Small Cars: Ankle Biting the Car Industry?

The Polo: Volkswagen's Bread, Volkswagen's Bane?

(Image Credits: www.jalopnik.com)

In an interesting summary of the state of the automotive industry on the even of the Frankfurt Motor Show, the Economist highlights some important trends that manufacturers must be aware of. Not the least important of these is that consumers--across most markets--are seeking smaller cars. For an industry accustomed to corporate/economic gluttony, this is a big problem for a couple of reasons.

1. The market is saturated

The car market as a whole is saturated. Demand cannot support the number of manufacturers that are currently offering products for sale. Even in relatively decision starved America, the process of purchasing a new car can be a very daunting task given the myriad of brands, let alone models that are vying for purchase. Companies rise and fall, but, in their latest actions, governments have cast doubt on whether the automotive industry can be allowed to endure such transience. This is a dangerous thing. Allow a mechanical analogy: a door. If a door is free swinging then it is possible to slam it shut. The faster the door is shut, the larger the slam. If, however, a damper is put on the door, then you can slam the door as hard as you like and it will still close at the same rate. If governments are going to take any meaningful and long-term action in the automotive industry, they must try and remove some of the energy of contraction, thus allowing it to occur gradually rather than suddenly. Keeping all the same brands open, whatever small demand may remain for companies like Saab, is not a solution. It only prolongs the fall.

2. Small Cars Have Small Margins

I grant you this: SUV sales were perpetuated by greedy and misguided consumers. People wanted big, strong looking vehicles to offer security, say something about them, and who knows what. But auto manufacturers were not unwitting accomplices to this trend. I have written before about how the Cash for Clunkers scheme had no teeth because the average fuel economy in US automakers' fleets was so abominably low. However, there was a simple financial incentive for producing SUVs: high margins. A margin, put simply, is the difference between what it costs to make something and the price for which you can sell that product. The Economist picks up on this:

To understand the importance of the mix, says Max Warburton of Bernstein Research, compare the cost of producing a small car such as the popular Fiat 500 with that of making a hulking sport-utility vehicle such as the Audi Q7. Mr Warburton calculates that the fixed costs are nearly identical, whereas the variable costs of making the Q7 (labour, raw materials and so on) are only about €10,000 ($14,700) higher for the Audi. Yet the Fiat sells for as little as €10,000, compared with a sticker price of at least €40,000 for the Audi. So a permanent shift toward smaller cars would devastate industry profits.

Large cars don't cost much more to make, but people are willing to pay a lot more for them. This, again, seems to be something that will be corrected over time. Automobile manufacturers like Toyota and Porsche have demonstrated unequivocally that massive amounts of cost can be cut by designing the process of assmebly as efficiently and intelligently as possible. This is how companies adapt to building a product with smaller margins. Higher margins provide a different kind of cushion, the sort that stunts rather than encourages efficient construction. Building a small car may be more expensive, but in the long run, its production that we can afford.