Detroit Profitability

Recently, I have seen several articles predicting the worst for Ford, GM, and Chrysler because of the swing away from trucks and SUV's. Analysts all fear that the Detroit automakers will lose sales due to a lack of product in the near future, while the longer term is just as bleak because Detroit has historically made all its profits on big vehicles.

I agree completely with the short term concerns. Ford has started to turn the corner with the new Focus. It seems to be getting very good reviews, and my impression is that it is leading the American compact car market (for what that is worth). GM has a good selection of mid-size sedans, although even their star, the Malibu, has some interesting quirks that would make me think seriously before buying one (the trunk opening being a big issue because it is not actually big). Chrysler is, unfortunately, at least one model generation away from competing seriously in the small and mid-sized car game.

But in the long term, I have less of a concern for automakers. Yes, recently these small cars have not been profitable for automakers, especially American automakers. However, I predict that the profitability of small cars is about to change.

The reason I make this statement is because the buyers of small cars are changing. In the past, no one in America wanted to buy a compact or mid-sized car if they could afford the big SUV. Truck and SUV sales went through the roof precisely because gas was relatively cheap. Now, quite suddenly, Americans are faced with decidedly more expensive gasoline.

These buyers, who had previously purchased $20k-30k SUV's, are now looking at smaller cars. If they can find a small car that helps insulate them from swings in the gas prices, they can still afford to spend the same $20k-30k for the vehicle. What would a $30k Ford Focus look like? No one knows. It tops out well under that mark.

But knowing that car buyers are looking at smaller cars, manufacturers can start to load on accessories and options that will raise the average sales price of the cars. And on these small cars, the options are where the profit is found.

That is why Detroit historically made little money on small cars. The cars were mediocre in what they did, and no one who could afford better bought one. The average sale was near the low end of the option list. Because these cars turned little profit, Detroit invested little in updating these cars. The cars continued to be mediocre, sales continued to suffer, no profit was made, and on, and on. Detroit helped perpetuate this cycle that brought the American small car to an "also-ran" status on dealer lots.

Now that the size of the car is an advantage in the buyer's mind, and as the base level cars are getting better, more people will consider buying the top level of these cars. Hence, the small car makes more profit for the automakers. Kudos to Ford, by the way, for having the fore-sight to offer a Focus with options such as leather seating. While the Focus doesn't give BMW or Lexus night-sweats, it is a big step in the right direction for Ford.

So, are Detroit automakers safe? Definitely not, and getting there won't be easy. Small cars are going to have to get good gas mileage, be fun to drive and still pamper the driver and passengers. But at least there is a light at the end of the small car tunnel. Who can make it that far, though, remains to be seen.