Small isn't beautiful - Economist.com

[whynot]

Reproduced from ...

http://www.economist.com/businessfin...=hptextfeature

Carmakers have escaped calamity. Now they face a big, long-term problem: people are moving to smaller vehicles.

BIG motor shows are good barometers of the car industry’s mood. Twelve months ago in Paris, in the wake of the collapse of Lehman Brothers, the mood was dread—the knowledge that something terrible was about to happen. At the beginning of this year, at the show in devastated Detroit, and a few months later in Geneva as Chrysler and General Motors prepared for bankruptcy, it was all about the struggle to survive. This week in Frankfurt the industry gave a sigh of relief, confident that the worst was over but painfully aware there would be no return to business as usual any time soon, if ever.

The sense of relief is understandable. After the collapse in sales and savage production cutbacks that took place in nearly every big market nine months ago—with the huge exception of China—volumes have started to rise as inventories are cautiously rebuilt. Balance-sheets appear to have been stabilised if not repaired. There is even a good chance that in the final quarter of this year some of the big carmakers will return to (very modest) profit, while others will do so next year. Credit, the lifeblood of the industry, is flowing again, albeit somewhat anaemically. Particularly in Europe, government-sponsored scrappage schemes have brought buyers back into the market. And manufacturers are now enjoying reduced costs, partly from lower raw-material prices and partly because they have laid off workers.

What has not happened is any substantial reduction in capacity, particularly in Europe where factories are capable of churning out 4m more cars than the market can take even in a good year like 2007 (see chart). Not long ago it was widely assumed that the downturn would be sharp enough to take out more than one big carmaker. For better or worse, governments have done their utmost to stop that happening. Like the bailed-out banks, GM was probably always too big to be allowed to fail. But few expected sickly Chrysler to survive in anything like its present form. The removal of Opel/Vauxhall, one of the weakest big producers in Europe, would have done the industry a power of good.

Yet, thanks to President Obama’s auto task-force and a shotgun marriage with Fiat, Chrysler motors wearily on. German government largesse paved the way for Magna, an auto-parts firm, and Russia’s Sberbank to buy a majority stake in Opel/Vauxhall from GM on the condition that no plants will be closed in Germany. GM even found buyers for tiny Saab in Koenigsegg, a boutique Swedish sports-car firm, and China’s Beijing Automotive. Volvo, which is bigger and healthier than its Swedish rival, may be sold to Geely, China’s biggest privately owned carmaker. Far from consolidating, the European industry has instead gone in the opposite direction.

Although cuts at GM and Chrysler have removed some (though not enough) excess capacity in America, not a single car factory in Europe has closed so far. That is one reason why the carmakers assembled in Frankfurt believe that the normal strong, cyclical rebound may not happen this time. There are plenty of others.

One worry is the effect of withdrawing scrappage incentives. These have propped up demand this year, especially in Germany where they drove volumes to record levels. Optimists say that at least 70% of the scrappage purchases were incremental sales made to people who would not normally have bought a new car. But car-company bosses fear that volumes in Europe could slide next year unless “normal” new car buyers—well-off people and companies—return to the market. Even if scrappage schemes are continued or tapered, there may not be many buyers left who meet the qualifications.

Although the scrappage schemes have kept factories going, most of the action has been geared towards cheap, small vehicles which are less profitable for carmakers. They have thus weakened the “mix”—the balance of small and large vehicles sold—and reduced margins. The balance may swing back slightly next year, but the mix is threatened on a number of fronts in the longer term, raising doubts as to whether margins will return to their previous levels over the next few years.

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.

One big reason to expect such a shift is that the very cheap lease finance that manufacturers have relied on to stoke demand for their more costly cars, especially in America, Germany and Britain, is probably a thing of the past. Credit is unlikely to be so easily available again. Also, one of the ways leasing made more expensive cars seem affordable was by attributing to them high second-hand values after the lease was over. But higher volumes have dimmed the aura of exclusivity on which high residual values depend. BMW in particular has been badly hit by losses on returned cars and has cut the number of lease contracts it writes by a third.

A second threat to the mix, especially for the German premium makers, is demographic change. Arndt Ellinghorst of Credit Suisse says that by 2020 40% of new car buyers in developed markets will be over 60, compared with less than 30% today. Although the affluent old like premium brands, particularly Mercedes, they tend to want smaller, cheaper cars. Being mostly retired, they are generally buying a car with their own, rather than with a company’s, money. Empty-nesters do not need much carrying capacity. Over-65s also drive 45% fewer miles than the average, which means their cars last longer. Together with the growing durability of modern cars, Mr Ellinghorst reckons that underlying sales in developed markets could fall by as much as 30%. For growth in the sales of big, powerful prestige cars, manufacturers will have to rely on emerging markets.

A third threat to the mix is the ratcheting up of emissions legislation in almost every important car market as governments struggle to meet ambitious carbon-reduction targets. That seems certain to reverse the trend in recent years toward ever heavier and more bloated vehicles. It is also forcing manufacturers to invest abnormal amounts to develop clean technologies in the hope that their bigger vehicles can be made socially acceptable and escape penal taxation.

The executives gathered in Frankfurt this week were aware that threats to the mix, and therefore profits, are long-term and structural rather than short-term and cyclical. They also acknowledge that the industry will have to wean itself from the habit of using profits from bigger cars to subsidise smaller ones, and find a way to start building downsized vehicles that make money. Nick Reilly, who heads GM’s international operations, says that part of the answer is to adopt low-cost manufacturing techniques and not to load cheap cars with unnecessary technology. By contrast, Lewis Booth, Ford’s chief financial officer, reckons that the solution is to make small cars that are as good to drive as bigger ones and charge accordingly. Half of the Fiestas sold by Ford in Europe come with the top-of-the-range Titanium specification and are decently profitable, he says.

The problem confronts everyone (with the possible exception of Fiat, which has problems of its own), but it is most acute for the German premium makers, which dominated the Frankfurt show with their huge displays. Mercedes and BMW have enjoyed the best margins in the business, but they have lost lots of money on their small cars. BMW struggled to make a profit until recently even on its very successful Mini. Their rival Audi, being part of the massive Volkswagen Group, already has access to the technology and platforms it needs to make profitable small cars. To compete, Mercedes and BMW may have to do the unthinkable and join forces—either that, or risk their brands by forming partnerships with high-volume producers.

At the same time, the industry must tackle the problem of overcapacity in mature markets. Paradoxically, that may be easier once economies have emerged from recession and unemployment is no longer quite so high on the political agenda. More than anything, overcapacity undermines pricing power. The industry may feel it has come through a near-death experience in better shape than it could have hoped at the beginning of the year. But a return to health will take a lot longer

[GT69]

Thats very interesting, thanks whynot

[mrbaxr6t]

that is interesting, but this statement is media rhetoric

people are moving to smaller vehicles.

I and pretty much every person I talk to have zero interest in going to a smaller car, out of a very large family I know of one that is moving to a smaller car, and that car isnt very "small" its a magna.

Once again treated like sheep and told what everybody is doing so we best go do it then to be a member of the flock : I look around me and I still see large Falcons and commodores everywhere outnumber by heaps the number of other cars on the road in my area.

I have been thinking that we are nearing a crunch in the auto sector, too many manufacturers, too much competition fighting for a diminishing market in developed countries. This is great for the consumers because it means high quality cars as cheap as possible due to the high competition but unless a quantum shift occurs that warrants every single person needs a new car (out of oil perhaps), or a change that warrants every existing old car redundant.

For example they gave us DVD, made a packet cause we all got DVD players now, the market is saturated with product and you can get a DVD player new for what $50 so they introduce bluray making our DVD redundant so they want us to go and buy bluray player and bluray movie collections thus maintaining demand in a particular product. once bluray is where DVD is now I bet we see a bluray2.0 or something so we all need new players again. This type of thing hasn't happened in the auto sector.

[XR Martin]

Originally Posted by mrbaxr6t

For example they gave us DVD, made a packet cause we all got DVD players now, the market is saturated with product and you can get a DVD player new for what $50 so they introduce bluray making our DVD redundant so they want us to go and buy bluray player and bluray movie collections thus maintaining demand in a particular product. once bluray is where DVD is now I bet we see a bluray2.0 or something so we all need new players again. This type of thing hasn't happened in the auto sector.

Huh? It happens every year with cars. Every 12 months theres a bigger and better model of a particular car

[mrbaxr6t]

martin what I mean by this is there needs to be a massive shift not similar incremental changes to the same base design - an AU shares drive train with EL that inherited it from EA which was gradually improved upon, the BA has a similar (but alloy) block and a new (DOHC) head. My point is that people can "do with their current" one and not buy a new one, in the case of DVDS I used standard DVD will not play in bluray player and bluray not work in standard dvd player, this encourages everybody to get a new player (especially when new movies come out bluray exclusive)

when there is a leap that makes them (cars) better buy a massive margin different fuel source or something off the wall like that, then EVERYBODY will want one (if done properly)

Its a market thing, if you have one you are not in the market for one - if you don't have it you are in the market for it. as I said the new car market is shrinking as there are many good condition older cheaper cars out there. When a new car is so good that a secondhand one just will not do because of any reason, if this doesn't happen the market will continue to contract and automakers' profit margins will continue to shrink.

I hope you understand what I am trying to say

[whynot]

Originally Posted by mrbaxr6t

that is interesting, but this statement is media rhetoric


I and pretty much every person I talk to have

Just to put some context around the article ...

First, it comes from The Economist magazine; the world’s oldest newspaper. The Economist is highly respected because of the quality of its journalism. (Unlike the typically Murdoch trash, it is quality journalism in the true sense of the word.) It was recommended reading when I did my degree in Economics at University.

Second, economists don’t give two hoots if people want big cars or small cars. However, they are interested in maximising “utility”, dead weight loss, rent extraction, production possibility frontiers, and operating near the long run average costs. While these terms are not specifically mentioned, they are “encoded” into this article.

Third, the comment that “pretty much every person I talk to have ...” can be attributed to statistical selection bias.

The point the article was making is that manufactures would dearly love to sell more large cars because there is significantly more profit in a larger vehicle. The market, however, is showing a clear preference for smaller vehicles and the manufactures - themselves – are struggling to come to grips with this new reality.

Interesting times ahead ...

[XR Martin]

DVDs will play in Bluray player

[saber]

I think what mrbaxr6t is trying to get across is that there in the auto industry there hasn't been a giant leap for a long time. Using the DVD as an example, people when out in droves and bought DVD's because it offered them a far greater quality picture and better sound than what a video tape could ever achieve. The same again can be said for blu ray, but correct me if I'm wrong, there seems to be a bit of a resistance to blu ray, as from what I've read, people cannot justify throwing out their DVD collection to swap to Blu ray if they have to buy a new TV/receiver/Speaker package to enjoy the full benefit of blu ray.

[outback_ute]

Originally Posted by whynot

Reproduced from ...

http://www.economist.com/businessfin...=hptextfeature

Ccompare 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.

That is why Ford is not building the Focus in Australia.

[MAGPIE]

So everybody is moving to smaller cars are they...

But most cars (especially small cars) are getting bigger, physical size and engine size.

Mazda 3 and 323 is a good example, engine size has increased 0.5L in less than 6 years!