September 17, 2008 / 3:19 PM / 9 years ago

Detroit's challenge: Making small cars profitable

By Scott Malone - Analysis

DETROIT (Reuters) - Small may be beautiful, but U.S. automakers are more worried about making it profitable.

As high gasoline prices have American car buyers ditching their cavernous sport-utility vehicles in favor of smaller, more fuel-efficient sedans, the three Detroit automakers are faced with a problem: They can make small cars, but haven’t always been able to make much money off of them.

Making smaller vehicles a more appealing business will take two things, industry officials said at the Reuters Autos Summit in Detroit. Step one is simplifying production lines.

After that, they will need to see if expensive fuel will nudge Americans to become more like European car buyers -- willing to pay a premium for feature-packed small cars.

Ford Motor Co (F.N) Chief Executive Alan Mulally already sees the shift happening, in the form of pleas for the No. 2 U.S. automaker to start offering its new Fiesta -- currently for sale in Europe -- in its home country.

“With fuel prices going up, we can’t get them here fast enough,” he said. “I get two to three e-mails a day saying, ‘I just saw the latest picture, can we get it here tomorrow?'”

The shift in demand played out dramatically this summer, as U.S. gasoline prices notched new record highs above $4 per gallon, leading Americans to buy more cars than light trucks.

Cars represented 51.4 percent of U.S. light vehicle sales in August, down from their recent peak of 57.8 percent in May, but still reversing the year-earlier trend, when trucks accounted for the majority, or 52.8 percent, of light vehicle sales, according to U.S. Commerce Department data.

While industry officials do not expect Americans to entirely abandon pickup trucks and SUVs, they also do not expect them to return to their dominant position.

“You could see some recovery in truck demand in the short term; though you haven’t seen it yet, declining oil could help us,” said Fritz Henderson, president and chief operating officer of General Motors Corp (GM.N). “I just don’t see it going back up to where it was.”

SIMPLIFY, SIMPLIFY

The first step is for automakers to find ways to use the same parts in more of their fleets.

“If you do globalization of platforms and commonization of parts that the consumer could care less about, things like door hinges, seat-track sets, catalytic converters, then you could end up saving $2,800 per vehicle,” said Jerry York, an adviser to Kirk Kerkorian, a longtime activist auto-industry investor with a 6.5 percent stake in Ford.

One way automakers can make smaller cars profitable is by persuading shoppers that not all small vehicles are bare-bones econoboxes.

“What you’re going to see is growth in small cars but you’re going to see growth in premium small cars and the profitability of premium small cars is better than that of small economy cars,” said Jim Lentz, North American sales chief at Toyota Motor Co (7203.T), the world’s top carmaker by sales.

Small-car profitability hangs on balancing the feature set -- putting in enough that buyers see a premium in the car, but not more than they are willing to pay for.

    “In a $60,000 SUV you can include a lot of stuff and you don’t necessarily need to make sure that every piece you put in there is a value add because there is so much profit margin in there it almost doesn’t matter,” said Pete Hastings, credit analyst at Morgan Keegan. “But when you’re playing on the small end, you need to be really crisp with that.”

    NOT ALL OR NOTHING

    While consumers are shying away from the largest trucks, like Expeditions and Suburbans, executives said that does not necessarily signal a shift entirely to small cars. Rather, mid-sized sedans and crossover vehicles -- built on a car frame but offering the style and some features of an SUV -- will likely take a large chunk of the market, they said.

    “That strong shift to small cars was really in my opinion a temporary phenomenon as people were overreacting to the price in gas because people didn’t know where it was going to stop,” said Erich Merkle, an automotive consultant at Crowe Chizek.

    ”As we get some stability, people will start to shift more towards the middle. They’re not going to say, ‘fuel efficiency

    is not important, we’re going back to our Suburbans,’ but they’re going to look for a blend of fuel efficiency and utility.”

    What has changed, perhaps permanently, is that Americans are unlikely to resume buying the largest trucks for looks.

    “The New Jersey cowboy, or the fashion buyers in the last five, six years, will pretty well erode out of that pickup buying segment,” said Dick Dauch, chief executive of American Axle & Manufacturing Holdings Inc (AXL.N). “But you’ll get back then to true functional use of why a pickup was ever created to start with. It basically replaced horses and mules. Nobody’s going to go back to that.”

    (Editing by Dave Zimmerman)

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