Small-Car Interest Surges With Gas Prices
By Dale Buss March 17, 2011
Americans are flocking to smaller cars as gasoline prices bust up through the $3.50-a-gallon mark, just as they have lurched toward fuel efficiency in previous fuel-price run-ups going back for a generation. Both Edmunds.com consideration data and the early-March sales patterns in U.S. automotive showrooms confirm that American consumers rather suddenly are placing much more urgency on fuel economy in their vehicle-purchasing decisions than just a few weeks ago.
Small cars as a portion of overall vehicle consideration on Edmunds.com poked up through the 18-percent level in February, as the average U.S. gasoline price rose to $3.26 a gallon. That was the first time the consideration ratio exceeded 18 percent since it registered nearly 19 percent in March 2008, on its way to a peak of more than 24 percent in June of that year. Gasoline prices peaked at more than $4 a gallon in the summer of 2008.
And small cars comprised 26 percent of U.S. retail sales of vehicles for the first two weeks of this month, up nearly seven percentage points from the identical two-week period a year ago, according to George Pipas, head of U.S. industry analysis for Ford. For January and February of this year, sales in “B” and “C” segments were only two percentage points ahead of the same period in 2010. “That’s pretty significant, even though the data is still skimpy,” Pipas said. “I’m fairly confident that trend will accelerate, not decelerate, as we move through March.”
Added Jessica Caldwell, director of U.S. industry analysis for Edmunds.com: “Last year, we saw gas prices rise throughout the year, but the movement was slow and steady. But when there’s a shock like this, people go crazy in terms of buying a smaller car.”
More Questions Than Answers
This acceleration of interest in smaller cars isn’t yet very consequential for the industry. Sales in just about all segments have been rising strongly so far this year; profitability of automakers is improving across the board; and the business is in the midst of a general and pronounced, if unspectacular, recovery in the United States.
But if the small-car trend and gasoline prices continue to surge in tandem, a number of crucial questions will confront automakers: While the industry fleet is far more fuel-economic than three years ago, do automakers have ample supplies of the smallest vehicles that are abruptly in greater demand than they forecasted even recently? Will the Detroit Big Three benefit this time around as they didn’t in 2008? Is the U.S. economy growing fast enough to outstrip any drag on the auto industry created by higher fuel prices? Will mid-size segments eventually benefit more than they have so far? At what point will sales of larger vehicles falter? And could the new pattern have permanent effects?
Halcyon Days
The oil-price shocks of the Seventies helped usher in the era of the Japanese import in the U.S. market, and small cars were their vanguard. American brands tried in vain for decades to make a bigger dent in the segment but were held back by a higher cost structure and the distraction of attending to the much greater profitability of the pick-up truck and sport-utility segments they grew to command.
Still, small cars grabbed more of the business annually for six consecutive years beginning in 2004, their overall hold on the U.S. market rising to 21 percent from 14 percent, according to Pipas. The gasoline-price shock of 2008 was the height of small-car demand during that period. But by last year – a long time of relative quiescence of gas prices at around $2.60 to $2.70 a gallon – small-car sales declined again. “We’ve traced the interruption of small-car sales growth last year to a period of very benign gas prices,” Pipas said. “People forgot how volatile gas prices could be.”
By late last year, however, Americans – and the auto industry – were remembering. Gasoline prices began creeping up during the third quarter as oil traders began factoring in a gathering global economic recovery and the certainty of ever-rising demand in developing economies including China and India.
Major Opportunity
Fast-forward to the last few weeks, as unrest in the Middle East has spiked gasoline prices above $3.50 much more quickly than economists had expected before they could account for such instability in the world’s biggest oil-producing region.
The earthquake in Japan is another wild card that world oil markets will be digesting uneasily this week. Already, it is credited with reducing gas prices in the U.S. because economic activity in Japan has slowed in the wake of the disaster. And yet, in the medium- and long term, the crisis will make the world’s third-largest economy more reliant on oil imports as it struggles with damage at its nuclear power plants.
Are automakers prepared to take advantage? There are lots more small-car models than three years ago. “Beyond rising gas prices, that factor alone is creating some interest in the segment,” Pipas said.
Toyota, Honda and Hyundai are among the Asian brands ready to take even more advantage with new or improved small-car offerings that launched recently or are in the pipeline for later this year, including the Kia Optima, Honda Civic and Toyota Corolla. Toyota’s Prius hybrid has been enjoying much-increased demand since December.
Is Detroit Ready?
Are the domestic Big Three going to be able to likewise capitalize on the small-car opportunity du jour? “They’re definitely better off than they were three years ago,” Caldwell said. “What will hurt brands like Chevy and Ford are perceptions more than the actual vehicles. People don’t think of them intuitively for small cars. They tend to think of Japanese imports, and of Asian imports in general, because that’s what we’ve been trained to think over the past few decades.
“It will be a challenge for these brands to promote the new small vehicles and let people know they’re out there. If they don’t, it’s a missed opportunity.”
GM has spent the biggest chunk of its marketing budget lately promoting the Chevrolet Cruze compact and Volt extended-range hybrid, as well as the Chevy brand overall, and has begun touting the upcoming Chevrolet Sonic subcompact at prime venues such as the SXSW interactive conference in Austin, Texas, this week. Ford’s renaissance in large part has come on the backs of its new and refreshed lineup of small cars, including the Ford Fiesta that it introduced last summer. A new high-mileage Ford Focus is the subject of the company’s largest-ever model launch, this spring.
And even Chrysler finally has a “new” small car to brag about: the Chrysler 200, a re-skinned Sebring that was the subject of the now-iconic Eminem ad during the Super Bowl. Fiat soon will be importing its chirpy little 500 to sell at select Chrysler dealers as well. “Introducing all these small cars is good for Detroit to prevent market-share loss and to keep starter buyers on a lifetime buying streak,” McAlinden said. “You don’t get that with a Chevette with a roof rack.”
A Better Small Car
Automakers and outsiders alike believe that, as they now investigate the segment further, new-car buyers will feel more comfortable about small cars because they’re nearly all so much more feature-packed than just three years ago. The new Focus is packed with new technology, Pipas noted. “It even has park assist, which is something that Lexus used to feature in its ads,” he said.
Another factor is whether the U.S. industry has enough inventories of small cars to keep up with a surge in demand. Pipas said that “the whole industry is reasonably lean,” with a 60-day supply – considered right and normal – at the end of February. “B” segment inventories were only about 55 days; “C” segment, 51 days; and small utility vehicles, just 50 days. “So you can see [smaller vehicles] are somewhat leaner” in supply, Pipas said, “but at this point there’s no reason those numbers would constrain the sales pace in March.”
Yet again, the Japanese wild card enters the picture: If small-car manufacturers must keep their plants in Japan closed for some time, it could set off a worldwide inventory imbalance that could easily result in constrictions on small-car supplies to the U.S. market.
Showroom Focus
About two-thirds of shoppers are looking harder at smaller or more fuel-efficient rides than they were just a month ago, according to an Automotive News survey last week of more than 300 dealers. About one-third of dealers in the survey were ordering more small cars.
Pipas said the rising interest in small cars has forestalled the possibility of higher interest in other categories that are looked at for fuel efficiency, such as crossover-utility vehicles which provide much better fuel economy than larger, truck-based SUVs. “Probably because the small-car segment has been so robust in early March, there’s not room for much of anything else to grow,” Pipas said.
Yet, just 17 percent of the dealers in the survey said that they had trimmed their orders for pickups. “What’s driving truck demand right now is really a resurgence in the economy ... and pent-up demand,” said Don Johnson, GM’s U.S. sales chief, earlier this month.
Economic Formula
The status of the economy and the auto-industry recovery comprise another huge piece of the small-car puzzle. Today’s surge in small-car demand comes as the industry is running at an annual sales pace of only about 13 million units – much-improved from the depths of the under-10-million-unit rates that were reached during the Great Recession, but still far below the 15-million-unit level of mid-2008, when the gas-price spike cleaned many automakers out of small cars in the early going. That, as Pipas noted, is another factor that gives small-car supplies some breathing room.
Sean McAlinden, chief economist for the Center for Automotive Research (CAR), pointed out that, in addition to stable gasoline prices, other economic factors restricted small-car demand during the Great Recession and still haven’t completely disappeared. One of them was a credit crunch that choked purchases by sub-prime borrowers, who have tended to be the most reliable demographic for the small-car market. As the economic recovery continues to gain traction, McAlinden believes, small-car sales again will level off or drop back because improvements in personal income can overcome higher gas prices.
A $1 increase in gasoline prices per gallon will increase the market share of small cars by 2.8 percentage points, he said. But a $1,000 increase in personal income will offset 0.8 percentage point of the small-car gain. “So if the gas price increases by $1, it takes a $3,646 increase on per-capita disposable income to cancel out the effect on small cars’ market share,” he said.
Back to the Future
The CAR economist believes that the disappointing sales performance of hybrids also underscores the reality that Americans only give so much leeway to fuel economy. Despite the fact that automakers continue to introduce new and improved hybrids, U.S. sales of hybrids peaked at about 360,000 in 2007 and since have trailed off to less than 300,000 last year.
For such reasons, McAlinden remains skeptical that small cars will ratchet up to a significantly higher long-term share of the U.S. market – even now. The real winners, he believes, will be mid-size vehicles, where more buyers will drift after an infatuation with small cars, attracted by the segment’s own vast improvements in fuel economy and the availability of significantly more interior space than with small cars.
“This segment is much more fuel-efficient than in the past,” he noted, saying that more than 70 percent of intermediate-sized vehicles now are powered by four-cylinder engines versus just 40 percent in 2005. “If it’s about fuel economy, why are Americans buying small?”
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