WHAT'S ALL THIS ABOUT INCENTIVES?

$Zero down, $zero interest, zero payments ever!

This would be the perfect incentive. Who could resist? They'll sell a million cars.

If you can find a better deal, take it.

OK, fun's over. Let's talk about incentives.

First, there always have been incentives, at least since I wrote my first car story back in 1958. But in the distant past they went to the dealer and salespeople: $200 for every sale over the monthly quota, or a trip to Bermuda, or a TV. The incentives might work their way back to customers because the dealer could spread money around to make the deal.

Lee Iacocca changed that. Chrysler was sinking, and his over-the-hill gang of ex-Ford men started offering incentive cash directly to the customers. Buy the Chrysler, and get $1,000 back from the factory.

This helped save Chrysler.

Now people say incentives have become a drug that artificially keeps sales up but erodes profits.

They are right, but let's see the big picture:

How are cars priced?

Here's a car, the Jerry-mobile, which we figure is good for 250,000 units a year: Its cost — meaning its share of all overhead plus its marketing costs (including advertising) plus the cost of the stamping machines and the paint shop, plus the labor and material for 250,000 units — comes to $5 billion, or $20,000 a car. Let's say we add $2,000 profit, which makes it $22,000, which becomes our wholesale price to the dealer.

This is very rough, but you get the idea.

But say we sell one extra Jerry-mobile, 250,001. For that extra car all the costs are already paid for but labor, materials and shipping.

Say those three are $13,000. So if we sell one extra car, the profit is $9,000 instead of $2,000. Incentive time: We give $1,000 back to the customer and spend $500 a car on extra ads. That's $1,500 off the $9,000. So we make $7,500, or $5,500 extra on each car in excess of the first 250,000. See, we make money on the incentive.

Maybe the Jerry-mobile is a dog and it looks like 175,000 sales instead of 250,000. So my company takes in a $3.5 billion loss without accounting for the planned profit. And how much money did we save by not building 75,000 cars? Not much. The overhead, the paint shop, the machinery, the real estate taxes are fixed costs whatever the volume. We said $13,000 for labor ($6,000), material ($6,000) and shipping ($1,000). Well, we didn't save on the labor because we pay them when they don't work. Medical and pension costs go on, too. So we save $7,000 (material and shipping) × 75,000 cars, or $525 million.

Remember, those cars cost us $5 billion for 250,000 Jerry-mobiles. Now it costs us $4.5 billion for 175,000 cars, or $25,600 each. We're losing nearly $6,000 a car. So if we give rebates, say $2,000 a car. We sell another 25,000 cars but give the rebates on 50,000 in all. That costs us $100 million, but when we do the numbers, each car has cost us $23,250 so we cut our loss from roughly $6,000 a car to roughly $3,000 a car.

You see, so many of the costs are now fixed, and some people argue that the company is better off making it and rebating it because it costs almost as much not to build it.

You could also say this is nutty, and it's just better not to build cars you can't sell normally. Shut plants if need be. And someone else would say, “Sure, but the Japanese don't care about profit, and they price for market share, and if we keep closing our plants, we will be out of business.”

Note there are no rebates on PT Cruisers or Honda Accords or BMWs — vehicles that are desirable.

So the answer I promised is a combination of better designs, better engines, better quality, better marketing and better advertising. I must make my products so desirable that people are willing to pay the list price or close to it.

Companies producing “commodity” cars will have worse rebate problems. My friend Fred says one day they will pay you to take the car.

“We've got to clear our lot. Now!!! No down payment, no interest, no payments ever. And we'll pay you $1,000 cash, on the spot, to drive one away.”

Now that's a deal.

Jerry Flint is a columnist for Ward's AutoWorld and Forbe's magazine.