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Small in Stature, Big in the Market-Why automakers maintain their small-car focus

Small cars have been bullied by the biggies, both in the revenue column and on the road, but they've been able to hold their own.Wildly robust truck and SUV sales make for good headlines - and fat profits - so much so that it sometimes appears automakers aren't concerned about anything else, least of all small cars. But automakers haven't been totally blinded by the short-term profits large trucks

Small cars have been bullied by the biggies, both in the revenue column and on the road, but they've been able to hold their own.

Wildly robust truck and SUV sales make for good headlines - and fat profits - so much so that it sometimes appears automakers aren't concerned about anything else, least of all small cars. But automakers haven't been totally blinded by the short-term profits large trucks generate. They continue to pour money into developing better vehicles at the other end of the market, even though these smaller cars make little, if any, money.

The math may not make sense, but the reasons automakers can't afford to abandon this segment certainly do. Consider that even though total U.S. sales for small cars have shrunk from 3.7 million units in 1988 to 2.35 million last year, the market still consists of some 31 different models and remains the second largest overall passenger-car segment, trailing just the midsize segment, but outpacing sales of minivans.

It's not a booming market, but it's one that has done a pretty good job of holding its own against those big truck bullies. These vehicles could become even more popular if these heady times for the U.S. economy suddenly slow and consumers decide they'd rather not spend upwards of $30,000 on SUVs and pickups. A new wave of smaller, safer cars, aimed at value-conscious buyers who want more upscale features, already are on the way, including the Ford Focus, Nissan Sentra and Toyota Echo.

"Small cars are important because the market is big," says Joseph N. Caddell, general product manager of small cars at DaimlerChrysler Corp. "The importance of small cars, the thing that gets overlooked, is stability. If you scan your eyes across all the vehicle segments, small cars beat just about every segment out there."

There are other not so obvious reasons, too.

n Small cars help automakers meet corporate average fuel economy standards (CAFE), thus allowing them to sell more highly profitable, but less fuel efficient large cars.

n These buyers typically buy from the same manufacturer for life.

n There may be profits to be made through global platform sourcing.

n Lower-priced small cars with rebates help draw entry-level buyers away from the used-car market.

n More powerful small cars packed with more upscale equipment to satisfy consumers' tastes are padding automakers' bottom lines.

The next generation of new car buyers may not want to drive the pickups or SUVs that their parents are tooling around in today (see Toyota story, p.30).

Automakers say they are just beginning to see some SUV and pickup owners switch over to small cars for fundamental reasons like better fuel economy and a smoother ride. The numbers aren't large enough to cause panic, but for automakers it's a discernable shift. These diminutive, fuel-sipping sedans, wagons and coupes have maintained a steady volume of more than 2 million units annually for more than five years running.

Al Kammerer, vehicle line director for the Ford Motor Co. Focus platform, sums up the importance of small cars: "The small car market represents a way to capture first-time car buyers."

Oh, those first-time customers. Making a small car buyer happy can translate into strong future business - an average of nearly 53% will purchase their second vehicle from the same manufacturer, R.L. Polk data shows. Large car buyers have a higher loyalty rate, 72%, but these are older buyers and less reluctant to change, Polk says. Cavalier and Escort buyers last year had a manufacturer loyalty rate of 66%, the highest among small cars, according to Polk. The highest performance among any model was 77% held by the Buick Park Avenue.

"The broader your coverage, the higher your loyalty will be," says Karen Piurkowski, director of loyalty at Polk. "For a manufacturer that offers a variety of makes, it is important to have a small car. That's why you see so many vehicles in that segment. The loyalty rate is a little lower because there are so many small cars to choose from."

That strong buyer loyalty among small car owners was one important motivation for Saturn Corp. to add the upcoming larger L-Series to its lineup. "We have 2 million Saturn customers out there," says Ken Wasmer, co-chair of the Saturn Vehicle Development Team. But when it came time for them to move up, we were losing them to non-domestics like Toyota and Honda."

The former Big Three's often-overlooked share of this lower end of the market is a dominating 58.4%. Certainly some of those numbers can be attributed to fleet sales and more basic retail incentives, but Motown's small cars still score high.

While the exact segmentation has gotten a bit confused, there are basically 31 different small car models to chose from today. These cars have an average transaction price between $12,000 and $16,000 with a maximum wheelbase of about 104 ins. The Ford Escort, Chevrolet Cavalier, Saturn SL and Dodge Neon are among the six top-selling small cars in the U.S. The other two are the Honda Civic and Toyota Corolla. Last year, these six cars accounted for 1 in every 10 light vehicles sold.

Americans bought a total of 2.35 million small cars in 1998, which represents 15.1% of all cars and trucks sold in the U.S., and are on a pace to top that this year. Sales through April are up 9.9% (when you subtract low-end economy cars such as the Daewoo Lanos, Suzuki Swift, Chevy Metro, Hyundai Accent and Kia Sephia).

These sales figures pale in comparison to the rest of the world, particularly in Europe where small cars are a staple. But that popularity could benefit most automakers' bottom line satisfying the demands of European buyers means U.S. consumers will be surprised and delighted when their version of the same vehicle arrives, automakers say.

The trick is finding a way to do it profitably. Ford believes it has with its new Focus that it plans to sell around the world. Unlike the Escort, which was a "world car" in name only, the Focus will be virtually identical in all countries with only minor tweaks to accommodate regional aesthetic differences. Honda, meanwhile, is interested in simultaneously launching its next-generation Civic in markets around the world, while Toyota's upcoming Echo borrows many parts from the Prius.

And GM, through its "Yellowstone" small-car project (see sidebar, p.29) also is attempting to leverage supplier involvement, new assembly technology and plant design and apply it to production of profitable small cars worldwide.

The "typical" U.S. small-car buyer hasn't changed much over the years. Younger entry-level buyers account for a large portion, and many small cars still are purchased as second cars and by retirees and empty-nesters. Women on average purchase four out of every 10 small cars, Polk data shows.

What has changed is these customers' expectations. Today's small-car buyers are more sophisticated than those who were content with the econoboxes and throw-away cars of the 1970s and '80s.

These new buyers still covet fuel-efficiency, reliability and durability - and of course, low initial cost - but they also expect higher and higher levels of refinement and standard features - and power - attributes typically found in larger, more expensive cars.

Automakers have happily added these extra-value items as the average transaction price of a small car creeps to nearly $16,000. Consider that in 1988 the best selling small car was the Escort that sold for a median price of just under $9,000 - about average for cars of that size.

Fast-forward to 1998 and the best-selling small car was the Civic, many selling for nearly $16,000. That increase is nearly double the rate of price increase on large luxury cars (absent the luxury car tax), which have tracked more closely to the consumer price index during that same period, says David Littmann, chief economist at Comerica.

"Automakers are loading these small cars up with options," Mr. Littmann says. "That's why these basic vehicles have gone up faster than the rest."

The reality, however, is that all of this upscale small car movement could disappear if there is an economic downturn and suddenly people are back shopping new small vehicles strictly on price. This could compel automakers to remove some standard items in small cars and further sweeten incentives.

Steve Wagg, Cavalier brand manager, says more people are moving away from the economy end of the market because they don't view small cars priced in the $10,000 to $11,000 range to be something worth buying. Today's buyers still are value-conscious, he says, but they want more upscale features.

"You can make a car so low priced that it lacks appeal," Mr. Wagg says. "Everybody is making cars better, instead of just commodities."

"It used to be that people got to a certain point in their lives and if they could get out of a small car, they got out of it," says David Bostwick, director of corporate market research for DaimlerChrysler. "But there are a lot of people who want to feel comfortable staying with a small car, and adding amenities happens to do that for them."

Today's smaller cars are more stylish, higher quality and don't necessarily make their owners feel like "This is all I could afford." But to offset some of that upward price creep, automakers continue to offer attractive incentives. Mr. Caddell of DaimlerChrysler says these incentives (already $1,000 on the '00 Neon), however, should be viewed as a strategy rather than an outcome.

"A lot of entry level buyers are younger, freshly out of college," Mr. Caddell says. "They may have the income but they don't have the down payment. So here is the rebate or incentivized leasing. Yes, it does help to incentivize to buy new. But that is part of the strategy. A used car doesn't give you a rebate or a good financing plan."

DaimlerChrysler believes its revamped '00 Neon, complete with a more grown-up exterior and more refined interior, will satisfy these new tastes. Ford touts the Focus as a cut above today's small cars, with more room and outstanding driving dynamics.

The Focus is Ford's latest attempt at a world-car. The U.S. version is nearly identical to the one that went on sale in Europe last year and goes on sale in the U.S. in October. Prices haven't been set yet, but Ford says it won't be too far of a stretch from the Escort's base price of $11,920. To keep Focus a notch above it predecessor, Escort will stick around for another year.

The Focus and Neon will face stiff competition from Toyota , which is trying to return to the small car market with its new Echo, a replacement for the Tercel. GM's upgraded '00 Chevy Cavalier and Pontiac Sunfire and Volkswagen AG's new Beetle/Golf/Jetta trio round out the list of small cars with serious intentions.

Donald Esmond, group vice president for Toyota Motor Sales USA, says the Japanese automaker has been responsive, "growing up" with baby boomers and providing them with products as they grew out of smaller cars. But the company hasn't done a good job of replenishing that end of the market.

"It is an extremely important segment for us to get back into," Mr. Esmond says. "We've done a poor job and kind of ignored that end of the market and went for more profitable cars. Our fear is, if we don't start drawing some younger buyers back to the Toyota franchise, we will wake up some day like other manufacturers and find that all of our folks are growing old and dying."

A difficult mitigating factor: profit margins on small cars run from slim to nothing. GM says it loses about $1,000 on each small car it makes, which is one reason the automaker is pushing its Yellowstone program so hard.

Other automakers won't reveal profits of small cars. When Chrysler launched the first Neon in 1994, executives swore it would be profitable; although the company won't officially part with the figures, high level sources tell WAW that never happened.

Yet Will Boddie, vice president in charge of Ford's small and medium vehicle center, says that the Focus "absolutely, with no qualification, will make money." To that end, Ford and everyone else is scrutinizing the compact-car assembly process, eager to eke out cost from the system.

Whatever the profits, no one can afford to turn away from small cars. In the U.S., small cars help automakers meet CAFE regulations, which require automakers' passenger-car fleets to average 27.5 mpg. Those who fail to meet the average can pay fines that reach millions of dollars. So even though some automakers lose money on small cars, it is easy to see why they continue to pump them out to balance the seesaw with large gas-suckers.

Long-term, the market for small cars could see even larger volumes when the heart of the NetGen group, those born between 1980 and 1994, begin hitting the road sometime in 2005, setting the stage for a mix of cars on the road that could be a lot smaller. The influence this generation will have on the auto industry could be huge. Consider that by 2010 there will be about 123 million Americans under the age of 30.

Craig Bierley, Pontiac Sunfire brand manager, says all of the brand's marketing is aimed squarely at the younger-buyer half of the Sunfire's market curve. Sunfire's gold sponsorship of ESPN's X Games, for instance, speaks to the division's desire to attract these younger buyers.

Ford is taking a different route with its 3-door Focus, although its underlying goal is similar. Ford is aiming the hatchback at the California crowd, in particular, the new generation hot-rodding front-drive compact cars. They can spend upwards of $10,000 hopping up a Honda Civic. Ford is convinced that if its 3-door Focus is a hit out West, it will also score well with the rest of the country.

"It is aimed at a younger group," Ford's Mr. Kammerer says. "If you can aim it at that group and get the credibility, we think we will create enough awareness and interest in the car it will capture the other groups." - with Dave Zoia and Trevor Boyer

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