Is Small the Next Big Thing?

Ryann Dekat felt like a petite in a Big and Tall store. Shopping for a new car, she wanted something small, cheap and fuel efficient–the last thing most carmakers want to sell, since the big profits are in gas-guzzling SUVs and sedans with large engines. Test-driving drab cars like the Nissan Sentra left her underwhelmed. Then she spotted the Mazda3, a sporty four-cylinder hatchback launched in 2003. You might think of hatchbacks as wheezy econoboxes from the 1970s. But Dekat, 22, a loan processor from Dallas, liked the Mazda’s svelte style and pep; she pictured herself blasting U2 out the windows and impressing her friends. “I fell in love with it at first sight,” she says.

A small car selling on sex appeal? Call it the return of pipsqueak chic. Small cars were supposed to have been bullied off the road by now, and to some extent they have been, with sales falling over the past few years as Americans traded up to SUVs and roomier, performance-enhanced sedans and minivans. With gas prices up nearly 70% since 2002, however, and a crackdown on tailpipe emissions looming in California, automakers are preparing a blitz of downsized models, from hatchbacks to wagons and minivans; even a pint-size Jeep is in the works. “There’s a lot of activity in the segment,” says analyst Jeff Schuster of J.D. Power & Associates. He forecasts that small-vehicle sales, far from disappearing, will hold their own, rising from 13.7% of the market today to 15% by 2008.

When the Detroit auto show opens this week, horsepower gains will take center stage as usual, with a parade of bulked-up cars, crossovers and light trucks. But some of the most interesting vehicles on display will be small, even tiny. Audi will showcase a model called the A3, a 200-h.p. hatchback sold in Europe and coming to U.S. dealers in May. Mercedes will unveil its smallest import, a wagonlike “sport tourer” dubbed the Baby Benz, expected to start around $25,000. And get this: DaimlerChrysler will officially launch in the U.S. the Smart brand that has been such a hit on Europe’s narrow roads–showing off models like the Fortwo, a two-seat runt you could practically stuff into a Hummer. Mercedes-Benz, which has sold Smart cars for DaimlerChrysler in Canada since last fall, aims to have a model at U.S. dealerships by 2006, marketed to parking-challenged urban drivers.

All this signals a U-turn for a stalled and much maligned part of the auto business. Detroit has traditionally viewed small cars as money losers, the province of low-cost Japanese and Korean brands; retirees and budget shoppers are considered the core customers, not the most desirable clientele. Sure, you need an economy car for first-time buyers, and small cars offset the lousy mileage of SUVs and pickups, enabling automakers to meet federal regulations for corporate average fuel economy–which, thanks to industry lobbying, have barely budged in more than a decade. Given a choice, however, most Americans opt for luggage space, leg room, horsepower and the perceived safety of large vehicles–making small cars an inherently tough sell. “Americans have a hard time with small,” says Clotaire Rapaille, an automotive consultant who psychoanalyzes consumer behavior and theorizes that deep down what we all really want is to wrap ourselves in a Hummer (a brand also downsizing with a new model, the H3).

Yet the old thinking about small cars looks increasingly dated. A fashion-conscious generation of Americans is coming of driving age, and automakers that fail to entice them with fun, inexpensive cars risk losing brand loyalties and future sales of pricier vehicles. At the same time, manufacturers are leveraging more components and platforms across a global portfolio of nameplates, defraying development costs and making it cheaper to adapt cars from Europe and Asia to American tastes. At the Detroit show, Mazda will unveil a compact minivan based on a Mazda3 platform, which also underpins the Volvo S40 and the European Ford Focus (Ford owns Volvo and a controlling stake in Mazda). Indeed, the concept of the small car is shifting as automakers slap different body styles onto similar architectures, reconfigure the interior and then niche-market the result to demographics like urban singles and upscale retirees, aiming to profit from annual sales of as few as 30,000 units.

What’s in store? At the low-price end, Ford, Honda and Nissan are developing U.S. subcompacts with maximum roominess and funky exterior packaging–taking cues from Toyota’s successful, boxy Scion xB–at basement prices under $15,000. “There’s a growing opportunity down there,” says Jed Connelly, senior vice president of sales and marketing at Nissan North America. “Everyone paid attention to what Scion did.” With eye-catching body styles (geared to the MTV generation) and a broad custom-parts program for hot-rodders (who boost profit margins when they load up on options like body kits and turbochargers), Scion has carved out a compelling niche. Jim Press, executive vice president of Toyota Motor Sales, says Scion helped boost sales past 2 million units for the first time in 2004. Toyota’s rivals aren’t planning their own youth brands; they don’t have $22 billion in cash and marketable securities to play around with as the Japanese automaker does. But Scion’s success wasn’t lost on the world’s largest automaker. “Scion said you can do things differently, be more expressive, have more fun [with small cars],” says GM design executive Mike Simcoe.

Simcoe acknowledges that bold styling has hardly been a hallmark of GM’s U.S. small cars. Chevy left its flagship compact, the Cavalier, to languish for 15 years without major changes in design, and Saturn has been cranking out dull iron like the Ion, whose sales have sputtered since it was introduced in 2002. But Simcoe says there’s a “change of consciousness” about small cars at GM, and executives vow to retake share in the segment with models like the Cobalt, an all-new Chevy that replaces the Cavalier. Critics have given the Cobalt solid marks for improvements in build quality and cabin design, and Chevy is pitching it hard to the Pimp My Ride crowd as the Corvette’s little brother; a hot-rod edition is already out. GM aims to market four more models based on the same platform, starting with a retro-themed small wagon called the HHR due this summer. As for Saturn, GM is pumping an estimated $3 billion into overhauling the lineup, and executives say they have reacted quickly to slack demand for the Ion with an interior redesign. “Small cars are an integral part of our strategy,” says Lori Queen, an engineer in charge of GM’s compact fleet.

Chrysler Group CEO Dieter Zetsche promises that Dodge’s next small car, due next year, won’t be another frumpy hauler either. “The Neon is a nice vehicle,” he tells TIME, referring to the current model, “but it’s just another box.” DaimlerChrysler, Mitsubishi and Hyundai have co-developed a high-tech, more fuel efficient small engine to be built at a new plant in Michigan, and sharing costs should save Chrysler as much as $100 million annually, money that could go toward packing more premium content into compacts and in theory boost their appeal.

The other side of the small-car equation: automakers see a new opportunity in premium-price vehicles. Volkswagen has tried that for years in the U.S. with mixed results, and the concept would have got you laughed out of most planning meetings a few years ago; indeed, BMW tried it in the 1990s, marketing a four-cylinder hatchback in the U.S., which fizzled. But that was before the Mini attracted Porsche and Hummer owners alike with its outsize personality. Four years into its life cycle, the Mini is selling strongly despite a price tag nearing $30,000 for a loaded convertible. Eyeing that market, Pontiac and Saturn intend to move up with forthcoming roadsters based on rear-wheel-drive platforms; meanwhile Audi and Mercedes-Benz plan to head downmarket, importing luxury compacts this year, with Mini’s parent, BMW, to follow with a derivative of the compact 1-Series launched in Europe last year. “We need to maintain our appeal to young people,” says Tom Purves, CEO of BMW USA, explaining the idea behind the budget Beemer, scheduled to arrive in 2006.

Whether there’s profit in these products is a matter of debate. The industry is terrified that the SUV party is winding down, forcing carmakers to scavenge for sales in segments once considered a dead end. Large-SUV sales weakened last year, driven down by higher gas prices (or lofted by low interest rates and generous finance deals, depending on your take). Ford is killing its largest, thirstiest and priciest SUV, the Excursion. “Detroit’s biggest fear is that consumers don’t want big SUVs anymore,” says Stephen Girsky, a managing director at Morgan Stanley. “Dealers have a 109-day supply on their lots, and all of a sudden their bread-and-butter market may be going away.” Girsky compares the situation with that in 1980, when the industry had a glut of big V-8 vehicles just as energy prices spiked and interest rates started rising. No one is panicking, but the Big Three face mounting pressure to profit from small and mid-size vehicles–not least because of ongoing encroachment by import brands into the light-truck market.

The free-for-all is terrific for consumers, of course. Some 300 nameplates are vying for shoppers, and features like power windows and antilock brakes are becoming standard equipment in modest-price models. Virtually all the new vehicles are roomier and faster too, including the small ones. Today’s Corolla sports larger dimensions and more horsepower than a 1983 Camry; every Civic has outgrown its predecessor. Seating positions are getting higher too. After all, everyone wants to feel big and tall in their small car. –With reporting by Adam Pitluk/ Dallas and Joseph R. Szczesny/Detroit