Friday, July 30, 2010

Eco-nomics: Supply and Demand and the GM Volt

A Portland-based car writer, Edward Niedermeyer, has an Op-Ed in The New York Times today criticizing GM and the US government for what he sees as filings of the Volt:

...G.M.’s vision turned into a car that costs $41,000 before relevant tax breaks ... but after billions of dollars of government loans and grants for the Volt’s development and production. And instead of the sleek coupe of 2007, it looks suspiciously similar to a Toyota Prius. It also requires premium gasoline, seats only four people (the battery runs down the center of the car, preventing a rear bench) and has less head and leg room than the $17,000 Chevrolet Cruze, which is more or less the non-electric version of the Volt.

In short, the Volt appears to be exactly the kind of green-at-all-costs car that some opponents of the bailout feared the government might order G.M. to build. Unfortunately for this theory, G.M. was already committed to the Volt when it entered bankruptcy. And though President Obama’s task force reported in 2009 that the Volt “will likely be too expensive to be commercially successful in the short term,” it didn’t cancel the project.

Nor did the government or G.M. decide to sell the Volt at a loss, which, paradoxically, might have been the best hope for making it profitable. Consider the Prius. Back in 1997, Toyota began selling the high-tech, first-of-its-kind car in Japan for about $17,000, even though each model cost $32,000 to build.

By taking a loss on the first several years of Prius production, Toyota was able to hold its price steady, and then sell the gas-sippers in huge numbers when oil prices soared. Today a Prius costs roughly the same in inflation-adjusted dollars as those 1997 models did, and it has become the best-selling Toyota in the United States after the evergreen Camry and Corolla.

I think Neidermeyer makes some pretty fundamental logical errors. To start with, given production limitations, GM should set a price that does not leave too much excess demand, the rationale at this point for selling the Volt at below cost is only if supply far outstrips demand and they expect reasonable economies of scale.

Comparing it to the roll-out of the Prius is nonsense. Give that the Prius was really the first of its kind, Toyota was trying to build a market to get precisely these economies of scale. But fortunately for GM, Toyota has done all the heavy lifting. Hybrid electric cars are now an established part of the market. I can't see any reason to think that GM should sell the Volt at a big loss. I think GM has the luxury of selling it at the high price initially and lowering it to grow the market as costs come down.

The fact that the government has a substantial incentive program in place is a separate matter, surely GM can figure this in as it figures out the initial price and if demand is high enough, the subsidy will end up being almost entirely for GM, not for consumers.

Neidermeyer has a number of other complaints about the car itself: not big enough, not distinctive enough, etc. But this is for the market to decide, not a single car writer.  Over the next number of years we will see how the market feels about GM electric ventures and how well GM can parlay its initial investment in R&D into newer and better vehicles and technologies.  This will be the real test of GM and whether it has a future.

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