delivery,accessorising, service, parts supply, warranty provision, safety recall, financing, marketing andrepurchase of their vehicles.

The franchise network comprises of franchisees who may vary from a family owned,independent, single brand, single store (dealership) to a multiple brand, multiple dealership publiccorporation1 to, in Australia and Europe, (although not most of The United States of America)franchisor owned dealerships.

Most importantly it is the competition for customers, staff and used vehicles betweenfranchisees within a regional franchise network that is the sole source of intra-brandcompetition – a key concept not yet universally understood by legislators and competitionregulators.

1. AutoNation Inc., the world’s largest, is a publicly owned UScorporation with over 290 dealerships in 18 states and hadrevenues of US$20.8 billion in 2001.

FranchiseNetwork

Tier 3 Tier 2 Tier 1 Suppliers Manufacturer

/Brand Owner/Distributor

Buyer-User(fleet-lease, govt,

hire-car, web intermediary,finance co, retail)

VehiclesServicePartsWarrantiesFinanceInsuranceTelematicsAccessories End User

Disintermediation?

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1.2 The Consumer

Competition is complex and multi-faceted - and so is its regulation. Any search of the literaturereveals well constructed arguments for and against the efficiencies of the current automotivedistribution system.

It should be looked at from the ultimate perspective, that of the consumer:

Recent independent large-scale research (over 4000 interviews and focus groups of new vehiclebuyers) in this field of consumer behaviour was conducted across the five major Europeanmarkets between July and October 2000 by Taylor Nelson Sofres (TNS) to guide the EuropeanCommission in changes to the block exemption regulations (‘Attitudes Towards The EuropeanAutomotive Distribution System’ November 2000). The European automotive market closelyresembles the Australian market in terms of market concentration ratio (Fig.3), distributivestructure and participants (although the participant market shares are somewhat different). In theabsence of large scale Australian empirical research, this survey may be considered indicative ofgeneral consumer attitudes in similar markets globally.

Fig.3 Market Concentration Ratios CR5 Autos: Aus/EC/Japan/USA. Source: accenture & VFacts

68 6485 84

020406080

100

% of market held by top 5

brands

Australia EC Japan USA

CR5 Market Concentration - Auto Brands

The TNS survey showed that consumers believed the competition within the automotive sector isstrong, comparable to and even stronger than that which exists in other consumer durable sectorssuch as hi-fi and household electrical appliances. Eighty percent of the sample believed thatcompetition between automotive manufacturers is strong or very strong (Exhibit 4.)

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Exhibit 4. Source: TNS Survey

Moreover, 76% of the sample considered that the inter-brand competition between automotivemakes has increased over the past decade. 46% of the sample believed that the intra-brandcompetition between franchisees of the same make had increased whilst 4% believed that it haddecreased.

79% of new car buyers think that it is “important for them to play dealers of the same makeagainst one another” (Exhibit 5.).


Consumers engage in complex buying behaviour when they are highly involved in a purchase andaware of significant differences between brands. This is usually the case when a product isexpensive, bought infrequently, risky and self-expressive.

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Exhibit 6. Source: TNS Survey 2000Typically the consumer does not know much about the product category and has much to learn.Complex buying behaviour involves a basic three-step process:

o Belief developmento Attitude developmento Thoughtful purchase choice

This is developed into a six-stage go/no go buying decision process (fig.4).

Fig.4. The Stages of the Consumer Automotive Buying Decision Process

Problem recognition is when a consumer recognises a problem or need, a difference between acurrent state and a desired state. With vehicles this may be triggered by change in occupation,remuneration, family size, peer group pressure, household location, age, marketing efforts orcondition of an existing vehicle.

The information search moves through two processes:

o Heightened attention – where the consumer becomes more receptive to informationabout vehicles, pays attention to advertisements, vehicles purchased by family andfriends and conversations about vehicles.

ProblemRecognition Information

Search EvaluationOf

AlternativesSupplierSelection Purchase

Decision

PostPurchase

Behaviour

Inter-Brand Competition Intra-Brand Competition

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o Active information search – where the consumer actively seeks information on vehiclesfrom personal, commercial (advertising, web sites, dealers), public (mass media,consumer groups, automotive organisations and the internet) and experiential sources(showroom examination and test drives).

The TNS Survey shows that not only do consumers perceive competition in the market place theyactively take advantage of it. Competition between makes is manifested by dealership visits.More than 58% of the sample had visited dealerships of at least two different makes; when brandloyal consumers are excluded, 67% of the sample have gone to dealerships of several makesbefore deciding which make to purchase (Exhibit 7.). Throughout the information search theconsumer learns about most of the competing sets of brands (the awareness set) and theirrespective value propositions. From this set the consumer will select the brands and products thatmeet their initial buying criteria (the consideration set) and develop that set into a short list ofstrong contenders (the choice set) – their buying alternatives.

Exhibit 7. Source: TNS SurveyThe evaluation of alternatives within the choice set centres around the closeness of fit between thebrand and model’s value proposition and the consumer’s perceived needs and ability to pay.When the consumer has evaluated the brand/model alternative that provides the best fit theyproceed to the dealer selection phase. In total, all makes combined, a new car buyer will havevisited an average of three dealerships (Exhibit 8) Exhibit 8. Source: TNS Survey

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The most important dealership negotiation variables are price or level of discount (70%), thetrade-in terms of the vehicle being replaced (32%), features and accessories (39%), paymentterms, vehicle availability and warranty/maintenance contract (each at 10%).Only 15% of the sample had not negotiated the price during the buying process. (Exhibit 9)


87% of the sample completely or somewhat agreed with the statement: “It is normal to have tonegotiate the price of a new car” and 56% with: “For me, negotiating the purchase price of a newcar is a pleasure in itself”. Other variables involved with dealer selection include location,reputation, previous dealings, after-sales service, community involvement, website presence,marketing spend and size. The consumer will make the buying decision with the dealer whoprovides the best total value proposition for their needs. The great majority of the sample believedthat the car market offering had changed a lot over the last ten years. 95% say vehicle safety hasincreased, 89% level of standard equipment has increased, 88% that the model range hasexpanded and 85% that vehicle reliability has improved. (Exhibit 10)


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The consumer’s post-purchase behaviour is very important to the supplying dealer and the brand.After purchasing a vehicle a consumer will experience a level of satisfaction or dissatisfaction.The greater the degree of satisfaction the more likely the consumer is to be a service and partsconsumer, a repeat purchaser and a brand and dealership advocate. The TNS survey also tried todefine more precisely what are the advantages and disadvantages customers see when comparingalternatives to the dealer system they know today. To avoid overloading the respondents, theyonly tested the following three alternative distribution systems:

o Multi-brand dealers, presented to the respondents as "dealerships that would operatesuch as those that exist today, but which had the official approval from several makes.”

o Specialised Independent Chains, presented as "automobile distribution chains, like Dartyor Fnac1. Specialised in automobiles, independent from the manufacturers, they wouldchoose models and versions offered to their clients."

o An automotive section in a hypermarket, that is, "an automotive department in a hyper orsupermarket such as Carrefour or Leclerc"2. There would be specific spaces withappointed salespeople where a choice of models and versions of different makes wouldbe presented, the choice of which would be determined by the store.

Then, going through a list of 15 items which characterise the expected performances of anautomotive sales point respondents were asked if, according to them, they would be significantlybetter, not as good as, or neither better nor worse served by today's dealers.

Exhibit 11.Source: TNS Survey

1. List adapted according to country- no direct Australian equivalent, think a ‘Bunnings’ car centre.(2) Very large K-Mart plus Coles plus Officeworks style operations.

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Throughout the sample the multi-brand dealers scored the highest on practically all the items withthe exception of "Feeling of safety in case of repairs", "Quality of after sales service" and"Manufacturer’s moral engagement". The difference between “significantly better” and “not asgood as” dealers today is particularly high on items related to purchase conditions and the phasesleading up to the purchase itself. "Quality of after sales service", “ Manufacturer’s moralengagement” as well as "Feeling confident when it comes to buying" are more favourable to thedealers of today (Exhibit 12).


Specialised independent chains were viewed only positively in relation to the current system interms of sales conditions and most particularly on price, the possibility of trying out vehicles andthe ease of comparing models. The negatives concerned all items relative to the warranty andafter-sales service as well as purchase confidence. It was the countries with the most amount ofexperience with this channel of distribution (France, Germany and the UK) which were the mostnegative (Exhibit 13).

The hypermarket car sales areas were unanimously rejected in all the countries, judged to be "notas good as" the dealers we currently know in all aspects of performance, apart from price.Rejection was particularly strong on items concerning safety and trust, both during the purchaseas well as after-sales. This format was incontestably said to be inappropriate by the great majorityof buyers/users of new cars (Exhibit 14).

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The main conclusions the of TNS study regarding consumer preferences were:

o The automobile is both a financial and major emotional investment whichconcerns the security of individuals; and therefore implies a need for reassurancefrom the make.

INTER-BRAND ISSUEo The competition within the automotive sector is perceived as strong by

consumers, both at a manufacturing level and at the level of distribution andcustomers are taking advantage of it.

INTER & INTRA-BRAND ISSUEo In their behaviour, consumers play off the competition between makes but equally

between dealerships of the same make in order to obtain the most favourableterms of sale.

INTER & INTRA-BRAND ISSUEo The automobile is a purchase greatly negotiated by consumers, the negotiation

based essentially on price (discounts), equipment and trade-in of the vehicle to bereplaced.

INTRA-BRAND ISSUEo Consumers clearly perceive that the automotive offer has evolved considerably in

the last decade. The improvement in product reliability, the increase in the rangeof models available and the level of equipment included as well as the level ofsecurity have clearly been of benefit to the consumers.

INTER-BRAND ISSUEo The strong established link between sales and after-sales in the mind of consumers

is largely practiced and approved because of the uniqueness of the product.

INTER & INTRA-BRAND ISSUEo Consumers expect a strong commitment by the manufacturers in the distribution

of their products and associated services.INTER & INTRA-BRAND ISSUE

o The present distribution system appears to a large majority of consumers as themode of distribution the most suited to the uniqueness of the automobile.

INTER & INTRA-BRAND ISSUEo The ideal system, according to those interviewed, would be to improve the

existing system rather than changing the fundamental basis of the current system.INTER & INTRA-BRAND ISSUE

o Among the alternatives tested, those, which were least likely to be rejected, arethe modes of distribution which preserve nearly intact the strong link of themanufacturer, with the brand. The sale of new cars in hyper and supermarkets isunanimously rejected in all countries.

INTER & INTRA-BRAND ISSUE

Thus the largest recent study of the automotive industry’s consumers’ preferences found thatintra-brand, i.e. franchisee, issues are involved in eight out of the top ten competitive issuesconcerning the consumer.

Any significant diminution of intra-brand competition would lead to a substantiallessening of total competition in the markets for new and late model vehicles, service,parts and skilled staff associated with that brand.

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Dr. Lademann & Partner Gesellschaft fur Unternehmensund Kommunalberatung mbHEuropean Commission Report December 2001: Most of the TNS Survey findings wereconfirmed and re-enforced by Lademann et al in their “Customer Preferences for existing andpotential Sales and Servicing Alternatives in Automotive Distribution” report (Dec 2001)commissioned by the European Commission Competition Directorate-Generale. Lademann useddifferent methodology (Adaptive Conjoint Analysis) with a smaller sample (500) and a differentmix of five European countries (The Netherlands replaced Italy). The remarkable similarity inthe findings of the two reports is therefore mutually re-enforcing and more robust. Weincorporate certain relevant parts of it here:

Exhibit 15. Extracts from The Lademann Survey Source: “Customer Preferences for existing and potential Sales and Servicing Alternatives inAutomotive Distribution” Dr. Lademann & Partner Gesellschaft fur UnternehmensundKommunalberatung mbH. (Dec 2001).

Importance of the marketing and competitive instruments studied

The survey showed that the various features investigated were of similar importance to theconsumers in the five countries chosen. The type of after-sales servicing alternative proved to bethe most important feature, followed by advice from a salesperson and the type of salesalternative. Then came, in order of importance: the ability to test- drive the vehicle, the distanceto the workshop, the delivery time and the freedom to select equipment.The high value placed on after-sales servicing, as well as the importance of personal advice,shows that, when a new car is being purchased, the buying phase is already overshadowed by theexpectations placed on the utilisation phase. Therefore after-sales servicing is already of utmostimportance at the time of purchase.

It is also worth noting that price and personal contact with the dealer are seen to be of lesserimportance in comparison to the other features. This initially surprising statement becomesplausible, however, when looking at the research method: faced with the question of whether ahigh discount on the purchase of a new car is more important than, for example, doing withoutexpert advice, a test drive or an authorized workshop, the consumers always choose theseessential features of quality rather than going for the price reduction.

Price levels and personal contact with the dealer only gain in importance when the quality-oriented expectations of the buying process and the servicing are absolutely assured. Converselythis finding shows that the price (or discount given) or personal contact are hardly suitableinstruments for giving a supplier a competitive edge, unless he also offers the highly valuedquality features. The comparatively small competitive value of price is also due to the pricetransparency of the market. Because of the transparency of the market, the high mobility of theconsumers, and their limited brand and workshop loyalty, car dealers tend to offer the samediscounts as their competitors in order to bind customers to them. In this way attempts are madeto compete with other distributors and after-sales servicing providers.

Brand and Dealer Loyalty

From the loyalty of consumers to a particular brand or dealer and his workshop, conclusions canbe drawn about the intensity of the competition within and between brands. The survey hasshown that approximately a third of the consumers buying a new car

o Intend to remain loyal to the dealer or the workshop and therefore also to the brand;

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o Intend to remain loyal to the brand but are prepared to change workshops;o Are neither loyal to a brand nor to a dealer or workshop, but rather look for the best offer

on the market for a particular type of car.

From the dealer’s (or brand’s) standpoint, this means that at least two (one) thirds of potentialbuyers of a new car will choose among different dealers (and brands). This possible loss ofcustomers forces the dealers to act competitively. This also applies to the third (of consumers)which is fundamentally loyal to the dealer, as their loyalty cannot be secured by qualitativelyinsufficient market efforts. (Pages 6-8)

o For dealer-loyal customers, who have already made their decision on the brand and thecar dealer, the question of the equipment and, in part, of delivery time is clearly moreimportant than for the other types of buyers. The other features are less significant than inthe other customer groups. This fact confirms the low level of preparedness to changedealers, compared to the other customer groups.

o For brand-loyal customers the opportunities to take a test drive and the sales options aswell as the workshop are important to a disproportionately high degree, which is quitelogical: They are loyal to the brand, but prepared to change the dealer and thereforeassign great importance to such factors.

o Type-minded consumers give great importance to the workshop and personal advice,which is logical since they are open as regards their brand and dealer choice.

The importance given by consumers to the examined features matches their loyalty habits in aplausible way. (Page 36)

Exhibit 15a. Source: Lademann Report

Competition in new car sales

The question of how the consumer approaches the purchase of a new car offers up interestingconclusions for assessing the competition on the distribution and servicing level of the automotiveindustry. This question showed that about a third of all the interviewees falls into each of the

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following categories:

o Loyal to the dealero Loyal to the brando Model-oriented

This result shows that inter-brand competition is mainly due to model-oriented consumers. Thisthird would, in our opinion, suffice to force the dealers to act competitively, as they wouldotherwise lose a third of their sales.

The survey shows that intra-brand competition is due to about a third of new car buyers, whoobviously seek out numerous car dealers selling one brand.35 It cannot be assumed that theremaining third, which is dealer-loyal (brand and dealer are decided on before the purchase of anew car) is insignificant for competition. For they will only remain loyal to their brand and dealeras long as the price and servicing of their car and dealer suit them.

Overall the findings regarding brand and dealer loyalty indicate intensive competition betweendealers and between manufacturers. For the brand-owners (industry) as well as the dealers sellingthese brands must, in their actions on the market, take into account that two-thirds of allconsumers are prepared to seek out other possibilities.36 This assessment is underlined by thebrand-loyalty in new car purchases in Germany, which is quoted at 57%.37 This also underlinesthe assessment regarding competition.

The findings regarding the accepted distances from servicing providers, which are clearlysurpassed by the distance travelled when buying a new car,38 show that the consumer currently hasa number of possibilities available, within one brand as well as among competing brands.

Functional competition is always present when the provider (here the automotive industry andtrade) must take the competitors into consideration in his actions on the market, and is forced totake these into consideration. One can assume this to be the case from the analysis of preferencesand in view of the mobility demonstrated by consumers, the limited brand and dealer loyalty aswell as the market transparency with respect to discounts.39

Market structure dynamics from the perspective of consumer preferences

The conjoint analysis of consumer preferences shows a tight, brand-exclusive connection betweensales and after-sales servicing. The consumer generally anticipates the later utilisation phase atthe time of buying a new car, or takes into account related experience. Already at the purchase ofa new car the subject of after-sales servicing has the highest preference. It is also noticeable thatthe benefit of a sales and servicing alternative is valued higher if it is brand-specific. Conversely,customer benefits decrease the more sales and servicing are manufacturer-dependent or notbrand-exclusive. In our opinion, this can be explained by the advantages of specialisation asopposed to all-brand suppliers and is incidentally a phenomenon that can be seen in otherconsumer goods areas apart from the automotive sector.40 New, stripped-down salesconcepts without their own after-sales servicing have practically no chance as long as carsrequire qualified maintenance and repairs (and the mobility of many people depends on thereliability, safety and durability).Based on this, the market simulations, from the perspective of preference analysis, can besummarised as follows:

o If sales alternatives that move away from the current pillars of sales brandexclusivity, an integrated workshop, personal advice and test drives - enter the

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market, extensive market opportunities for direct sales by manufacturers wouldresult.

o The separation of sales (trade) and servicing (craft) would lead to dramatic structuralchanges in distribution. The market shares lost by franchise dealers would againbenefit the manufacturers direct sales systems.

o The market opportunities of pure sales channels would not rise above a nichefunction, as long as they operated in a system without servicing, personal advice andtest drives. This is especially true for the manufacturer-independent Internet dealerand car-sector-unrelated retailers.

o From a competitive view, these structure scenarios would not fit consumerpreferences better than the current situation. It could even lead to a lowering ofquality in sales and servicing provision, if certain services (workshop, advice, testdrives, even choice of equipment) are reduced or disappear due to a price wardeveloping in an even more fragmented and intensively competitive market.

A radical change in today’s sales and after-sales servicing structures due to the entry of salesalternatives without workshops, personal advice and test drive possibilities into the market wouldstrengthen the influence of manufacturers in new car trade on the retail level through an increaseon direct sales. Overall this would lead to market structures that fit consumer preferences lessthan today’s. 35 This result corresponds to the findings of the Taylor-Nelson-Sofres Study, according to which two-thirds of new carbuyers who are not brand-loyal seek out different brands and different dealers. Only 47% of brand-loyal consumers, onthe other hand, go to dealers selling the same brand; Cf. Taylor-Nelson-Sofres. Publ., Attitudes towards the EuropeanAutomotive Distribution System, Executive Summary Report, 2000, in the following TaylorNelson-Sofres/2000.36 In fact the purchasing process is a fairly complex process with many phases, which for most buyers, by the way,overlaps with the utilisation phase of the car owned before, and is shaped by this. Brand-loyalty (and probably alsodealer-loyalty) wavers throughout the planned utilisation and buying- decision that follows: see Diez/2000.37Cf. DAT/Veedol Report 1999, p. 4138 So on average 52 minutes by car are accepted here; Cf. Automobilverkauf/1999, 20.39 On the other hand, particular market results (e.g. size of discounts, amount of re-imports, etc.) are not decisive forthe competitive structure of a market. These do not allow conclusions on competition because they can be aconsequence of, for example, overcapacity (discounts) or of tax systems (amount of re-imports) or simply ofconsumer preferences (a lack of acceptance of re-import offers). From anti-trust legislation, only those restrictions thatcome from companies are relevant (e.g. hindering re-importers or consumers buying directly abroad), not the consumerdoing without other possibilities (e.g. regarding re-import providers). In addition, market results are not known inadvance, because they are the result of market processes. For this reason it cannot be said, which market results reflectcompetitive restrictions and which reflect essential competition. Therefore, also with Article 81, Section 81 (EU treaty)one can only ask whether the market results follow from a competitive market structure characterised by latentpossibilities; only then is competition taking place in new car sales . no matter what the market results are.40 For example, an ADAC comparison of customer service quality shows serious qualitative disadvantages to fast-fitrepair chains in comparison to authorised workshops, Cf. issue 11/2001; the quality of the advice given in specialitystores is as a rule higher than in department stores, but often even better in manufacturer-run outlets, see e.g. o.V.Outlet Malls in Consumer Reports 1998, p. 20ff. Particularly with technically sophisticated products requiringexplanation (e.g. in the areas of hifi, video, computers, software) it can be observed that retailers with a wide range ofgoods compensate for the lack of qualified advice with an aggressive price strategy. (Pages 61 – 63)

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Intensity of competition

The findings regarding brand and dealership loyalty listed in this report have been taken as anindirect indication of intense competition in new car sales.

o Taylor-Nelson-Sofres (TNS)44 confirms this assessment in two ways. First, they askedconsumers directly about their perception of the intensity of competition betweendealerships. 80% assessed the competition as strong or very strong, 46% also noted arecent increase in the competitive intensity.45

o Secondly, TNS came to results similar to this study’s regarding the choice of dealer.According to TNS, barely 37% of all interviewees (4,000) remain loyal to their brand (re-purchasers)46 while our study found that about 63% intend to buy the same brand again.This is no contradiction, as TNS investigated the actual, and this study the intendedbrand-loyalty.

o Besides, other studies show that the intended brand loyalty is subject to considerablevariation during the utilisation and buying process; shortly after the purchase it is mostlyabout 90% and then it drops throughout the length of the utilisation period.47 Neverthelessour findings regarding intended brand loyalty are confirmed by other reports.48

The extent of brand loyalty may differ from study to study, but all the findings from theviewpoint of the private end consumer confirm a high intensity of intra-brand and inter-brand competition in new car sales.49

44 Cf. Taylor-Nelsen-Sofres Automotive, Attitudes towards the European Automotive Distribution System,Executive Summary Report, November 2000, Taylor-Nelsen-Sofres Automotive, Perception de laDistribution Automobile enEurope, Rapport Europe, Phase Quantitative, December 2000; cited in thefollowing text as TNS, Summary or Rapport.45 Cf. TNS Summary, p.4.46 Cf. TNS Summary, p.6.47 Cf. Diez/2000, 64f.48 According to the DAT-Veedol Report only 57% of new car buyers in Germany remain loyal to theirbrand, Cf. Diez/2000, p.64; Auto-Motor-Sport reports similar data regarding brand loyalty, Die besten Autos2001; among those consumers who have already made a decision, about 48% are potentially brand-loyal.49 However it is conceivable that the intensity of the competition could increase even more, e.g. throughnew sales alternatives or concentration of dealerships (Page 65)

Conclusions

Overall, the results of the consumer survey show that new distribution channels will in generalonly be accepted in connection with a minimum of quality-related services. New car retailerswho did not also provide brand-specific servicing facilities, test drives, a choice of equipment (atleast within limits), advice, and integrated customer service, would be likely to have only a verylimited success on the market. The preference structure shows that a lack of any or all of theseadvantages cannot be countered by price reductions.

In addition the survey made clear that brand-exclusive distribution and after-sales servicingconcepts are preferred. The skills possessed by dealers which sell and possibly maintain differentbrands are less valuable to most consumers than those possessed by dealers that specialise in onebrand, and have a close connection to, the manufacturer giving these brand-specialist dealers acompetitive advantage. In our opinion, this is connected to the present demand for qualified salesand servicing offers on the basis of which consumer expectations of safety, reliability and

23

durability can be better met by brand exclusivity.

Thus, the current market structures in new car sales and the brand-exclusive linking of sales andservicing are in line with the preferences of most consumers. Left to consumer preferences alone,the importance of re-importers will only increase slightly, and this in spite of the still inadequatedegree of price convergence within the European Union. The same applies to new car sales bymanufacturer-independent Internet suppliers. Younger buyers of new cars - contrary to what onemight expect, prefer the franchise dealers more than older consumers do, because for a majorityof them buying a new car involves taking a high risk and at the same time they have less buyingexperience. Only the multi-brand dealers, assuming they offer brand-specific after-sales servicing,appear to have some chances of success on the market. A growing number of possible new salesalternatives would however mainly improve the chances for manufacturers to increase their directsales. (Page 10)

End of extracts from Lademann’s Survey.

1.3 Evidence of Regional Collaborative Behaviour

1.31 Europe

Despite the apparent competitiveness of the automotive industry the major vehicle manufacturershave recently displayed regional anti-competitive behaviour. The major changes to Regulation1475/95 in the European Community, the ‘block exemption’ regulation, being enacted this year,were predicated by the major automobile companies failing to behave in the competitive mannerprescribed by the original regulation.

The EC Treaty lays down a basic rule (Article 81(1)) banning agreements which could have anti-competitive effects. However many common pro-competitive agreements, includingmanufacturer/dealer franchise agreements, contain clauses which limit the ability of one of itsparties to compete. Therefore Article 81(3) permits the EC to exempt such agreements from theban. The Commission often exempts a whole class of such agreements on condition they respectcertain competitive requirements and that they do not contain clauses proscribed by the Treaty.Such exemptions are called ‘Block Exemptions.’ The current automotive industry distributionblock exemption, Regulation 1475/95, expires in September this year and the new draft BlockExemption will be phased in over 24 months from then. The new regulation will have a ‘sunsetclause’ requiring its review in 2010.

In November 2000 an EC evaluation report evaluating the block exemption regulation(downloadable from: http://europa.eu.int/competition/car_sector/distribution…/report ) found thatthe terms of the 1995 block exemption had not delivered the degree of either inter or intra brandcompetition expected of it and, as a consequence:

o Consumers were unable to access their ‘Single Market’ right to buy their vehicleswherever in the EC the price was lowest.

o Dealers were still too dependent upon the manufacturers and

o Consumers were paying too much for service and parts.

24

Exhibit 16, from the 2000 report, shows the scope of the problem of new car and authorised partsprice differentials within the supposedly single market. The vertical axis demonstrates the spreadof parts prices within the community, the cheapest being Germany, which is indexed at 100, andthe most expensive being Denmark, indexed at 155. The horizontal axis demonstrates the spreadin pre-tax new car pricing, the lowest being Denmark, indexed at 100 and the most expensivebeing the UK at 147. Typically the manufacturers have been charging lower new car prices inhigh consumption taxing countries such as Denmark and higher new car prices in lowconsumption taxing countries such as Germany. The manufacturers then set their authorised partsprices in inverse proportion to the new car pricing mechanism. These measures have had theoverall effect of smoothing the differentials in the total cost of ownership throughout thecommunity. The UK and to a lesser extent Sweden got the thin end of the manufacturers’ wedge(there is a more appropriate Australianism) with both substantially higher new car prices andrelatively high parts prices. The report suggested the manufacturers were treating those countriesas ‘Treasure Islands.’ Further, in 2001, two manufacturers were found guilty of restricting theconsumer’s ability to purchase from lower priced countries through: quota systems, restricting theavailability of cars to other EC countries specifications e.g. RHD, and threatening the terminationof dealers sourcing authorised parts or non authorised parts of equivalent quality, from cheapercountries within the EC. Daimler Chrysler were fined US$65.5million and Volkswagen GroupUS$26.4million – other cases are in progress.

In response to a number of pressures, primarily:

o Those substantial fineso Pressure from the UK governmento The transparency brought about by the recent introduction of the Euro common currency o The proposed changes to the automotive block exemption regulation

Exhibit 16.

25

there has been some movement towards pricing convergence within the EC over the last fifteenmonths. It has been this convergence rather than a buoyant economy that led to a record year fornew car sales in the UK in 2001 and year to date 2002. There is still some way to go to achieveCommunity pricing parity; as of yesterday it was possible for a UK consumer to source a newPeugeot to UK specifications from a Dutch dealer via Virgin Cars via the internet at 20% belowthe UK list price.

1.32 Echoes from North America

Other evidence of collaboratively charging what a market will bear, with scant regard to costcurves, exists much closer to Detroit:

Exhibit17. ‘The borderline price wheeze’Source: Institute of the Motor Industry Journal, Wyatt, (12/6/02)

The scene is familiar - wide discrepancies between new vehicle prices on either side of aninternational border. In one country, dealers grateful for the low prices they enjoy and theopportunity of selling across the border; on the other side, dealers either complaining bitterly ofunfair competition or else joining in the disputed traffic. And in the middle are indignantmanufacturers threatening legal action against what they perceive as infractions of their franchiseagreements.

The British reader might well have the sense of déjà vu, but this is not a European story, it’s apricing anomaly in the very cradle of commercial competition – North America. The past severaldecades have seen a steady fall in the value of the Canadian dollar against its American counterpart.At one time almost at parity, it now rates at only 58 U.S. cents. Manufacturers, however, have donelittle to adjust for this devaluation, thereby progressively causing a substantial gap as expressed inUS dollars.A good example is the Dodge 1500 Pick-up truck, listed at US$22,456 in the United States and atC$22,500 (US$17,540) in Canada, a difference of US$4,916. If one factors in various popular add-ons such as automatic transmission, leather seats and a cassette/CD player, that difference widens toUS$7,811 (leather seats are $889 in Canada, $1,380 in America). Studies taken two years agoshowed the average difference to be US$2,515, before accessories, since which time the gap hasfurther widened.

Unlike Europe, the controversy on this side of the Atlantic centres less on carmakers being accusedof gouging the retail customer by their lopsided pricing policies than on the damage done to thosevery manufacturers by wayward dealers taking advantage of the loophole. Dealers in NorthAmerica may well enjoy greater legal protection than in Europe, but in this instance it is thecarmakers that have resorted to the courts, not only to stop the traffic but to punish by financialsanctions those they regard as law-breakers. One can appreciate their concern; the traffic hasrocketed from 15,000 vehicles in 1996 to well over 200,000 in 2001 as the currency gap haswidened.

The litigation is aimed at Canadian dealers, on the grounds that export sales (whether direct orindirect) are expressly forbidden under the terms of their franchise agreement. Legal actions takevarious forms. Marlborough Ford of Calgary was penalised approximately $125,000, representingthe price difference on 23 vehicles (later reduced to $52,000 on ten vehicles), but the Alberta Courtof Queen’s Bench handed down an injunction, heading off Ford’s action. However, in legalcircles, nothing is final until ‘the fat lady sings’, the fat lady in this case being Canada’s SupremeCourt, where the case is likely to end up.

26

Already Ford has given notice of its intention to appeal, but it may face an uphill battle, judging bythe Alberta judge’s comments. Criticising Ford for its “lack of clearly-defined procedures toestablish an even playing field”, he characterised the manufacturer’s practices as a “nebulous andill-defined state of affairs that is constantly subject to its own unilateral and arbitrary review”. So, one may ask, what’s new?

Echoing a point made by the dealer’s attorney, the judge went on: “The charge is a clear penalty,not justified by way of any credible evidence of a figure commensurate with the loss suffered byFord of Canada or its network of dealers.” These last words have an ominous ring, perhaps castingdoubt on the legality of the manufacturer’s dealer agreement, not to mention questioning the logicof its Canadian pricing policies. After all, a not inconsiderable number of vehicles retailed inCanada are made in the US. Certainly the precise clause in the agreement that forbids export saleswill come under close scrutiny. When I spoke with Ted Babie, owner of Marlborough Ford, heconceded that these cross-border sales do contravene the terms of the agreement, but points out thatthe clause arose in an unusual way. Some years ago, as the price gap became significant, Fordissued a single-page addendum to the agreement outlawing such sales, asking for it to be “stapledbetween pages 15 and 16”. Over the years since, dealers have been instructed to interrogatepotential customers, culminating in a four-page questionnaire. Not exactly the way to encouragebuyers. Babie explains that brokers across the border go to great lengths to evade being detected,using relatives’ and neighbours’ names. He therefore challenges Ford’s action, not only in itsprecise financial form but as an unreasonable, even unenforceable, burden on the dealer, effectivelytrying to prevent the buyer getting the best price. In terminating the franchise of a dealership inQuebec, Poirier Valleyfield, Ford accuses the dealer of being “an egregious and long-time repeatoffender [in engaging in export sales]”. Ford pleads that it is merely enforcing its dealer sales andservice agreement. Poirier Valleyfield, for its part, contends that there has been no contravention ofits agreement, and consequently repudiates Ford’s decision. Both parties have accepted court-appointed arbitration, the hearing to take place late summer. Literally, the jury is still out.

Of course, Ford is not the only manufacturer aggrieved over this traffic. Faced with a growingproblem in 1999, Honda abruptly stopped honouring warranties on the ‘grey’ cars, and claims nowto have halted the traffic. Other manufacturers point to dealer support. In backing Chrysler/Dodge,Ken Zangara, owner of Zangara Dodge of Albuquerque, New Mexico, and chairman of theNational Dodge Dealer Council, reserves particular contempt for non-franchise middlemen(brokers) who hover around this trade like bees around a honeypot. One broker in Port Huron,Michigan, last year processed 10,000 cars and has set his sights on 15,000 in the current year. Forhis brokerage income, he merely deals with compliance and the paperwork, posting a bond andconverting the speedometer to miles from metric, before passing on to a car dealer.Chrysler/Dodge is also threatening to withhold warranty, complaining that “thousands of cars” arefinding their way across the border. Even so, one Canadian Dodge dealer, who denies any part inthe illegal traffic, doubts the carmaker’s resolve to do so, having itself for years bought off-leaseand fleet cars in Canada and resold them in the United States. Then again, one dealer in Montana,just 100 miles south of the border, shrugs off the warranty issue anyway. He says he would just buythe customer an aftermarket warranty.

No one could have resisted the pressure for change more fiercely than Europe’s motormanufacturers, but the result was inevitable – a trend to more consistent pricing, which it is hopedwill continue with the advent of the euro. Not only are the courts in North America traditionallypro-dealer, and these artificial pricing policies appear to be difficult to defend, but themanufacturers have chosen to air the conflict. They may well live to regret doing so.

27

1.4 The Australian Automotive Industry - Overview

1.41 Relative Economic Importance of the Australian Motor Industry

Exhibit 18

Australian automotive exports reached a record $4.9 billion in 2001 and motor vehicle exports, at$3.1 billion, made it into Australia’s top ten exports for the first time - they were the onlymanufactured goods in the top ten. Exports of Passenger motor vehicles rose 35 percent to $3.1billion in 2001 (Exhibit 18) and accounted for 3 percent of total exports. Since 1997, vehicleexports have increased by an average 28 per cent per annum.

Principal export destinations for Passenger motor vehicles in 2001 included Saudi Arabia ($1.4billion); the United States ($591 million); New Zealand ($364 million); the United Arab Emirates($206 million) and Kuwait ($186 million). In 2001 exports of Passenger motor vehicles toSaudi Arabia rose by 54 per cent and to the United States by 59 percent

Imports of Passenger motor vehicles rose 11 percent to $8.7 billion in 2001 and accounted for 7percent of total imports. Since 1997, imports of Passenger motor vehicles have increased by anaverage 15 per cent per annum. The major sources of imports of Passenger motor vehicles in2001 included: Japan ($4.9 billion); Germany ($1.4 billion); Korea ($642 million) the UnitedKingdom ($399 million); and the United States ($352 million). In 2001, imports of Passengermotor vehicles from Germany rose 42 percent and the United Kingdom 54 percent. Exports fromKorea fell 18 percent.

Imports of Motor vehicles for transporting goods decreased 11 percent to $2.2 billion in 2001and comprised 2 percent of total imports. Imports increased on average by 6 percent per annum

28

between 1997 and 2001. In 2001, imports of Motor vehicles for transporting goods weredominated by Japan ($1.1 billion) and Thailand ($475 million). Other major import sourcesincluded the United States ($287 million); and Germany ($92 million). In 2001, imports fromJapan of Motor vehicles for transporting goods fell by 19 percent, and imports from Thailand fellby 32 percent. Imports from the United States increased by 53 percent in 2001.

Imports of Motor vehicle parts decreased by 15 percent to $2.2 billion in 2001, and comprised 2percent of total imports. Between 1997 and 2001, imports increased by an average 9 per cent perannum. Major sources of imports of Motor vehicle parts in 2001 included: Japan ($867 million);the United States ($542 million); Germany ($202 million); Sweden ($83 million); and Taiwan($54 million). In 2001, imports of Motor vehicle parts from Japan fell by 30 percent and importsfrom the United States fell by 11 percent. (Source: ‘Composition of Trade Australia 2001’ MarketInformation & Analysis Section, Dept. of Foreign Affairs and Trade).

Thus Australia’s trade balance for all motor vehicles was negative $7.8 billion and for motorvehicle parts negative $0.4 billion, a total of negative $8.2 billion. This total vehicle trade netimbalance is roughly equivalent to all of Australia’s gross wheat and aluminium ores exportscombined. The recently announced Ford 4 wheel drive project, GM Holden’s sale of 18,000Monaros, re-badged as Pontiac GTOs, to the USA, the continuation and re-investment ofMitsubushi and the probable expansion of Toyota’s Altona plant are all likely to reduce thisdeficit in the near future. 1.42 Market Size & Characteristics

29

0

100000

200000

300000

400000

500000

600000

700000

800000

900000

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01

Total Annual Vehicle Units - Market Australiaest.

Exhibit 19. Source: Paxus & VFacts

Exhibit 19 demonstrates that the last six years have delivered historically high domestic unitvehicle sales in Australia and Exhibit 20 that 2002 could be the highest unit sales ever.

30

Year To Date Sales 2000 v 2001 v 2002 Australia Total Vehicle Market

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC

Sales Month

Vehi

cle

Sale

s

200020012002

Exhibit 20. Source: VFacts

The industry is prone to high levels of cyclicality:

Brand market share can vary quite considerably over the product life cycles and with theoverall value propositions offered by the brand owners and their franchised networks. From1995-7 Ford were the Australian brand leaders with some 20% of the new vehicle market(against 12.9% YTD May 2002). Since 1998 market leadership has variously been betweenToyota and GM.

Total market size varies with the prevailing economic cycle. The level of new motor vehicleregistrations is a primary indicator of economic performance and consumer confidence.Exhibit 19 demonstrates a 35% drop in annual new vehicle registrations between 1985 andthe 1987 recession and a 58% lift in annual registrations from the 1991 recession trough tothe 1998 peak.

In an industry characterised by high fixed costs, the challenge for the whole value chain ishow best to control their variable and semi-fixed costs in response to market share and marketsize. Inevitably, given the industry characteristics, each recession brings economic casualties,franchisees of under-performing brands at their forefront.

31

1.5 Competition in the Australian Automotive Industry

1.51 The Competitive Intensity Landscape (after Porter’s 5 Forces Model) Figure 5.

Even though competitive pressures in various industries, and at different links of an industry’svalue chain, are never precisely the same, the competitive process works similarly enough to usea common analytical framework in gauging the nature and intensity of competitive forces. AsProfessor Michael Porter of the Harvard Business School has convincingly demonstrated (“HowCompetitive Forces Shape Strategy”, Harvard Business Review 57, no.2 [March-April 1979], pp.137-145), the state of competition in a market is a composite of five competitive forces:

o The internal field of rivalry – the rivalry between competing sellers in a market.o Substitutes - the market attempts of external rivals to win customers over to their

products.o New entrants – the potential entry of new competitors.o Suppliers’ bargaining power – the bargaining power and leverage suppliers of inputs can

exercise.o Customers’ bargaining power – the bargaining power and leverage exercisable by the

consumers of the product.

Porter’s 5 Forces Model (fig.5.) is a powerful tool for systematically diagnosing the chiefcompetitive pressures in a market and assessing the strength and importance of each. Not only isit the most widely used tool of competitive intensity analysis, but it is also relatively easy to useand understand.

In Figure 6 it is applied to the competitive intensity landscape of an Australian franchised vehicledealer’s new vehicle division (the competitive forces are different for each of a dealer’s six toeight profit centres). Here the model has been amended to:

a. Recognise barriers to entry to the potential new entrants and

b. Recognise that all of these competitive forces act against a background oflegislation, existing and potential, that can act as a driver, moderator or eveneliminator of competitive intensity.

Internal FieldOf Rivalry

SuppliersBargaining

Power

CustomersBargaining

Power

Threat ofNew

Entrants

SubstituteProducts

32

Here the rivalry between competing sellers – the intra-brand competition, is between the regionalfranchise network (1.54) of the franchisor, which is itself the dominant supplier (1.56). Thesubstitutes are the offerings of the other manufacturers, other brands of this manufacturer and latemodel used examples of the desired vehicle (1.53). The potential new entrants are varied as isexamined later (1.55). The customer mix for non-prestige brands is some 60% fleet content(government, business, fleet-lease companies, hire-car companies etc.) and 40% retail (privateconsumers and micro businesses) (1.57). The legislative background is discussed in 2.0.

1.52 The Competitive Intensity Landscape of a Franchised Vehicle Dealer’s New VehicleDivision (after Porter’s 5 Forces Model) Figure 6.

Each of these five forces in the Australian new vehicle market is formidable, as evidenced bythe average net profit before tax of 1.5% of revenue (Aon Martec ‘Dealer Performance andProfitability’ March 2002) and the U.S.A. figure of 2% (Exhibit 21). Exhibit 21 also demonstratesthat competition in the automotive retail industry, as delineated by margin to revenue, is moreintense than in the grocery, specialty retail, drug store, department store/discount chains, appareland home improvement retail markets. These studies are confirmed and made more robust bythe European consumer perceptions described in the TNS Survey (exhibit 4) andLademann’s Report (exhibit 15).

Legislation Legislation

Legislation Legislation

Barriers to entry

Regional Franchise Network1.54

OEM BrandOwner or

Distributor1.56

CustomersFleets 60%

Private 40%1.57

PotentialNew

Entrants1.55

Competing Brands1.53

33

Exhibit 21. Source: ‘Bringing Science to Automotive Retailing’ – accenture ‘Automotive Insight’ 2002.

The relative strengths of each of these forces is examined in sections 1.53-1.57:

1.53 Inter-brand Competition - Competing Brands

As previously noted the Australian vehicle market concentration ratio for the top fivesuppliers at brand level is a relatively low 68% (Fig.3). The top four brands produce some oftheir range indigenously both in Melbourne and Adelaide. If we look at the concentration ofthe Australian market for the top five brand owning OEMs (e.g. Ford = Ford + Mazda +Volvo + Jaguar + Land Rover etc.) the concentration moves up to 84.4%1.

This increase in market concentration is a direct result of the merger and acquisitionactivity of the last five years.

As the top five brands are all owned by different OEMs, and no one of them has more than a22% market share1, the market is still one of imperfect oligopoly with vigorous inter-brandcompetition in all segments.

1. Source: Vfacts May 2002

ProblemRecognition Information

Search EvaluationOf

Alternatives

Figure 7. Inter-Brand Competition

Intra-BrandCompetition

Table 1. Top Ten Brand

1.54 Intra-brand Com

As previously discussed more than 50%concerns involve intra-brand competition new-vehicle sales, authorised service aselling) of late model used vehicles of regional franchise network. The franchisethe manufacturers have historically transale, pre-delivery, accessorising, servicfinancing, marketing and repurchase of th It is the vigorous, sole source of intra-br

The degree of intra-brand competition in the metropolitan capital cities. The francompetition – competition where a large slightly differentiated offerings and withThe internet and web based intermediarcompetition. Monopolistic competition (sdescribes all market structures from justgroup of sellers, has any degree of marketor increasing supply) to almost oligopolcan only differentiate between themselvelevels, product augmentation expertise anwith the same franchisor’s standardised p

EvaluationOf

Alternatives

Inter-BrandCompetition

urce: VFacts.

ork

s Market Share Australia YTD May 2002 So

petition -The Regional Franchise Netw

34

of the buying decision process and 80% of consumer(fig.8.). This is the competition in a regional market fornd parts, skilled staff and the trading (buying andthe franchised brand, between the franchisees of the network is the retail distribution mechanism by which

sacted the localised: stocking, display, demonstration,e, parts supply, warranty provision, safety recall,

eir vehicles.

and competition.

Australia is generally intense and at its’ most intense inchisee system delivers ‘monopolistically competitive’number of sellers, relative to the market, compete with therefore limited ability to effect price in that market.ies have served to increase pricing transparency andometimes referred to as ‘Chamberlin’s Large Group’) short of perfect competition, where no one seller, or power (the ability to effect market price by withholdingistic competition. Independent new vehicle franchiseess via location, staff selection, service levels, inventoryd marketing effort. Until recently they have all startedroducts supplied under standardised trading terms and

SupplierSelection Purchase

Decision

PostPurchase

Behaviour

Figure 8. Intra-Brand Competition

35

with standardised franchisee (dealer) agreements with the brand franchisor – which may be thebrand owning OEM or its authorised distributor.

Figure 9.Types of MarketCompetition

Table 2. Demonstrates the average available total market share available to each of the MelbourneMetropolitan (inc. Geelong) franchisees of the top selling five franchisors, and was until recentlytypical of the monopolistic competition exibited in all major metropolitan markets for mostbrands:

Table 2. Total Market Share Per Franchiseee - Melbourne Top 5 BrandsBrand GM

HoldenToyota Ford Mitsubushi Nissan

Number of Melbourne MetropolitanDealerships:

Average % Brand Share perFranchisee:

%YTD Market Share:

Average % Total Market Shareper Franchisee:

29

3.45

22.2

0.77

22

4.55

18.4

0.84

30

3.33

12.9

0.43

21

4.76

7.8

0.37

16

6.25

6.3

0.39

Recent developments in Perth, Melbourne, Sydney and other NSW market centres have, orare likely to have, the effect of substantially lessening intra-brand competition by changingregional market structures from monopolistically competitive to unbalanced oligopolisticand, in two examples involving Inchcape Automotive Australia Ltd., Subaru - Melbourneand Volkswagen – Sydney, monopolistic.

MonopolyCR1=100

Duopoly CR2=100

Monopolistic Competition CR>10<90

Perfect Competititon CR >100<5

Oligopoly CR<10 >90

Degree ofMarket

Imperfection

36

Subaru Australia Ltd

Subaru (Aust) Ltd. is 90% owned by Inchcape PLC, a specialist UK based, multi-national automotive distribution, logistics and, latterly, retail company, and 10% FujiHeavy Industries the Japanese 80% brand owner of Subaru (20% General Motors). Itis the authorised Australian distributor of Subaru vehicles.

Exhibit 22. Major Shareholders Inchcape PLC. Source: www.Inchcape.com

Major Shareholders – Inchcape PLC.

1 Jul 0277.57m 150p Ords

Barclays Bank PLC 11.93%

Fidelity Intl Ltd6.49%

Standard Life6.02%

Toyota Motor Corp5.43%

Other Dirs0.20%

On 23/9/97 Subaru (Aust) Ltd. wrote to their franchised network advising them of an extensionof Dealer Agreements expiring on or around 1/10/97 until 31/12/97. In December 1997 Subaru(Aust) Ltd. instituted a dealership enhancement and identification programme requiring eachmember of their franchised network to invest between $250,000 and $800,000 on upgradingdealership facillities and Subaru corporate identification to be completed by March 1999. At theend of this programme each dealership was to be accorded a four or six star accreditation. Non-compliance with the programme would lead to non-renewal of the franchise agreement. Inmany cases the franchisees were expending the investment on rented premises.

On 1/6/98 Subaru (Aust) Ltd. wrote to ‘All Dealers with Expired or Near Expired DealerAgreements’ (sic) advising them of “a great deal of uncertainty surrounding the introductionand application of the Franchising Code of Conduct (scheduled to apply from 1/7/98)”. Theletter offered to extend expired or nearly expired agreements under the same terms andconditions as had previously existed with the inclusion of a dispute resolution mechanismreferred to as “new clause 16”. The letter stated that this would “allow greater stability for the

37

introduction and management of the Subaru 6 Star Revitalisation Programme”. Franchiseeswere advised that the extension offer would lapse by 19/6/98 after which renegotiating a dealeragreement “may prove challenging”. The letter concluded with: “Should all reasonable attemptsto negotiate an immediate post-Code Dealer Agreement (sic) fail, we have been instructed byInchcape Motors Ltd to formalise the conclusion of our relationship.”

On 18/6/98 Subaru (Aust) P.L. wrote to all dealers with expired or near expired dealeragreements “clarifying” their letter of 1/6/98. They claimed that ‘due to the onerousrequirements’ of the franchising code that they, Subaru (Aust.) P.L. were still several monthsaway from the finalisation of their new dealer (franchise) agreements. They again reccomendedthe acceptance of the existing dealer agreement extension to 1/10/99 to “give Subaru Aust (sic)some breathing space to digest the requirements of the code and finalise the redesign of ourdealer agreement.” They further stated: “The renewal of the agreement will provide you withsome certainty that many of you have requested especially while undertaking improvementsto your facilities.” It is unlikely that other major franchisors or their franchisees lived with thisdegree of uncertainty.

On 26/6/98 Subaru (Aust) P.L. wrote to franchisees that had not formally agree to the non-negotiable, non-compliant with the Franchising Code of Conduct, proposed extension of theirDealer Agreements (to 1/10/99) extending the terms and conditions of the lapsed DealerAgreements until a new dealer agreement “is agreed”. This was the first of theircommunications to acknowledge copies to “Inchcape” and Minter Ellison, a firm of solicitors.In September 1999 Subaru Australia Ltd. submitted their new draft dealer agreement to theSubaru development board for approval / negotiation and on 24/3/2000 wrote to theirMelbourne franchisees with a new ‘final,’ take it or leave it, non-renewable franchiseagreement expiring on 1/1/2002 and informing them that Subaru Aust. (sic) would be takingover retail operations commencing mid 2001. Together with the new agreement was the offer ofa ‘consideration’ to offset business exit costs. This varied between $50,000 and $450,000 withthe most common offer being $150,000 and was conditional upon the franchisee granting arelease to all Subaru associated entities and their employees from any legal action. Theseamounts were, in some cases, subsequently negotiated upwards by $50,000 to an averagepayment of $165,000. Inchcape Automotive Australia P.L. had therefore taken monopolycontrol of the Melbourne market for Subaru sales, service and parts for a little over $1.1million.

In a ‘Dealer Bulletin to all Subaru Dealers & Staff’ of 27/3/2000 Subaru (Aust) P.L. advised thefranchise network of the terminations and their intention of “moving into the retail car marketin the Melbourne Metropolitan area”. The Bulletin went on to assuage ‘discomfort todealerships elsewhere’ as the initiative ‘relates only to the Melbourne metropolitan market.’ Itwas at about this time that the corporate entity known as Inchcape Automotive Australia P.L.was re-defined, which according to the Inchcape PLC annual report (2000) differs from Subaru(Aust) P.L. in two important respects:

o It is 100% owned by Inchcape PLCo It is concerned with retail operations as well as import and distribution

It is clear from Inchcape PLC.’s 1999 Annual report (Exhibits 23) that although the AustralianSubaru franchised network was vastly outperforming the market, Inchcape PLC. was intent onpursuing a global strategy of automotive concentration and forward integration into retail. Theyclearly prioritise regional clustering and regional market monopoly (their preferred andbelaboured euphenism is “exclusivity”). Their expenditure of 10.2million pounds sterling on

38

two Sydney retail groups delivered them (among other franchises) the monopoly retail positionfor Volkswagen products in Sydney.

Exhibit 23. Source Inchcape PLC Annual Report 1999

With the Subaru (Aust) P.L. inspired uncertainty over dealer agreement renewals fortheir franchisees it is probable that Inchcape saw a way of gaining another regionalmonopoly for a lot less than that of Volkswagen in Sydney. It is entirely possible this hadbeen their intention, even their strategic plan, for inspiring that uncertainty.

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By 2003 Melbourne consumers will have had their Melbourne metropolitan choice of dealersreduced from eight vigorously competing independent businesses to one: Inchcape AutomotiveAustralia P.L. – 100% owned by Inchcape PLC. A distributor owned, regional monopolyconsisting of a centralised ‘experience’ centre, four sales and service satellite outlets and twosatellite service only outlets. In addition to concentrating the Melbourne market for new Subaruvehicles to a CR1 of 100% (ie monopoly) it delivers an average total market share perfranchisee of 3.7% - nearly four times that of the next highest (Toyota), seven times that ofFord and over four times that of the market leader (GM Holden) (Fig.9).

This market restructure alone would appear to be a prima facie breach of s45 & possibly s50 ofThe Trade Practices Act 1974 - but there are other real market effects, little understood outsideof the automotive industry (particularly by legislators and regulators), that have the potential,even likelihood, of breaching most sections of The Act.

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Variable Brand: GMHolden

Toyota Ford Subaru2002

Subaru2003

Number of Melbourne Metropolitan*Dealerships:

Average % Brand Share perFranchisee:

Brand %YTD Market Share:

% Total Market Share perFranchisee

25

4.0

22.2

0.88

19

5.26

18.4

0.97

26

3.85

12.9

0.50

8

12.5

3.7

0.46

1

100

3.7

3.7

*Excluding Melbourne Satellites: Geelong, Lilydale & Frankston

Figure 9. Total Market Share Per Franchisee - Melbourne

Consider:

o The franchise network acts as a mechanism in establishing the value of late modelused vehicles. When a used vehicle consumer begins the information search,evaluation of alternatives and supplier selection stages of purchasing of a late model(up to five years old) vehicle their search usually begins with the authorisedfranchisee network (fig.4). These consumers share many of the concerns andpreferences identified earlier in this paper with the new vehicle consumer.Consequently late model trade-in vehicles are of more value to the used vehicledepartment of a franchisee of their own brand than to that of a different brand due toeconomies of scope and experience. Whether the vehicle is being traded-in ‘in-house,’ or at a dealership of a competing brand, the expert opinion of the brandedfranchisee’s used car manager or valuer will be sought to ascertain its current marketvalue. The wholesale market and producers of ‘dealer guide’ price books and onlineservices also source their primary values this way (in practice ‘dealer guides’ areanything but – values exist and change in real time – their primary usage is to givefinance and insurance companies a reference point). In 2001 in the Melbournemetropolitan area there were eight franchisees in active competition for late modelSubarus, by the end of 2002 there will be one. This is substantial lessening ofcompetition in the market for late model Subarus and will cause the trade-in valueowners of late model Subarus receive, to diminish, regardless of whether they arebuying another Subaru or a different brand.

o The sole Melbourne metropolitan retailer of new Subaru vehicles is to be the Australiandistributor, Subaru Aus. Ltd. The distributor has the power to control or limit supply ofnew Subaru vehicles to Melbourne satellite and Victorian country franchisees so as

SubstantialLessening ofCompetition

41

to limit the consumers’ ability to purchase a new Subaru outside of the Melbournemetropolitan area.

o The sole authorised Melbourne service and parts outlets for Subaru vehicles is to be theAustralian distributor, Subaru Aus. Ltd. – substantially lessening the competition in themarket for service and parts sales to consumers, independent mechanical repairshops, panel shops, car hire companies, insurance companies and fleet leasecompanies.

o The restructure substantially diminishes the regional choice of employers andconditions of employment for staff who have invested in becoming skilled in Subarusystems, technologies and product knowledge.

o Subaru Aus. Ltd. have recently issued a dealer termination notice to their Newcastlefranchisee, acquired certain key NSW dealerships and advised their NSW franchisednetwork of their intention to re-organise the NSW market around ‘mega-dealerships’.

Exhibit 24. Their Own Petard: Extracts from 2000 & 2001 Annual Reports Inchcape PLC. INCHCAPE ANNUAL REPORT 2000 CHAIRMAN’S STATEMENT (part)

We will develop our core markets – the UK, Greece, Belgium, Australia, Hong Kong andSingapore by broadening our business base, moving closer to the end customer andexpanding the retail offering. “The emergence of Inchcape as a pure automotive group has brought with it a stronger focus inthe business and greater clarity for shareholders.”In Australia we have invested in retail and provide exclusive* representation for VW and Jaguarin Sydney.We have launched an exciting new initiative with Subaru to represent themexclusively* in Melbourne. Sir John Egan, Chairman Inchcape PLC 5/3/2001

INCHCAPE ANNUAL REPORT 2000 CHIEF EXECUTIVE’S REVIEW (part)

In our other key markets where we have pure import and distribution businesses we are pursuingour strategy of moving further into retail, where we can achieve a major market position. Thiscombination of retail and distribution increases our margin. In addition we are exploringdiffering retail structures. In Melbourne, for example, our Subaru retail investment will requirea significantly lower asset base and cost structure than the existing retail infrastructure in thatmarket.AUSTRALASIAOperating Profit £9.4m 2000, £11.4m 1999Subaru remains the cornerstone of our Australasian operations and again performed exceptionallywell. It increased both market share and sales volumes in a declining market. Outside of Japanand the USA our Australia Subaru market share of 3.5% is the highest in the world.However, with the Australian dollar falling to its lowest level for 10 years against the Yen,margins came under pressure. Profits for Jaguar were static at £1.5m. As envisagedthe Jaguar distribution business will revert back to the manufacturer during 2001, but our Jaguarretail operations in Sydney have been granted exclusive* rights of representation. We also haveexclusive* VW representation in Sydney. In addition in 2001, we are investing in Melbournewhere, from 2002 onwards, we will be the exclusive* Subaru retailer. Melbourne represents22.1% of the Australian market. Our Peugeot business reduced losses during the year to less than£1.0m, and profits are expected in 2001. Peter Johnson CEO, Inchcape PLC 5/3/01

http://www.inchcape.com/

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INCHCAPE ANNUAL REPORT 2001 CHAIRMAN’S STATEMENT (part)

“In Australia we continue to invest withSubaru, VW and Jaguar. We will become theexclusive* retailer for Subaru in Melbourne during 2002 introducing a new retail conceptwithin this market. This will be a scale business selling over 6,000 new and used cars in a fullyear. We are also examining retail expansion plans in Sydney, particularly with the PAG group.CURRENT TRADING AND PROSPECTS“Our Australian business continues to grow and improvements in the exchange rate environmentsince year end will be beneficial. We should also see an improved performance from our retailinvestments. On balance there are a number of positives, which are expected to offset anypressures felt in Asia. Taken as a whole the outlook is encouraging and we are confident that2002 will see further progress.” Sir John Egan, Chairman of Inchcape PLC. 4/3/02

INCHCAPE ANNUAL REPORT 2001 CHIEF EXECUTIVE’S REVIEW (part)STRATEGY UPDATEDuring 2001 Inchcape successfully completed its strategic transformation from a traditionalautomotive importer to a group focused on the retail customer, whilst rapidly expanding intothe business services sector. We now have a core distribution and retail business centered on fourkey manufacturers, Toyota, Subaru, Ferrari and the Premier Automotive Group (PAG) of Fordoperating in six markets, UK, Greece, Belgium, Australia, Hong Kong and Singapore.These businesses continue their drive into retail, developing the customer relationship throughincreased vehicle sales, aftersales and financial products. At the same time, by improving systemsand processes whilst reducing working capital, we have increased our operating margins.Recent weeks have seen an acceleration in the consolidation within the UK retail sector. Inchcapepre-empted this consolidation, completing the Bates Motor Group Ltd (Bates Group) acquisitionon a very attractive multiple. We will continue to take advantage of ‘in fill’ opportunities withour selected partners as they arise.AUSTRALIA/NEW ZEALAND“Operating Profit £12.8m 2001, £8.7m 2000 Subaru Australia continues to outperform themarket, achieving a record volume (over 27,000 units in 2001) for the fifth consecutive year.Market share was 3.6%, the largest share for a major Subaru market outside Japan. Thegrowing Sydney Retail business achieved 4,750 unit sales in the year and improved profitabilitywith VW performing particularly well. The launch of Subaru Melbourne, our exclusive* newretail concept for this city, which represents some 20.0% of the Australian market, isscheduled for the second quarter of this year. The real benefits from this substantial newbusiness (over 6,000 new and used cars per annum) will start to impact in 2003”.“ We have represented Subaru in Australia as Importer and Distributor for ten years. In line withour strategy to broaden our earnings base we will become, later this year, the exclusive*retailer for Subaru in Greater Melbourne. This territory represents some 20% of theAustralian market and the business is expected to sell c. 6000 new and used cars per annum.In Sydney we exclusively* retail VW and Jaguar, part of PAG, through six dealerships andhave long term contracts with the manufacturers. We also represent Volvo, also part ofPAG, and acquired a Subaru dealership in 2001. We are looking to expand this business asour retail strategy for Australia develops.”PETER JOHNSON – CEO InchcapePLC Source: Annual Report 2001 (March 2002)*see Exhibit 24a.

Exhibit 24a. Source: Macquarrie Dictionary 2000.

exclusive 1 & 8:

“To exclude all others” – “Available through only one channel of marketing”

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It is apparent from the Inchcape PLC annual reports of 1999, 2000 and 2001(downloadablefrom www.inchcape.com ) that their retail business model does not work, or fails to meettheir required internal rate of return, in monopolistically competitive markets. The company’sthree year strategy has been to abandon ‘low profit,’ high volume retail outlets in favour ofregionally ‘exclusive’ and/or regionally clustered (eg Guildford UK) retail operations. It is nofault of the company that it seeks to profit maximise – it is however the fault of regulators ofcompetition law that they have thus far failed to recognise the importance of intra-brandcompetition to the consumer and failed to act to prevent its substantial lessening.

The ACCC’s understanding of the automotive and other complex industries would beconsiderably enhanced by utilising external, industry specific expertise in aiding it makefar reaching decisions.

Ford – The Retail Joint Ventures: Perth and Sydney

Another mode of forward integration is being employed by Ford Australia Ltd. in Perth(1999) and Sydney (2000). These ‘retail joint ventures’ (RJVs) had their genesis in Detroit.Then senior Ford marketing guru, Ross Roberts, convinced then Ford global CEO, JacquesNasser, that marketing cars wasn’t much different than marketing McDonalds fast food and inthose states that didn’t prohibit the forward integration of the OEMs (for competition reasons)they should buy some stores. Over three years they formed their ‘Ford Retail Network’(FRN) in Tulsa, Oklahoma, Rochester, New York and Salt Lake City by taking control ofmost of their dealers in those cities. Such was the success of this FRN programme that all ofthese ventures have now been sold, or are in the process of being sold, some to the largechains eg. Rochester FRN to AutoNation and some back to the original dealers. It is notthought that the experiment was cash flow positive for Ford.

Nasser was ex CEO Ford Australia and was anxious for Australia to play a prominent role inthis bold endeavour. His hand picked Australian successor, ex-retailer Geoff Polites, wasinvited to form RJVs in all the major capital cities. These were to be willing buyer / willingseller joint ventures with the RJV buying the goodwill from individual franchisees at a P/E ofbetween 3 and 4, assuming stock at value and taking brand new ten year rental agreements onthe franchisee’s premises (these multiples are in line with Australian case law – see 2.34).The RJVs are operated by the Ford Enterprise Investment Company (FEICo). The franchiseeswere invited to leave all or part of their purchase price in the RJV as equity or take the moneyand run. Initially the five out of eight Perth dealers who participated kept some equity butmost didn’t take to the new regime and sold down to Feico and left. Their Sydney colleaguesa year later left less in the RJV and it is now understood to be held: Ford Australia 60%, FordCredit 30% and 10% ex-franchisees. There are currently no ex-franchisees in executivepositions and Feico is headed by an ex Inchcape executive, Keith Williamson. TheMelbourne franchisees couldn’t think of a big enough number in time and have, for themoment, been left in abeyance. Initially fifteen of the twenty Sydney Ford franchisees agreedto join the RJV, the Japanese conglomerate giant Sumitomo and Paul Warren with two outletseach, and one smaller north suburban dealer, electing not to participate. After a Japaneseboard level intervention by Jacques Nasser, which is said to have involved $14 million and alot of tyres, Sumitomo relented and sold into the RJV.

These RJVs have changed the market for new and late model Ford vehicles, authorisedservice and parts in Perth and Sydney markets from a state of monopolistic competiton to thatof imbalanced oligopoly. Although Williamson is instituting classic economies of scale

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measures such as centralised back office functions, centralised buying and valuing,centralised marketing (not easy when you still have fifteen or seventeen different brands) it isbelieved the RJVs are haemorrhaging money. It is hard for a corporate entity to be morecompetitive or efficient than an astute, hard working, self-motivated businessman witheverything to lose.

Table 3. The concentration ratio effects of the Ford Sydney Retail Joint VentureFord Metro SydneyMarketConcentrationRatios

1999 Sept 2000 July 2002

Substantiallessening ofcompetition:

CR20 =100 CR1=89CR2=97

CR3=100

CR1=82CR2=95

CR3=100

Paul Warren has increased his Sydney Metro market share for new Ford vehicles from 8% to13% in the twenty- two months he has been competing with the RJV (Table 3).

11.1 11.714.3 15.7

12.5 12.7

0

5

10

15

20

NSW WA SA VIC QLD National

Ford Market Share - Total Vehicles YTD May 2002

Figure 10. Ford Market Share by State YTD May 2002 Source Vfacts.

The end of May YTD market share by state figures would indicate that Sydney and Perthconsumers are less than enthralled with the offerings and intra-brand competition of the FordRJVs (Fig.10). This superficially appears to support previous ACCC positions that intra-brand competition is unimportant because consumers dissatisfied with one brand’s valueproposition will opt for a different brand. Both the Landemann and Taylor Nelson Sofressurveys show this approach to be naïve. Approximately one third of consumers are shownconclusively to be both brand and dealer loyal and an additional third of consumers brandloyal. This is substantiated by Ford Australia’s current national market share, despite anaging model range and a vastly inferior value proposition they have maintained some 65% ofthe market share they held as brand leaders in 1997. Thus the ACCC position ignores thebuying behaviour of fully two thirds of new vehicle consumers.

The new regimen at Ford Corporate Headquarters is not thought to be supportive ofoperations generating red ink. The all-new Falcon is due for release later this year and is thekey to the future of both the RJVs and Geoff Polites. Even if the new model is a huge successthe ownership of retail dealerships is no longer regrded as a core Ford business and the RJVs

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are likely to be divested at a loss, if not by Polites then his successor. The anti-competitiveintra-brand damage has been done. Without regulatory involvement Ford’s preferred exitwill be a single trade sale to an industry behemoth with a taste for regional monopolies.

Ford are well acquainted with Inchcape PLC through their Performance Automobiles Group(PAG). Certainly FEICo’s general manager and ex- Inchcape executive, Keith Williamson,could perform any necessary introductions. As has been observed Inchcape are morecomfortable with complete regional “exclusivity” and so Paul Warren (Warren Ford) may beable to look forward to an even more comfortable retirement following an offer he will findhard to refuse.

The behaviour exhibited by both Subaru and Ford is forward integration leading tosubstantially diminished regional intra-brand competition. The only difference is thatbetween forward integration by stealth and forward integration by cheque-book.

1.55 Potential New Entrants:

The forward integration of the franchisor via the web, factory owned stores, jointventures with existing franchisees, direct fleet and government sales. Most of theseactivities are already occurring (the Subaru and Ford scenarios, Volvo owned franchises, theToyota super dealership concept etc.) although not across all brands or all states. Aspreviously discussed this is largely driven by the OEMs perception of where in the vehicletotal lifetime value chain superior profit opportunities lay (Exhibit 3). These developmentsare occurring despite the OEMs’ lack of appropriate core competencies in these value chainactivities or customer relationship management capabilities. The Ford global strategy is inparticular disarray following the axing of CEO Jacques Nasser, whose vision was constructedaround forward integration and downstream continuous diversification. To some extent thepursuit of the Sydney and Perth Ford retail joint ventures are already passé, or at least in theair, in terms of the new Ford global strategy (Exhibit 22).

o The concerns of the franchised dealers in this scenario are the potential for the brandowners, or their distributors, to use anti-competitive predatory pricing and/or popularmodel distributive discrimination to force independent franchisees out of business.

o The concerns of the motor repair industries (panel and mechanical), insurers and fleet-lease companies is the substantial lessening of competition for their business.

o The concern of employees is the substantial lessening of competition for their brand-specific expertise (technical, systemic and product based).

It is precisely these concerns that have underpinned the legislation enacted in forty-fourof the United States of America to prohibit the forward integration of the franchisors intoretail outlets.

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At the heart of the Kwik-Fit issue is whether an automotive group is a vehicle maker, or adiversified service provider. Answering the question has delineated a trend that began soon after thefirst automobile spluttered into motion.

When the car was in its infancy, the manufacturing theory of vertical integration saw iron oreshipped into one end of a factory and completed cars roll out of the other. The practice waspioneered by Ford at its River Rouge plant in Michigan, transferred to Dagenham (RIP), and wasstill widely copied in the Soviet era with monstrosities like the Lada factory in Togliatti. There, thevinyl off-cuts from seat construction were turned into handbags for fashion-conscious buyers on theNevsky Prospekt.

Over the century, the car manufacturing process was gradually flattened as companies divestedthemselves of material-making and parts construction. Today, responsibility for seat production, forexample, is delegated to a specialist like Johnson Controls, which wisely leaves handbagproduction to the likes of Prada.

Ford is arguably the most extreme example of the evolution. Its tractor-making operations, a corebusiness when founder Henry Ford was in charge, were sold to a Fiat group company and are nowknown as CNH, or Case New Holland. Its European medium and heavy truck operations werebought by Iveco, another Fiat company, and its heavy truck business in North America is now partof DaimlerChrysler. More recently, Ford swept its component-making interests into Visteon, whichit then launched on the New York stock exchange as a separate company.

On the face of it, the changes redefined the once highly diversified Ford as a straightforward carand light truck producer. But it is not even truly that these days. The latest Fiesta is clearly a Fordbecause it says so on the badges. Look a little more closely at the Cologne factory where it is made,though, and one finds a supplier park. The dozen suppliers located there do not produce simplegaskets or gear levers. They are responsible for the design, development and manufacture of highlycomplex and critical sub-systems that collectively constitute a large proportion of a completed car.

Fiesta’s doors, complete with electrical connectors, air bags, locking mechanisms, window liftersand all the trim are made on contract by Faurecia. The complete Fiesta driveline, together with thecooling, steering, suspension, brakes and exhaust, is put together by Ferrostaal. Each sub-system isthen delivered in sequence, just-in-time at the appropriate point on the car’s final assembly line.

But they are not the only change within the factory. Ford introduced the principle of pay-on-production when it commissioned new paint shops in the mid-1990s. The equipment was installedby suppliers, which retained ownership even after production began. Ford simply paid the supplieran agreed amount for each painted body. At Cologne (and Valencia in Spain), the equipmentleasing concept was extended to the press and body assembly shops. The machinery is owned bythe suppliers, and Ford pays for the units they produce.

Throughout all this, Ford remains responsible for the overall quality of the product. At the macrolevel, it is the guardian of the brand. But most of the metal bashing, plastic moulding and micro-assembly that go into its products is carried out by contractors -- frequently non-union organisationsthat pay lower wages and provide fewer benefits than their client companies.

The vision thing

What this adds up to is a revolution by evolution. Former Ford chief executive Jacques Nasser

Exhibit 25. Kwik-Fit: why the Ford venture fell flatSource: Institute of the Motor Industry 17 Jun 2002

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wanted to refine the role of the car maker further. His vision of Ford was as a vehicle maker andprovider of related services. Nasser’s thinking was shaped by the fact that profit margins in serviceslike finance, leasing, insurance, repairs and after-market sales dwarf those of manufacturing andretailing. In pursuit of the Nasser ideal, Ford bought Kwik-Fit, car dealerships in the United Statesand the UK, a warranty company and some car recycling centres.

Now Bill Ford, Nasser’s replacement, is taking apart the policy, which he regards as a destructivedistraction. He is convinced Ford has to return to the central tenet of its operation: designing,making, selling and financing high quality cars and light trucks. The decision to sell Kwik-Fit mustbe particularly painful, because few believe Ford will get back the £1 billion it paid for thecompany only three years ago. But Ford, with its product quality and dealership morale furtherbattered by last year’s Firestone/Explorer controversy, had to do something. Not that Ford wasalone in changing direction. While not as radical, other automotive groups took part in similarprocesses over the past couple of decades. They bought and sold companies, sometimes to reinforcetheir own core businesses, sometimes in order to diversify. And sometimes they got it wrong.“There is an ebb and flow in these things,” notes Brian Knibb, chairman of Knibb Gormezano andPartners, the Derby-based management consultants. “Sometimes companies are bought on thewhim of the chief executive, but cost and experience forces them back to their roots.”

Sticking to the knitting

There were several prime examples of that when vehicle demand was very high during the 1980s.Hard to believe, but each of Detroit’s Big Three was making more money than it knew what to dowith at the time. Investors were well rewarded and product programmes were fully funded, so thetrio invested in aerospace companies (GM in Hughes, Ford in Loral, Chrysler in Gulfstream) in thehope they would act as counter-cyclicals in the bad times. At the same time, GM also bought EDS,the IT systems specialist created by gung-ho entrepreneur Ross Perot. The initiatives wereencouraged by Wall Street, which loved high tech and never liked heavy manufacturing. Timeschanged. All the acquisitions subsequently became subject to disposals by the car makers.“Investors are much less positive about diversification these days,” explains John Lawson,managing director of equity research at Salomon Smith Barney in London. “Sticking to yourknitting is the favoured strategy, especially for industrial companies.” And that is what hashappened. General Motors ditched its medium and heavy-truck operations and later spun off aseparate component entity known as Delphi. Renault’s former truck business was sold to whatremains of the Volvo group, now the world’s second biggest truck and bus maker afterDaimlerChrysler. Both GM and Renault dabbled in producing their own manufacturing robotsbefore abandoning their ventures to more qualified professionals. What was once the broadly basedSaab-Scania group was broken up into three wholly unrelated elements: the Saab car maker ownedby GM, the Saab aerospace company that has an alliance with BAe Systems, and the rump Scaniatruck and bus maker. Rover’s period of ownership by British Aerospace (now BAe Systems) was adiversion, a political expedient rather than an industrial solution, as events proved. Even Fiat, anhistorically diversified industrial group, was part of the consolidation in recent years. Its interests incivil engineering, chemicals, telecommunications, retailing and railway rolling stock were sold.And so will Fiat’s Magneti-Marelli components business as well as soon as a realistic price can beraised.

What none of the automotive companies seems prepared to abandon, though, are their profitablefinancial and leasing operations. Provided they cost little to operate – and that’s because they arelargely Internet-based -- they can generate better returns than manufacturing and retailing. Indeed,Volkswagen, DaimlerChrysler and BMW are now firmly established in retail banking, issuingcredit cards that can be used for more general shopping and services. Where vehicle makers’policies do differ, though, is the rental car business. GM and Renault are evidently not interested,having sold their respective shares in Avis and Europcar in recent years. Renault’s shares in

48

Europcar were bought by its partner, Volkswagen. More recently, Ford last year completed itsownership of Hertz by buying out the remaining shareholders. “We sell a lot of cars to Hertz,” saysa spokesman for Ford in the US. “Hertz could be seen as part of our sales organisation.”

To outsiders, though, the policy does not neatly dovetail with other Ford actions like the proposedsale of Kwik-Fit and all the recently bought dealerships in the United States. Those changesinevitably raise questions about the future of other Ford services. If Kwik-Fit is not part of thegrand plan, what does that mean for Ford’s Rapid-Fit aftermarket operation? If fast-fit tyres andexhausts do not comply with the new definition of Ford, does a warranty company or car breakers?Now that Ford has agreed the sale of its US dealerships, will it do the same to those it bought in theUK?

• New brand introductions sourced from emerging low cost production centres such asChina via new franchise networks. The past fifteen years have seen the emergence ofKorean produced global brands and the transfer of productive facilities to lower cost centressuch as Japan to Thailand, USA to Mexico and from Western to Eastern Europe. With the acceptance of China into The World Trade Organisation (WTO) the ten year steadystream of ‘Big Six’ investment in Chinese productive capacity has turned into a tidal wave,exacerbating the global industry’s overcapacity problem. With the world’s largest populationand, at 13 vehicles per 100,000 population, the world’s lowest vehicular ownership rate, thegrowth potential is enormous if not immediate. The other driver of investment is theavailability of a large and compliant work force at a small fraction of the costs of first worldcountries (Chinese skilled labour costs in 2002 are at just 5% of Australian, and 3% ofEuropean and North American rates - a differential that will pay for a lot of shipping costs).There would seem to be little in the way of a large proportion of global automotiveproduction shifting to China as the workforce is trained and the infrastructure established.The Big Six are partnering with Chinese automotive entities supplying investment capital,design, technological, marketing and production expertise in return for a bridgehead in whatis seen as the next biggest game in town and the only one with significant growth prospects.(Exhibit 23).

Exhibit 26. China exports first car shipment to US Source: Data Monitor 12/6/02

China has exported its first shipment of compact cars to the USA. A batch of 252 Xialieconomy cars was loaded on to a cargo bound for the much prized American market. TheXiali cars were manufactured by the state-owned Tianjin Auto Group in cooperation withToyota in north China's port city of Tianjin. The area is the leading manufacturing centre foreconomy cars in China. The shipment is part of an agreement signed in April between themanufacturer and American Automobile Network Holdings Inc., which will be the soleagent for the Xiali cars on the international market. According to the deal, the Americancompany will be responsible for selling over 25,000 Xiali economy cars, retailing at $10,000each, during the next five years.

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Exhibit 27. suggests that whilst there may be some corporate governance issues to overcomewhen doing business in China, if the headline is taken literally, the Chinese may havesomething to teach the developed world about penalties for corrupt executives..

Exhibit 27 CHINA: Brilliance China head axed - paperSource: just-auto.com editorial team 24 Jun 2002

Minibus maker Brilliance China, whose share price has plunged recently, has replaced itspresident, chairman and key shareholder Yang Rong who departed mysteriously, theFinancial Times (FT) said. Yang is being investigated over suspected asset-stripping withinthe complex Brilliance group and the investigations have lapsed while authorities considertheir findings, the FT said, adding that officials had told it that Yang could expect morequestions.The FT said Yang remains a director of the company he founded in the early 1990s, andBrilliance has denied that he was being investigated, but has not explained why China's third-richest man has not answered media questions since reports this month caused a fall in theshare price. According to the FT, company executives, briefing analysts in Hong Kong, saidthe board had removed Yang because his goals and views were no longer in line shareholders'but no explanation of the differences was given. Other members of the board have beenpromoted, the FT added.But the newspaper added that the company seemed to be sound asBrilliance executives hinted that a stalled joint venture with BMW was close to approval byChinese authorities. The two companies have been waiting approval for well over a year, theFT said, adding that the reason for the delay from China's State Council was unclear and thatapproval would mean official approval for the company despite investigations intoindividuals. The Financial Times said the official investigations included examining whyYang, one of China's most respected businessmen, did not carry out in full an internal 1999finance ministry decree that ordered the transfer of the 55% stake in Brilliance then held bythe foundation to Zhongjin Fengde, an asset management company owned by China's financeministry.

• New intermediaries such as supermarket chains and virtual, web-based retailers:Inevitably the skills and capital being invested in China will lead to the evolution of both newChinese owned brands and Big Six partner brands being exported to the rest of the world.These will be marketed through the establishment of new franchised networks, as Big Sixbrands through existing networks and possibly as internet only brands along the DellComputer model. There is a strong possibility that ‘own label’ vehicles, perhaps onetechnological generation old, could be produced for large hyper-market chains such as Wal-Mart, K-Mart and Tesco. These strategies would enable some players to capitalise on the non-exclusive distribution changes to the E.C. Automotive Block Exemption Regulation whilstmaintaining exclusive distribution for current brands.

• New prime market areas (franchise outlets) being declared and appointed within thefranchise network by the franchisor. The number and location of franchised outlets withina region are at the discretion of the franchisor who may seek to increase marketrepresentation by expanding the network.

• Emerging large, and sometimes foreign owned, corporatised chains. Partly because of thefranchisors’ reluctance to have significant market share invested in any one franchisee andpartly because of the relative unattractiveness of the retail automotive sector to capital

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markets, large retail auto groups have, until now, been slow to establish in Australia. Withmodern database functionality and the internet as a consumer research tool, there are nowmore economies of scale than just marketing available to large dealer groups. This trend ismost evident in the USA (Exhibit 28.) and the UK. There have been recent large acquisitionsin Australia by the South African group, Barlows( t/a Barlow World), at price earningsmultiples well beyond the Australian norms. It is thought that this was partially driven by adesire to remove capital from South Africa. Additionally the massive Japanese conglomerateSumitomo Corporation has acquired a number of large Australian dealerships (some soldback into the Ford Sydney retail joint venture). Some of the local activities of Inchcape PLChave been previously noted. It is evident that whilst Australian venture capital finds theautomotive retail sector unattractive, overseas corporations are taking large, clusteredpositions.

Exhibit 28. Revenue & Earnings Growth of 5 USA Listed Auto RetailersSource: Data Monitor June 2002

1.56 OEM /Distributor – The Franchisor.

! From the forgoing it is evident that, from the franchised network’s perspective, thefranchisor is all-powerful. The franchisor is the supplier of most inputs, the arbitor of allaspects of the franchise agreement and its renewal, sometime retail competitor and oftenthe primary financier through a wholly owned finance company.

This imbalance of power has often led to a total absence of good faith on behalf of thefranchisors in their dealings with their franchisees. Various inadequacies in regulatorylegislation (discussed in 2.0) have encouraged these global behemoths to construct onesided franchisee (dealer) agreements that abrogate normal commercial realities (discussedin 2.0). It is doubtful whether any more blatant, recent, example of this lack of good faithexists than that displayed by Subaru Australia Ltd. in their termination of their Melbournemetropolitan dealers after five record growth years, a large dealership investmentprogramme and contractual obfuscation designed to satisfy Inchcape PLC’s statedcorporate strategy shift into retail.

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1.57 The Consumer – Fleet & Private

Australian new vehicle sales consist of approximately 60% fleet sales (national company,business, governments, institutions, car-hire, fleet-lease) and 40% household and micro-business.

In the mass market the new vehicle pricing for national company, governments, fleet-leaseand major car-hire company fleets is usually pre-arranged with the franchisor and thesupplying franchisee is paid a small handling fee for pre-delivering and supplying thevehicles. The level of discount for non-national company and institutional fleets is usuallystipulated by the franchisor and relates to the total number of cars in the fleet in question. It isusually equivalent to the franchisee’s total gross margin and the franchisor rebates a sum of afew hundred dollars on approving the fleet claim. Where applicable, the franchisees handlethe trade in vehicles at their own risk. In fleet business the trade-in value is often the onlydifferentiator between franchisees and the competitive pressure to pay over the wholesalevalue for the trade-in vehicles is high. There is a strong systemic risk in fleet business in thathaving quoted too much for a trade-in vehicle, on a marginally profitable new vehicletransaction, the market value of the trade-in may drop relatively substantially between thedate of quotation and the date of supply.

The household and micro-business market, or “retail,” is also highly competitive. Thefranchisee’s two stage objective is win first the inter, then the intra-brand competitions.Lademann’s survey found that almost one third of consumers were both dealer and brandloyal (ceteris paribus), and contrariwise, two thirds were not. Consumer issues and bargainingpower were extensively canvassed in section 1.2.

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2.0 Legal Discussion of the Draft Charter of Fairness

2.1 Background

Under the Trade Practices Act (1974) (“TPA”) a motor vehicle dealership agreement is deemedto be a franchise agreement. The mandatory Franchising Code of Conduct (the “Code”) assistsin regulating the relationship between the parties to a franchise agreement. However, the Codedoes little to address the inequality of bargaining power between a powerful franchisor and asmall business franchisee so that an agreement may leave a franchisee with few rights and afranchisor with many powers. As a result, a franchisee is often vulnerable to suffering significantfinancial and other losses during the term of the agreement and upon termination of theagreement.

Many clauses in the agreement render the franchisee vulnerable to the actions of the franchisor,for example:

• Allowing the franchisor to terminate the agreement for a technical, unimportant reasonand with or without notice;

• Restricting the term of the agreement that effectively means the franchisee has nosecurity of tenure;

• Allowing the franchisor to unilaterally vary the agreement in important matters includingcredit terms, stock levels, advertising or promotional contributions, level of warrantyclaims etc;

• Preventing the dealer opening any other dealerships in the area upon termination of theagreement or making the territory of the franchise during the agreement ineffective.

• Restricting changes to management of the franchisee unreasonably.

• Insisting on unreasonably high levels of stock.

• Withholding any commitment by the franchisor to provide satisfactory stock levels.

This paper looks at the three things:

• legal issues that arise from the state of current franchising agreements (2.2);

• the current law applicable to those issues (2.3); and

• recommendations as to how to improve the relative bargaining power and statutoryprotection to franchisee (2.4).

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2.2 LEGAL ISSUES

The legal issues that arise from the current state of franchise agreements are:

1. The franchisee’s legal protection from unfair dealer agreements;

2. The franchisee’s right to collectively negotiate with other franchisees against thefranchisor to increase or protect the franchisees rights under the franchise agreement; and

3. The state of the dispute resolution processes. 2.3 APPLICABLE LAW AND INADEQUACIES IN LAW

As a general rule Courts seek to enforce contracts rather than overturn them, and will implyconditions into them only to put into effect the otherwise unclear intentions of the parties.Commercial practice requires that contracts can be relied upon, that a party’s rights under acontract are protected and that parties will not regard a contract as merely an option or as astatement of intention. It is important to a society that parties to a contract understand and acceptit is capable of enforcement.

The basic requirements for a contract are:

o An intention to enter into legal relations and be bound by the contract. In commercialmatters this is usually not an issue.

o Consideration. Where the parties to a commercial contract promise to provide services inreturn for payment this also is not an issue.

o Certainty. The basic terms eg the parties, the subject matter and the price must be clear.Some contracts must be in writing before they are enforceable e.g. a contract involvingland, hence Leases and Franchise Agreements dealing with land must be in writing beforethey are enforceable. For the sake of certainty and enforceability it is desirable thatcommercial contracts are in writing and signed by the parties.

If the parties have agreed on a deal on an arms length basis without a disparity of negotiatingposition, duress, fraud or mistake Courts will not seek to undo the contract. Problems haveoccurred in many circumstances e.g. where a party has misunderstood the contract because of aninability to understand English, the party has signed the contract because of a misrepresentationor deception or fraud, the documentation has been so difficult to read that it is unfair that anyparty should seek to rely on it or the negotiating process was such that one party entered into theagreement under duress. The Courts and government have adopted different procedures fordealing with these problems.

o Bank documents. Courts have been critical of mortgage documents as being toodifficult to read and have interpreted the clauses strictly against the bank. As aresult many mortgage documents and guarantees are now prepared in easy toread format, rather than in difficult to read legalese. The courts will not seek to

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protect a party against his or her own decision to enter into an agreement withknowledge of the risk being taken.

o Many Mortgagees have adopted a practice of not proceeding with loans until theBorrower (or a Guarantor or Third Party Borrower), provides a certificate from asolicitor to the effect that the documents were explained to them and that theyunderstood the nature and effect of the documents. This is to meet the usualarguments of special disadvantage raised by some borrowers. In Franchisingthere already exists a requirement for a certificate, so the benefit of a mandatorycertification will only apply for non franchise dealers. In addition, this process isunlikely to protect a franchisee against an unreasonable manner in which therights are exercised by the franchisor.

o The various state governments have sought to underpin shopping centre and otherretail leases with Retail Tenancies Legislation. In Victoria it provides for:

! Compulsory disclosure statement.! Security of Tenure for first time Tenants.! Notices and other protection for an exercise of an option to renew.! Restrictions on underpinning for rent reviews.! Dispute resolution process, ! Protection against delay or unreasonably withholding consent to an

assignment of Lease etc.

These arrangements have had some success however Parliament has still not been able to resolvethe difficult issue of security of tenure and the dispute resolution process can still be costly andtime consuming. During the reign of the previous Victorian Government it was even suggestedthat parties who sign unreasonable shopping centre leases should blame their advisers, (orthemselves) and not expect the government of the day to interfere in commercial matters. Theview is the parties are free to contract on whatever terms and conditions they decide upon and aGovernment should therefore be careful as to the circumstances in which it will involve itself inthat process.

In some areas e.g. Insurance contracts, banking documents, relationship with lawyers, privacy,dealing with governments etc the appointment of an ombudsman has been an effective way ofdealing with disputes and culture problems in the relevant industry.

The present legal alternatives available are as follows.

2.31. Legal Protection from unfair dealer agreements

Here, the relevant law is concerned with the exercise of power in relational transactions.In the TPA there is a prohibition against taking advantage of market power and theexercise of private power in the context of unconscionability. Much of the conductwithin the category of unfair dealer agreements will fall both within the market powerand the private power prohibitions. The Law of Contract has in some cases imported animplied duty of good faith into a broad range of commercial contracts including franchiseagreements. For our purposes the relevant laws to consider are:

(a) Section 46 TPA;

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(b) Section 51AC TPA;

(c) Section 51AA TPA;

(d) Common Law of Contracts –implied duty of reasonableness and good faith;

(e) Franchising Code of Conduct; and

(f) Fair Trading Act 1999 (Vic)

(a) Section 46 TPA - Misuse of Market Power

In 1989, the High Court delivered a unanimous judgement in Queensland Wire. The caseis significant because it was the first time misuse of market power came under scrutiny bythe High Court. Mason CJ and Wilson J held that the object of S46 is to protect theinterests of consumers, by encouraging competitive conduct (CLR at 191). Similarly,Dean J stated that the primary role is the protection and advancement of a competitiveenvironment and competitive conduct, by precluding advantage being taken of asubstantial degree of market power for any of the proscribed purposes outlined in S46(1).

Although the case was handed down over a decade ago, it is still regarded as the mostimportant S46 decision and, despite some concerns, its importance continues mainlybecause it outlined the objectives of the section, clarified the way in which the relevantmarket is to be defined and set out how market power is to be determined. These conceptsare still relevant in the most recent cases on S46.

These concepts originally outlined in Queensland Wire make the section notoriouslydifficult and problematic to apply and therefore create uncertainty for a small business toeffectively establish a breach of the sectionSection 46 has three elements: it prohibits a company that has a substantial degree ofmarket power from taking advantage of that power for a prohibited purpose, such aseliminating a competitor.

(i) Substantial degree of market power

! Substantial

The term substantial has no precise meaning and whether a corporation is foundto have a substantial degree of market power is determined by defining themarket the corporation is competing in.

In the context of S46 substantial is intended to signify “large or weighty” or“considerable, solid or big”Palsner v Grinling [1948] AC 291 at 317

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A company with a 60 per cent market share was found to have a substantialdegree of power in the market within the meaning of S46.Williams v Papersave Pty Ltd (1987) 16 FCR 69

A taxi owner, whose contract with the base operator was cancelled, failed toprove that the operator had a substantial degree of market power in any relevantmarket. Its fleet accounted for slightly less than 40 per cent of the licensed taxisin Adelaide.Venning v Suburban Taxi Service Pty Ltd (1996) ATPR 41-468

The Full Federal Court in ACCC v Boral found that Boral, with a market sharethat varied between 18 per cent and 30 per cent, had a “substantial degree ofpower” in a narrowly defined market. The decision is of particular significancefor companies in concentrated markets in AustraliaACCC v Boral Limited (2001) 106 FCR 328

! Market

“When identifying the market, the objective is to discover the degree of thedefendant’s market power. Defining the market and evaluating the degree ofpower in that market are part of the same process. After identifying theappropriate product level it is necessary to describe accurately the parameters ofthe market in which the defendant’s product competes: too narrow a descriptionof the market will create the appearance of more market power than in fact existsand too broad a description will create the appearance of less market power thanthere is”Queensland Wire Industries Pty Ltd v Broken Hill Pty Co Ltd (1989) 167 CLR177 at 187

There are early cases which recognized single product markets, but they are nolonger recognized as authoritative; a problem therefore exists for the new-cardealers as the car market is broadened by the existence of other markets within it.The existence of the spare parts market creates an appearance that a new carmanufacturer has less market power than it actually has.

In Regents Pty Ltd v Subaru (Aust) Pty Ltd (1998) ATPR 41-647 the applicantwas unsuccessful in a S46 claim where its Subaru dealership was cancelledwithout reason. The court found on the facts that spare parts for Subaru vehicleswas not a market on its own, nor was there a separate market for appointment asan authorized dealer for servicing Subaru vehicles.

! Market Power

“The term market power means capacity to behave in a certain way (which mightinclude setting prices, granting or refusing supply, arranging systems ofdistribution), persistently, free from the constraints of competition”Melway Publishing Pty Ltd v Robert Hicks Pty Ltd (2001) ATPR 41

(ii) Prohibited Purpose

A proscribed prohibited purpose in S 46 (1) is the purpose of:

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(a) eliminating or substantially damaging or a competitor of the corporation or of abody corporate that is related to the corporation in that or any other market;

(b) preventing the entry of a person into that or any other market; or

(c) deterring or preventing a person from engaging in competitive conduct in that orany other market.

S 46(7) makes it clear that the purpose may be ascertained by inference from the conductof the corporation or of any other person or from any other relevant circumstances.“Purpose will usually be inferred from the nature of the arrangement, the circumstancesin which it was made and its likely effect.”Dowling v Dalgety Australia Ltd (1992) 34 FCR 109

In Regents Pty Ltd v Subaru (Aust) Pty Ltd (1998) ATPR 41-647, the court accepted thatthe applicant’s dealership had been cancelled because the dealer had not put sufficienteffort into selling cars. The respondent’s purpose was found to be to promote competitionand preserve competitiveness of the market.

In ACCC v Boral Limited, the Court found, on the basis of some “smoking gun” internalmemos, that Boral had used its market power for a prohibited purpose when itparticipated in a price war and priced below cost, even though its competitors were alsoparticipating in the price war.

(iii) Taking Advantage

To prove a breach of S46 “the Act requires not merely the co-existence of market power,conduct and a proscribed purpose, but a connection such that the firm whose conduct is inquestion can be said to be taking advantage of its power”Melway Publishing Pty Ltd v Robert Hicks Pty Ltd (2001) ATPR 41-805 at 42.

In Melway Publishing Pty Limited v Robert Hicks Pty Limited [2001] HCA 13, Melwayas a distributor of a leading street directory in the Melbourne market had in place asystem of exclusive distributorships. The system of distribution had existed for manyyears even when Melway did not have substantial market power. Robert Hicks, adistributor had his distributorship terminated but nevertheless asked Melway for resupplyof between 30,000 and 50,000 directories as it wished to sell them in the retail market.Melway refused the request on the basis that it wished to maintain the structure of itsdistribution network (i.e. the purpose was to prevent Hicks competing with the existingexclusive distributors). The issue was whether or not a corporation that on all accountshad a substantial degree of power in the wholesale market, could legitimately refusesupply. Both in the first decision and later on appeal at the Full Federal Court level thedecision was that it could not refuse supply, however the High Court disagreed.

The High Court warned that we should not proceed too quickly from a finding about acorporation that it had a substantial degree of market power to a conclusion that it wastaking advantage, even if the words “take advantage” mean no more than “use”.

The Court looked at whether the market power “materially facilitated” the conduct or“made it easier”, even though it was not absolutely impossible to engage in that conductwithout the market power. In this case, no such conclusion could easily be made as

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Melway had an exclusive distribution system in place at the time it had no substantialmarket power. It therefore could not be said that the maintenance of the system ofdistribution was necessarily a use of market power.

The provisions of S46 make it hard to succeed against a manufacturer who it is allegedhas breached the Act. It is extremely difficult, time consuming and expensive for a cardealer/small business to establish the criteria necessary to prove a breach of the Act.

(b) Section 51AC TPA - Unconscionable Conduct in Business Transactions

The ACCC has identified franchising transactions (amongst other transactions) as “highrisk” in relation to unconscionability. Section 51AC was introduced as part of legislationspecifically designed to improve the legal protection and remedies available to smallbusiness. It applies to transactions which occurred after 1 July 1998 involving goods andservices priced below $3 million. S 51AC provides that a corporation or person must not,in connection with the supply of goods or services to or acquisition of goods or servicesfrom a small business, engage in conduct that is, in all the circumstances, unconscionable.

Since the enactment of the Part IVA unconscionable conduct provisions, case law hasprovided several different views on the breadth of the meaning of the term“unconscionable conduct”. However, in relation to s 51AC the view is that the wordingof 51AC is clearly intended to prohibit broadly unconscionable conduct in the range oftransactions to which it applies.

The section sets out a list of non-exhaustive factors a court may take into account indetermining whether the conduct is unconscionable. They include in brief:

• the relative bargaining strengths of the parties;

• whether the small business was required to comply with unreasonable conditions;

• whether the small business was able to understand relevant documents;

• whether undue pressure was exerted on or unfair tactics were used against the smallbusiness;

• the amount for which, and the circumstances under which, the small business couldhave acquired/supplied similar goods or services elsewhere;

• whether the defendant’s conduct was consistent with its conduct in similartransactions;

• the requirements of any applicable industry code;

• the extent to which the defendant unreasonably failed to disclose to the smallbusiness any intended conduct which might effect it;

• whether the supplier/acquirer was willing to negotiate the terms and conditions of anycontract; and

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• whether both parties acted in good faith.

Recent case law

Since its introduction, the ACCC has initiated a relatively high number of legalproceedings in actions based on alleged unconscionability for the purpose of establishinglegal precedent under section 51AC. The following is a brief overview of some of thesecases.

ACCC v Simply No-Knead (Franchising) Pty Ltd 22 September 2000 unreported

Simply No-Knead was a company that supplied to franchisees training and material formaking bread products in the home. The ACCC alleged a breach of s51A, theunconscionable conduct including:

• refusing to deliver franchised products to certain franchisees;

• unreasonably refusing to negotiate matters of concern to franchisees;

• producing and distributing promotional material which omitted the names of thefranchised businesses;

• competing with franchisees in an unreasonable manner; and

• refusing to provide current disclosure documents to the franchisees in response towritten requests.

Justice Sundberg held that the conduct of Simply No-Knead displayed “an overwhelmingcase of unreasonable, unfair, bullying and thuggish behaviour” against its franchisees thatamounted to unconscionable conduct for the purposes of S 51AC.

ACCC v Leelee Pty Ltd 2000 unreported

The Federal Court found that Leelee Pty Ltd, landlord of Adelaide’s International FoodPlaza, had engaged in unconscionable conduct towards one of its tenants by:

• consenting to, or giving approval for, another tenant to infringe on the exclusivemenu entitlements conferred by Leelee on one of its tenants; and

• specifying the price at which its tenant sold their dishes in a manner which unfairlydiscriminated against, or inhibited, the tenant’s ability to determine the prices atwhich its dishes were sold in competition with another tenant.

In both of these cases, the Court found that directors of the companies had been involvedin the contraventions.

(c) Section 51AA

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This section does not apply to conduct that is prohibited by S51AC, i.e. goods andservices for less then $3million, however it will apply to unconscionable conduct inrelation to listed public companies, and for goods and services for more than $3 million.

To prove this form of unconscionability it is necessary to establish:

(i) the weaker party was in a position of special disability;

(ii) the stronger party knew about (or should have known about) the disability; and

(iii) the stronger party took unfair advantage of its position

Recent case law

In ACCC v Berbatis Holdings Pty Ltd, Federal Court, 26 September 2000, unreported, the owners of a shopping centre were found to have breached S51AA when they refused to renew a lease to tenants unless the tenants agreed to droplitigation under an existing lease. The tenants were found to be at a special disadvantagewhen bargaining with the landlords because of their financial dependence on the leasenegotiations. In particular, the inequality of bargaining power seemed to be enough toestablish a special advantage (at the time of the decision it was necessary to establishknowledge and exploitation of the disadvantage).

Similarly in ACCC v Sampton Holdings Pty Ltd [2002]FCAFC 4 it was held that a lesseewho had recently acquired a lunch bar business and taken an assignment of the lease butthen omitted to exercise an option to renew within the stipulated time, was "over abarrel" and in a position of special disadvantage which arose out of unequal bargainingpower. However, in the circumstances of this case, the respondents (lessors) had therights which the lessee needed to acquire in order to operate the business and they had toacquire those rights from the respondents. The respondents were under no legal orequitable obligation to make them available and their conduct in requiring $70,000 torenew the lease fell short of being unconscionable. It was more a case of toughbargaining than unfair conduct.

(d) Contract Law - implied duty of good faith

Recent case law has shown an inclination of the Courts to import a duty ofreasonableness and good faith into certain commercial transactions which obligeseach party to exercise the powers conferred upon it by the agreement in good faithand reasonably. The agreements that this implied duty has been imported into arevaried and include cases of franchise agreements.

Burger King Corporation v Hungry Jack’s Pty Limited [2001] NSWCA 187

This case involved the interpretation of a number of agreements entered into betweenBurger King and Hungry Jacks in relation to the use of trademarks, franchises and othermatters. Burger King was the party providing each of these assets for which HungryJacks paid fees.

One of the issues in the case was a right of termination provided to the parties under theseagreements in the event of breaches of their terms. The agreements were extremely

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detailed and set out a broad range of matters regulating the relationship between thecompanies.

The Trial Judge held that he was bound by decisions of this court to hold that there is animplied term of either reasonableness or a duty of good faith or perhaps both, in therespective contracts and as a result Burger King was not allowed to enforce the Notices ofTermination.

Burger King appealed the decision. The Court of Appeal said that in a review of relevantcase law since Renard Constructions (ME) Pty Limited v Minister for Public Works(1992) 26 NSWLR 234, that there could be an obligation of good faith implied intocommercial contracts. “In NSW a duty of good faith, both in performing obligations andexercising rights, may by implication be imposed upon parties as a part of a contract.There is no reason why such a duty should not be implied as part of this lease” AlcatelAustralia Limited v Scarcella & Ors (1998) 44 NSWLR 349

Since Alcatel, courts in various Australian jurisdictions have proceeded on theassumption that there may be implied, as a legal incident of a commercial contract, termsof good faith and reasonableness.

In Far Horizons Pty Ltd v McDonalds Australia Ltd [2000] VSC 310 Byrne J in dealingwith the provisions of a standard licence agreement whereby independent operators werelicensed to conduct McDonalds fast food stores, said “I do not see myself at liberty todepart from the considerable body of authority in this country which has followed thedecisions of the NSW Court of Appeal in Renard Constructions (ME) Pty Ltd v Ministerfor Public Works. I proceed, therefore on the basis that there is to be implied in afranchise agreement a term of good faith and fair dealing which obliges each partyto exercise the powers conferred upon it by the agreement in good faith andreasonably, and not capriciously or for some extraneous purpose. Such a term is alegal incident of such a contract”

In Garry Rogers Motors Aust Pty Limited v Subaru (Aust) Pty Ltd (1999) ATPR 41-703which involved a standard form motor vehicle dealership agreement, Finkelstein J said ifsuch a term [of good faith] is implied it will require a contracting party to act in goodfaith and fairly, not only in relation to the performance of a contractual obligation, butalso in the exercise of a power conferred by the contract. There is no reason to think,prima facie at least, that the obligation of good faith and fair dealing would not act as arestriction on a power to terminate a contract, especially if that power is in generalterms.”

In the Burger King case their Honours observed that the term will be more readilyincorporated into standard form contracts however, there is no limitation on the types ofcontracts in which it will be implied, and also that the implied term cannot conflict withthe express terms of the contract between parties. Their Honours concluded that unlessthere was an implied requirement of reasonableness and good faith, Burger King couldat the slightest breach by Hungry Jacks terminate the Agreement. The Court alsoupheld the trial judges decision that implied terms of reasonableness and good faith areimputed into the franchise agreement.

Therefore, in both the Burger King case and in Far Horizons Pty Ltd v McDonaldsAustralia Ltd [2000] VSC 310, the implied term of reasonableness and good faithwere imputed into franchise agreements which obliged each party to exercise the

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powers conferred upon it by the agreement in good faith and reasonably, and notcapriciously or for some extraneous purpose.

This case law arguably provides persuasive authority or strengthens Section 51AC(4)(k) which provides that in determining whether there has been a breach of section51AC (1) or (2) the Court may have regard to “the extent to which the acquirer andthe small business supplier acted in good faith”

There are a number of criteria the courts must follow when deciding to imply a term orcondition into the contract e.g. it must be necessary to give commercial effect to thecontract, so one should not assume the courts will automatically do just because itappears appropriate.

(e) Franchising Code of Conduct

The TPA prescribes for the purposes of Section 51AC (3)(g) the Franchising Code ofConduct (the “Code”) – a mandatory Code set out in the Trade Practices (Industry Codes –Franchising) Regulations 1998.

The TPA provides that a corporation must not contravene the prescribed provisions of theCode and sets out as sanctions for a breach injunction, damages, undertakings, correctiveadvertising and other orders.

The sections of the Code that are relevant to preventing the franchisor from unfair dealingare:

(i) Section 20 Transfer of the Franchise

20(2) A franchisor must not unreasonably withhold consent to the transfer

20(4) A franchisor is taken to have given consent to the transfer if thefranchisor does not, within 42 days after the request was made, give thefranchisee written notice:

! that consent is withheld; and! setting out why consent is withheld

This provision does not provide sufficient protection for a franchisee as the parties mayhave to wait 42 days for any certainty in the proposed transaction, and in most cases thepurchaser/assignee will often use its contractual right to withdraw from the purchase andmove on to the next business opportunity rather than become embroiled in a legal dispute.

If consent is withheld the franchisee faces a dispute resolution procedure which may take afurther 14 days before a mediator is appointed to the dispute pursuant to section 30(1) andeven then there is no firm commitment as to when the mediation will begin. There ismerely an obligation under S30 (2) that after the mediation has started, the mediator musttell the mediation advisor within 28 days that mediation has started.

In addition, clause 30A provides that if 30 days have elapsed since the start of mediationand the dispute has not been resolved, then if either party asks the mediator to terminate themediation, the mediator must do so.

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Effectively, the franchisor can terminate the mediation after “playing the game” for 30days, leaving the franchisee with an unresolved dispute.

(ii) Section 21 Termination – breach by franchisee

The effect of this clause is that a franchisor can terminate a franchise agreement after 30days notice. Whilst the Code requires the franchisor to tell the franchisee what can be doneto remedy the breach, and allow the franchisee a reasonable time to remedy the breach,S21(3) provides that the franchisor need give only 30 days for the franchisee to remedy thebreach otherwise the franchisor can terminate the agreement.

This may be used unfairly if exercised in circumstances where the franchisor may requirethe franchisee to spend a significant amount of money on remedying a supposed breach or abreach may not be reasonably capable of remedy within 30 days. When used with thepower of the franchisor to unilaterally vary the agreement to require certain works to becarried out at the franchisee’s expense, the franchisee may be in an untenable position if hemust comply with any unexpected and varied conditions of the agreement.

(iii) Section 22 Termination – no breach by the franchisee

The effect of this section is to refer a termination made in accordance with the terms of thecontract, but without the franchisee’s consent, to the dispute resolution process. Thefranchisee nevertheless may receive little benefit from the Code dispute resolutionprocedures. This is because whilst section 22(4) provides that Part 4 of the Code (resolvingdisputes) applies in relation to a dispute arising from termination, the franchisor mayrequest to terminate the mediation after 30 days from the start of the mediation and thefranchisee is left without a franchise or a settlement. In addition, each party must pay theirown costs of mediation.

(f) Fair Trading Act 1999 Vic (“FTA”)

The FTA which repealed the Fair Trading Act 1985 Vic, was amended last year by the FairTrading (Unconscionable Conduct) Act 2001 for the purpose of prohibiting persons fromengaging in unconscionable conduct in business transactions (Sections 8A and 8B wereinserted into the Act). Previously, the FTA (amongst other things) prohibited persons fromengaging in unconscionable conduct in transactions of a kind ordinarily for personal,household or domestic purposes only.

Section 8A largely imports the provisions of section 51AC of the TPA with the exceptionof 51AC (1) i.e. the FTA prohibits a person in trade or commerce from unconscionableconduct, not a corporation.

Therefore, whilst the FTA covers small business transactions of up to $3million, it will notbe relevant to an incorporated car-dealer/ franchiser as corporations are regulated by theTPA not the FTA.

2.32 Inability to collectively negotiate

(a) Section 45 TPA

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Currently, it is not legal for franchisees to associate or come to an arrangement orunderstanding about on what terms they will negotiate with a franchisor who is thecommon supplier of goods to the group of franchisees. The purpose of such anarrangement is boost the franchisees’ bargaining power when dealing with the franchisorand in competition law terms the effect of this would be to substantially lessen competitionin the market.

Section 45(2) is the main operative provision. It prohibits the inclusion in any contract,arrangement or understanding of a provision that has the purpose, or have, or be likely tohave the effect of substantially lessening competition.

Arrangement or understanding

The terms arrangement and understanding describe something less binding than a contract.These terms describe a plan between two or more people that may not be legallyenforceable. For an arrangement or understanding to be found to have been made, theremust be:

! a meeting of the minds of those who are parties to it;

! a consensus as to what is to be done, rather than a mere hope that something willbe done.

Amcor Printing Papers Group Ltd (2000) 169 ALR 344

A meeting of the minds may be inferred from circumstantial evidence such as:

• evidence of parallel conduct;• evidence of joint action by the parties in relation to relevant matters;• evidence of collusion between the parties;• evidence of similar pricing structures; or• evidence of opportunities such as industry meetings for the parties to reach an

understanding.

TPC v David Jones (Aust) Pty Ltd (1986) 13 FCR 446

The TPC alleged that, at a meeting of the respondents (all retailers in Adelaide) they came to an understanding they would sell certain items of Manchester products in theAdelaide metropolitan area at prices stipulated on a particular price list. There was nodirect evidence that this occurred. The court was nevertheless prepared to draw theinference that the understanding had been reached from circumstantial evidence, including“subsequent concurrent acts and the lack of sworn evidence from the respondents.”

Purpose or effect

A provision will be deemed to have the purpose of substantially lessening competition ifthe provision was included in the contract, arrangement or understanding for purposes thatincluded that particular purpose, and that purpose was a substantial one.

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It is the likely direct effect of the arrangement that is relevant to a determination of whethera breach of S 45 has occurred. If the likely direct effect is a substantial lessening ofcompetition, a breach will have occurred.

Substantially lessening competition

Stirling Harbour Services Pty Ltd v Bunbury Port Authority (2000) ATPR 41

The concept of substantially lessening competition is evaluative. It requires that there be apurpose, effect or likely effect on of the conduct on competition which is substantial in thesense of meaningful or relevant to the competitive process.

In summary, if the purpose or effect of franchisees collective bargaining will be tostrengthen the position of the franchisees in the market and therefore substantially reducecompetition in the market, it will be in breach of S 45.

(b) Franchising Code of Conduct

Currently, the Code is silent on franchisees collectively negotiating with the franchisor,probably based on the assumption that to associate for the purpose of collectivenegotiation is not a lawful purpose - although Section 15 provides that a franchisor mustnot induce a franchisee not to form an association or not to associate with otherfranchisees for a lawful purpose, so it does provide some legitimacy for it.

2.33 Legal Processes Available for Dispute Resolution

Currently, a franchisee may take one of two options in order to resolve a dispute arisingunder a franchise agreement or contract:

(i) follow the dispute resolution procedures in the Code or those set out in thefranchise agreement (if any); or

(ii) commence proceedings under Part IV or V of the TPA.

Both procedures are costly and the Code procedures, which are meant to provide aninexpensive method of resolving a dispute, could be terminated by the franchisor,pursuant to section 30A of the Code, 30 days after the mediation has begun. In this event,each party must bear its own costs of mediation.

The fact that there is not much precedent for S 51AC, and S 46 is difficult to establish,both act as a deterrent to legal proceedings.

2.34 Dealership Valuations

This paper has examined franchisee buyout scenarios between next to zero, SubaruMelbourne, and close to eight times EBIT (earnings before interest and, tax), BarlowWorld. In 1999 the New South Wales Industrial Commission established a valuationbenchmark:

The value of goodwill for compensation purposes was considered by the New South WalesIndustrial Relations Commission in Canberra Star Motors Pty Ltd and Ors. V Chrysler Jeep

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Automotive Distributors Australia Pty Ltd in July 1999. The Application was broughtunder Section 275 of the Industrial Relations Act 1991. It related to a Jeep dealership aspart of a larger dealership business

The Court found that the Dealership Agreement was unfair, in that it did not contain anAssignment Clause and gave the manufacturer an opportunity to terminate the Agreementon 6 months notice when the Dealer at the time was seeking to sell the Dealership on theopen market. The agreement therefore was not as set out in the initial letter of offer. TheAgreement also allowed the Manufacturer to set minimum levels of sales and theManufacturer apparently acted unfairly in refusing to co-operate with the sale of theFranchise.

The Commission found that the cumulative effect of all of these matters was to render theagreement unfair and accordingly made Orders varying the Agreement. The Commissionthen considered the compensation payable for a breach of the Agreement. It found:

1. The signs that the Dealer had installed on the site were not saleable and therefore nocompensation was paid.

2. The tools which had a value of about $9,000.00 and for which the dealer had refused$6,000.00 were assessed at $4,500.00. There was no specific reason given for thiscalculation.

3. The Goodwill was considered after taking in the following criteria:o The size and nature of the Dealership.o The volatility of the industry.o The fact that the Goodwill was for the entire Dealership and not just a small

parcel of shares o whether there should be a discount for limited life i.e. a short term franchise,

on which evidence was heard that radio and TV stations with a similarlimited life results in valuations without any discount for same.

o The recent introduction of the Jeep to Australia.o The small market share of the vehicle.o The need to move the Dealership to another site.

$138,252.00 was the asking sale price by the Plaintiff. This figure was based on one yearsmarginal contribution less Income Tax plus stock at valuation.

The Commission heard from expert valuers on both sides who assessed the value ofGoodwill at between 2 and 5 times EBIT (Earnings before Interest and Tax). TheCommission split the difference and made an award for 3.5 times EBIT. This resulted in avalue of goodwill of $420,000.00, a substantial increase on the asking price.

2.4 Conclusions & Recommendatios

The various recommendations the association can consider to assist members with the particularproblems are as follows:

a. Amend Section 46 of the TPA to reverse the onus of proof and insert an effects test.b. To amend Section 51AC to specify the behaviour that would be deemed to be

unconscionable and a breach of good faith.

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c. To amend Section 45 of the TPA to provide a safe harbour for small businesses tocollectively negotiate with a Franchisor.

d. To amend the Franchising Code to provide greater protection to a Franchisee inrelation to termination and transfer.

e. To create a new Car Code within the franchising Code to import the U.S.A. typerestrictions on manufacturer involvement in the industry.

f. To set up an industry Ombudsman with powers to impose dispute resolution uponfranchisees and franchisors.

g. To establish a standard dealer agreement to apply to all manufacturer dealerarrangements and which can be departed from only in certain specifiedcircumstances.

(a) Section 46 TPA

As S 46 is hard to use against those alleged to misuse their market power (in our case, thefranchisor), the section could be amended to apply equally and in the same way to thosewanting to take action against a misuse of market power (i.e. the franchisee).

In a press release from the Prime Minister dated 15 October 2001, the Prime Ministernoted that the focus of the independent review of the competition provisions of the TPAis on whether the relevant provisions protect the balance of power between small andlarge businesses. It is anticipated that this review will be completed by August 2002.

The Senate is also carrying out an inquiry into S 46 of the TPA which is proceedingregardless of the independent review of the TPA. The questions being examined by theSenate are:

• whether S 46 should be strengthened by reversing the onus of proof required toestablish a contravention, so that once it is established that a corporation with asubstantial degree of power in a market has used that market power, the onus ofproof shifts to the corporation to prove that it did not use that power for aprohibited purpose; and

• whether an effects test should be introduced in Section 46 (to supplement thecurrent purpose test).

There has been a lot of debate on the issue of the “purpose or effects” test, and if the TPAprohibited conduct that had the purpose or effect of substantially lessening competition inthe market would be a less difficult test to establish than the present test.

The House of Representatives Committee rejected an “effects” test. These changeswould in the main , benefit small business as the section does not work effectively for itat present. Presumably big business will argue that small business already has theprotection of the unconscionable conduct provisions of the TPA (s51AA and 51AC) anddoes not need any additional protection.

(b) Section 51 AC TPA

Due to the lack of precedent case law under this section, there is uncertainty about itsadequacy at protecting the interests of small business. The element of uncertainty deterssmall business from commencing proceedings under the section.

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Whilst outside of the sphere of S 51AC, recent law has developed requiring partiesto an agreement to act reasonably and in good faith, this element of Section 51AC -the extent to which the parties acted in good faith, has not been specifically tested.However, it is important to note that the implied duty to act in good faith has inrecent cases been imported into franchise agreements to prevent corporations fromlegally terminating agreements without reasonable grounds.

Within time this precedent for the requirement of good faith will be used in arguments forS 51AC but until that happens uncertainty still remains about the effectiveness of thesection.

It seems a reasonable proposition to amend the section to protect small business from theunconscionable actions of big corporations. The following amendments to S 51A havebeen discussed amongst the car industry groups and would prevent conduct breaching aduty to act in good faith. The following behaviour would be considered unconscionable:

(i) unilateral variation of the contract or associated documents;

(ii) the termination of contracts by one party without just cause or due process;

(iii) bringing into existence documents or policies after the signing of the contractwhich are binding on the parties and which can also be used to vary the originalcontract or agreement; and

(iv) the presentation of "take it or leave it" contracts.

(c) Section 45 TPA

Currently a proposal exists to amend S 45 by inserting provisions in the section whicheffectively act as a "safe harbour" for small business with the effect that small businesscan collectively negotiate with a franchisor in order to redress the inequality ofbargaining between the parties.

It is proposed that the following groups would fall within the provisions. Either:

(i) a "safe habour" group of small business with a collective market share of 20 percent or less in any relevant market; or

(ii) the exclusive relationship "safe habour"; this would allow collective bargaining by all small businesses involved in exclusive buying or selling

relationships with the same big business buyer or seller.

Alternatively, a small business commissioner could be appointed to the ACCC with aresponsibility for determining requests for consent from small business to collectivelynegotiate. A specific criteria could be set out by the ACCC which would require thepurpose of the collective bargaining to be to enable small businesses to enter into faireragreements with big business rather than those currently entered into on a "take it orleave it" basis. The ACCC would be able to regulate and balance the need of small

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business to collectively negotiate and protect the need to prevent any substantiallessening of competition in the market.

(d) The Franchising Code

As the Code does not adequately address all aspects of the unequal bargaining position ofparties to motor vehicle agreements, either the Code should be amended or an industryspecific car code should be created ("Car Code").

Amendments to the Code

The following amendments should be made to the Code:

• Section 21 - Termination by breach

S 21(3) should be amended to allow 90 days, instead of 30 to remedy a breach ofthe agreement unless the franchisee has acted in a criminal manner;

• Section 20 - Transfer of the franchise

This provision needs to be strengthened by further limiting the time thefranchisee must wait (in the absence of consent or refusal from the franchisor)before they can proceed with the commercial transaction of transferring thefranchise. The period should be shortened to 21 days.

• Section 22 - Termination with no breach by the franchisee

This clause should either be amended to prevent franchisors from terminating atany time without a breach occurring or alternatively provide that upontermination of the agreement without breach by the franchisee, the franchisermust pay reasonable compensation to the franchisee. A further provision shouldthen be added to provide what constitutes reasonable compensation andstrengthen the rights of franchisees under the Dispute Resolution Process bymaking the process speedy and more effective and less costly.

(e) Proposed Car Code

In Australia, the legislature recognises the special relationship that exists in the motorvehicle dealership and regulates that relationship by the TPA and Code.

However, in the U.S. the vast majority of states have set out the importance of the retailmotor industry to consumers and the economy by legislating separately for the industry.The Alabama Code states that "the legislature finds that the distribution and sale ofmotor vehicles within this state vitally affect the general economy of the state andthe public interest and welfare, and that in order to promote the public interest andthe public welfare… it is necessary to regulate motor vehicle manufactures,distributors, dealers and their representatives and to regulate the dealings betweenmanufacturers and distributors or wholesalers and their dealers in order to prevent

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fraud and other abuses upon the citizens of this state and to protect and preserve theinvestments and properties of the citizens of this state."

In essence, the rights of franchisees are protected by this industry specific code.

An example is the clause providing for compensation upon termination without breach or non-renewal of the franchise. This compensation is a right that the terminateddealer does not have to fight for.

The following clauses and the problems they encounter, from the AADA’s draft ‘Charterof Fairness’ have been the suggested as provisions to be inserted into a Car Code inAustralia:

Provisions for proposed Car Code

(i) Limiting supplier’s involvement in retail to the extent necessary to ensure thesupplier’s representation in the market.The effect of a clause like this would be to substantially lessen competition inthe market, as franchisees would not have to directly compete with thefranchisor. This clause contradicts the purpose of Part IV of the Act thepurpose of which, amongst other things, is to maintain competition in trade orcommerce.

(ii) Ensuring at the state/territory government level that suppliers are prevented fromselling motor vehicles at retail.

Again, the effect of the clause is a restrictive trade practice the purpose being tosubstantially lessen competition for the car franchisees.

(iii) Preventing suppliers from direct selling to fleet buyers and at prices less thanthose available to individual consumers through the suppliers franchised dealernetwork.

Again – a restrictive trade practice.

(iv) Prohibiting unilateral variation of franchise agreements by franchisors. (v) Outlawing “take it or leave it” agreements and termination of franchise

agreements at will without just cause

(vi) Enshrining the inalienable right of franchised motor dealers to sell more than onebrand of motor vehicle from their premises.

(vii) Providing for a minimum of five years tenure in franchise agreements withautomatic renewal for a further period of five years.

Whilst items (i), (ii) and (iii) would currently breach the provisions of Part IV of the TPAbecause they substantially lessen competition in the market, these clauses are standardprovisions in U.S Codes.

Most states in the US provide that

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! a manufacturer may not have an ownership interest in, or operate or actin the capacity of, a new motor vehicle dealer or a used motor vehicledealer;

! a manufacturer may be restricted from retailing vehicles, products orservices except through their franchised dealers; and

! manufacturers are prevented from terminating, cancelling or refusing torenew franchises without good cause or without acting in good faith .They are required to give at least 60 days notice except where a dealerhas been involved in criminal activity and "good cause" for terminationto exist is defined as:

(a) if the dealer fails to comply with a provision of the franchise agreementwhich is both reasonable and of material significance to the franchiseagreement and the dealer has been given ample time to remedy thebreach; or

(b) if the dealer has failed to achieve satisfactory performance in service orsales, has been notified well in advance and has failed within a period ofat least 6 months to comply with the established standard.

Clauses (iv) and (v) of the proposed car code if tested would be likely to fall within theimplied duty of each party to act in good faith and therefore not complying with theseprovisions may in the future amount to unconscionable conduct in S 51AC. Thereforethese provisions would sit well in the proposed car code. Following recent case law(pages 58-9) we regard this implied duty of good faith as a ‘golden bullet’ to be usedat the earliest suitable opportunity where good faith has been demonstrablyabsented by a franchisor in negotiations with a franchisee.

Clause (vi) has two competing principles. Firstly, the TPA aims to protect againstrestrictive covenants being placed on persons by corporations, and to that extent theprovision would sit well in the car code. However, the other principle is the right for thefranchisor to contract for what his business purposes, the franchisor should have the right,if agreed up front in manner of good faith be able to stipulate that the franchise agreementis for the exclusive sale of one brand of car only. In conclusion, this clause wouldprobably not be acceptable in a Car Code.

(f) Industry Ombudsman

This could be set up pursuant to The Trade Practices Act or the Franchising Code ofConduct or separate legislation. It should provide that the manufacturers adopt the rulesand procedures of the Ombudsman and agree to accept and put into effect its disputesolution processes. An arbitration process should be specified to enable dissatisfieddealers to make a complaint against the manufacturer and have it dealt with in accordancewith the procedures laid down by the Ombudsman. The powers of the Ombudsman mustinclude the right to amend unfair or unconscionable terms of a Dealer Agreement, toprohibit unfair or unconscionable exercises of the powers within an agreement and toorder compensation. As extensive automotive industry experience is rare amongstsuitably legally qualified candidates for industry ombudsman, or advising counsel, theposition could sit as a tribunal with the ombudsman advised by eminent independent

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representatives of the franchisees and franchisors. This tribunal format would help theregulator understand the complex realities of the industry and avoid the repetitionof such basic misunderstandings as that concerning the importance of intra-brandcompetition and its source.

(g) Standard Agreement

A Standard Dealers Agreement could be established under the Car Code or FranchisingCode of Conduct. It would be a complete document setting out all the terms andconditions between the manufacturer and the dealer. It would mandate reasonable fairterms and conditions and restrict unreasonable or unfair exercise of powers by eitherparty. It would allow an amendment to the Agreement only with the consent given byeither party and require a certificate from a solicitor practising in the area that theFranchisee has understood the nature of any such amendment. As an adjunct to this theindustry bodies should provide an information package informing dealers of the process,the risks they undertake in agreeing to any amendment to the Agreement and theprotection the agreement gives. It should be noted however that standard agreementshave been promoted with in other areas e.g. shopping centres and to date Governmentshave been less the keen to adopt them. One area where this general approach works is forAustralian Workplace Agreements where they must be approved by the EmploymentAdvocate and he must be satisfied they pass the no disadvantage test.

Regarding the ‘Charter of Fairness’: the AADA’s alternatives are to concentrate onthe achievable or to disperse effort on the achievable and the wish list - in the natureof an ambit log of claims. Our recommendation is to launch concerted efforts at allapplicable levels of governments, inquiries and regulatory authorities pursuing theachievable.

We thank you for your instructions in this matter.

The Sirius Consulting Group

5/7/2002

The Sirius Consulting Group Sharing The Brightest Ideas™ Managing Partners: Mark Wainwright MBIM. MBA Dr. Nick Billington BSc (Hons) PhD Dr. Clive Morris FASCA. MA. PhD Jake Jacobs BSc (Hons) Frank Denis LLB

The Sirius Consulting Group is a multi disciplined advisory firm specialising in:

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The group is Melbourne based and operates within the Australasian, Pacific Rim and UKenvironments. Our client base includes local and global corporations (including fiveFortune 500 corporations 2001-2), industry associations and institutions.

Our mission is simply to provide optimal solutions to client needs in a timely,innovative and cost effective manner.

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