A Reflection on Niche Vehicles

Discussions of GM’s “small” pickup touch on several deep issues. One is the nature of competition in the industry at the OEM level: to what extent is it an oligopoly, in the sense that each firm takes explicit account of the anticipated behavior of rivals in their product planning? The other is as murky, what is the cost structure of the industry? Neither is readily observed, even by executives at the Toyotas and GMs of the world.

The first strategic dilemma shows up in the history of small cars in the US. My non-scientific [definition: I’ve not gone back to look at data] sense is that there have been 5 waves: the late 1950s (when AMC’s Rambler sold well, a various European cars had their followings, including , the late 1960s (VW sold 600K Beetles in 1968), the latter 1970s through 1982 (following the first and second oil crises), and then again circa 2007. Each led the Detroit 3 to consider their strategy: enter or not. Or rather, not. Making cars is a fixed cost industry, and it’s also a status industry where larger vehicles carry higher prices. Now if Ford entered, so would GM – and vice-versa. The result would be a blood-bath, as no single firm would be able to sell enough cars to pay back development costs and overhead, and – if the market was flooded – discounts might even swamp direct costs.

So time and again we see new entrants eating away at the margins, sometimes doing well enough to turn their beachhead into an ongoing business (or given Toyota’s and Hyundai’s initial withdrawals from the US, biding their time for the next small vehicle surge and doing well enough the second time around). Sometimes (Daihatsu and Suzuki and [de fact] Mitsubishi) they don’t. (It’s too soon to tell whether Fiat will make it this time around.)

This action-reaction story has other variants. Dominant firms slowly lose share, because if you’ve got a 500K-a-year model, it’s better to change slowly and lose share gradually than to change quickly and lose share quickly. To rephrase: if you’re selling 500K, there’s no upside to being “edgy” in a redesign, You can’t gain much more in sales, but you sure can lose that replacement sale. Better to be conservative and boring, and then do the same the next model change, and the next. Bob Lutz shook up GM on the design front, but not before repeated downsizing left it with more legacy costs than it could handle. Akio Toyoda is now trying to shake up Toyota, after the firing [pardon, early retirement] of the top 4 in the firm back in 2009 by the firm’s elder statesman, Shoichiro Toyoda.

Ditto the elder Ford’s firing of the top people at Ford, er, his successful CEO succession strategy with Mullaly. At Ford it was a very close call; the firm was already in crisis, as nicely documented in Bill Vlasic’s book, Once Upon a Car. The shadow emperor Shoichiro didn’t wait as long, reacting to internal quality and cost data, and data on their increasing reliance on aging repeat buyers in the US and on a weak yen. But Shoichiro also had the memory of his family losing their stake in Toyota in the firm’s de facto 1950 bankruptcy, and a temper that led to him screaming at the Board. No such disruptions were permitted at meetings of GM’s board.

The larger point is that these strategic dilemmas are, well, dilemmas, and all of the leading firms face them on a regular basis. It doesn’t mean that GM didn’t have horrible management. It does mean that in the face of such dilemmas all management looks terrible. Just some look less terrible – perhaps Ford? – than others. For a while.

So … if GM launches a smaller pickup, what of Ford? Chrysler? others? The Chicken War tariff provides insulation from competitors from India and elsewhere [remember Mahindra?], but it’s a small market. A pyrhhic victory is all too likely: the Colorado does well and others enter, and all GM sees is red. There’s another downside risk, too: even if others don’t mimic GM, if the does Colorado too well it can cannibalize fat-margin Silverado sales. The only way around is to not refresh too quickly any small truck too quickly, to keep costs fixed costs from escalating. That strategic response holds its own dangers, as comments on TTAC of the Colorado pointed out.

To the second issue, the cost structure. Car companies have a hard time separating “fixed” from “variable” costs, and they have a hard time allocating those to a specific vehicle in a specific market – when two model cycles of multiple vehicles can come off a platform, how much should you be charged for development, engineering, tooling and general overhead? This requires a large measure of guesswork, between marketing and logistics and incentives, as ex-factory costs run 25% of the retail price. Purchased parts add perhaps another 45%, and only a modest part of that will change with vehicle size. Direct factory costs add 15%, and while a luxury vehicle may need extra steps, a small car and a large car all require brakes, and window molding, and so on – so assembly costs change little. My sense is that including the various upfront and overhead costs, 25% of the OEM total consists of fixed costs [and a portion of the price of purchased parts is likewise hides a big slice of fixed costs]. When sales fall, they sweat and then bleed, then bleed profusely. When sales rise the cash just keeps rolling in – and the temptation to dip into it, to fritter it away on acquisitions and perks and vanity projects typically becomes irresistible.

Perhaps the fixed costs of a small pickup platform can be leveraged on a global basis. But we are living in flush times, with a 16+ million SAAR and (for GM, a Chinese market where they can do no wrong). So my gut feeling is that for GM small pickups are one such a vanity project – as was for Toyota the Tundra, which loses money in big-truck-sized quantities.