The End of Luxury Margins

...luxury at low cost is a potential disaster for the industry...

Diana Kurylko at Automotive News has a front-page story in the January 21st issue [online here arguing that "$30,000 is the new luxury-car hot spot". The evolution of CAD systems (linked now to engineering databases) and the revolution in materials science means that it is feasible to provide the NVH (noise vibration handling) of a luxury vehicle at little or no incremental development cost and a modest manufacturing cost. Leather remains necessary – a $1,000 cost premium for two front buckets and a rear seat?) – and additional speakers and other spiffs add cost. But safety mandates mean that stability control, keyless entry and so on are either present or can be added at low cost as the underlying IT backbone is in every vehicle.

While a boon for consumers, luxury at low cost is a potential disaster for OEMs as it will undermine their ability to earn fat margins on their upper-end vehicles. Yes, there are consumers for whom a car is used to enhance their social status, and so expensive cars won't go away. Ditto those auto enthusiasts who want unnecessarily large engines or other add-ons (and have the wherewithal to buy them). But my sense is that at present many consumers buy higher-end vehicles because of their NVH attributes. They don't mind the status symbol aspect, but what they really hanker for is simple ... or not so simply ... luxury.

Now having test-driven a wide array of vehicles the past few months, my own personal observation is that a few really stood out for a combination of comfort, quiet and superior drive. And I didn't drive any luxury cars. So maybe those are yet nicer; I suspect not. I've also been in anechoic chambers a couple times in my rule as a judge for the Automotive News PACE supplier competition, evaluating the (lack of!) contribution of one or another component to vehicle noise. I've seen presentations on recycled materials that turn out to be both inexpensive and really good at insulating drivers from noise. I've been in the Chrysler wind tunnel. Creating a quiet car does entail cost, but it's now at a point that can be fit into the cost target of a $30,000 vehicle, both in terms of purchase price and weight (because adding lots of rubber goop adds lots of weight and attendant indirect costs.)

The old saw that small cars mean small profits continues to hold; absent the ability to differentiate (here I think of the Mini) you get the old progression of larger size and larger price, without of course a commensurate increase in costs. The luxury end accounts for a disproportionate share of industry profits.

That may change -- not that the higher end won't generate higher profits, just that it will generate a lot less profits. Can the BMW's of the world maintain their relative position? Perhaps. But it may be harder and harder for Lexus, Cadillac and Lincoln to provide potential purchasers with a good value proposition when a Ford offers comparable luxury.

...mike smitka...