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SUVs help automakers cross rough financial terrain

Consumers are swapping sedans for the rugged styling and cabin space of the SUV in unprecedented numbers, a shift that is helping boost automakers' profits but also risks putting them in the crosshairs of regulators clamping down on exhaust emissions.

The SUV in its multitude of present-day forms now outsells the low-slung sedan in key markets as the boxy body style proliferates across segments from compact to premium, figures from researcher Kelley Blue Book and data provider IHS Markit show.

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Automakers have no plans to stop at this milestone in the process of "SUV-ization," as automotive analysts have dubbed it. Volkswagen AG intends to increase the SUV component in its range to 40% by the end of 2020 from about 35% now, while recent announcements from Ford Motor Co. suggest it will soon build little else.

Hyundai Motor Co. says a more SUV-rich product mix will become the cornerstone of its push for a larger presence in the U.S., where the mass-market SUV was born. General Motors Co. and others say the SUV's greater profitability has been a balance sheet buffer amid a global slump in auto sales.

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The case for focusing more on SUVs is appealing from an operational standpoint as costs are limited by the ability to perch a larger body shell atop a platform often shared with a sedan. The end product, with its extra space, imposing styling and high driving position, justifies a higher price tag for many consumers, which is crucial at a time when overall vehicle sales volumes are stagnating. For example, the Ford Escape SUV commands about $6,000 more than the Ford Focus sedan, despite being built on the same underpinnings. Meanwhile, lower interest rates and budget-stretching leasing packages are helping consumers move into a pricier segment.

"[SUVs] are good for margins when you are facing massive headwinds from the technological transition. It's a very handy way to counter those headwinds," said one U.K.-based automotive analyst in an interview, referring to swelling costs related to the development of electric vehicles and self-driving cars.

"You don't want to leave that money on the table and while there is demand they should grab that share of the profit pie," the analyst said.

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But while consumer tastes are dragging the market in the direction of bulkier, more fuel-intensive cars, the urgency to act on climate change and air pollution means regulators are pulling it in quite another. The European Union for one has demanded that automakers slash the carbon footprint of their products with a 95 grams of CO2 per kilometer 2021 target so stringent that many look set to miss it and pay millions of euros in fines.

That has put automakers at the center of a tug-of-war between consumer and regulator. Electrified powertrains offer a way out but raise hurdles of their own, a higher price and anxiety about vehicle range chief among them.

"When you look at the plans of OEMs, everyone will be offering EV solutions around SUVs," said Salvatore Campolo, Ford's Europe consumer marketing manager for SUVs.

"SUVs are becoming the first [target] for hybrid solutions because of CO2. Most of them are now coming into the market as plug-in hybrid electric vehicles," Campolo said.

U.S. government data says the Mitsubishi Outlander plug-in hybrid, or PHEV, can achieve the equivalent of 74 U.S. miles per gallon equivalent, or MPGe, using its 28-mile electric-only range. This compares with an average 25 MPG delivered by the 2.0 liter gasoline-only version of the same car. Toyota Motor Corp. recently ran out of batteries for the hybrid version of its RAV4, with nine in 10 buyers in Western Europe opting for it over the conventional gasoline power plant, the region's sales and marketing chief told Automotive News.

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If the SUV offers a lot in the consumer's eye, the novel appeal it once possessed has evaporated as this market segment grows more crowded.

"[A]nytime you have strong margins, strong revenues, competition is going to be fierce, more and more entries are going to come in. And the risk is the segment is going to get commoditized," said Kumar Galhotra, president of Ford North America, at the J.P. Morgan Auto Conference in New York on Aug. 13. "So we're being really thoughtful on how to play in these segments."

Ford's strategy is to make urban-oriented vehicles in an SUV-style and some true off-roaders, Galhotra said. Halfway-house products offering a bit of both were the models most vulnerable to commodification, he added.

That peril has not deterred the auto sector's most haloed automakers such as Ferrari NV, Lamborghini, Maserati, Bentley and Porsche from exposing their elite brands to the SUV frenzy. Their low-volume SUVs bear little resemblance to the sleek coupes and limousines on which they have forged their image but offer the space that SUVs have now led buyers to expect.

Take Rolls-Royce, a by-word for automotive refinement and elegance. It has perched its "Spirit of Ecstasy" mascot that adorns its coveted sedans onto its new 6.7 liter-engined, $300,000 Cullinan SUV, fittingly named to evoke the attributes of the world's largest known rough diamond.

"We believe that with the Cullinan we will conquer new customers and we will continue to conquer new customers who were driving different products before. And it shows that there is a demand for those types of cars in the world, not high volume but profitable, I can say clearly profitable, and also very good for the brand," Harald Krüger, then-CEO of Bayerische Motoren Werke AG, parent company of Rolls-Royce, said in a quarterly earnings presentation Aug. 1.

While some have suggested the headlong rush means the market is headed for "peak SUV," the automotive industry's multiyear planning cycles often run beyond five years, meaning the SUV looks set to remain on a summit that now looks off-limits to the sedan.

"I think we are getting close to peak SUV in the U.S. but may have a little way still to go," said Charlie Chesbrough, senior economist at U.S.-based consultancy Cox Automotive. Cox predicts the sedan's market share in the U.S. will slide to 25% in two to three years versus 50% five to six years ago. Chesbrough expects the SUV's market share to simply flatline rather than fall in a post-peak scenario.

"I don't think this is a cyclical trend — the car's share is not coming back," he said.