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China's auto market: a mix of developed, developing and emerging

-- GAF interview with Ashvin Chotai, managing director of Intelligence Asia Automotive

by Wayne Xing   2012-09-14

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Q: What is your assessment of the growth dynamics of automobile demand in China?

How much more growth potential is there in China?

Chotai: Despite the impressive boom in vehicle sales since 2002, vehicle ownership levels at national level are still very low and hence there is still huge potential for growth, especially outside the mega-cities and in the inner provinces. However, there are clear signs that the market has reached at least the first stage of maturity. 

Whilst demand growth in many of the major cities will be constrained by congestion and infrastructure bottlenecks plus more stringent controls on vehicle registrations, there is still significant scope for growth in inner, Northern and some Southern provinces as well in the smaller cities in the more developed provinces such as Zhejiang, Guangdong and Jiangsu. However, controls on car registrations in Beijing and Guangzhou and negative developments in cities such as Wenzhou are a warning that

car demand in many cities across China are in “bubbles” and could see a sharp correction from the high levels of 2010.

If we just focus on passenger cars, SUVs and MPVs, it can be said that in 2011 there were four provinces (Shandong, Jiangsu, Guangdong and Zhejiang) with sales of around 1 million units. If minibus and commercial vehicles are included demand was well over 1 million units in these provinces. So the auto market in many of China’s provinces is much bigger than many country markets. For example, the size of Thailand’s auto market in 2011 was less than 800,000 units. I estimate that there were five provinces in China with a bigger market than Thailand.

Overall, I expect around 80 percent of the growth in the next decade to come from outside the top 10 cities (as measured by current size of the car market). The role of Beijing, Shanghai and Guangzhou is declining because of congestion and other ownership controls and also relatively high car ownership levels.

Q: Several big cities in China have imposed restriction on the purchase of cars. Will this affect the role of auto industry in China’s industry?

Chotai: Beijing demand in 2011 was less than half of the demand in 2010. In the next 12 months we can expect a similar slump in Guangzhou while Xi’an is also considering moves to impose some controls.

The impact of controls in Beijing, Shanghai and Guangzhou has already been factored into most manufacturer plans. As other cities are smaller markets, the impact of controls will not be as severe as Beijing. My own estimates indicate that we could see a negative impact of around 1 million units in 2015, if say 15 significant cities impose similar controls between 2013 and 2015.

Q: What about vehicle production?

Chotai: Unlike Japan or Korea or Germany, China domestic demand is the primary driver of vehicle production levels. Growth in exports by Chinese brands has been very healthy in recent years and I expect further healthy growth but export are likely to account for around less than 10 percent of production during the next decade. Imports are restricted to luxury and niche vehicles and this situation is also unlikely to change.

China’s expected production level of around 19.5 million units in 2012 will be over twice Japan’s level and over 30 percent higher than combined production of the U.S., Canada and Mexico. However, with so many players and joint ventures, the industry structure is highly fragmented.

Q: Do you think the government should introduce stimulus measures to boost demand?

Chotai: What happened in 2009 and 2010, while positive for the industry in the short term, was not necessarily healthy from a medium and long-term perspective. Incentive fuelled boom generally result in market distortions and over-optimism when it comes to future planning and there is generally always a “post-stimulus” hangover when demand growth either declines sharply or actually falls. It is unhealthy for automotive market and the industry to become addicted to government support measures.

Q: China features more prominently in the global strategies of foreign automakers? What key challenges do they face?

Chotai: In 1990, China’s share of global auto sales was just 1.1 percent. Even in 2002, it stood at just 5.2 percent. But by 2011 this had risen to 22.7 percent. In the same period, the share of North America, Europe and Japan (so called developed triad markets) dropped from 76 percent to 47 percent.

So, it has been not surprising that global automakers and component suppliers have been putting more and more emphasis on China to support their global growth objectives. Even with moderate growth, China will continue to remain a key market for virtually all automakers and the main growth engine for their global sales, production, revenues and profits. China will also continue to be their main destination for investment.  There is no other growth market like China. Other BRIC countries have not enjoyed such spectacular growth and there are few signs that they will do so consistently in the future.

Operating in China via a JV structure does make it much more complex for foreign automakers to properly integrate their China operations into their global strategies and supply chains. This is one of the major reasons why foreign brands are reluctant to even plan to use China as a significant export base in the same way as they are using countries like India and Thailand. For example, Hyundai is a major exporter of cars made at its Indian factories while Toyota is major exporter from Thailand but neither of these companies is exporting from China. Of course, most companies have had their hands full expanding their operations to satisfy domestic demand rather than consider exports from China.

The challenge for most manufacturers continues to be to build a competitive product portfolio, have high level of local content and cost competitiveness, establish an extensive and efficient distribution network and have sufficient products and production capacity to take advantage of the growth opportunities. It is fair to say foreign companies are becoming more “Chinese” while Chinese companies are learning from foreign players. In the current environment, they also need to exercise some caution when planning major investments. A slowdown in China and excess capacity could trigger a change in strategy and put more pressure on join ventures to step up export activity.

Q: Do you think it is time for the Chinese government to change its provisions regarding the 50:50 equity ratio for Sino-foreign joint ventures?

Chotai: Foreign auto assembly cannot have a wholly owned assembly ventures and under the current regulations, foreign assemblers can have a maximum of 2 joint ventures per vehicle category and the maximum stake in restricted to 50 percent.

In a sense, I find it quite surprising that China has not faced more pressure from developed countries to relax these restrictions especially as China has been in the WTO for nearly 10 years.

These types of restrictions were common across Asia until the 1990s. In India, these restrictions were removed in 1997. In countries like Thailand and Indonesia, most such restrictions were removed in the post Asian crisis period, in 1997/1998 when the IMF started putting pressure on the respective governments to deregulate and many of the local players were facing financial difficulties.

Today, large parts of the auto assembly sector in India, Thailand, Indonesia, Brazil, and Mexico are wholly owned by global OEMs and fully integrated into the global strategy and operations.

Immediately after China joined WTO there was a lot of debate on this issue but it is interesting that this no longer seems to be a talking point.  Part of the reason is that many of the foreign companies have already signed very long term JV agreements and accepted this situation and see this restriction as a small price to pay for participating in China’s booming market. China has not really been put under any international pressure on this issue and without significant external pressure the government is unlikely to change these rules.

In the meantime JVs have become bigger and bigger and quite mature. Now we have a situation that even if China relaxed the restrictions, the current JV structure will continue to dominate. Exiting or restructuring current JV agreements would be very complicated and most foreign assemblers may not even be able to afford to buy out the Chinese partner’s stake even if this became possible in law.

So in theory, wholly owned operations of foreign companies could one day be possible but they would most likely face a whole new set of new obstacles.

So we have to assume that the current JV structure will remain as the only way in which foreign assemblers can participate in China’s auto industry.

From Chinese point of view, it can be said that Chinese government and SOEs have been able to maintain control over the industry and reap significant financial benefits from the current rules and industry structure but it can be argued that this structure has not helped in the development of independent technology and brands. Independent Chinese automakers such as Geely, Great Wall and Chery who have operated without JV partners have made more progress.

Q: How will the competitive dynamics between JVs and independent brands evolve ?

Chotai: 13 major Chinese groups plus their JV partners currently account for over 90 percent of the vehicle production.

Chinese brands are dominant in the commercial vehicle market but in the car sector (excluding minibus), more than two third of the production is accounted for by JVs.

Will JVs continue this type of dominance? In summary yes, mainly because of JVs continue to improve their competitiveness and will continue to be the main mechanism for bringing in the latest products and technologies into China and also for producing and marketing vehicles that modern Chinese customers want.

Initially, independent Chinese brands enjoyed success with low price strategies and focus on smaller cities but in recent years, most JVs have made very impressive progress in terms of having a broad product portfolio, becoming very price competitive and expanding their distribution to inner provinces and smaller cities. Meanwhile, operating performance of individual Chinese companies has also been erratic.  In 2011 and 2012, most Chinese independent brands have been underperforming in the market.

The most recent development is introduction of joint venture brands such as Baojun, Linian, and Kaili etc. The product strategy is based on the use of old/outgoing platform from the foreign partner, carrying out some restyling and upgrades and then repositioning the model to appeal to price sensitive buyers, especially in smaller cities. This development will be putting even more pressure on Chinese independent brands.

So overall, the outlook for independent brands is becoming very challenging. I expect JVs to continue their dominance and account for at least 60 percent of China’s car production in the medium term.

Q: How rapidly can Chinese auto assemblers close the competitive gap? Is there scope for cooperation between different players?

Chotai: The global auto industry is highly competitive. Barriers to entry in areas such as sophistication of technology, capital intensity and production scale, brand development and distribution presence are very high and it is rare to see new players emerge and succeed.  So in this global context it has been amazing to see so many domestic brands emerge in China in the last decade.

 Progress made by larger automotive SOEs in areas such as building their engineering and development capabilities, launching competitive models, building brands and eventually gaining market share has been slow. But, a small number of newer private Chinese companies have made more impressive progress.

Of course, we have to again mention China has a unique industry structure, shaped and tightly controlled by government policy. Without such controls, it is almost certain that China’s industry structure could have become similar to India or Brazil where foreign automakers dominate and only a very few globally competitive domestic automakers emerge and succeed over a longer period. In India, we have just Tata and Mahindra who can compete with global brands and even they face a lot of challenges.

In China’s unique situation, although there has been a fair bit of consolidation already, there are still too many players and the industry structure is too fragmented. While demand was growing strongly, the fragmented industry structure was not an issue but a prolonged period of slow growth will put pressure on several of smaller automakers to exit, consolidate or seek other ways of operating. 

In an environment of slow growth and intense competition, it becomes even more important to have highly competitive products and strong branding. So, the main challenge is to continue to focus on product quality and technology and continue to improve brand image and customer acceptance.

Q: The auto industry of China and South Korea both started basically in the 1980s, but now Korean-brands have been well recognized by the global market, especially in China. What is the weakness associated with China’s auto industry by comparing the two countries, and what do you think China should learn from South Korea?

Chotai: The situation in China is very different from Korea and so we have to be careful when making direct comparisons. But of course, these are some lessons China can learn from the experiences of the Korean automakers.

In 2011, Korean domestic vehicle sales were only 1.5 million units while vehicle production was 4.66 million units. So both sales and production levels are a lot lower than in China. There are also major differences in industry structure, number of players, export orientation and government policy. In 2011, South Korea exported 3.15 million vehicles or over two thirds of the production.

Historically, high tariffs and tight control over foreign participation in the industry were crucial factors in the nurturing and development of strong national champion companies in the form of companies such as Hyundai, Kia and Daewoo. During the 1970s and 1980s the Korean automotive industry entered into numerous joint ventures and technology agreements with overseas manufacturers.  Daewoo co-operated with GM through to 1992, Hyundai with Mitsubishi, and Kia with Mazda.

From the mid-1980s, the Korean industry started to transform itself from CKD assembly of foreign designed vehicles to fully fledged manufacture with a high level of domestic design, engineering and component production.

The situation in China is a lot more complex with so many players, a large domestic market and low dependency on exports.

So far, Chinese penetration of export markets has been low and restricted to emerging markets such as Russia, South/Central America and Africa/Middle East. Moving up to the next level would require success in the major developed regions of North America and Europe. In this respect, it appears very unlikely that Chinese brands can emulate the success of Japanese brands in the 1970s and 1980s or the success of Koran brand in the last decade.

The main lessons individual Chinese companies can learn from Hyundai/Kia are:

• A strategy based on low prices and to other emerging markets should be regarded as only the first stage of international expansion focused on emerging markets.
• Significant volumes can only be built up by achieving presence in developed markets such as North America and Europe. Customers in these regions are brand loyal and winning them over requires a major leap in quality and technology level. New brands also need to make significant investment in marketing, brand building and distribution network.
• It will be much more challenging for new brands to build up sales momentum in the current environment than it was for Japanese and Korean brands when they first entered USA and Europe.

(Reprinted from www.ga.forum.org)

 
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