Help: Why Are SUVs More Profitable?

Many discussions of auto company economics include the assertion that SUVs and pickup trucks are more profitable than small cars, and so a shift from the former to the latter – as discussed by Felix Salmon, for example – will not be good for the auto companies, particularly GM and Chrysler (since they are in the news these days). I accept that as a historical statement, but I don’t understand why that is the case.

Textbook micro tells you that price equals marginal cost, so the gross margin on every product is zero; that’s clearly no help here. Profit margins should be higher in product segments with less competition, but basically every manufacturer makes a small, midsize, and large SUV, so I don’t think that’s the explanation.

I can think of a few other possibilities:

  1. Small cars help manufacturers meet their CAFE targets, and so manufacturers are willing to accept lower profit margins on them. That is, each small car allows them to sell one more big car, so the marginal benefit of selling the small car includes the profit on the big car. There may be something to this, but not as much as you would think, because CAFE targets are scaled by vehicle footprint (length x width), so big cars have lower fuel economy targets; the more big cars you sell, the lower your overall target. It’s possible that the targets are carefully engineered so that, all other things being equal, it is easier for small cars to hit the small-car targets than for big cars to hit the big-car targets; if so, that would lead to manufacturers accepting lower profits on small cars.
  2. The customer lifetime theory: The goal is to get a loyal customer for life and upsell him to bigger and bigger cars – you sell him a Civic out of college, an Acura RSX when he gets his first bonus (oh, wait, no more bonuses . . .), an Accord when he gets married, an Acura MDX when he has kids, and an S2000 when the kids go to college. In that model, the Civic can be a loss leader, because it pays for itself with the later models.
  3. There’s more scope for differentiation with big cars. The bigger the car, the more bells and whistles you can throw in. Differentiation from the competition creates pricing power.
  4. Big-car buyers are less price sensitive; they are buying the cars with their bonuses (sorry, forgot about that) or their home equity lines (whoops, none of those, either), while small-car buyers are saving up tips from waiting tables.

However, except for #1, all of these theories just say that you get higher profit margins on cars that you sell to people later in life (2), that are fancy (3), and that are expensive (4). And I don’t see any reason why these have to be big. You can imagine a world in which most cars are small-to-medium-sized, but they range from undistinguished ones like a low-end Honda Fit to expensive luxury cars with all the bells and whistles, like self-parking systems and haptic warnings when a car is in your blind spot, and with the latest fuel-efficiency technologies. In that world, manufacturers could rake in the profits on the high-end small-to-medium cars.

Anyway, is it really all about CAFE standards? Or is there another reason why big cars are inherently more profitable than small ones? I figure someone out there must know.

Thanks.

Update: There have been many helpful comments, so I’m not going to single any out. I would say there are two main explanations.

The first is that SUVs offer a better ratio of perceived value to production cost. That is, there’s an amount of stuff you need to build a functioning car; once you’ve done that, it doesn’t cost twice as much to make it twice as big, because you’re just adding raw materials. (I’m simplifying, obviously.) But people, being not that bright, think something is worth twice as much if it is twice as big. I still think competition should eliminate this larger profit margin, but see the second argument . . .

which is that SUVs and pickup trucks have been less exposed to foreign competition, so instead of having twelve or so viable competitors in the small-car segment, you mainly had three for SUVs.( Some commenters did not agree with this, pointing out that Toyota and Honda have been building pickup trucks for a long time.) With fewer suppliers, you can charge higher prices.

I should clarify that I don’t think there is anything wrong with the hypotheses I listed above; my point was that hypotheses 2-4 do not depend on SUVs/pickups being bigger, but on other characteristics of them. So there is no fundamental reason why, in the future, the profit margin on big things should be bigger than the profit margin on small things. Similarly, if the advantage is due to less foreign competition, then I think that would have gone away in any case, since just about everyone makes an SUV now (every major Japanese or Korean manufacturer, Volvo, Mercedes, BMW, VW, etc.) – though maybe not a pickup.

If the answer is the perceived value/production cost advantage, then that is arguably fundamental to big things as opposed to small things.

By James Kwak

98 responses to “Help: Why Are SUVs More Profitable?

  1. I think you missed the big one. SUV’s are not cars! Cars and trucks have vastly different regulations associated with them from different CAFE reguirements and other differing environmental regulations to different import/export restrictions.

    I would also hypothesize that its somewhat do to such large fixed costs and short term profit maximization. The big three have billions of fixed costs associated with plant and technology around big 6 and 8 cylander engines. Most changes have been slow and incremental keeping them locked into big engine and drive train designs. Along these same lines, cars are not commodities, the big three don’t compete well with foreign cars in these segments. They have to offer lower prices to sell their small cars – traditionally.

  2. D. Christopher Leonard

    large SUVs (not so-called ‘cross-overs built on a car platform) are built more or less like trucks have been built since their inception: a ladder frame with a chasis bolted onto it. typically unsophisticated suspension (solid rear axle, leaf springs in rear) hence very low development cost compared to an auto platform. lower manufacturing cost as it requires less retooling of assembly lines, and probably, lower assembly costs?

  3. A lot of it is down to the costs of production versus the cost of materials. While the material cost for a Yukon’s hood, for example, might be twice that of a Mini’s hood, the other costs (labor, tooling, etc) are only marginally higher, if that.

    In effect you have a ‘fixed cost’ of (say) $5,000 to build a car, no matter what size or style it is, before you’ve shaped a single panel. Spending an extra 20% to make it twice as big lets you charge 50% more, the difference being additional profit.

  4. Jim Wallace

    A related question would be way are trucks so expense relative to mini-vans, (or even hybrids).

    At Edmunds.com there are 71 trucks reviewed, 56 of them cost $25K or more, and 30 (54%) of them cost $35K or more.

    Edmunds lists 35 mini-vans with 26 costing more than $25K, but only 11 (42%) costing more than $35K.

    (Again, same site, there 36 hybrid models reviewed, 33 of them cost $25K or more, but only 17 (51%) cost more than $35K.)

    I might be wrong, but I would think that the technology and labor which is required to construct a mini-van or hybrid is significantly more than what’s required in building a truck.

  5. Could this be a legacy issue that no longer really applies? Up until recently, the imports didn’t build trucks and SUVs, as the segment was assumed to be small and the costs were high to develop a platform. The domestics had the segment to battle between themselves resulting in reduced competition and bigger profit margins. All of a sudden, everybody wanted a big SUV and the good times were here. Now the imports have had a chance develop new products to compete in this space, and I would expect profit margins to be compressed for all but the largest vehicles (full sized vans, suburbans).

    For example, Toyota making full sized trucks where that historically was not a space that they played.

  6. S. R. Barbour

    “Textbook micro tells you that price equals marginal cost, so the gross margin on every product is zero;”

    That textbook micro is not only wrong, but so absurdly wrong as to prove that everything it touches should be viewed with deep skepticism is easy to prove. ‘Bottled Water’. Somehow, I don’t think the marginal costs are anywhere near ‘$1′.

    SUV’s are/were more profitable for a simple reason. The Asian competitors spend/had spent more energy making small cars. Therefore, the construction of large cars and trucks is/was a way of ‘escaping’ the pressure from superior competitors. It is, in simple terms, a different ecological nitch.

    Wow, how easily evolutionary theory describes what economics cannot!

  7. I think it’s behavioral economics. When we stand in front of an SUV it fill more space. It’s bigger. It’s more powerful. Of course we are willing to pay more, ask fewer questions.

  8. The answer give above about the relationship between materials cost and labor costs is correct. Remember that the domestics are disadvantaged on labor costs, due to both the union contracts and their internal processes. Anything that changes he mix from labor to materials helps close that gap. Secondly, the American brands are meaningful. Until recently, you couln’t sell a Toyota full size truck because the buyer would get laughed off the construction site. Finally, there is the experience curve of producing them. I think these factors basically sum it up.

  9. Well, the following account of the story doesn’t make sense for when some large vehicles were exempt from fleet fuel-efficiency standards, but I think there’s something to it. Perhaps the explanation has to do with the CAFE standards having a similar market manipulation effect to the existence of a cartel or monopoly. The essence is power to cap production and enhance total profitability (think OPEC). The same situation exists in the luxury car market (and in most luxury markets, as I understand it, where limited availability is the point).

    The CAFE standards are said to both create an “artificial scarcity” in the number of large vehicles that can be produced (as a percentage of a market-dictated whole, I presume) and higher prices through the subsidization of the “artificial surplus” of more fuel-efficient models.

    Since less large vehicles are produced than would ordinarily be desired if the price were close to the marginal cost, the market will bid up the price, even in the presence of stiff competition, and thereby increase the producer surplus per vehicle.

    For the rest of the explanation, I think Paul is on the right track with regards to “fixed costs” per vehicles being the same for large and small vehicles, but profit margin being a percentage of the vehicle’s base price (which makes sense given the capital costs). If an auto dealer has to spend the same amount of time, real estate, and so forth selling a large expensive car as she does with a small cheaper car then the enhanced profitability of more expensive vehicles is a natural result. This would apply to luxury cars as well, and I believe that those vehicles produce more profit per vehicle than other brands.

  10. In my opinion many Americans see size, power, and toughness as desirable traits and thus are willing to spend extra to include those traits in their vehicle. Thus, for many folks in our culture, a large SUV serves as a status symbol and so consumers are willing to pay extra for it.

    In a sense, then, the answer to this question might be the very simplest answer of them all. Americans like big cars and they are willing to pay extra specifically for that.

    Combine this with reason #4 from above, that consumers of SUVs are less price sensitive. This follows naturally from the fact that consumers who aren’t considering fuel-efficiency in their vehicle are already demonstrating a lack of price sensitivity. If they are already willing to pay extra for fuel, it would follow that they are less price sensitive in other areas. In contrast, a buyer of a small fuel-efficient car is already demonstrating price sensitivity with respect to fuel costs so it would follow that they are likely to demonstrate price sensitivity elsewhere.

    Less price sensitivity combined with an actual desire to own a large and powerful car is what I think the reason is.

  11. Eli Rykoff

    A key factor is good ol’ protectionism. Due to a spat with German chicken farmers in the 60s, we imposed a 25% tariff on imported trucks — which is still in effect. See:

    http://www.nytimes.com/2008/09/12/opinion/12fri4.html

    No competition = higher margins.

    Only recently has the Japanese competition moved into the full-size pickup and SUV market in large numbers, by putting plants in the US. Of course, the timing couldn’t have been worse for Toyota…

  12. 1) SUV’s are more profitable because end-consumers want them and are willing to pay more for them
    2) Pricing power was also maintained by the relative lack of foreign competition (a gap that has been filled in the past 10 years or so) and historical import taxes on foreign imports (which i also think have faded away)
    3) SUV’s are based on ancient truck engine and chasis designs so there is an engineering and capital cost savings here; exterior refreshes are less frequent and more subtle also yielding significant savings
    4) low taxation on fuel in the US and lax US regulation on emmissions also acts as a subsidy to the consumer and incents buying bigger.
    5) Americans spend more time in their cars than anyone else and also happen to be big people, so the SUV has become an extension of the home.

  13. I think people see SUVs and trucks as having more economic value. I can transport more people, more stuff, or bigger stuff, the bigger my car is. It’s nice to know someone who has an SUV, so that person can drive on a group trip, or so you can borrow it when you need to move something. So people are willing to pay more for the added utility…as long as gas prices are low enough, that is.

    But I would guess that the cost of constructing an SUV is not much more than that of a small to midsize car. Maybe it takes a little more raw materials, but I can’t imagine it takes much more time or workers to build the SUV compared to the small car.

  14. winstongator

    The explorer was sold > 400k units in 1999. Toyota was making 4-runners then which were slightly smaller. Honda was selling the Izuzu Rodeo clone Passport. The market has always been big, as has the full-size truck. Hasn’t the F-150 been the highest selling vehicle for many years – http://en.wikipedia.org/wiki/List_of_bestselling_vehicle_nameplates

    I think it boils down to the price & fixed costs.

  15. winstongator

    If price=marginal cost no product would ever be profitable because you can’t have negative fixed costs.

  16. Lawrence Baxter

    Don’t SUVs also get a government subsidy in the form of specific tax breaks because they are taxed as trucks? So in effect we subsidize these vehicles as well?

  17. winstongator

    Aren’t light-trucks and cars in separate CAFE groups with different standards? Wasn’t that one of the reasons that the big 3 leaned towards SUV’s instead of bigger cars because they were dealt with differently than big cars?

  18. winstongator

    http://www.nhtsa.dot.gov/cars/rules/cafe/FuelEconUpdates/2003/index.htm

    For a long time, the car mpg target was 27.5, while the light-truck was 20.7.

  19. Luis Enrique

    Why aren’t you satisfied with 4. – the price elasticity of demand differs between large and small cars? Am I missing something, or doesn’t 4. have the potential to be explain things entirely, while being intuitively sensible.

  20. I think there’s alot to the cultural factor some of the commentors alluded to.

    While an automotive aesthete who has money to burn may prefer a small, elegant speedster, that’s not the type of person which America has been producing lately.

    Rather, the American system in recent decades has unfortunately (and disgustingly) vomited up a kind of moneyed yahoo, an aggressive lout who values size, ugliness, noise, wastefulness, gracelessness, clumsiness, environmental destructiveness, and aggression, for their own sakes.

    Studies have shown that SUV owners are more likely than the average to have aggressive, bigoted religious opinions, but less likely to regularly attend church. And they are more likely to have belligerent flag-waving jingoistic opinions, but less likely to have served in the military.

    It’s this kind of sociopathic lout, all-too-common in recent decades, who has been enamoured of SUVs.

  21. Really “textbook micro”? Where is this idealized marketplace?

    In almost every major area of modern life markets are oligopolies and competition is an illusion. If there ever was any real competitive pressure it vanished when anti-trust laws stopped being enforced.

    Just look at cell phones, cable TV, recorded music and movie producers, etc. I dare you to find a segment with more than a handful of companies of any consequence. Google has about 70%+ market share, Intel 80%+, Microsoft 90%.

    So firms engage in phony competition, creating meaningless product differentiation (have you looked at the variety of tooth paste on the shelf? Now look at how many actual firms are represented). With nothing left to compete over management goes through elaborate charades about gaining market share and makes a big fuss when they go from 18 to 19% or whatever. They have to create some metric to justify their high salaries, otherwise the supply chain management software could just run things.

    SUV’s are more profitable because they can charge more for them, and they can charge more because there is limited competition in this segment.

    What would it take for economics to give up its idealized models and start dealing with a world where classic markets don’t exist?

  22. As the absolute price of the vehicle increases, the relative price of the high margin extras (e.g., extended warranty, underbody coatings, luxury mats & trim, etc.) goes down. These high margin extras thus make up a smaller percentage of the total price for an SUV than for a small car and are more acceptable to the buyers. Add in extended financing (another high margin extra) and the incremental monthly cost to the buyer is very small but the marginal gain to the seller is very large. In other words, the higher the base price of the car (or almost any other capital asset or consumer durable) the easier it is to add relatively fixed price, relatively high margin accessories or services to the total without adversely affecting consumer decisionmaking.

  23. The fact the profit margin is higher on trucks does not mean that it is unnaturally large. More likely the profit on small US cars is small or negative for the reasons given in other comments. After all, the Detroit companies have not made much, if any, overall profit in recent years.

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  25. Another datapoint:

    Trucks, as in pickup trucks, have been and are cheap, if you buy a stripped down commercial model (vinyl floors & seats, just AC, etc). Around $14K or so.

    When you load them up, they get super expensive.

  26. I suspect that at least one factor could be brand loyalty, somewhat like an inter-generational form of your point #2. The textbook micro theory assumes perfect competition, which almost certainly doesn’t apply here. Some people, and even whole families, are strict “Ford People,” or “GM People,” and for a long time, SUVs were just more popular that small cars. That could have at least contributed to keeping P > MC.

  27. Lots of SUVs and trucks are written off by small business owners as business expenses, which you can’t do with a small car. So they can pay more for them and put more goodies on them.

  28. One reason that pickups are more profitable is that there is a large tariff on imported units. This is a reason why Toyota launched its pickup as a US product and was also one of the major hurdles in stalled US/Thai free trade agreement talks. Thailand is Asia’s largest producer and market for pickups and US auto unions feared Ford and GM could “offshore” to their existing pickup operations there. But in general Americans seem to place a much higher premium on quantity/size relative to quality than most other nations. Bigger is better. i.e. vehicles, food portions, houses, houses/mortgages, wealth disparity, banks, financial crises and of course breasts.

  29. There is a 25% import tariff on “motor vehicles for the transport of goods” that applies to light trucks and SUVs; imported cars are subject to only a 2.5% tariff. (Check the US Harmonized Tariff Schedule.) So the Big Three faced import competition on cars but not on SUVs (until recently when foreign manufacturers started building SUV plants in the US). Hence big profits for GM on SUVs.

  30. I think #1 explains it all.

    You can do more with a large car than a small car. If a person is going to spend $20K for a vehicle, why not spend $30K and get an SUV? With a small car you can transport yourself, a friend, and maybe 2 other people. But with a large car or an SUV, you can transport 4-6 people comfortably, throw furniture in the back, throw a bike or skiis in the back, be safer, drive through snow better, etc. Though it may be more difficult to park in the city, a bigger car lets you do more. It makes sense to buy a car that lets you do more.

    Assume this increases demand for larger cars, and that manufacturers can sell only a limited number of these cars because CAFE. Lower supply + higher demand = higher price and more profits when costs are fixed. Manufacturers will price small cars lower so they can sell more large cars.

  31. In the early 00′s it was the tax break reason. I bought my big, polluting, ego stroking SUV in 2004. Since it was over 8,000 lbs. curb weight I got to deduct the entire cost of purchase off my small business taxes – even though my company had no use for an SUV, I’m not in construction etc. This is why you see Hummer’s with “Sue’s Dance Studio” and “Green Pond Real Estate” written on the sides.

    Anyway, with a tax deduction meaning the US government was paying 30% of my purchase cost – adding the leather seats, better suspension package etc. didn’t seem like such a big deal. After all it wasn’t $2,000 in upgrades, it was only costing me $1,200 at the most – maybe less. Then of course I was able to finance it at 0% on top of that – and still deduct my mileage, excise taxes and repair costs going forward.

    If I could have gotten the same deal on a BMW sedan I probably would have bought one, and got all the upgrades on that. But the government (a “free market advocating government presumably) made me an offer I couldn’t refuse and pushed off the GM and Chrysler bankrupcies via a hidden, but actual subsidy, for another five years. But Obama is the Socialist.

  32. The world is a little strange when you step outside the textbook.

    Large SUVs and pickup trucks (in the good old days) came from three places — Ford, GM and Chrysler. Each (again, in the good old days) had capacity constraints which they were in no hurry to eliminate because they kept margins high. Early SUVs were fancy pickups made in pickup factories. Sort of icing on the truck-profit cake.

    Over time (the 15+ years since SUVs became mainstream) demand increased nicely and production capacity grew but not enough to hurt margins.

    Capacity was also constrained because it is not “easy” to convert a factory from producing small front wheel drive automobiles to large front engine all wheel drive SUVs — essentially trucks. Nor is it cheap.

    And finally, unless a manufacturer has an appropriate pickup/truck on which to base an SUV the cost of getting into the business is staggering for what is a relatively low volume but profitable product. Toyota was in early with the small pickup based Four Runner — a smallish and trucky but expensive model. Similarly Nissan with the Pathfinder.

    What happened when high gasoline prices tempered demand? The market clearing price went below cost and big SUVs became unprofitable.

  33. Mike Malecki

    I think the above comment pretty much sums it up, but I would add that foreign automakers had no incentive to lower the prices of SUVs when they entered the market, as U.S. consumers already were willing to pay more. I think this is an example of the saying that, “You’re only as smart as your stupidest competitor”; meaning, don’t start a price war if you don’t have to…

  34. I would go with this one.

  35. The protectionism, not the subsidies.

  36. I think that ODOGRAPH at 8:31 AM is heading in the right direction.
    We don’t necessarily buy products just because of lowest cost. As G. Clotaire Rapaille has demonstrated numerous times — “It’s all Reptilian.” That is, we decide many purchases based on responses by our primitive lizard brain — not based on rational thought. Malcolm Gladwell discussed this response for SUV’s in a Jan 12, 2004 New Yorker article. SUV’s give you an incredible feeling of safety and power — primarily because of the height, as well as the mass. The feeling of safety is just that — a feeling; but the safety statistics prove otherwise. It’s a great article.
    The bottom line is that most SUV buyers are seeing more than just a car — the reptilian brain is screaming safety/power — and are willing to pay a premium for the illusion of safety.

  37. Considering that the world’s largest manufacturer of SUV’s just declared bankruptcy, we may need to re-examine this assumption.

    I think it’s likely that the Big Three were historically better at building big cars, possibly because they operated in a market where oil was subsidized. And so they may have found SUV’s more profitable simply because they were not very good at building small cars.

    In other words, it’s not that SUV’s are more profitable and small cars less. For some automakers small cars were more profitable than big ones, and for others they were less.

    I think Honda would say that small cars are far more profitable.

  38. John Thacker

    because CAFE targets are scaled by vehicle footprint (length x width)

    The new targets are. The old ones weren’t. Of course, the new targets provide their own loopholes. For example, on the margin it may make more sense to bump up the size of a car’s footprint to reach an easier target rather than cut consumption. You also now still have the result of where larger cars have easier targets. Some people have large families or work or are tall and need large cars. But others don’t. So for the latter group, you get the odd situation where, e.g., a high performance Honda Civic Si doesn’t meet its new standards but gets better mileage anyway than the larger Accord V6, but the Accord V6 meets its standards. So some people will shift to larger cars because of the new standards.

    The old “light truck” loophole had its own reason for existing. Some people do need large vans and trucks for work, so you can’t just ban them. Lots of other people want them. We didn’t choose to have an intensive bureaucracy investigating if people “really needed them,” nor did we have a tax to separate want from need. (In most places in Europe, diesel for farm use is taxed less and dyed red, as they try to distinguish want from need.) So, loopholes.

    You can imagine a world in which most cars are small-to-medium-sized, but they range from undistinguished ones like a low-end Honda Fit to expensive luxury cars with all the bells and whistles, like self-parking systems and haptic warnings when a car is in your blind spot, and with the latest fuel-efficiency technologies. In that world, manufacturers could rake in the profits on the high-end small-to-medium cars.

    Yes, you can imagine such a world. But people don’t actually buy those cars enough, on the whole. For one thing, to imagine such a world you’d need to imagine a world where the great mass of the upper middle class and lower upper class don’t have kids. Or, alternatively, a world where gas taxes are enough higher to shift preferences.

    The claim that Europeans are so much less vulgar than Americans in cars ignores that the only real reason for different car choices is gas taxes. (Yes, street widths, etc. play a small role, but in the US street widths also come after cars. People desire the cars, then want the roads to fit.)

  39. “Textbook micro tells you that price equals marginal cost, so the gross margin on every product is zero … ”

    That is true at equilibrium. However the big money is made (and lost) during the transitions — while demand is growing (shrinking) faster than supply.

  40. John Thacker

    Considering that the world’s largest manufacturer of SUV’s just declared bankruptcy, we may need to re-examine this assumption.

    Why? They declared bankruptcy partly because Toyota (and Lexus) and Honda (and Acura) and Nissan/Infiniti and even BMW and Audi have been moving in on their previously unoccupied SUV segment, especially the luxury SUV segment.

    For all the companies, the profits per unit on large cars are larger. Honda and Toyota are efficient enough to make a profit on small cars, but make larger profits on larger cars. GM could only make a profit on large cars.

    I think Honda would say that small cars are far more profitable.

    Not really. Nor would Toyota. Both make more profit per unit on large cars.

  41. It’s the R&D costs. To make an appealing car that also meets CAFE standards costs a ton – for example, I believe Ford spent $7B in R&D on the Contour.

    SUVs have none of those costs as they are just traditional platforms with traditional materials.

  42. Malcolm Gladwell has an article that touches on the genesis of SUVs:

    http://www.gladwell.com/2004/2004_01_12_a_suv.html

    The opening paragraphs are the relevant ones:

    In the summer of 1996, the Ford Motor Company began building the Expedition, its new, full-sized S.U.V., at the Michigan Truck Plant, in the Detroit suburb of Wayne. The Expedition was essentially the F-150 pickup truck with an extra set of doors and two more rows of seats—and the fact that it was a truck was critical. Cars have to meet stringent fuel-efficiency regulations. Trucks don’t. The handling and suspension and braking of cars have to be built to the demanding standards of drivers and passengers. Trucks only have to handle like, well, trucks. Cars are built with what is called unit-body construction. To be light enough to meet fuel standards and safe enough to meet safety standards, they have expensive and elaborately engineered steel skeletons, with built-in crumple zones to absorb the impact of a crash. Making a truck is a lot more rudimentary. You build a rectangular steel frame. The engine gets bolted to the front. The seats get bolted to the middle. The body gets lowered over the top. The result is heavy and rigid and not particularly safe. But it’s an awfully inexpensive way to build an automobile. Ford had planned to sell the Expedition for thirty-six thousand dollars, and its best estimate was that it could build one for twenty-four thousand—which, in the automotive industry, is a terrifically high profit margin. Sales, the company predicted, weren’t going to be huge. After all, how many Americans could reasonably be expected to pay a twelve-thousand-dollar premium for what was essentially a dressed-up truck? But Ford executives decided that the Expedition would be a highly profitable niche product. They were half right. The “highly profitable” part turned out to be true. Yet, almost from the moment Ford’s big new S.U.V.s rolled off the assembly line in Wayne, there was nothing “niche” about the Expedition.

    Ford had intended to split the assembly line at the Michigan Truck Plant between the Expedition and the Ford F-150 pickup. But, when the first flood of orders started coming in for the Expedition, the factory was entirely given over to S.U.V.s. The orders kept mounting. Assembly-line workers were put on sixty- and seventy-hour weeks. Another night shift was added. The plant was now running twenty-four hours a day, six days a week. Ford executives decided to build a luxury version of the Expedition, the Lincoln Navigator. They bolted a new grille on the Expedition, changed a few body panels, added some sound insulation, took a deep breath, and charged forty-five thousand dollars—and soon Navigators were flying out the door nearly as fast as Expeditions. Before long, the Michigan Truck Plant was the most profitable of Ford’s fifty-three assembly plants. By the late nineteen-nineties, it had become the most profitable factory of any industry in the world. In 1998, the Michigan Truck Plant grossed eleven billion dollars, almost as much as McDonald’s made that year. Profits were $3. 7 billion. Some factory workers, with overtime, were making two hundred thousand dollars a year. The demand for Expeditions and Navigators was so insatiable that even when a blizzard hit the Detroit region in January of 1999—burying the city in snow, paralyzing the airport, and stranding hundreds of cars on the freeway—Ford officials got on their radios and commandeered parts bound for other factories so that the Michigan Truck Plant assembly line wouldn’t slow for a moment. The factory that had begun as just another assembly plant had become the company’s crown jewel.

  43. I think Gary is right. Rather than CAFE or manufacturing costs I think we should see this as similar to the question of why luxury goods have high margins. That’s what these SUVs are to 98% of buyers won’t don’t need any off-road capability.

    Luxury (especially mass luxury) plays on insecurities. So it is with SUVs in most cases.

    In other words, they bring more money because they are sold to idiots who can be convinced to pay more. Manufacturers know that and they all keep the prices high. No collusion necessary, they are just all looking at the same market research. But that’s my judgmental and hatchback-driving side speaking of course.

  44. Bernardo Morais

    The textbook is not wrong.
    Before making this type of judgments think once or twice, and then ask a friend whether you’re instincts are right.
    Even if the marginal cost is zero, there will be a point where the marginal benefit is zero. At that point the elasticity of demand is zero.

  45. Bernardo Morais

    My bad “elasticity of demand is one”

  46. The main two reasons have been mentioned.
    1) On larger cars they squeeze non-union part suppliers to reduce costs. But on smaller cars the UAW is a higher percentage of the final costs. Simply, fixed costs are relatively the same but the variable costs in the larger cars give room to adjust the cost of inputs.

    2) Tariff protection did help trucks and minivans for a period. But as far as I know every Toyota, Nissan, Honda, and Suzuki truck or minivan sold in this country is assembled in this country. This has been true for a few years. So even with tariff protection GM and Ford could not build a minivan to compete and the Chrysler minivan came in third. The protective tariff claims do not explain the complete story.

    3) Some is behavioral/demographic. Older Americans like bigger cars and they buy Detroit cars in greater numbers, Rural Americans tend to buy American more and they buy more trucks.

    4) Also I think the elasticity of smaller car buyers is greater, more responsive to small changes in price (and smaller Japanese cars are consistently perceived to be of higher quality). Domestic companies can not cut prices below the Japanese price (and turn a profit).

  47. BTW
    CAFE does explain much of the trouble. i.e left to their own inclinations, GM would have gotten out of the small car business or would have just ramped up production in China and imported more econo boxes.

    CAFE is 65% of the story. Detroit did not have the cost structure to compete in this end of the market. Excess capacity at GM made a merger with a Japanese (or Chinese/Korean) out of the question. Especially after new work rules that followed the last GM strike in Flint. That is 15% of the story. Overall cost structure is 18% of the story. Truck tariffs is 1%. And the Reagan import controls in the early 80′s is 1%

  48. Good info, with this comment and the next. I suppose I wasn’t really answering the question.

    In your opinion, would a floor on gas prices help or hurt US manufacturing long-term? Can we catch up?

  49. “Textbook micro tells you that price equals marginal cost, so the gross margin on every product is zero”.
    Price = MC only under perfect competition; the automotive industry is an oligopoly, where price does not equal marginal cost.

    “Profit margins should be higher in product segments with less competition”. Sounds to me like they are, or at least were. For the many reasons listed above, including relatively higher fixed/lower variable costs, favourable regulation, stronger protectionism, etc., there was less competition in trucks than in cars, hence the higher profits.

  50. FearItself

    I’m not an auto engineer or an economist, but I think it works (or worked) like this:

    Because they are governed by “light truck” regulations instead of “car” regulations, SUVs not only can get worse mileage, but they don’t have to meet the same crash-test standards. For those reasons (along with others mentioned by other commenters), a big SUV is cheaper to make than a car with the same horsepower and interior room (say, a big station wagon).

    Yes, all SUV manufacturers benefit from those rules, but SUVs don’t only compete with other SUVs; they also compete with cars of all sizes. When the consumer weighs factors of horsepower, size, and price (especially in a world where fuel is cheap and so mileage is relatively trivial), the SUV will seem like a better deal, even after the manufacturer has pocketed much of the difference in lower manufacturing costs as profit. That’s especially true because a large vehicle just gives its designers you more opportunity to add creature comforts like back-seat DVD players.

    At first this mattered only at largest end of the auto market; I think one might be able make the case that the Ford Explorer basically killed off the large station wagon. But then automakers started making more modestly-sized, cheaper SUVs (like the “Bronco II”) and finally “cross-overs” (like the Cadillac SRX) which were basically only “trucks” because the manufacturers said so, to capture the benefits of lower manufacturing costs at smaller-size and/or lower-price areas of the auto market.

    In a nutshell, it’s all because of the lower manufacturing costs associated with the different emissions and safety regulations governing “light trucks.”

  51. Brooks Gracie

    Bottled water costs $1 because of bottling and shipping costs. Coca Cola’s ingredients only cost marginally more than bottled water, and soda usually costs 50% more than water.

  52. Actually, textbook micro says that Price = marginal cost only when the market is perfectly competitive.

    When it’s not perfectly competitive, as in the auto industry, which is mostly an oligopoly, firms price to maximize profit, such that marginal revenue = marginal cost. Thus, price is going to be way above marginal cost. The marginal cost of creating a truck is relatively low, and thus, SUVs are quite profitable.

    That’s all there is to it.

  53. Technically, trucks are much simpler than cars. Independent rear suspensions cost more than live axles. Overhead cam multivalve engines are more expensive than pushrods. Packaging lots of stuff into smaller vehicles requires more engineering. Smaller engine compartments require better planning and design to enable maintenance and repair. Cars are just more sophisticated and require more engineering (at least compared to Suburbans).

  54. Subsidy through regulation.

  55. Brett Conley

    Having worked in Finance in manufacturing, transportation and wireless telecom, I can tell you the answer is always the same. The Pareto rule applies and somewhere between 20% and 35% of the customers provide 65% to 80% of the direct marginal profits. (Misallocation of fixed overhead often skews these profitability analyses.)

    High “desire” customers will pay the highest percentage of their income for a product. Low “desire” customers will pay the lowest percentage of their income for a product.

    So who buys smaller cars? Customers with lower desire and/or lower income. Because they are less willing and or less able to pay more, the margins are lower. There are undoubtedly a fair number of higher income/lower desire buyers who would be willing to pay more. But they don’t need to – because they are not the price setters

    Who buys bigger, expensive SUV’s – customers with higher desire and/or higher income. Both are willing to pay more for the car. And, as explained by Paul, the marginal cost to build a bigger or fancier product is not as much as people often assume.

    Once you understand product segments in terms of income and “desire” then you understand how and where everyone falls and how the product profitability plays out.

    Low desire customers will always pay relatively lower prices for a product and will never “move up.” High desire customers will move up as their income increases. Products get differentiated to capture more specific “desires” of customers. SUVs are a category aimed at a particular “high desire” segment. Pickup trucks also target a separate “high desire” segment. Sports cars capture another “high desire” segment – and are very profitable. It is just that the SUV appeals to the greatest number of “high desire” buyers.

  56. James Kwak

    Are you saying that they have lower costs per dollar of perceived value by the customer? Even so, why don’t the SUV manufacturers compete on price, then? Is the industry just in a state where everyone keeps prices high on SUVs but low on cars? That’s possible, but my impression is the industry is generally pretty price-competitive.

  57. SUVs have added utility as compared to small cars – simple as that.

  58. strike three

    This is true, but still, as owners, we need to limit the desire seekers from their own bad instincts, or price their product at its true econonic cost, — like cigarettes or liquor. Gas guzzlers destroy highway and local infrastructure, demolish lives and property in wrecks, consume too many scarce resources, pollute 10x the carbon footprint, besides just generally being rude obnoxious people and drivers in general. You’ve been to England, Scotland, Wales, I’ve never seen a oversized truck or honking SUX barreling woen their roads,…. never, they are in tiny Skoda’s and Coopers.

    To hell with the SUV and monster trucks … …. unless and until we make heroin and cocaine legal.

  59. Come on, seriously. People in England, Scotland, and Wales don’t drive small cars because they have better instincts than Americans, or are more environmentally conscious, or somehow have higher moral standards – they drive small cars simply because gas in the U.K. is very expensive.

  60. It doesn’t work like that. Marginal cost is the cost of making the next widget, not the marginal cost of all the ones made before. Once the plant is up and built, variable costs like labor and material become higher as the plant produces more. The average cost is reduced by economies of scale until, at a certain point, the increase in variable costs of producing one more outweigh the savings in average fixed costs.

    In other words, a plant stops making stuff when cost of the next widget becomes higher than the average total costs. Since perfect competition is assumed and firms earn zero profit, the price equals that average total costs and thus equals marginal cost.

  61. Why Brent Conley’s answer above is incomplete.

    Basic economics tells us that in a free competitive market competitors will enter or exit a market until the risk adjusted economic profit (not accounting profits) equals zero.

    If a firm has some ability to block entry, they may be able to earn economic profits for a period. But the higher the potential profits the harder people work around those barriers.

    In this case, in the long run, profits from small cars and SUV’s should be equal.

    If the industry has high fixed costs, the long run can be rather long. i.e. firms may continue to produce at a loss if the contribution margin is positive (they are recovering all of the variable costs and some of the fixed costs). That is why GM limped along for so long.

    But eventually firms that can not profitably build small cars exit the field. If other firms are making money building SUV’s you will see entry from competitors. The most productive firms in each sector will come to dominate that sector.

    In this case, Japanese firms overcame tariff barriers by building plants in America.

    In addition, the Asian builders clearly dominate in econo cars. GM could not compete in this sector. If GE executives had been running the company they would have told them if they cannot dominate a market exit the market. But GM had CAFE standards that they had to meet.

    If GM had exited that end of the market they would have had more resources to concentrate on markets they could dominate and been profitable.

  62. Given that SUVs and luxury sedans (lexus, etc) are both luxury item, this begs the question:
    Why are US companies able to provide luxury SUVs, but not luxury cars?

    I think the answer is that the engineering requirements of a SUV are less stringent than in a sedan. US automakers have had difficulty in making a finely engineered luxury sedan. A SUV – since it has an image like a truck – does not requie the same level of quiet, smooth ride, and engine performance. The SUV provides the one area where the less-skilled US automakers can make a luxury item.

  63. The pickup and SUV market have one thing in common: neither has any significant end market demand elsewhere in the world, so an entrant needs to be able to justify an entire line based on his US market penetration (as opposed to cars, where the difference between US-spec and European-spec is fairly minor). In most other respects the two products are different.

    The pickup market is highly profitable because it has very little competition. It is arguably the last slice of the auto market where brand really means something – an F-150 guy isn’t going to drive a Silverado. Toyota has poured money into trying to make this a four-player game, but even accepting Tundra as a participant in some markets, there just isn’t the same kind of market pressure. And yes, the pickup is the most archaic design in the fleet, so in the absence of price competition, the return on invested capital is extremely high.

    Note that the limited competition is exacerbated by the need to distribute the product between the coasts. Ever wonder why GM and Chrysler dealers who have high sales volumes but sit in suburban areas are getting closed while rural dealers are still in business? It is because they need a channel to sell trucks. The other companies have bypassed this channel because that’s not the way to make money selling passenger cars.

    SUVs are a trickier matter, and I would suggest that on the lower end (where they hit crossover and just plain boxy cars) it is not obvious they really are more profitable than cars. Not that this stops car companies from thinking they are more profitable; it’s not a business full of the inquisitive.

    What is true is that there was a period of time when the SUV was the only vehicle an American manufacturer could make and sell for north of $40,000. Expensive sedans were the province of Mercedes/BMW/Lexus/Audi, and the Detroit Three do not have the systems (management, design, or labor) to build similar products. So they hit on the SUV, which did not need any better fit/finish/performance than the core fleet but could sell for materially more money.

    This brought the windfall profits of the 1990s, and along the way the Detroit Three were able to build decent brands that isolated them somewhat from the (delayed) competitive responses of other manufacturers. Remember, there is virtually no SUV market outside the US and nothing except a pickup truck (again, US only) lends itself to the same chassis line, so marginal players (eg Nissan) are often hard-pressed to reach minimum efficient scale in the product.

    The luxury players came in above the Detroit Three price point, so they never competed directly with the core SUV business, and if anything helped justify competition based on “features” instead of raw price. That challenge, if it is to come, will come from Toyota/Honda. Toyota was planning on putting up the fight from its San Antonio plant, but their timing hasn’t been exceptional.

    To end a very long comment – there is nothing inherently more profitable about an SUV than a passenger car, but it has been a less competitive market due to its initial conditions and the greater barriers for the fast followers, who did not have brands or platforms fifteen years ago.

  64. 25% tariff on imported light trucks.

    Fewer competitors in the heavier end of the market.

    The domestics also have a comparative advantage. We’ve been working on V-8s, big automatic transmissions, and personal use trucks for a really long time and are pretty good at it. We’ve amortized a lot of the development costs already. Their Japanese competitors are still paying full freight for R&D costs.

    Brand Equity. The Big 3 still have positive brand equity in light trucks. So there are still plenty of buyers willing to pay more for a Chevy or a Ford or a Cummins.

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  66. Explaining why people think large cars are more useful doesn’t explain why they are more profitable…

    Having said that, the utility argument has a related
    mystery. I love small cars but utility is a high
    priority and so of course want to own hatchbacks.
    Miniscule downside, huge flexibily gain is how I see it. The rest of the world sees things my way, but the U.S. market uniquely loathes them. (Overgeneralization, but if you into it you’ll see that this is less so than it sounds; there really is some strong cultural, and nearly unique, US bias against hatchbackcs.) The “factual” arguments I’ve heard generally don’t pass the laugh test (favorite: “I need a trunk to lock stuff in”)

    I may have missed something (I’m sincerely curious
    to known what) but it sure looks to me like the
    “average” U.S. car buying public really isn’t
    strongly movivated by utility arguments.

  67. Automakers might be able to extract more marginal profit from selling SUVs, but when you view this phenomenon in an international context, you see that European auto dealers don’t seem to care as much about extracting the maximum profit from each sale as American dealers do.

    You have only to visit a city like Milan where 90% of the cars on the road are what Americans would call “subcompact”, and the SmartCar is overwhelmingly popular, to see that the obsession with SIZE is something of an American phenomenon.

  68. I wonder if it is really just supply and demand. When I was a teenager, the cheapest vehicles you could buy were pickup trucks, presumably because they were bought for use by farmers and in construction. They were simple workhorses. By the early 1970s pickups suddenly became popular, maybe as an expression of “down-to-earth”ness. You started to see them in the suburbs, often with a bale of hay in the back. The manufacturers found a new source of demand, with bigger pocketbooks. If they simply added carpeting, a radio, and AC, suddenly they could ask, and get, a lot more money. I think it likely that this early transition in the customer base for trucks is why trucks are now more profitable: because they are so popular!

  69. A bit late to the party, but here are my two cents:

    I believe that SUVs get pretty favorable tax considerations for small businesses and contractors.

    eg: http://www.taxationlawfirms.com/national-content.cfm/Article/40501/Business-Purchase-SUV-Tax-Credit.html

    Don’t take this the wrong way, but textbook models are *just* models. They don’t actually describe the real world. So an alternative explanation could be that the models taught in economic textbooks are wrong. Ha ha just kidding! The textbooks are always right! Just ask Paul Krugman.

    Finally, you write “Textbook micro tells you that price equals marginal cost, so the gross margin on every product is zero”. The gross margin is almost always higher than zero or else it would not be worthwhile to make the product. Just look at any balance sheet of any public company and you will see positive gross margins. I never took microeconomics but I can tell you with absolute certainty that pricing is never set exclusively based on marginal cost. For one, it can be very difficult to even know what the marginal cost is for a single manufactured item. I could go on with my anti-textbook diatribe but you get the idea…

  70. I think it’s “what the market will bear”. It’s not just trucks and SUV’s. Why would anyone pay upwards of $10,000 for a Lincoln MKX instead of a Ford Edge. A few extra touches, leather, a different grille, (Ford just has to get rid of the blue oval, it makes every car look like a Model T) But surely not one half again as much. a Towncar? $40,000? Why not a Grand Marquis for $20,000? Same with Cadillac, it’s just a Chevy with stainless steel exhaust. Same thing with trucks and SUV’s everybody wants them. Marketing. Buying an automobile is for most not a logical procedure. It’s cachet, it’s testosterone, it’s image, its color, its whim. How many people have you known, when they get into a financial situation, and then have a car repair bill, think that the solution is to buy a new car, and get rid of the repairs? Why do so many people get upside down? Why would anybody pay $2.50 for Fiji water , when they can buy Dasani for $1.00, and can drink tap water for free. It is not logical. But it is fact. People will pay more for these cars.

  71. How about, people buy a fixed number of vehicles, one per person, or occasionally two. All cars now last about the same length of time.

    So, if selling a declining number of cars into a skowly growing market, you maintain or increase revenue by selling increasingly at the high end.

    Let’s say you sell 10 cars at the start, 5 at $5K and 5 at $10K, for total revenue of $75K. Population increases but so does competition, so if the competition sells 3 cars at $5K (with more features making it effectively cheaper) into a market for 12, you want to sell 6 at $10K and 3 at $5K for total revenue of $75K, so your revenue is flat even as losing market share. Even better, you drive demand for the big cars, so you sell 7 at $10K and 2 at $5K showing revenue growth.

    If profit is 10% across the board, then profit increases $500 even while selling fewer cars into a growing market.

    Even better, drive up the price of the cars on the high end and focus all marketing on the high end.

    With inflation and other factors diverting attention, the steep decline in market share, unit volume, and real revenue and profits gets lost in the weeds of blaming the unions for the failure to put money into pension funds, failure to consolodate model lines and dealers so relative overhead increases which is blamed on labor costs (more overhead means more labor means more labor per car), what is noticed is the shift to nearly entirely big cars and no small cars.

    That ignores the general rule of three tiers: the lowest tier is very attractive on price, but lacks the most important feature, say the engine that gives it pep. The bigger engine can be added for a price and a special order, or for slightly more you get the big engine and a lot of other nice features, except, cup holders and A/C, but those are standard at the top tier which adds 30% to the base for an added 10% in cost.

  72. And why is gas in the UK “very expensive”, i.e. more correctly priced according to its real costs?

    Could that be because they have “higher moral standards”, e.g. in this case they believe consumers of gasoline should actually pay a price based on its real costs, while Americans characteristically try to get others to pay for their indulgences?

  73. I’m at a loss as to why the US has been infatuated by these rather large horrible vehicles for so long, particularly given the low milage they achieve per gallon.
    As soon a gas prices hit US$4 per gallon, habits changed.
    In most of Europe, US$4 per gallon would be considered a give away price.
    As such, most European vehicles, including vans and cars are both lighter, safer and more efficient than their US counterparts, much of this driven by European wide regulation and desire by Joe public to get as many miles out of a gallon as possible.
    I note that Europeans are as reliant on their vehicles as US peers, although they do seem to like style over brute force.
    Perhaps this is US exceptionalism at its worst – that the ‘big three’ failed to move with the times – particularly, when their European operations were manufacturing good vehicles – seems crass stupidity to me.
    As Henry ford once observed of the Model T, “you can have any colour you like, as long as its black.”Hence emphasising the ‘big three’ could have driven change, but failed to do so – maybe the consumer is not always right on this occasion, particularly when given all the wrong choices by the manufacturers.

  74. Just to add a few thoughts in addition to those from several other posters and the excellent Malcolm Gladwell excerpt, the answer to the question has a lot to due with consumer preference.

    SUV’s are, in a low cost of fuel environment, preferred to cars. The only reason people would rather buy a Civic than a truck/SUV is the low cost of a Civic. A minority would buy the Civic due to environmental reasons but most people won’t sacrifice comfort for the environment. SUV’s fit more people/stuff, make people feel powerful when they are able to look down on cars, and are safer (or at least perceived to be) in case of an accident. Car companies realize this so, since building cars has a high barrier to entry, the existing competitors compete on features rather than price for SUV’s and compete on price rather than features for small cars. This is one reason why Japanese automakers were late introducing multiple models of SUV’s. They had to understand the design aesthetic and features that Americans required for SUV’s and build the capabilities to meet the requirement whereas with a small car they could use their low cost advantage to profitably sell small cars and gain acceptance in the marketplace.

    With their low cost structures, why didn’t the Japanese manufacturers lower prices on SUV’s to further pressure domestic manufacturers? The Japanese manufacturers probably realized that the domestic manufacturers didn’t want to risk lowering prices on SUV’s and not seeing a subsequent uptick in sales because the domestics had to make up the money they were losing on the small cars required by the CAFÉ standards. Thus the number of competitors that could compete on price was essentially cut from 6 to 3. With rebates an accepted practice in the car industry, Honda, Toyota, and Nissan could just start offering rebates if there was any real pricing pressure. Combined with the fact that until the past year or so foreign manufacturers did not have excess SUV manufacturing capacity, there was no real incentive to cut prices. Brands such as Hyundai are starting to build quality cars and gain a good reputation so it will be interesting to see if the profit margins continue to stay high.

  75. An automotive aesthete in a small, elegant speedster sits where one’s head is roughly at the same level as those SUVs’ bumper.

    Also two seater with a significant partition between the driver and passenger for the gearstick/hand brake presents an almost impossible obstacle to certain amorous activities.

    That’s at least two channels through which natural selection can take place to produce an increased demand for SUVs.

  76. Nick Danger

    Marginal revenue = marginal cost implies that the MARGINAL gross profit equals zero — the gross margin on the LAST unit you make — not that the average gross margin on all the units you make. Should make everyone else wonder what else you don’t understand in your analysis, no . . . ?

  77. No textbook in economics claims that the gross margin is zero in the long run.

    Economic profits are zero in the long run. That means that the firm is earning an accounting profit, otherwise it would exit the industry.

    “The concept is that a firm only adds value for its shareholders if it makes a profit in excess of what could have been earned if its capital were invested elsewhere. The basic formula is

    economic profit = NOPAT – opportunity cost of capital [1]

    where NOPAT denotes net operating profit after taxes. A positive economic profit indicates that a firm has added value for shareholders. Implementations of this basic formula vary, both in how they define NOPAT and in how they define the opportunity cost of capital.”

    http://www.investopedia.com/terms/e/economicprofit.asp

    http://www.riskglossary.com/link/economic_profit.htm

    And Krugman is pushing a social agenda most of the time rather then an economic agenda. He is wrong more often then he is right.

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  80. Thom Nealssohn

    James…

    What is rarely discussed in this matter is the need for size to accomodate size. The US has a population that is physically larger (on average) coupled with the fact that the country is physically large. Trying to pack 3 kids and two weeks worth of clothing in a Honda Civic for a two week trip 1200 miles away is almost impossible.
    Consider the baggage limitation differences between the US and Europe in air travel. Americans are used to being able to carry more with them. We’ve been hearing for years about the obesity epidemic in the US.
    This all relates to why SUVs are more popular (aspirational) and seeing as the marginal difference in cost is lower than owning two vehicles (insurance, maintenance and upkeep, etc). Because there are no good solutions to procuring a larger means of transportation when it is necessary, the buyer buys the largest vehicle possible at the price point (one could argue this is true in real estate as well).
    The auto companies have discovered this and build in more margin because these vehicles are aspirational – loading them up with “neat” features sold at double the cost to enhance the margin. It has the effect of driving the perception that the value is enhanced, even though the utility is not greatly improved.
    Until there is recognition that the US geography and physical size change the requirements (at least in the heartland) you’ll never see widescale adoption of the inner-city smart cars in the US.

  81. James,

    I think the reason that the SUV’s are more profitable is simply because the companies can charge a premium for the vehicles.

    SUV’s were very well marketed as the epitome of the American dream. A house in the suburbs and an SUV.

  82. It is about practicality. Off late, the price difference between SUVs and small/medium sized cars is becoming lesser and lesser. A big car will always serve a lot of other purposes which small cars can’t. I am sure, a lot of buyers first try to get a SUV which fits in their budget. When that is not possible, they settle for smaller cars.

  83. steve schmandt

    I’m surprised nobody else so far has mentioned the marketing genius coupled with the aging boomer mentality. Many SUVs are 4-wheel drive, but most owners never even use the 4 wheel drive off-road capability of these machines. But almost all of the advertising shows SUVs in inaccessable natural places like mountain-tops. I believe a good part of the marketing success was due to selling to people who wished they were off-road adventuring campers! That image really helped sell imo, lots of SUV’s to boomers who wanted to believe they do serious adventure camping but only really drove in the city.
    Another selling point is the strong illusion of safety. In a larger pickup or SUV the driver is a) in a much heavier vehicle and b) sitting much higher than in a passenger car. This combination makes you feel much safer on the highway — you have better vision of the road, and in a serious crash it feels like a heavier vehicle will be much safer. I have no idea of the truth, i do imagine that all things being equal a heavier vehicle *might* be safer. I do know from personal experience of highway driving in a camry and a Tundra full sized pickup, the Tundra *feels* much safer.
    Note that these pickup/SUVs are also top heavy and tend to roll much more easily that a sedan so the actual accident and seriousness of injury stats may be contrary to the feeling that the Tundra is a lot safer. Again the buyer may be paying more for an illusion there too.

  84. steve schmandt

    Well put. Your reasons and i guess the tariffs mentioned also applied to the SUVs and together they explain why the US SUV segment was so free of competitive pressures to drive the prices down and cut into the very high profits from outfitting a truck as an SUV.

  85. steve schmandt

    Just out of curiosity what was your Krugman reference appro of? I see no reference to him anywhere in this article or these comments.

  86. I haven’t read all of these, but in skimming them I didn’t see anyone mention the height effect. People pay more for SUVs because the view is better making them feel a little less frustrated while trapped in traffic. Interesting how if one believed in vehicle-caused global warming, one could say that office heights caused the hubris that drove the banking meltdown in the same way that SUV heights are driving the climate meltdown.

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  88. It has to do with the price sensitivity of the consumer segment that purchases inexpensive vs. more expensive cars and the competition the product is exposed to.

    With regard to SUV’s vs. small cars, the price sensitivity of the small car consumer segment is much higher than for SUV’s. Since a price sensitive consumer will switch brand/product for a small difference in price, the price competition among small cars is much greater. Conversely, an SUV consumer is less price sensitive, meaning that a consumer will not switch brands/product due to only a small difference in price. In other words, inexpensive cars compete on price while expensive cars compete on features, performance, styling, etc.

    Trucks are in a world of their own, because until recently there was no serious competition from anyone but the big three. Truck consumers are also generally much more oriented toward buying domestic. These limited competition, meaning that as long as none of the big three started a price war, the big three could maintain high profit margins on trucks.

    So it really doesn’t have much to do with the size. You would have seen the same profitability in luxury cars that were not as big as SUV’s if the big three made any. Unfortunately, no one really views any domestic cars as “luxury”. Luxury cars are traditionally believed to be BMW, Mercedez, or Lexus, and they have similar profit margins on those due to the limited price sensitivity of that consumer segment.

  89. Nobody ever wants to ride in my Honda Civic del Sol. They find it too small, too low to the ground, too painful to get in and out of. So when there’s only two of us, we take the SUV anyway.

  90. Tippy Golden

    I am no expert, but this discussion feels a bit silly.

    0% financing for gas-guzzling SUVs resulted in securitized loans (aka toxic assets)that partly fueled the financial melt down.

    Where exactly is the profit here?

    Rather, it seems, the zero sum gain is billions of government debt to bailout GM and Chrysler, and to save jobs.

    Some land planners consider the American city an — historical aberation. — Cheap and plentiful gas, subsidized infrastructure, and vast tracks of car-dependent single-family housing.

    An economy based on oil, housing starts and car sales. But this formula isn’t working right now, and most likely, cannot last forever.

  91. Tippy Golden

    I might add here:

    Are we pining for a lost dystopia where anyone can take out a loan to buy an SUV and the life-style branding that comes with it?

    Are we suggesting that the American auto industry — under pressure to build smaller, more fuel-efficient cars — will be less profitable?

    I live in the city of Vancouver. It’s June and we have these beautiful, tree-lined streets. But the noise, and pollution, and congestion, drives me nuts. Streams of cars in downtown gridlock with one or two people inside.

    In my daydream I’d like to see more user-friendly public transit; and small, quiet, low-emission electric cars on our streets.

    Any hope the American auto industry will build such cars?

    A taxi driver told me not in our life time.

  92. “studies have shown…”

    pic? link?

  93. SUV’s are I disaster for the environment they should not be legal in this day and age. I agree with the poster above we need more mass transit.

    Search for tons of great documentary films.
    Educate yourself: http://geofftop.com/gt_graphic.php

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  95. I think this post hits the nail on the head. I think it comes down to fuel use and millage per gallon. Why would a car that burns so much be “more profitable” than and electric one in the long run?

  96. Bottled water costs 0.15 in bulk and $1.25 at retail.
    That is the profit for the retailer.