Small Cars, A Big Question

Jerry Flint, 06.05.07, 6:00 AM ET

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Long-term, it seems certain that more of us will be driving small cars. The big question is whether manufacturers will build any of these vehicles in this country or whether plants in Korea, China, Eastern Europe and elsewhere will grab most of the business.

The domestic manufacturers are already sourcing a large number of passenger cars from outside the U.S. Ford Motor (nyse: F - news - people ) builds its Ford Fusion, Mercury Milan and Lincoln MKZ in a Mexican factory. Half of Ford's Focus output also comes from Mexico, while its Ford Crown Victoria and Mercury Grand Marquis come from a Canadian plant that also builds the Lincoln Town Car.

Chrysler builds its PT Cruiser in Mexico and its Chrysler 300, Dodge Magnum and Dodge Charger in Canada. General Motors (nyse: GM - news - people ) also builds some passenger cars in Canada--including its best seller, the Chevy Impala--and will soon import the Saturn Astra from Europe and the Pontiac G8 from Australia.

Most of these models are large cars. Right now, ''Detroit's'' only tiny passenger car, the GM Chevy Aveo, which sells at a 60,000-per-year rate, comes from Korea.

Some critics say it is not possible to build small cars in the U.S., with its high wages, benefits and taxes and heavy regulations. Personally, I think it is still possible to build them here, or at least in North America.

The key is volume. To build small cars and make money, the trick is to build lots of them, and variations of the same platform. This has been a problem in the U.S. because the market for such vehicles was limited.

It could make sense for Ford, for example, to build a plant's worth of small cars, meaning 200,000 to 300,000 per year, in Mexico. Ford could ship some to the U.S., sell some locally and export the rest to Central America and the Caribbean, a small-car market now dominated by the Japanese and Koreans.

I believe the scheme I just outlined for Ford is viable, because that is precisely what Nissan (nasdaq: NSANY - news - people ) is already doing. It builds the Nissan Versa in a factory in Mexico and exports the car to the U.S. and other markets. The Versa is a bit longer (169 inches) than the Honda Fit (157 inches), but it's part of that small-car group. In the first four months of this year, Nissan sold 21,000 Versas in the U.S., which puts it on pace to sell 60,000 in a year. Add in local sales in Mexico and exports to other countries, and Nissan has the kind of volume it needs for a successful small car.

Suzuki (other-otc: SZKMF - news - people ) built the Suzuki Swift and the Geo Metro in Canada a few years ago. General Motors sold the latter in Chevy dealerships. Those vehicles never caught on and never attained critical volume. I suspect that Suzuki lost money on the venture.

What went wrong? Gasoline was cheaper than it is now, and the cars were not that good. That is a key point: Buyers of small cars want the same thing as buyers of big cars--quality, style, performance and handling.

A good example is the Mini, which BMW builds in the U.K., a high-wage country with a strong currency. Yet BMW is building this car at a 200,000-per-year pace. The difference is, the Mini is not cheap. In the U.S., it typically costs $26,000. At that price, it seems plausible that a manufacturer could build a little car in this country and make a profit on it.

The trick is to have a small vehicle so appealing that Americans would pay a high price for a little car. With gasoline now north of $3 per gallon, the idea that a Detroit company could sell a factory's worth of such a car--say, 200,000 units a year--is not so far-fetched.

One reason why small cars have failed here in the past is that U.S. car buyers have equated ''small'' with ''inexpensive.'' American manufacturers made too many design and engineering compromises to keep their vehicles affordable, but that strategy has not worked. It would also be a good idea for the U.S. government to force other producing nations, like Japan, China and South Korea, to strengthen their currency. Doing so would help prevent manufacturers in those countries from using a weak currency to dump their small cars in our market.

The U.S. market for premium small cars may be limited, but the idea of producing a low-cost car in a high labor cost country is not necessarily doomed to failure. Toyota (nyse: TM - news - people ) builds its small, low-priced Yaris in France, another high-wage country. Except for the health care, the labor costs are probably like ours, maybe higher. If Toyota can build such a car in France, then a manufacturer could do something similar in this country.

Ford Motor is thinking about designing and building a new generation of small cars in North America, but General Motors seems to have settled on Korea as a small-car source, at least for now.

Chrysler has talked about building a smaller low-cost car, but in China and with a partner, Chery. Of course, Chery has a reputation of borrowing without asking, so working with it might have some penalties, like giving technology to a future competitor.

It is possible the Detroit automakers could reach some special agreement with the auto workers' union--lower wage and benefit rates in plants so that smaller, low-priced cars can be built in the U.S. Such concessions and some great automotive designs might prevent the type of offshore production similar to what Chrysler has talked about with China.