Why Does It Cost So Much For Automakers To Develop New Models?

The late former Illinois Senator Everett Dirksen, when discussing federal spending, once said, "A billion here, a billion there, and pretty soon you're talking real money." I don't know about you, but it only takes a couple of zeroes to the left of the decimal to start being real money to me. But it's not just governments throwing around all of those zeroes. Car companies, too, spend enormous amounts developing new models. The price tag to develop a new vehicle starts around $1 billion. According to John Wolkonowicz, Senior Auto Analyst for North America at IHS Global, "It can be as much as $6 billion if it's an all-new car on all-new platform with an all-new engine and an all-new transmission and nothing carrying over from the old model."

Big Bucks
So what makes a new car model such a substantial investment?

According to Bruce Belzowski, Assistant Research Scientist at the University of Michigan's Transportation Research Institute, it's the complexity of the project. "The vehicle, when you think about it, is an extremely complicated piece of machinery," he says. "You're looking at hundreds of thousands of parts that have to work every time you turn the key and every time you press the accelerator and every time you press the brake. And they have to do it for about 15 years. And they also have to pass all the government inspections."

Ford's Global Product Communications Manager Said Deep adds, "Cars are far more complicated to engineer than airplanes and Space Shuttles. [Airplanes] don't have to be subjected to the same conditions customers subject cars to. I don't think there is anything more complex than the amount of engineering that goes into an automobile."

That complexity comes courtesy of an enterprise that takes several years to complete and starts with a design process that involves more second-guessing than a season of The Bachelorette. When an automaker designs a new car, it not only tries to identify consumer tastes a few years down the road, but also needs to create a car that is feasible to produce on an assembly line and still make a profit. Once the design gets "locked down," meaning the physical parameters of the vehicle are set, the engineers go to work.

It's The People
A new car development team usually includes a few hundred of these engineers, split into such groups as chassis and body, suspension, drivetrain, control systems and other major subsystems. Other teams may be dedicated to exorcising "NVH" (noise, vibration and harshness), meeting government regulations, or finding the most ergonomically correct setup for the widest variety of differently sized humans that could get behind the wheel. With the rise of in-car infotainment systems, you can be sure there is no shortage of engineers working on the latest gadgets to distract you while your drive.

And what do all of these engineers do? They devise solutions and then they test, test, and test some more until they get it right. They test to meet performance requirements. They test for durability. They test for fuel mileage. They test for aerodynamics. They test for safety compliance. Testing costs money.

Today many tests can be done on the computer before prototypes are built, but those computers and the software cost more money and eventually, real-world tests must be done and unique prototypes must be built. Some of that real-world testing can take place at automakers' private proving grounds or closed test tracks, but the need to test in extreme weather conditions lures them to the roasting desert of Death Valley and the frigid winter of Lapland. The logistics of getting humans, prototypes and test equipment to these regions does not come cheap, either.

Of course, this engineering and testing is all for naught if they don't come up with a car that appeals to Joe Consumer in a way that makes him want the car more than a competitor's and at a price he is willing to pay.

That means you will find designers (interior and exterior), model makers, marketing people, manufacturing specialists, assembly line workers, purchasing analysts, and any number of outside consultants -- not to mention plenty of accountants -- working on new product development at any given time. Throw in the obligatory executive decision makers, highly compensated individuals under extreme pressure to get it right, and you begin to get an idea of the number of people involved in creating a new car. We haven't even considered the support staff assisting with human resources, IT and other essential services of a modern corporation.

Substantial Fixed Costs
IHS Analyst Wolkonowicz, a three-decade veteran of the automotive industry, says, "Thousands and thousands of people input their work to the design and [preparation of a] new vehicle. You have to re-do the assembly plants. You have to create tooling to stamp parts out. It's an endless array of things that have to be done. It's an incredibly complex process that occupies thousands and thousands of people for several years."

Let's say the average total compensation for each engineer, designer, accountant, marketing person and executive runs in the neighborhood of $100,000 per year (counting benefits such as medical insurance, pensions, education, vacation and other perks). A team might be 1,000 people. That makes $100,000,000 per year for our estimate. With four years to develop a car, that's at least $400,000,000. Those employees need computers, office space, engineering labs and countless other resources required to design and engineer such a complex machine. The Blackberry bill alone is probably in the neighborhood of a million bucks a year for such a group.

Meanwhile, another group of engineers and autoworkers are preparing factories for the commencement of production. Re-tooling a factory can easily eclipse the human cost of developing a new car. And if they require a whole new factory, another billion dollars is not out of the question.

But automakers just don't throw money into the pit. They use common platforms to derive more than one vehicle from substantially the same development investment. They also use engine families across broad swathes of models. Some carmakers may use the same engine in a coupe, sedan, SUV, CUV, truck, minivan and even among a slate of luxury vehicles. Now global platforms like the new Ford Fiesta and coming Chevrolet Cruze are also leveraging investments across a much wider spectrum of the world market. For such companies, it is impossible to overstate the need to get it right. And getting it right often requires a substantial investment.

A few decades ago, there wasn't so much a development process as there was an annual styling exercise. But with competition so fierce for consumer dollars, automakers now need to produce safe, reliable and clean cars and we see that now in the showroom. Michigan's Belzowski says, "The competitiveness in the industry in the end is a wonderful thing for the consumer, because we've just have gotten fantastic cars out of this process the last 20 years."

Indeed, some things we take for granted today, like the fact that rust has pretty much been banished, would have seemed unimaginable in the past. Owners expect to get 200,000 miles from their cars today, which are far safer and cleaner than they were just a generation ago, all thanks to the dedicated teams in new car development.

And what do those engineers, designers and bean counters do once they finish their work and watch the first cars roll of the assembly line? They probably get a chance to toast their new ride, but as soon as the bottle of champagne runs dry, they get right back to work creating the next car because their competitors haven't exactly been sitting still. As Ford's Deep points out, "In this industry, there is no end game. You have to be on to making the next great thing. There is no finish line."

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