Luxury automakers haven't found a way to build profitable small cars yet, but they will continue to try.
Prestige brands have several incentives to enter small-car segments currently dominated by mass-market brands. Small cars add volume and capture young buyers likely to buy more cars of the same brand over their lifetime. Beyond market forces, luxury brands need small cars to help them meet impending European Union rules for lower fleet-average carbon-dioxide emissions.
Analysts are skeptical that luxury brands can break into smaller-car segments profitably. They warn that small cars may significantly reduce overall margins for luxury brands.
So far, the results are mixed.
* Sales of the Smart urban car built by DaimlerChrysler's Micro Compact car unit have picked up after a relaunch in 2000, but the division is not expected to become profitable until after a new generation of Smarts go on sale later in the decade.
* Audi's aluminum-body A2 is well below sales targets.
* Mercedes-Benz executives acknowledged last year that they don't expect the A class to earn a net profit over its first six-year product cycle.
* BMW's Mini launch has thrived so far as buyers opt for high-specification models. But analysts remain doubtful about plans to launch a BMW 1 series in 2004.
John Lawson, auto analyst with investment bankers Schroder Salomon Smith Barney, believes the second-generation Mercedes-Benz A class may be more profitable than the first. He said the current A class in mid-cycle is starting to earn a thin profit.
The A class was financially crippled from the start when it failed the so-called Elk test in Sweden, said Deutsche Bank analyst Christian Breitsprecher. When the A class couldn't handle the sudden swerve needed to avoid the huge animal, Mercedes-Benz had to add costly electronic devices to solve the problem.
'But it is close to breakeven now,' Breitsprecher said. 'In the second and third generation, it will have a similar experience as the 190 and C class Mercedes.'
But Audi missed its target market with the A2, Lawson said.
'The customer was not ready to pay the price needed to meet the variable costs, which were quite high,' Lawson said.
Lawson and Breitsprecher say Audi may not stick with aluminum-body construction for the next A2.
'The A2 has this costly aluminum technology and only limited component sharing with other [Volkswagen group] products,' Breitsprecher said. 'There's no chance of being profitable.'
Lawson doesn't expect the BMW 1 series to be profitable despite using many 3-series components.
'It doesn't look to be a very appealing economic prospect to us, but it fills an important position in their lineup,' he said.
Deutsche Bank projects that the Mini and 1 series will reduce BMW's pre-tax margin to 7 per cent from 8 per cent by 2005.
That is despite a strong Mini launch. Since its debut last year, BMW has raised the Mini's production target to 120,000 units a year from 100,000.
'BMW was able to create a premium sector in the small-car segment. People are just crazy for it. They load up with extras and pay a lot of money,' Breitsprecher said. 'But BMW-like margins? Not at the moment.'