This is the first part of a series that I started writing last year. Most of the second part is written, too. Let’s see if I get to the third part.[hr]
A full service car company is a busy, busy place. Technical development, engineering, engine development, refinement testing, crash testing, safety labs, exterior and interior design, marketing, public relations and much, much more. And it all costs money — a L-O-T of money.
There are three basic ways in which car companies make their money:
1) Vehicle Manufacturing and Sales
2) Parts and Accessory Sales
3) Financing Services
Let’s work through those in reverse order.
Financing Services can make a company some serious coin. Cashflow is the oil that lubricates the whole company, so a manufacturer that has its own finance arm has a distinct advantage over its non-financed competition, including the ability to earn money in a wider variety of ways.
There aren’t many dealers that have the liquidity to fully stock their dealerships. Dealers use credit facilities offered by the manufacturer’s finance arm to get cars in their showrooms at favourable interest rates. The dealer not only gets competitive financing, they also put more cars in their forecourts to sell and those vehicles are booked as sales for the manufacturer. When it works (ie: when the company has a desirable product to offer) — it’s a win-win situation.
The finance company can also underwrite lease deals, loans for customers and even insurance, earning the manufacturer ongoing interest revenue on top of the initial sale of the vehicle.
How much can financial operations contribute to a car company? In the third quarter of 2003, General Motors made just $15 profit per vehicle as a manufacturer. Its finance arm, GMAC, contributed three times more than manufacturing towards the company’s profits that year. Bear in mind that those were troubled times for GM with onerous labour contracts but still, there’s no doubt that GMAC carried the company through those turbulent times.
GM sold 51 per cent of GMAC in 2006 in order to raise some much-needed cash. No wonder there’s been talk for a few years about a restructured and financially stable GM wanting to buy it back.
Parts and Accessories are a matter for another article, but when Saab Automobile filed for bankruptcy in December 2011, the only arm of its operation that wasn’t included in that filing was Saab Parts. That should tell you something about how profitable spare parts can be.
That leaves us with vehicle manufacturing and sales.
Car companies exist to develop, build, and sell cars. This is essential for feeding the Parts and Finance arms of the business, but they can make bucketloads of money selling cars if they do it right.
Manufacturing is the spring from which all other elements of the industry flow and it’s also a good source of income if you have strong enough margins. That means building the price up and keeping costs down — neither of which are easy.
If you’re wondering why every car company wants to move into the premium/luxury segment, it’s all about the margins. This is why Toyota created Lexus, why Nissan has Infiniti and why GM is so fixated on making Cadillac a global brand. Essentially, companies can ask much more money for upmarket cars, even though the incremental added cost of taking what might be considered as a generic chassis and applying premium parts is relatively small.
Let’s look at an example from a company with which the writer is very familiar. I covered the operations of Saab Automobile for nearly seven years, including the sale from General Motors to Spyker Cars in early 2010. In addition, I worked for Saab Automobile in 2011 until their bankruptcy in December of that year.
In Saab’s case, it would make, on average, around US$5000 on its bread-and-butter model, the Saab 9-3. You can increase that amount by around US$3000 for a 9-5 large sedan, a 9-4x SUV or a convertible 9-3. You should note that that figure is a qualified estimate, but a reliable one that changes from country to country and according to currency fluctuations. Also note that other companies in the same segment would benefit from better economies of scale. Move either upstream towards the luxury segment or downstream towards volume and you can adjust those margins up or down accordingly.
Saab wanted a small car but did not have the money to develop it. If it had made that smaller vehicle, however, the margin would have been around US$2000 per vehicle.
With materials and labour accounted for, the remaining margin per vehicle has to cover all the other aspects of the company’s operations: technical development, safety, crash testing, NVH, global marketing resources, events, PR…. and many more functions.
Indeed, the car industry has an insatiable hunger for cash, so it’s important that companies develop a product mix that’s profitable and sustainable. That leads us to model/segment choice – in short, how to get the greatest output from your inputs.
Picking the right segment of the market is essential for remaining profitable because of the cost/margin relationships that prevail.
The costs for developing a small car and a large car don’t actually vary as much as you might think. The larger car will indeed cost more to develop, but it’s a matter of degrees. Call it a ratio of around 1:1.25. At the sales end, however, the company can command a price for the larger car that’s more in the 1:1.5 or even the 1:2 range, depending on the size and perceived luxury difference.
Customers will accept paying a lot more for a larger car without a thought given to the fact that both large and small cars go through the same development and manufacturing processes. The larger car’s ride and engine are usually more refined, the car is usually more powerful and there’s more space to give an impression of luxury, comfort and safety. All those extras justify the price difference in the mind of the consumer and importantly, if they’re well executed, they deliver a driving experience that builds brand loyalty.
Regulatory costs are remarkably similar. Both cars have to get government certification; both have to be crash tested, climate tested, pollution tested, economy tested and so on.
The costs to manufacture aren’t that different, either. Both cars need panels, four doors, glass, an engine, a gearbox, interior carpets, a dashboard, four wheels and tyres, et al. Getting some components in more premium materials and slightly larger for a larger vehicle does cost more, but the increment is fairly small compared to the price the end product can command. Fitting those parts together is basically the same process whether the vehicle is large or small.
Premium manufacturers can make a $2K margin on a small car or an $8K margin on a larger car. If you were allocating resources inside a car company, which one would you choose?
It’s logical to think that the smaller car will sell at a lower price and therefore may appeal to more people, but it’s also subject to more competition and, in the premium sector, reduced desirability.
For premium manufacturers, larger vehicles still outsell smaller vehicles. The Audi A4 outsells the A3 by a large margin. The BMW 3 Series Sedan is not a small car by any means and it outsold the entire 1 Series by nearly 70,000 vehicles in 2012. Both were outsold by the 5 Series.
The vehicle that saved Porsche early in the new millennium wasn’t the 911, it was the Cayenne SUV (which has been Porsche’s best-selling vehicle since it was first introduced). In the premium and luxury sectors, to an extent, bigger is better.
Another recent trend has been for companies to entrench their smaller vehicles even more firmly in premium territory. Hence we have the movement towards premium small cars: the Fiat 500 Abarth, RenaultSport models, Alfa Romeo’s MiTo and Giulietta, BMW 1 Series, the Mercedes A-Class and the car that started the whole movement, the MINI Cooper.
Margins for everyday small-class vehicles are much thinner than the $2K estimate for premium small cars and companies can’t make up losses by selling in greater volume.
Mainstream brands such as Toyota, Volkswagen, Holden, Fiat, Ford, Honda, Mitsubishi and others all face constant pressure to improve their vehicles whilst keeping them affordable. Now that Hyundai and Kia are mainstream, they have joined the others in trying to head off the next looming challenge from Chinese car-makers.
Making money in the car business is no easy task. You’ve got margins to play with, but they’re not huge and every decision you make involves a compromise.
Cost vs quality. Smaller segment vs brand perception.
The smaller your company is, especially in terms of model diversity, the finer the line you have to walk.
Get your formula right, including some genuine size and synergy (hello, Volkswagen Audi Group) and you can make a ton of money and secure your future.[hr]
Next: Model Design And Development