The Trouble with Hybrids

Consumers' passion for hybrid-engine cars may be tested as a wave of more attractively priced diesel-powered models hits showrooms

It has been a trying week for those who think hybrid-engine cars are destined to be a mass-market phenomenon. First, on June 5, Honda (HMC) confirmed that the next generation of its Accord sedan won't feature a hybrid option. The current Accord hybrid, which went on sale in 2004, has sold only 25,000 units and just 6,100 last year. "Americans didn't accept the Accord hybrid," a spokesman for Honda told reporters.

Hybrid market leader Toyota (TM) continues to dominate the field and recently announced that it has sold more than 1 million gas-electric cars since first introducing the Prius in Japan in 1997. However, Toyota earlier this year had to start offering sales incentives on the Prius for the first time ever, to boost sales of the second-generation model (see, 3/19/07, "Why Hybrids Are Such A Hard Sell").

On top of that, Britain's advertising watchdog earlier this month ordered to Toyota to pull ads for its hybrids for the second time in two weeks, ruling that some of its environmental claims were misleading. Nissan faces no such problems, but that's because it only recently launched its first hybrid car, a version of the Altima sedan that uses Toyota technology, and is now trying to catch up with its Japanese rivals.

The Diesel Specter

Of course, the setbacks don't suggest it's the end of the road for hybrids—it certainly isn't for hybrid pioneers like Toyota and Honda. But it's clear that the difficulties that automakers face in marketing their hybrid engines are still vast, despite the growing awareness of environmental issues.

What's more, with the specter of "clean" diesels looming on the horizon, hybrids may be an even harder sell in future. "Diesel's cost burden is lower than that of hybrids with similar fuel economy—even with the 'clean' technologies needed to meet tough U.S. emissions regulations," UBS (UBS) noted in a May 24 report.

That's one reason Honda is tweaking its strategy and dropping the Accord. It now plans to focus on hybrids for smaller models, and diesels for larger models, including the next-gen Accords, CR-V crossover sport-utility vehicles, and Odyssey minivans, where the cost benefit is most marked. Honda will keep the hybrid Civic and introduce an even smaller subcompact hybrid in 2009.

Americans Are Watching Fuel Economy

Still, it's clear Honda chose the wrong strategy with the Accord hybrid. The automaker gambled that U.S. consumers would prefer more power and a little more efficiency than go flat out for higher fuel economy. That meant the Accord hybrid had good performance, producing more horsepower and torque than the V6 Accord, but in miles-per-gallon terms it wasn't a match for other hybrids.

The Accord hybrid delivered just 27 miles per gallon, compared with 42 for the smaller Civic hybrid and 46 for Toyota's Prius. "Honda thought Americans weren't willing to sacrifice performance for economy, but the reality is Toyota found a niche that will," says Kurt Sanger, an analyst at Macquarie Securities in Tokyo.

Sales of the Accord may also have suffered because it's not a well-known "green brand" like the Prius. While it's clear everyone driving a Prius has impeccable environmental credentials, the Accord hybrid looks much like other Accords but costs $3,600 extra.

Honda must now hope it can do a better job of marketing its diesels. "Even if Honda may be right technologically, it may not be right commercially," says Yasuhiro Matsumoto, an analyst at Shinsei Securities in Tokyo. "It will take a while for consumers to realize the performance of new diesel engines."

Battery Headaches on the Horizon

Toyota's challenge is slightly different. While Honda has given up the game on larger hybrids, Toyota continues to plow ahead, aiming to introduce new hybrids irrespective of size and cost. In May, Toyota launched the Lexus LS 600h and LS 600HL, which at $126,000 is the most expensive car ever made in Japan and will debut in the U.S. in the summer.

Persuading the buying public that hybrids are a mainstream option continues to be a challenge even for Toyota. By 2010, Toyota aims to sell 1 million hybrids per year, but that will still only be about 10% of its total sales. What's more, while Toyota says its hybrids are profitable, they're not nearly as profitable as cars powered by standard gasoline engines.

One reason is the cost of the hybrid systems for larger vehicles. UBS estimates that a hybrid equivalent to a conventional 4.0 liter, gasoline V8 costs about $7,000 to $8,000 extra to produce, compared with a premium of $3,000 to $4,000 for a clean diesel capable of meeting strict U.S. standards.

Nevertheless, Toyota expects the premium to fall. Last month, Masatami Takimoto, an executive vice-president at Toyota, said that by 2010 margins will be at the same level as conventional gasoline cars.

Another headache could be rumored delays in the introduction of lithium-ion batteries. In February, Toyota CEO Katsuaki Watanabe told BusinessWeek that Toyota's next-generation Prius, due late 2008 or early 2009, would include the cells, which are lighter and more powerful than the current nickel metal hydride batteries (see, 3/19/07, "Toyota's Bid for a Better Battery").

Tight-Lipped on Plans

However, last month a report in Japan's Nikkan Kogyo newspaper, said that Toyota may delay the models' introduction to guarantee safety. Delays in introducing more efficient hybrids could hand rivals with different green techs a marketing edge.

There's also the question of how Toyota handles demand for clean diesels. While Honda is committed to unveiling a clean diesel for the U.S. by 2009 and Nissan (NSANY) by 2010, Toyota has so far been tight-lipped on its plans, despite selling diesels successfully in Europe, where about 40% of new cars sold use the fuel.

Analysts say one reason may be that it's difficult for Toyota to promote green diesels and hybrids at the same time. "I think they have the technology, but they're struggling how to communicate it. How can Toyota all of sudden say diesel is promising?" says Tatsuo Yoshida, an analyst at UBS in Tokyo of UBS.

Then there's Nissan, the other member of Japan's Big Three. Until recently, Nissan CEO Carlos Ghosn had been agnostic at best on hybrids, regularly arguing that the technology isn't yet mainstream. But while Ghosn was right in many respects, his stance was interpreted as being anti-hybrid and handed rivals a headstart in the increasingly import environmental image stakes.

Pinning Hopes on Lithium-Ion

Notably, in recent months, Nissan has been taking steps to improve its environmental standing. The new Altima has a hybrid option, albeit using technology borrowed from Toyota, but Nissan is also developing its only hybrid system for the next generation. Also, on Apr. 13, Nissan and electronics maker NEC (NIPNF) revealed that they had signed an agreement to establish a joint-venture company called Automotive Energy Supply, which will focus on the development and marketing of advanced lithium-ion batteries.

That's timely given that li-ions are expected to be vital for the success of next-generation hybrid systems and electric vehicles.

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