Why small cars are actually selling now

August 4, 2011: 4:48 PM ET

American motorists have had a long-standing love affair with large, powerful vehicles. Until now.

By Doron Levin

Ford Fiesta small carFORTUNE -- Engineers have long known that designing smaller, lighter vehicles is an ideal way to meet tighter fuel-economy standards. Less bulk, higher MPG. Problem is, American motorists have a long-standing love affair with large, powerful vehicles.

Automakers are finally breaking their dependence on heavier models and managing to create comfortable, luxurious small cars consumers actually find appealing. As new models roll out -– especially from Ford (F), General Motors (GM) and Hyundai -- the category is gaining in popularity and competitiveness. That trend is likely to continue as regulations grow tighter.

Through July, the small-car segment rose to 17.4 percent of all car sales, accounting for nearly 1.4 million cars built in the U.S. Midsize, large and luxury cars gained as well, though less so proportionately. In other words, small cars, accounting for a third of all car sales, were the only category to gain share.

Last week, President Obama announced Corporate Average Fuel Efficiency (CAFE) standards of 54.5 miles per gallon by 2025, with special exemptions for pickup trucks and incentives to encourage advanced technology like electric vehicles. Currently fleets must average about 27 miles per gallon and are required to improve to 34 miles per gallon by 2016.

Toyota's (TM) Corolla leads the segment, trailed not far behind by the Chevrolet Cruze from GM, Honda Civic, Hyundai Elantra, and Ford's new Focus. All of these vehicles offer advanced entertainment systems, comfortable seating, premium-feeling interior fabrics and materials. Advanced engines and transmissions provide decent power as well as fuel efficiency.

The Cruze, Focus and Elantra represent the most remarkable break with history. Chevy's Cruze replaces the Cobalt and its predecessor, the Cavalier, whose mediocrity earned GM a well-deserved reputation for indifference in the small car segment. Ford's new Focus is a vast improvement over the previous model by the same name, and an earlier unlamented Ford Escort.

"The new models from GM, Ford and Hyundai have been accompanied by a big marketing campaigns, which no doubt has sparked interest," says Jessica Caldwell, an analyst for Edmunds.com, an automotive website. "And while the incentives aren't as big as they once were, you can find them in the form of low-interest rates or attractive leases."

A number of new subcompacts known as microcars overseas is also adding to the small-car category and drawing shoppers from larger vehicles. Notable for their popularity are Nissan's new Versa, which sold about 51,000 units in the U.S. through July, and Ford's Fiesta at about 48,000 during the same period.

GM's Chevrolet Aveo, built in South Korea, has been a laggard with sales of about 25,000 in the first seven months of 2011. But that could change soon as that dull utilitarian machine is replaced by the new Sonic, which is starting in production in suburban Detroit. Not surprisingly, the new Sonic offers many of the design and comfort features that the Aveo lacked.

Consumers will buy what they wish, but to comply with federal standards the automakers must create incentives so they can sell enough small models to keep the fuel economy average high. Large cars, which hurt the average, could become more pricey as automakers try to limit demand and prod buyers toward smaller models.

Small cars in most cases come powered with four-cylinder engines that are tuned for fuel efficiency. The recent run-up in the average price of gasoline, which passed the $3 a gallon mark the week of New Year and peaked at $3.90 in May, no doubt is motivating some motorists to downsize.

The price of gasoline remains a wild card for the future of small cars. Conventional wisdom says gas will only grow more expensive. Should the opposite happen, consumers may once again seek big and powerful transportation, leaving automakers with lots of little flivvers on hand.

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