Managerial Economics & Organizational Architecture 6th Edition by James Brickley , Clifford Smith ,Jerold Zimmerman

Exercise 22

ANALYZING MANAGERIAL DECISIONS: Oil Industry Distribution Systems
Major oil companies use a dual distribution system for gasoline. Some stations are direct-serve , where the oil company delivers gasoline to the station. Other stations are served by distributors. Distributors are independent businesspeople who buy gas from the oil company and sell it to stations. Distributors also own their own stations. The land, tanks, and equipment at the direct-serve stations are owned by the oil company and leased to the dealer (franchisee). The dealer buys gas from the oil company and pays rent for the land. The dealer keeps the profits from the station over the life of the lease. (Some direct-serve stations are centrally owned by the oil company. At these locations, the oil company hires a manager to operate the station.) At direct-serve stations, the oil company is responsible for environmental cleanup, local advertising, monitoring of the station (to protect the brand name), and so on. The distributors are responsible for these activities at the stations they serve. Typically the oil company sells gas to distributors at about 7 cents less per gallon than it sells gas to dealers at its direct-serve stations.
Oil companies do not allow dealers (franchisees) to buy gas from distributors. Dealers must buy gas from the central oil company. Dealers often complain that this is unfair. The practice has been the subject of antitrust lawsuits. Oil company executives argue that this policy is important because it limits free-riding on the part of the distributors. Explain the executives' arguments in more detail.