Car giants in search of a few small comforts

Slowly, but it seems inevitably, the unthinkable is happening. General Motors, icon of American capitalism for nearly a century, is going bust. If it does file for bankruptcy under Chapter 11, there will be incalculable consequences for the huge supplier network that depends on it, for consumer confidence and for peak US unemployment figures, which are likely to soar by a whole percentage point to 11.5%.

That might seem bad enough, but it is only one episode – though a highly dramatic one – in the unfolding crisis engulfing the global auto industry. This crisis, though accelerated by the recession, has not been caused by it. It is a long-festering saga of overcapacity, wafer-thin margins, insufficient structural reform, ever-tightening regulation and inadequate technical innovation, which – like a pustulating boil – has finally been pricked by the credit crunch. The US manufacturers are the most severely affected with, leaving GM aside, Chrysler likely to be bankrupted if it is not given away to Fiat, and Ford barely keeping financially afloat. But in some measure all their competitors face the same dilemma.

Is there a silver lining in this cloud? Well, yes there is – and I mean by that more than an opportunity to mop up the rump of the US car market. The most successful mass manufacturers of the future will be those who crack the small car problem. Traditionally, car companies make a loss or near loss on their small vehicles, however popular. All the money is to be made further upscale, the more upscale the better the margin.

There are, however, a number of interrelated reasons why it is becoming more difficult for the makers to turn a profit simply by segmenting, engineering and selling more luxurious vehicles.

The first, fairly self-evidently, is the depth of the present recession, which is creating a climate of austerity very different to the conspicuous consumerism of the last 15 years.

Reinforcing this is a more fundamental change in consumer attitudes towards car ownership. In some respects, car marketing is still fixated in an era when motoring was a lot more fun than it is today. It glamorises the motor vehicle as a status symbol in need of constant upgrade in order to “keep up with the Joneses”. Yet what is the point of renewing a car at 75,000 miles when it will easily complete 150,000 miles before it needs serious mechanical attention? Add to this the virtual disappearance of company car culture and it becomes apparent just how much the traditional replacement cycle is under pressure.

The third reason concerns environmentalism, the limitations of the internal combustion engine and the technological inadequacy of its potential successors. It might be thought that growing awareness of carbon emissions, and the need to curb them, was exactly the kind of paradigm shift that would help to address the replacement issue. Not so. The motor industry has preferred to concentrate on lean-burn engine solutions – a refinement of existing technology – rather than make a full-scale commitment to the alternatives of electric and hydrogen fuel cells, which involve huge investment and an uncertain outcome. It has done this partly (but only partly) because there has been a lack of systematic government support for the necessary policy changes to underwrite such a revolution.

In view of this, the motor industry is now caught in the jaws of a tightening vice. Brussels is passing legislation that will require CO2 emissions to be cut from an average 158g/km to 120g/km by 2012 right across the EU. That will put great pressure on the gas-guzzling end of the petrol and diesel engine market, precisely where the manufacturers make most of their traditional profit.

The emerging picture is one of chronically depressed demand over a number of years. Several upmarket marques may cease to compete. Lexus looks highly vulnerable in Europe and Saab just looks vulnerable.

It’s an environment which, if it favours any segment at all, will advance the cause of small, thrifty cars. One way to make these both fashionable and profitable was in evidence at last year’s Paris Motor Show in the form of small, luxurious concept vehicles, such as the Audi A1, the BMW X1 and the Mini crossover.

However, although engines will become still leaner and smaller, they will continue to be conventionally powered in the majority of cases because the green trend, despite its obvious marketing appeal, looks bigger than it really is. The motor manufacturers may have been caught on the hop by emissions regulation, but their “alternative” solutions are unappealingly expensive. In addition, hybrids like the Toyota Prius are only slightly more efficient than conventional engines. Pure-bred electric cell technology, on the other hand, remains clunky. The best of recent electric car prototypes, the Mini recently piloted by Messrs Hoon and Mandelson, is three years from production, requires the removal of the back seat, takes 2.5 hours to charge and has a range of only 150 miles.

Might government subsidies, in the form of the scrappage schemes and “green” purchase incentives, help? Only marginally. The UK scrappage scheme, introduced in last week’s budget, is a morale-booster for dealers and makers, but at 300m it is too small and too poorly targeted to make a real difference. Where scrappage has worked is in Germany. Two notable features of the German scheme emerge. First, that the taxpayer investment, at 4.5bn in a market about one-third larger than our own, is huge. And, second, that the principal beneficiaries are (with the exception of VW) foreign-owned brands: those, that is, which excel at making small, thrifty vehicles.