How Do You Solve The Small Car Conundrum?

Peugeot have been going gangbusters under the leadership of Carlos Tavares, and  after a huge year, have announced that they will return to the US market in 2026, with mobility and software solutions preceding the reintroduction of cars. But unlike others, they don’t have trucks – their brand portfolio is built on small cars and SUVs and vans.

In the meantime, the US manufacturers are exiting the passenger car segment and focusing on SUVs and trucks. In Europe, partnerships and mergers are all over the place, citing the inability to make small cars profitable. So how do PSA solve the small car conundrum?

The laws of automotive economics

The fundamentals of economics and manufacturing built the foundation that make small cars a very low margin prospect

  • Facilities Cost – a car plant is a car plant. If you go into BMW’s plant in Spartanburg SC or Ford’s plant in Cologne, Germany, many things will seem familiar. Many machines are broadly the same and the layout is often very comparable. This extends to different cars – it takes about the same size of plant to build 350,000 X5s as it would to build 350,000 Fiestas. So the facility costs, when spread across each vehicle will be the same.
  • Material Cost – in much the same way, there is more metal (or carbon fibre, or wood (Morgan)) in a larger vehicle, but given the volume, the materials are considered at $ or £ per tonne. This means that the material cost goes up relatively slowly with the size of vehicle, giving higher margins for larger vehicles rather than a consistent margin when looking at the retail price versus the base cost.
  • Engineering Cost – similar to facility costs, this is usually pretty similar regardless of the size of vehicle and more tied to feature content. So, if there are new features, engines, software, etc, the engineering bill will be higher, but if you spec a Polo or a Golf similarly, the cost will broadly be the same regardless of vehicle size.

Retail price is a key limit against which small cars are squeezed. There is a certain level of price acceptance that consumers have for a given vehicle size. It is important to note the relationship between an OEM and a dealer (and why Tesla prefers not to use dealers). In terms of margin, the OEM sells the vehicles to a dealer at a given price. The dealer then applies a margin to that to get to the list price. From there, dealers can provide financial incentives like deposit allowances or money off, as can the OEM themselves.

To illustrate the issue, see the chart below:

Between segments, the costs are likely to increase. Taking assumptions of a 20% uplift in Engineering and Facilities and a 50% uplift in Material costs, you are left with the cost price.

Looking from the customer side, there is a given market price for each segment, let’s call it a 50% uplift between segments. From this, the dealer will take a margin (let’s say a steady 20%). This leaves the price the dealer will pay for a car from an OEM.

 Now the problem appears. The cost price for a car in the B-segment (Ford Fiesta/VW Polo) is actually more than the price a dealer would be willing to pay. So while the dealer continues to make their 20%, the car company takes a -2% hit.  As the retail price goes up, that headroom increases, leading to 8% margin at C-Segment and 17% at CD-Segment. This is all before you budget for marketing incentives that may come from the dealer, so this will dramatically reduce in reality.

This is why US companies put so much effort into Trucks and SUVs – a more premium retail price gives more opportunity for margin to the company rather than just for the dealer.

So, what can be done?

PSA have been a leading light in the European sphere, through aggressive streamlining of manufacturing, they have been able to reduce the facility costs associated with their cars. VW reduce their material cost through their scale. Toyota have been pioneers on “waste reduction” and unnecessary improvements, leading to reductions in all three categories.

Where does the market go?

SUVs are becoming more popular, so the industry gladly tags along as they are also more profitable. But people still need and love their small cars. In 2018, Ford sold 271,000 Fiestas (data from carsalesbase.com) and 200,000 Focuses. Peugeot and Citroen sold 440,000 208/C3s. The trend suggests that SUVs are taking away sales in the C-segment but the B-Segment is still a huge volume. Manufacturers need to find ways to make a slim margin to keep the segment alive. It would be a shame to lose the cars that give personal mobility to so many. It’s hard, but some are still succeeding.

Driving is still, in my view, a skill and something to be appreciated. Most people start with small cars, and SUVs don’t appeal to everyone and in many cases are a choice of style over substance or form over function. It would be a shame for the industry to abandon the small car market.

What’s your take? How much effort is really justified for the sake of wafer-thin margins? Share your thoughts, leave a comment below.

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