Wednesday, December 21, 2005

Hybrids Down to Earth

Lately I keep running into articles and commentaries (subscription required) suggesting that hybrid cars are a disappointment and simply not worth their price premium over conventional cars. Most of these critiques miss some fundamental aspect of the hybrid value proposition, but taken together they provide a useful reminder that hybrids will achieve full success--wide popularity that translates into a large market share--only if they can satisfy large numbers of consumers.

The chief complaints seems to focus on a basic cost/benefit analysis of gasoline savings. Taking the most popular hybrid, the Toyota Prius, as an example, the car costs $3,280 more than a base-model 4-cylinder Camry. I've seen others compare it to the Corolla, but it's really closer to the former, based on passenger room and cargo space. The Camry is rated at 28 miles per gallon, versus the Prius at 55. With gasoline now at $2.26 per gallon on average in the US, and assuming the national average usage of 12,000 miles per year, the non-discounted payout for the implied hybrid premium is 7 years, or about the average time most folks keep a car that they buy, instead of leasing.

But I don't think this tells the full story, for two reasons. First, if you think about a hybrid's value in terms of consumer utility, only part of this relates to fuel savings. At least for environmentally-minded consumers, some of the utility derives from the Prius's lower emissions of greenhouse gases and tailpipe pollutants. The value of the former can be quantified by looking at the alternative of buying emissions offsets from TerraPass at $50 per year. This shortens the hybrid's payout period by at least a few months. Finally, if the buyer is of the "Geo-Green" persuasion, he would also derive some utility from the knowledge that he is doing his bit to reduce our dependence on imported oil, including oil from the Middle East. I don't know how to put a value on that.

The other problem is that you need to make an assumption about how much of the initial premium will persist in the car's resale value. Resale values from Kelly Blue Book give us early estimates of this, recognizing that the market for used hybrids is pretty thin. Comparing a 2001 base Camry to a 2001 Prius with the same mileage, the Prius is worth $5,000 more, based on KBB's "private party value." That suggests that the added cost of buying a hybrid might not be more than the time value of money on the up-front premium. It may even be negative, if hybrids consistently retain more of their initial value than their conventional counterparts.

Finally, we need to recognize that hybrids are still pretty new, and part of their high cost relates to the relatively low volume built so far. Eventually, hybridization should effectively become an option on most models, rather than creating a separate and distinct models. In that way, it will end up being priced like more traditional options, such as automatic transmissions and air conditioning, which have declined substantially as a fraction of total car purchase price since they were first offered. At that point, the tradeoffs involved in buying a hybrid should be simpler and more transparent.

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