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Domestic Brands, New Markets Changing China Landscape

China’s domestic auto industry is divided into two parts, the giant state-owned enterprises that dominate the market and the hungry national car makers that are gaining traction on all fronts.

Winds of change continue to sweep across China’s turbulent automotive industry.

The frantic pace that pushed total car, truck and bus sales from 2.3 million units in 2001 to 18.1 million units in 2010 is slowing. Yet fresh demand is rising – and being met – in the Tier 2 and Tier 3 cities of China’s vast interior.

And China’s domestic car manufacturers are seeking more independence from foreign auto makers, as well as paying more attention to reliability, fit and finish.

“Our ratings show the quality gap between Chinese domestic brands and foreign brands has narrowed from 396 problems per 100 cars in 2000 to only 89 problems per 100 in 2010,” says John Zeng, director-Asian automotive forecasting for J.D. Power Asia Pacific.

China’s domestic automotive industry today is divided into two parts, the giant state-owned enterprises that dominate the market and the hungry national car makers that are gaining traction on all fronts.

All enjoy government support to one degree or another, ranging from the media’s encouragement of “indigenous innovations” to free land, tax exemptions, export credits and interest-free loans.

The big groups, such as Shanghai Automotive, Dongfeng, First Auto Works, Guangzhou Auto, Beijing Automotive and Changan, “get all the government financial backing and support they need, as well as very fat profits from their joint ventures with foreign auto makers,” Zeng says.

“Smaller, national auto makers like Chery, BYD and Geely don’t have as much government support and are not as financially strong as the big groups. But they are more independent and market-oriented, using all the resources they can leverage, including IPOs (initial public offerings), and are becoming serious competition for the big groups.”

J.D. Power reports China’s domestic brands controlled 34% of the passenger-vehicle market last year, up from 31% in 2009, and is forecasting about 40% for them in 2020.

“China’s national car makers get direct and indirect support from the Chinese government and the local media. The leadership of their CEOs is strong and their response to the rapidly changing environment is quick,” says Tomoo Marukawa, an industry expert and professor at Tokyo University.

“But their management and R&D teams are very unstable and job-hopping is common. The rise and fall of some of these companies is sometimes due to the transfer of key personnel.”

Adding to the market mix these days is a proliferation of new private brands from the major groups such as SAIC’s Roewe, Dongfeng’s Fengshen and FAW’s Besturn that compete with models made by their JVs with foreign companies.

“State-owned automobile groups are under pressure to create their own brands,” explains Marukawa. He calculates these private brands held 8% of the passenger-vehicle market last year, up from 7.2% in 2009, and may be growing faster than the pure independents. But he doubts they will become more important than the Chery, BYD and Geely brands.

At the same time, countervailing currents in model lineups have begun to make marketing more complex and a bit confusing.

“Competitors are moving in opposite directions,” says Zeng. “The Chinese-foreign joint ventures are coming out with smaller cars, while Chinese OEMs are moving into medium and high-end sectors with larger cars.”

How this competition in both upper and lower market segments will work out is by no means certain.

“Five years from now, Chery and Geely will still be recognized mainly for making small affordable cars,” Zeng says. “But SAIC with the Roewe and FAW with the Besturn (brands) have a chance to move successfully up market.”

So far, the declarations of independence have limits, and how much – and how much longer – foreign help will be needed to develop engines, platforms and appealing designs is unclear.

“Many national car makers have hired Italian companies to design their models and will probably continue to rely on foreign design and other technologies for at least 10 more years,” Marukawa says.

Nor is he impressed by the entrepreneurial spirit of the Chinese JV partners.

“The speed of learning has been disappointingly slow,” Marukawa says. “State-owned enterprises lack the incentive to absorb technology and make money.

“For example, FAW copied Audi to develop the Hongqi and copied Mazda6 to develop the Besturn. Foreign partners must have been angry about such attempts but remained silent, probably because the clones were less successful than the originals.”

Zeng adds that “Most of the big groups have been relying on their foreign partners for technology but it is outdated and they have begun to do their own research and development.

“However, since it takes at least four or five years to develop a new model, in the near future they will continue to rely on their foreign partners. The current SAIC Roewe 750 has an old Rover 75 platform, but the next generation will be based on a (General Motors) platform.”

SAIC, in JVs with GM and VW, has become China’s No.1 auto maker and continues to work closely with both foreign partners. At the same time, Reuters reports SAIC plans to invest RMB10 billion ($1.51 billion) over the next five years in its Nanjing plant, where the Roewe and MG are made, to boost its own brands and raise capacity there to 1 million units.

Zeng believes SAIC will have a full lineup of Roewe models competitive with foreign brands within about five years.

The growing capability of domestic auto makers is another disadvantage for foreign producers, already handicapped by central government rules that they must enter JVs with a domestic partner and should share their technology.

“The Chinese OEM market share is growing around 3% a year,” Zeng says. “This means the share of the joint ventures is decreasing that much and weaker foreign brands like (Mitsubishi) will definitely have trouble.

“But a decline in market share does not mean lost volume. For example, Volkswagen’s share of the passenger-car market has shrunk from 49% in 2000 to 13% in 2010, yet the company is doing very well in China, with sales last year of 1.95 million units in joint ventures with SAIC and FAW.”

Despite the new road hazards, few if any foreign auto makers in China have lost heart or faith in the future of the country’s automotive industry. Among examples:

  • In early January, the China Daily reported Volkswagen China is planning to spend $13.9 billion over the next five years to expand production facilities and develop new models.
  • #Ford and Chinese partner Jiangling Motors are constructing a $300 million greenfield plant in Nanchang to produce commercial vehicles, and Ford recently signed a memorandum of understanding for a $500 million engine plant in Chongqing to be shared with partners Mazda and Changan Automobile.
  • GM is running out of production capacity in China and considering adding new plants. The small Chevrolet Sail, jointly developed with SAIC and launched in China a year ago, has been a hit domestically and exports to emerging markets have begun as well.

For most OEMs in China, however, exports have been relatively small, down from a peak of 614,000 units in 2007 to 567,000 units last year. The main destinations: Algeria, Bangladesh, Brazil, Chile, Egypt, Russia, Syria and Vietnam.

“Chinese vehicles as a whole have a bad reputation in export markets for their poor quality,” Marukawa says.

He feels the periodic announcements by Chinese auto makers of plans to export to the U.S. and Europe “are made in order to let Chinese consumers think these cars are acceptable even in developed countries.”

In the foreseeable future, at least, the domestic market is expected to command the most attention and few ill winds appear likely to dry up the enthusiasm for motor vehicles by China’s 1.3 billion people, who already have turned the Chinese automotive market into the world’s largest.

The limit of 240,000 new passenger-car sales per year imposed this year by city officials in Beijing to reduce traffic congestion barely ranks as a blip on auto maker radar screens.

“The impact of Beijing’s new quota on the passenger-car market will be relatively small, a reduction of around 300,000 sales for this year,” estimates Zeng, “and so far there is no solid information about what other big Chinese cities may do. All have a much smaller parc than the 5 million (vehicles operating) in Beijing and may adopt different policies.”

What counts most to vehicle producers are nationwide sales, and much of the action is shifting to the inland provinces, a new frontier where car ownership is still only 10 to 12 per thousand people.

Although the whopping annual sales increases of past years are unlikely to be repeated, growth in the years ahead should still be sizable, satisfying and sustainable.

As government incentives vanish, J.D. Power foresees the sales growth of passenger vehicles slowing this year, up only about 11.8% to 13.3 million units, but rising about 16.9% to 15.6 million units in 2012 and about 9% to 20.9 million units in 2015.

Goldman Sachs Japan expects total annual sales of cars, trucks and buses to reach 30 million units in 2020.

It looks as if the automotive pie in China will remain big enough to yield a juicy piece for any auto maker, Chinese or foreign, willing and able to compete.

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