Asked which automaker will win China, more than one analyst or accountant says simply, "China will win."
Yes, the world's fastest-growing auto market tantalizes automakers with its potential for growth and profits. American automakers see China as a growth market that could help make up for falling profits at home. They aren't alone. Japanese and European carmakers also have high hopes for China. Volkswagen, Europe's largest car company, now sells more cars in China than it does in its home market of Germany.
But the real beneficiary of the automotive investment will be China itself, which is building its own car business with the help of foreign investors, who, according to a law stipulating that an individual foreign investor may not own more than 50% of a Chinese manufacturer, must partner with Chinese companies to enter the market.
Thanks to advantageous laws like this one and the financial and regulatory backing of the government, as well as China's growing economy, low labor costs and enormous population, the Chinese automotive landscape could ultimately resemble that of Japan or South Korea: developed with the help of the West, with Western investors gradually reduced to minor players. Today there are more than a dozen state-run automakers in China.
Still, even if they have not been able to set up standalone shops there, foreign automakers salivate over the potential in China--even if the Chinese economy is still in many ways underdeveloped. General Motors estimates that 74 million Chinese families (about 20% of the population) can afford to buy cars, even if per-capita annual income in China is only $930 in the cities and $299 in the country. This 20% of the population that can buy cars holds about 80% of the savings deposits in China. Cars are not more affordable in China, but the Chinese are great savers, and credit has become easily available in the last couple of years.
The auto business is growing in China at a considerably higher rate than the GDP there. According to the China Association of Automobile Manufacturers, production for the first eight months of 2003 has been 2,781,800 units, up 36% from the same eight months in 2002. For passenger cars alone, output accelerated almost 92% to 1,223,400 units through the start of this month.
The highway infrastructure also continues to expand, even if the quality of the roads is improving at a disproportionately slower rate. The U.S. Department of State assesses road conditions and maintenance in China as good in urban settings and only fair in rural areas; it also points out that the availability of roadside assistance is only fair in or near large cities and nonexistent in rural areas. Despite this, the total length of highways in China ranked second among nations at the end of 2002. In 1997, China was 39th.
All of this growth might seem to suggest that the auto business in China will be crowded with more foreign investors as time goes on, but China believes there are a fixed number of leadership positions to be had there.
The tenth Five-Year Development Plan for the Automotive Industry, issued by China's State Economic and Trade Commission and covering 2001 through 2005, says that "there will be two to three large automotive groups that have considerable strength in international competition by 2005. Auto marketing and after-sales service systems that conform to international standards will take shape, and the domestic-market shares of products will exceed 70%, with some for export. Five to ten large auto-parts enterprise groups with competitiveness on the international market will be formed. The top three key parts producers will occupy 70% of the home market, and the value of exports of parts and accessories will make up 20% of the total sales volume."
Who will these two or three large automotive groups be? More important, what does this mean for foreign automakers? The biggest Chinese automaker right now, First Auto Works, has partnerships with Volkswagen and Toyota. Of the foreign players, Volkswagen is still the leader in China, although its market share has slipped to under one-third. This is in spite of the fact that, in the first nine months of 2003, Volkswagen's Chinese sales rate increased by 33% over the same period in 2002.
General Motors, with a market share of less than 10%, is the second-biggest foreign automaker in China right now. Its sales increased by about 38% in the first nine months of 2003, owing largely to a strategy that calls for introducing new products in China and then revising them quickly.
Ford Motor has been late in entering China and is struggling to get off the ground there. Toyota is selling cars, although it is not nearly as well entrenched in China as Honda. Nissan is making new investments of about $2 billion in its Chinese enterprises, and Hyundai is investing about $1 billion.
Companies like Volkswagen, GM and Honda (arguably the three with the most momentum in China) are finding that their capacity cannot keep up with demand in the country. Honda's vehicles take from a week to a month for delivery there (China does not have an established delivery infrastructure, or the hordes of delivery trucks available in America). To help ease the backlog, the big three American automakers are planning to feed the market with thousands of imported cars, built in America, before 2006. These will complement the extensive efforts they are already making to build cars on Chinese soil, with Chinese partners.
"Everybody's number one priority is just making sure they have a toehold and they are increasing capacity," says Brian Lund, equity analyst for Morningstar. "The numbers for announced capacity in the coming years are huge."
Right now, success in China can be considered more a matter of market share than profitability, according to an Asia-based automotive industry analyst who insisted on speaking anonymously. The analyst says that this strategy--occupy a position and wear down your opponent--stems from Sun Tzu's The Art of War; that the Asian automakers tend to have more patience for this sort of thing; and that Western automakers, who are under pressure to report quarterly profits, may have a hard time turning the focus to market share.
But some have speculated that the rapid growth of China's auto business is a bubble that will eventually burst, and flooding the Chinese market with cars could be more problematic than automakers expect. "There isn't too much capacity right now," says Lund, "but the announced increases in the next three to five years are going to outpace demand. That's the big concern." Specifically, the concern involves the potential for cheap Chinese cars to be exported overseas, and the possibility that there won't be enough people able to afford the cars to sustain production levels in five years.
One goal of the planned increases in capacity is to give automakers a chance to round out their lineups, and to sell more modern products. China's entry into the World Trade Organization in 2001 curbed its tendency to sell dated cars, and Chinese consumers with increasing amounts of discretionary income now demand the latest and greatest products. As part of its acceptance into the WTO, China had to lift restrictions on imported cars, making its own inferior, older cars no longer salable. For a long time, the Chinese protected their local industry by prohibiting or outrageously taxing products (a strategy employed by Malaysia and Vietnam). The WTO has changed this strategy, and China now invites foreigners to import their cars--provided that they also make cars on Chinese soil.
Foreign automakers may be migrating to China, but they are finding the trends are different there. The sport-utility craze in America has not caught on in China. SUVs have a market share of 2% or less in China, where they are regarded as work vehicles with peasant connotations (even if Honda's CR-V and Toyota's RAV4 are winning hearts). Instead, more upscale Chinese buyers have tended to gravitate more toward high-margin, affordable sedans like the Buick Regal, Honda Accord and Volkswagen Passat. Maintaining the market share of sedans is the key to short-term profitability for automakers; in the first ten months of 2003, sedans accounted for 19% of Chinese vehicle sales--the largest market share. Analysis of the Chinese industry has not yet evolved to the point at which we can study residual values, or other indications of how the quality of Chinese cars compares with those made in other countries.
Analysts do agree that Chinese-built cars are getting better. More important, they are being produced at rates that exceed the already-blistering growth rates of the Chinese economy in general. General Motors, Volkswagen and Honda may be the companies to watch right now, but they cannot be considered valid answers to the question of who will win the automotive race in China.
Comparatively speaking, China will be the only winner. After China begins to import cars en masse to Japan and Korea, expect it to head to America. You can walk into an appliance store today and walk out with a Haier refrigerator or a Lenovo PDA--both Chinese brands. Ten years ago you couldn't have found either. Within another decade or so--it may be only five years--Americans may be seeing Chinese cars in their auto showrooms too.