Small Is Big in Luxury Cars

The Wall Street Journal

Luxury auto makers have typically offered vehicles in three sizes: medium, large and extra-large. Beginning this fall, they're adding a new one -- small.

Environmental concerns and high fuel costs have given diminutive, efficient vehicles a boost in the size-obsessed U.S. marketplace as consumers begin to swap their large, thirsty vehicles for alternatives such as the Mini Cooper. In the past year or two, Toyota Motor Corp., Nissan Motor Co. and Honda Motor Co. have all introduced new, low-cost subcompacts to satisfy the perceived demand.

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Now AG's Audi, BMW AG and Ford Motor Co.'s Volvo are getting into the act. Those high-cachet brands are lining up products that will test American tastes for small vehicles with outsize performance, posh amenities and premium price tags.

Other manufacturers, like GM's Saab unit and DaimlerChrysler AG's Mercedes-Benz, have similar models in development that could make the leap to North America.

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The first of the new crop to hit U.S. shores was Audi's luxurious but small A3 hatchback, which has been sold in the U.S. since 2005. Volvo is set to launch an all-new, two-door C30 hatchback in the coming weeks that gently echoes the company's sleeker 1960s models.

BMW, which built its reputation on smaller, efficient, fun-to-drive vehicles, is bringing its small premium 1 Series to the U.S. next spring, having sold it in Europe since 2004.

Prices for the smaller luxury models range widely, anywhere from two to four times as high as those for the newest batch of economy-oriented, similarly sized hatchbacks and small sedans made by mass-market brands such as Toyota and GM's Chevrolet unit, whose Aveo, at $10,560, is one of the cheapest cars on the market.

By contrast, Volvo's entry-level C30 model starts at $22,700; a slightly sportier model will cost $25,700. Though the company has yet to finalize pricing, BMW says the 1 Series should cost about $30,000. Audi's smallest vehicle, meanwhile, ranges in price from $25,340 to well over $40,000 for a well-optioned model with all-wheel drive.

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David Gasser, 55, a retired banker in Big Sky, Mont., has already placed his order for the most powerful 135i version of the 1 Series. "I actually desire the smallness of the 1 because it'll be more sporty, have more pickup and be more fun to drive around curves." he says.

Yet the broader market for more-expensive small cars is still untested, and sales of currently available models have stayed relatively low, says Erich Merkle, an analyst and director of forecasting at IRN Inc. Audi sold just 8,040 A3 models in 2006, according to J.D. Power & Associates. By comparison, the company sold nearly 50,000 of its next-smallest vehicle, the A4 sedan. Overall, the market share for all compact premium cars has grown to 4.24% in 2006 from 3.35% in 2000.

It isn't the first time luxury manufacturers have tried to lift sales by providing less expensive models. BMW produced a 3 Series Compact hatchback in 1995, which, while popular in Europe, didn't sell as well as expected in North America.

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In 2001, Mercedes tried to broaden its popular C-Class line by introducing the Sportcoupe, a small, three-door version. Like its main competitor, the BMW Compact, it failed to connect with the younger buyers it was aimed at, partly because of high prices. Mercedes stopped selling the model in the U.S. in 2005.

But since then, according to product planners, the Mini Cooper -- which is made by BMW and was launched in the U.S. in 2002 -- has proved consumers will buy well-designed premium small cars. In 2006, the company sold 39,171 of its Mini Cooper models, currently the smallest car on the U.S. market.

Its competitors hope that their small luxury vehicles will help draw in younger customers. "People still say we're boxy and boring," says Art Battaglia, Volvo's C30 product manager. "What C30 is supposed to do is help change the perception of what the Volvo is. We can be fun."

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Volvo says the small, peppy package could help its image. Its line of high-performance "R" cars has gone little-noticed in the marketplace. It hopes the C30, both versions of which will come with a five-cylinder turbo-charged 227 horsepower engine, will have a bigger impact. Taking its cue from the Mini Cooper, Volvo is playing up how easy it is to customize the model when ordering, which it thinks will particularly appeal to younger buyers. Early marketing materials feature twentysomethings toting snowboards and yoga mats.

BMW, for its part, says the 1 Series is partly an attempt to recapture some of the low-pretense, high-performance mystique its original models had. The model will be marketed as a high-performance car, not an economy vehicle like the company's previous small efforts. The most-powerful version will rocket from zero to 62 miles per hour in 5.3 seconds, with a top speed of 155 miles per hour.

In contrast, Audi says its A3 is aimed at the company's traditional customers, who may want a smaller package for its efficiency and practicality. According to Carter Balkcom, the A3 product manager, the average buyer is 40 years old and earns $93,000 annually. The average customer of the larger A4 sedan, by comparison, is only slightly different, at 42 years old with an annual income of $105,000.

Some industry observers warn that these cars might be perceived as downmarket and ultimately hurt the companies' image. "Offering less-expensive models opens you up to an entirely new customer base, but it might also weaken the brand," says Chris Li, a research specialist for marketing and product strategy with Power Information Network, a division of J.D. Power.

Still, the segment is only likely to get more crowded. Other manufacturers are studying the space, with some going so far as to design future models.

Saab recently discontinued its small-car offering, the 9-2X, a modified Subaru WRX that it had sold through an agreement with Fuji Heavy Industries. It drew a rabid if small following that nicknamed the model the "Saabaru." But Saab sold only about 10,000 models in North America.

Now, the company is actively looking at developing a new vehicle smaller than its 9-3 sedan model, says Jan-Willem Vester, a Saab spokesman. The model could arrive by 2011. While the company is remaining tight-lipped, GM has confirmed that it has the capacity in its Swedish factory to produce the vehicle.

So far, Mercedes-Benz hasn't yet jumped on the bandwagon. In Europe, it sells a B-Class, which could compete with the new U.S. small-luxury offerings, as well as an even smaller compact, the A-Class. A Mercedes spokesman says the company is looking at the market but has yet to make any decisions.

Still, if small premium cars catch on with American consumers, it could set off a wave of new imports from Europe.

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