Hybrid Autos: Will the Big Three Catch up with Toyota and Honda?Published: September 10, 2003 in Knowledge@Wharton
The news that Toyota outsold Chrysler in August to take the No.3 position in U.S. car sales for the first time is the latest reminder of the vulnerability of Ford, General Motors and Chrysler to foreign competition. In addition, it focuses attention on a growth area where all three U.S. manufacturers are lagging several years behind – the market for gasoline/electric hybrid vehicles.
Although hybrids currently represent a tiny fraction of the market, they are being developed by both Japanese and U.S. manufacturers who are seeking to replicate the performance characteristics of conventional vehicles while producing sharply higher fuel economy and lower emissions.
The crucial difference between the Japanese and the Big Three is that Toyota and Honda have been selling the vehicles in the U.S. since 1999 while the first model from a U.S. manufacturer – the Ford Escape compact sport utility – isn’t expected until the third quarter of 2004.
All manufacturers recognize that high-volume hybrid sales will depend on their ability to make hybrids that look, feel and perform just like regular gasoline-powered cars. Relying on sales to drivers who make their purchasing decisions on the basis of emissions, fuel economy or energy security is never going to create a mass market, analysts say.
The three models on the market now – two from Honda and one from Toyota – are in the compact category whose sales aren’t likely to demonstrate public demand because they are too far out of the mainstream.
50 Miles Per Gallon
“So much hinges on power and performance,” said Wharton management professor John Paul MacDuffie, co-director of the Reginald H. Jones Center for Management Policy, Strategy and Organization. “The real test is going to be whether people buy bigger cars with hybrid engines.”
As a result, the 2004 version of Toyota’s hybrid Prius model is bigger and more powerful than its compact-sized predecessor yet is more fuel efficient, offering a combined 50 miles per gallon and producing fewer emissions. It is being sold for a base price of $19,995, the same as the first version which was launched in the U.S. in 2000. The 2004 hybrid version of the Honda Civic, priced at $19,650, officially consumes a gallon of gasoline every 51 miles overall. Those figures compare with 29 and 38 miles per gallon, respectively, for the Toyota Corolla and 30/38 m.p.g. for the conventional Honda Civic.
The superior fuel economy is achieved by the use of an electric motor that drives the car at low speeds or when idling. The gasoline engine automatically kicks in when higher speed or sharper acceleration is needed. Energy generated during braking is captured and stored in the battery.
U.S. manufacturers’ planned hybrids cater to the same public demand for bigger, more powerful cars. The first General Motors hybrids in the showrooms, for example, will be the Chevrolet Silverado and GMC Sierra, both full-size pickups expected in late fall next year.
But Detroit has little immediate incentive to play catch-up with the Japanese for several reasons. First, the market is small – an anticipated 50,000 U.S. sales this year in a total market of about 16 million. Second, tax incentives fail to offset purchase prices of $3,000-$4,000 more than equivalent conventional models, and third, consumer choice is very limited.
The Big Three, whose share of the U.S. market fell to a 22-year low of 57.9% in August, are also loath to spend scarce funds on a commercially unproven technology at a time of financial hardship. Both Ford and GM second-quarter profits were lower than a year earlier while Chrysler posted a loss for the period. “They are preoccupied with their own survival,” said MacDuffie.
There’s little expectation of regulatory pressure for cleaner, more economical vehicles from the pro-business Bush administration which has signaled its skepticism about global warming by pulling out of the Kyoto Treaty and has endorsed hydrogen fuel cells – a distant prospect – rather than hybrid technology as the key to future green transport.
And that’s fine with the U.S. automakers who are not anxious to invest in new technology for which there is no proven mass demand. “They have managed to put the environmental issue on the back burner,” said MacDuffie. “Ford was the one that announced a goal of more green technology but they have backed away from that.”
The Big Three are also constrained by their dependence on economies of scale, a factor that is less important to the Japanese. “Japanese producers have managed to minimize economies of scale,” said MacDuffie. “It’s more feasible for them to do low volume.”
High Cost of Hybrids
The Japanese lead in the hybrid race is also explained by their apparent willingness to subsidize each car that comes off the production line. “The costs of developing hybrids are extremely high,” said Rex Parker, vice president of Autopacific, an industry consultant based in Los Angeles and Detroit. “It’s entirely possible that the first few units cost half a million dollars each. A lot of this is being done as an investment in future technologies.”
The high cost of hybrid development may be the reason behind Toyota’s decision to offer just 36,000 of the new model Prius, a number that’s unlikely to meet demand, said Parker. “They have achieved their political statement and their technology statement; to go beyond those costs becomes uneconomic.”
Toyota will produce more of the new Prius if demand warrants, said Dave Hermance, executive engineer for environmental engineering at the company’s technical center. All high-volume Toyota models are likely to have hybrid options within the next 10 years, Hermance noted. He declined to say how much the company has invested in hybrid development overall.
For their part, the Big Three are planning to launch 10 hybrid models in the next five years, and claim there is increasing interest from potential buyers. Angela Coletti, a spokeswoman for Ford, said the company had received some 15,000 requests for information about the hybrid Escape SUV within a week of inviting requests on its website. “We definitely think the market demand is growing,” said Coletti, who added that Ford has plans for further hybrid models after the Escape and the mid-size sedan Futura (expected in 2005). She declined to say how much money Ford has invested in hybrid development so far.
But with Detroit’s first hybrid still a year away, the Big Three may yet get cold feet about the whole project, said MacDuffie. “If they are way behind in being able to have prototypes that work, they may be ready to write it off.”
U.S. automakers will also be keeping an eye on Europe, where sharply higher fuel prices and tougher clean-air rules suggest there’s scope for hybrids to take off. But they will have to overcome competition there from the widely used diesel engine that gets better mileage than the gasoline version.
Estimates of the market’s potential depend partly on being able to dislodge public misconceptions that owning a hybrid doesn’t mean “having to plug it in every night.” It will also be influenced by how many states follow the California’s lead in enacting clean-air regulations that have the potential to boost demand for hybrid and other low-emissions vehicles. So far, four other states have adopted similar measures.
David Friedman, research director of the Clean Vehicle Program at the Union of Concerned Scientists (UCS) in Washington D.C., estimates hybrid sales could reach 1-2 million a year, or up to 40 times their current rate, in the next 10 years. That rate will partly depend on whether Congress passes measures currently under debate to provide tax incentives that would cut up to $3,000 off the price of a hybrid, bringing those vehicles into line with their conventional counterparts.
Missing a Market Opportunity
Under a scenario advocated but not expected by the UCS, the United States could stop the growth in oil consumption at 2010 levels if hybrid sales rose to between 4-5 million a year. But Friedman concedes the market doesn’t yet have that potential. “The drivers are not there yet for rapid growth.”
Even without the most optimistic projections, there’s a danger that U.S. manufacturers are getting left behind in the hybrid competition, Friedman said. General Motors, for example, is preparing to offer some “half-hearted” models that use conventional technology to achieve fuel savings. “GM is already hedging its bets on hybrids.”
It may regret doing so if hybrid technology fulfills its potential to offer better performance than conventional gasoline engines, suggested James Winebrake, chairman of the Public Policy Institute at the Rochester Institute of Technology in Rochester, N.Y. “Hybrids are going to have an incredibly big impact. Some will be able to outperform conventional vehicles while being efficient and clean. By dragging their feet, I fear that the U.S. companies are missing a huge market opportunity.”
Winebrake declined to forecast the size of the market, but predicted hybrids will become very attractive to consumers when they combine economy and efficiency with performance that is actually better than that of conventional gasoline vehicles.
The dual nature of the hybrid engine allows greater scope for technological advances than the conventional version because engineers have the flexibility to develop both the gasoline and electric components of it, he argued. “This is the beginning of the technological curve; in a few years’ time, hybrids’ performance will be better than regular cars,” he predicted. He dismissed as “extremely low” an estimate by the U.S. Department of Energy that hybrids will comprise only 4% of the market by 2025.
But some evidence indicates that automakers will have to work hard to create significant demand for hybrids. A 2002 survey by auto industry consultant J.D. Power and Associates found only 37% of respondents said fuel efficiency influenced their vehicle choice, the eighth-most important factor. The most important factors were drive, handling and performance, cited by 69%.
Consumers’ top concerns about hybrids are that they have insufficient power and performance, cited by 34%, that they will cost too much to own and maintain, and that they won’t be reliable, the survey found.
Respondents were also more inclined to buy diesel-powered vehicles – provided they include clean-burning technology – in the search for fuel economy, the survey found. Demand for clean-diesel vehicles exceeds that for hybrids as fuel prices rise.
But at times of heightened concern about energy security, more people seem willing to at least think about buying a hybrid car. In late September 2001, shortly after the 9-11 attacks, almost two-thirds of consumers said they were likely to consider buying one of the vehicles.
J.D. Power has recently reduced its forecast for hybrid sales to 531,000 or about 3% of the market, by 2013 compared with a previous estimate that the half-million mark would be reached in 2008. The reduction is because of the settlement of a case in which General Motors and Daimler Chrysler sued the California Air Resources Board over its zero-emissions rule. The settlement effectively reduced the fuel economy requirements of the law and so is expected to result in decreased demand for hybrids and other low-emissions vehicles, said J.D. Power auto analyst Walter McManus.
For now, attention is focused on the new Toyota Prius, to be launched Oct. 17, for any signs of a new level of demand for hybrid vehicles. “The new Prius would appear to be a substitute for the Corolla,” MacDuffie said. “Larger hybrids will be the key to this market.”