Savage competition is driving the profitability out of building and selling passenger vehicles.
Manufacturers struggling for volume in a fragmented marketplace are offering too many choices with too few common components to profit from their core business.
'The car business has a flawed financial structure,' said Graeme Maxton, economist at automotive analyst firm Autopolis. '[Automakers] are making money from parts and financing and not from the cars themselves.'
Automakers must cut back on the bewildering amount of choice available to consumers - and raise prices, he said. New banks, stronger leasing companies and changing European distribution rules are threatening automakers' finance and parts revenue streams. So car manufacturers 'have to do something about carmaking to make it profitable,' Maxton said.
The return on sales generated by building vehicles is minuscule for most mass-market automakers. The industry's hefty capital investment levels and sensitivity to sales volume create profit volatility. Automotive stocks tend to be valued lower based on revenue than in other industries.
Few automakers besides Porsche and BMW post consistently high per-unit net profits.
Automaking is an industry out of equilibrium, said Garel Rhys, professor of motor industry economics at the Cardiff Business School in Wales.
'There are too many manufacturers making too many cars chasing too few customers,' he said. '[Transaction] prices are simply not high enough for all the industry to make a profit at the same time.'
Among the hundreds of vehicle nameplates on sale in western Europe alone, there are enormous variations in profitability.
Some mass car manufacturers produce best-selling products such as the Volkswagen Polo and Peugeot 206 and make big profits from them, said Arnaud Jeudy, European car analyst at Enskilda Securities, Paris.
Others may launch a new concept that opens up a new segment. Jeudy reckons the Renault Scenic, as the first compact minivan, could command margins of 7 percent to 8 per cent when it was first introduced.
The booming sport-utility segment is currently the most profitable in Europe, said Howard Wheeldon, an analyst with Prudential Bache. He considers the Toyota RAV4, Land Rover Freelander and Mercedes M class as leaders, but he doubts high margins will last much longer as new entrants flood the segment.
Wheeldon believes the upper-luxury segment, with the Mercedes S class, BMW 7 series and Audi A8, is nearly as profitable and has greater potential for growth. He sees coupes, roadsters and other specialty vehicles such as BMW's Mini, the Mercedes CLK and VW Beetle as the No. 3 segment for profits.
At the other end of the spectrum, he said heavy discounting in the USA makes all sizes of minivans the 'least profitable' segment there.
'In Europe, the [least profitable] would have to be lower-medium cars - the VW Golf, Ford Focus and Renault Megane,' Wheeldon said.
Maxton calls the supermini segment the most competitive, with the lowest overall profits.
Automakers generally have two paths to profitability, said professor Karel Williams of Manchester University in England.
Too many products
Either they can sell in a segment limited to two or three competitors, much like luxury rivals BMW, Mercedes and Audi. In more crowded segments, they need to produce runaway successes such as the VW Golf or Renault Scenic to profit, he said.
Williams cited as US-market successes the 1990s sport-utility segment or high-volume sedans such as the Toyota Camry.
Competing against too many products kills profits, he said.
'If there are two or three dominant products, the manufacturers can hope to make a lot of money out of every model,' Williams said. Beyond five or six, 'they compete each other's profit away.'
He said the classic example is Europe's upper-medium segment, which has half the volume of superminis or lower-medium cars but has the Ford Mondeo, Opel/Vauxhall Vectra, Peugeot 406, Citroen C5, Renault Laguna, VW Passat, Toyota Avensis and several others.
'Most of these entrants will not make money,' Williams said.
German luxury brands have had less competition and higher profits, but that may change.
'If companies have a big success with a product, everyone piles in,' Williams said. 'It is happening with sport-utilities in the USA and it will happen to BMW, Audi and Mercedes-Benz when Alfa Romeo, Saab, Volvo, Jaguar and Lancia finally get their acts together. They all have the ability to spoil the market.'
In the mass market, profitable big sellers may not need have the highest quality, said Enskilda's Jeudy.
'The Peugeot 206 is not top of the class in terms of quality,' he said. 'But it is the top-selling vehicle in western Europe.'
Profitable automakers must weigh vehicle costs against customer perception of value.
'It's always a balance between cost of total quality and what's required by the market,' Jeudy said.
Powerful brand image
For big family cars and luxury vehicles, assembly standards and material quality must be higher. In less demanding sectors, buyers may be attracted by design, roomy accommodation or fuel-efficient engines. Quality might not be crucial, he said.
'The new VW Polo and the current 206 I assume make money on a per-unit basis, but when you look at their position in quality surveys they are not top of the range,' Jeudy said.
If buyers perceive a car has weak resale value, they will either not buy or insist on a big price discount.
'That is the big issue with Fiat - its pricing power is so weak,' said Virginie Casin, analyst with Standard and Poors. 'Buyers know that they lose money when they sell back. With a Golf it is understood that you can sell back at a premium because of the accepted quality.'
Brand image exerts a powerful influence on margins, and thus profitability, said Williams.
'The Fiat Stilo seems to be a pretty comprehensive failure,' he said. 'The Golf is an example of a car with what I call a franchise on the sector.
There are lots of other excellent cars such as the Ford Focus and Opel/Vauxhall Astra, but the Golf sells early in the cycle, late in the cycle.
The Golf is the answer of how to make money out of cars.'
But automakers must do more than find one good car, said Maxton.
'Their return on sales is tiny and they typically only make money on vehicles selling more than 400,000 units,' Maxton said. 'Almost anything Ford or GM produces these days, they are not selling enough to cover the cost of development.'
Price competition has gone too far, he said.
'Manufacturers will ultimately have to offer less choice and higher prices,' Maxton said. 'The industry has got to overhaul the primary business of making cars by reducing choice and raising prices.'
Automakers must get back to basics, Rhys said.
'The industry has beguiled itself by looking at other income streams,' he said. 'That has taken away the edge in making sure that the product itself is profitable.'