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Swimming with sharks

There have been mixed debates on the question of China’s automotive industry and market potential, but one thing is for sure, any carmaker hoping to be a major player in the future shouldn’t risk absence.

The S16 concept car, unveiled at the Shanghai Motor Show in April, is part of Chery’s mini car family, but also a statement that suggests the carmaker is creating its own brand identity. The entire car has been designed to resemble a smiling face

With an estimated 1.3 billion population, China is bound to become a substantial future market. Analysts at Goldman Sachs have predicted that China’s economy will overtake Japan’s by 2015 and the US by 2039; automotive production volume will probably exceed Japan by 2014 and the US by 2020; and that the all-important middle class, who constitute the bulk of consumers, is predicted to grow from an estimated 60 million in 2002 to 160 million by 2010.

On the one hand the likes of Max Pemberton of Autelligence predict that total sales of vehicles including commercial vehicles, will reach 15.6 million units per year by 2020 and that 160 million vehicles will be sold between now and 2020. On the other hand experts also see China as developing into a major export base for automotive components and vehicles.

Big ambitions, but does China have the balls to play on a cut-and-throat global market? Turn most labels in department stores and you are likely to see the words: ‘made in China’. Will the future of motoring too become ‘made in China’?

Exporting goods

Mike Stevenson, automotive analyst at KPMG thinks that it is inevitable that a country like China should end up exporting its automotive goods. “Two or three years ago, apart from Honda, the other oversees OEMs who were established in China, had the capacity to meet local demand,” he explains. “Over the last couple of years the view has almost turned 180 [degrees] and China will now be a significant source for car exports for both the North American and Western OEMs.”

Pemberton predicts that China will need the equivalent of an additional 40 new assembly plants, each with a capacity of 300,000 units a year to meet domestic and export demands. Added to this it will need to build an entirely new supply chain as well as dealer network that has need to be established to enable this mass motorisation to take place.

There were only 14 vehicles per 1,000 people at the turn of the millennium in China. By 2020, the forecast shows an increase of something near 78 vehicles. Yet this is what we expect the average level of ownership in developing countries to be at the time. There is therefore even more potential in a country that boasts such a vast population.

China will undoubtfully be the world’s largest market in 20 to 25 years. Pemberton believes that there is every chance that the country in the long term will become one of the most open and competitive markets in the world, with every major player operating there. However, he doesn’t see China necessarily becoming a massive exporter like Japan or Korea have become. Stevenson disagrees with this and sees China as becoming both a strong maker of domestic and export automotive products.

The old masters

Everyone who is anyone is in China, although foreign OEMs generally function in alliance with Chinese manufacturers. The Volkswagen Group is perhaps the oldest of the lot, having been present in the country with the VW badge for twenty years.

VAG is involved in two car producing joint ventures in China. The Golf, Bora and Jetta as well as the Audi A6 and A4 models are produced at the Chinese First Automobile Works (FAW)-VW joint venture company in Northern China. Shanghai Volkswagen (SVW) builds the Passat, Santana, Santana Variant, Santana 3000, Touran, Polo and Gol. Another joint venture assembles gearboxes for vehicles built by FAW-VW and SVW.

FAW, founded in 1953 in the northeastern Chinese city of Changchun, is the oldest car manufacturer in the People's Republic. Its production capacity is around 300,000 vehicles a year, of which some 200,000 are commercial vehicles and buses. It too seems to have caught the bug exporting a total of 10,336 units to foreign markets last year.

Business hasn’t been going swimmingly well for VAG in the last year or so. The main drawback for the carmaker ironically seems to be its long history in the country. In 2003, almost 32 per cent of all passenger cars sold in China bore the badge of a company belonging to the VW Group. In Shanghai this is specifically noticeable and the outdated styled Sontana taxis can surely do nothing than harm for the brand.

Global interior supplier, Johnson Controls, works with most of the major players in China and they have regional operations located around the country. “We work with Volkswagen too, but not so closely in terms of design because they tend to bring their design over,” says Richard Chung who heads the Asian operation. He sees this as negligence on the part of VW. Certain designs may work but on the whole this is a strategy that VW will need to think about. He points out that the Santanas and the Jettas that we see on China’s roads are twenty years old.

Audi has been present in the market since 1989 with12 models in China so far, the latest being the second generation A6L unveiled at the Shanghai Auto Show in April. The car has been designed with a longer wheelbase and is aimed at the “new successful entrepreneur” generation. Note that this group are specifically different from the old Audi buyers who tended to be government officials. Audi has been producing the A6 there since 1999, when a special version was created with the help of FAW, whose workers were sent to Ingolstadt for training. “The Audi A6L will be built exclusively as a long-wheelbase version in China for the Chinese market,” said Prof. Dr. Martin Winterkorn, chairman of the board of management at Audi.

Trevor Hill, executive director Audi division at VW China, has had a long history of working in Asia but admits: “although there's only a small piece of ocean between China and Japan, there is 180 degrees difference in the maturity of the market and how the motor industry is viewed.” Hill is witnessing a fast moving country where these “new successful entrepreneur” from Beijing and Shanghai would think nothing of purchasing highly prices Western premium products. When the new TT was unveiled there recently, a young and female property developer from Beijing made an order for not just the first car to come off the production line, but for the second, for a her friend.

Then there is General Motors, which has been under a lot of pressure lately with Beijing’s attempt to cool down the market by ordering a credit squeeze and price cuts. Saying that GM, alongside its Chinese joint venture company, SAIC, have out performed some of the others recently. GM China now has seven joint ventures and two wholly owned enterprises in Mainland China. Its unit sales in China grew 27 per cent in 2004 to nearly half a million units.

The US giant launched its all-new ‘world car’ in advance of the Shanghai Show. The Chevrolet Aveo will go into production later this year and will be marketed in 120 countries. Interestingly enough, its European debut will come second-place at the Frankfurt Show in September. The compact saloon is based on the architecture of Daewoo Kalos and was a joint development by GM's Pan Asia Technical Automotive Centre (PATAC) in Shanghai and the GM Daewoo R&D centre in Busan, South Korea. The Aveo will initially be built in Korea and at GM-SAIC in Shanghai. It will then be launched into all major markets including Europe, Japan, North and South America and will eventually be added to production lines worldwide.

Unveiling the car, Bob Lutz, GM vice chairman for global product development, declared: “This is the first global product from GM, the first global production car from any international automaker, ever launched in China.”

Ford’s Asia Pacific & Africa region finished 2004 with an 18 per cent increase in sales, led by China where sales grew 119 per cent.

China, for BMW is part of its intense internationalisation plan that includes plans to double sales in Asia by 2008 to 150,000 units. BMW’s partner in China is Brilliance China Automotive Holdings based in Shenyang, the capital of the Liaoning Province in the North-East of China. A total of €450 mn ($577 mn) is to be invested by 2005 at the plant there. In the medium term, an annual production of around 30,000 BMW 3 and 5 Series vehicles is planned.

Other German premium carmaker, DaimlerChrysler, is in talks to set up a China venture that would make and export Chrysler cars to the US market, Ruediger Grube, head of the carmaker’s operations in China, told reporters on the fringes of the Shanghai show. He indicated that a final decision would be made in the second half of this year. He did not specify the local partner, though DC is builds Chrysler Jeeps and is planning to build Mercedes-Benz cars with Beijing Auto.

“We would like to establish here in China an export joint venture for Chrysler products,” Grube said. “Exploring the idea and actually doing it are worlds apart. We are being very cautious on this because we see how quickly market conditions can change, in China as well.” DC is aware of the political implications of exporting Chinese built cars to the US, given the state of the US Big Three in their home market. He did add that the fact the any Chinese exports would not be of current Chrysler product but “a totally new segment” might lessen the political impact. DCX has announced plans to invest €1.2 bn ($1.5 bn) over the next five years in China but any export-oriented operation would require additional money.

Despite recent anti-Japanese sentiments in China, the carmakers are present un-force in the region. Toyota sells the Vios, which went into production in 2002, and the Corolla, which has been in the market since last year. The Crown has started rolling off the production line at a second plant operated by Tianjin FAW Toyota, taking annual capacity to 220,000 and Toyota is already flagging a step up to 270,000. The production of the Camry begins mid next year at a joint venture with Guangzhou Auto, with initial capacity calculated around 100,000 rising to 250,000 units. Not to forget buses and CV production that is expected to reach half a million units, with its official target being set at 10 per cent share of the light vehicle market by 2010.

Back in 1999, Honda began automobile production at Guangzhou Honda with the all-new Accord at a production volume of 30,000 units. Honda currently has 12 joint ventures and subsidiaries in China covering. The market size is around 12 million for motorcycles and 2.6 to 2.7 million for passenger cars in 2004. The Japanese carmaker is also on the game in regards to export from China. It is about to ship the Jazz (Fit) from Guangzhou to Europe out of a factory that is purpose built for European exports.

Hyundai too has been strengthening its presence in China, who sees it as a closer Asian ally then the Japanese carmakers. “In fact for the last two months the best seller in China has been the Hyundai Elantra,” says Chung, whose operations are based in the Korean capital, Soul. “It has been the best selling single model in China.” As in the US, the Chinese seem to view Hyundai as a brand that is very high on value. Hyundai/Kia has a very aggressive plan ahead. The company is trying to increase its volume by 1 million units in China and Asia, a million units in Europe and a million units in the US. So they are effectively setting their eyes on over 6 million units a year.

The new Chinese voices

Some of the key home players to watch out for are Changan, Chery Automotive and Geely. They vary in size, but share the same global ambition and to achieve this they are religiously learning as much technological know-how from the advanced world as possible so to compete on the world market.

The largest of the three, Changan is the third biggest carmaker after FAW and Shanghai Auto. It specialises in small vehicles, which KPMG’s Stevenson sees as an important segment in the future of China. In its mission for this century, Changan notes that the main purpose for education is: “to make the nation strong and enable Changan to take its place on the world stage.” The company’s philosophy, says vice-chairman Ma Yun is to: “outperform a foreign nation by learning experience from it.” This, it sees as the sole way for future survival.

Government owned Changan already has dealings with Ford, Suzuki, and Mazda which has invested €377 mn ($483 mn) in an assembly plant in Nanjing, strategically located at the confluence of Yangtze and Jialing rivers to help expand the domestic market. Abroad, Asia and even the US and Europe are on its radar. In 2004, sales rose by 43 per cent to 570,000, outpacing the market’s 15 per cent rise, though the latter part of the year saw a small drop.

Ma explains: “They [international carmakers] can come here, why should we not be able to go over there? The home market is limited and there will come a day when we have to go down the international path.” He would rather go it alone, but if need-be he thinks it will be okay to work with the likes of Ford to reach a more global market. “Core competency cannot be gained without cultivating a capacity for independent development,” he says. “The power of brand has become a significant signal to demonstrate the strength of a company, even a nation.” Strong words.

As a step towards ‘improving itself’, the company has adopted an advanced IT system, it has been working with Italian design and engineering firm IDEA since 2001, and two years ago, it opened an R&D centre in Italy. Chery’s staff are trained in Europe and clever employees are awarded with all sorts of bonuses including free housing. The scheme has been so successful that internal staff are now responsible for over half the R&D work carried out at the Changan Automotive Engineering Institute in Shanghai. It was here that the all-Changan CM8 was produced, which is currently sold on the domestic market.

Chery Automobile may only be the eighth biggest carmaker in the country, but it has huge ambitions with its export market, aiming at building cars within five years as well as export from China to Asia and the US by 2007. Like Changan, Chery is state owned. In 2002, it got the back of GM up with the QC car that everyone thought looked a little too similar to the Daewoo Matiz, sold in China as the Chevrolet Spark. At Shanghai last month it went out of its way to prove to the world that its products are now wholly Cherry-designed with the vibrant green S16. Chung thinks that the car represents a new direction for many of these brands. To compete ‘legitimately’ on the global market, these carmakers will have to stop imitating and find their own design language.

Chery has signed a deal with entrepreneur, Malcom Bricklin, the founding president of Subaru in the US and a known risk taker, to sell 250,000 units a year in the US in the next two years through the newly established Visionary Vehicles company, which aims to bring five new models to the US including three saloons, a coupe and an SUV. The company has employed US consultancy Harbour to review Chery’s factories and make sure they up-to-scratch for the US venture and that they can make cars that reach our regulations in terms of safety and pollution. “They’ll go through a learning curve. The Japanese and Koreans did,” says president Ron Harbour.

Chery’s mission is to export first and see how the advanced world feels about its cars, before making cars in the advanced world for the advanced world. “This is the most incredible opportunity in the car business,” he told China’s Forbes magazine a while back. “I would like to look at it as being the next Toyota.” Indeed like its mentor, certain sites, predominantly in the old Eastern block, have been vetted for future possible manufacturing sites and Chery’s eyes are also well focused on doing the same in the US in not such a distant future.

“We are going to see the likes of Cherry doing substantial exports,” says Stevenson. “People perceive their cars to be poor quality design, but this is not necessarily true. They are reasonably quality cars that are well designed with good specs.”

Austria’s AVL is to design diesel, gasoline and even hybrid engines to be manufactured at the engine plant in China. Michael Zhang, Chery international European Union regional sales manager explains: “I think AVL is a very strong company to design engines. We send some of our engineers to AVL because not only do we want to import engines, we also want our engineers to find out how to design and develop engines. In the meantime we get the AVL engines but after that we can design our own engines.”

Italian design houses, Pininfarina and Bertone, have been leveraged to create a range of stylish vehicles. It seems that Asians are quite fond of Italian-styled cars. Japanese designer, Cavax has also been brought in to advise on a crossover. “Everyone knows Peninfarina and again we learn from their skills,” admits Zhang. Cherry displayed the entry-level S16 concept car at the Shanghai Show. Asked if there was a market for small cars in China, he seemed positive: “This kind of car is very popular in China. More and more people are buying these cars in China.”

Asked if Chery would consider manufacturing there the Toyota way, Zhang lets out a laugh, the company he says already has facilities in areas like Iran, Venezuela and Pakistan and is negotiating deals to assemble cars in and has already exported some 10,000 units to Malaysia and Cuba. Altogether around €780 mn ($1 bn) is needed to expand and upgrade its facilities for this purpose. “They’re ambitious like crazy, they want to be a major global player,” says Bricklin.

Geely is altogether a different story. Small and private owned, it wasn’t even allowed to build passenger cars at first, but soon the owners found ways of misleading the State, with its first car appearing on the market in 1998. Li Shufi who runs the company has a cut-and-throat attitude to expansion. Firstly he believes that the likes of VW and GM should drop their prices so as to at least match that of Japan’s. His own prices are extremely competitive with the cheapest model selling at €2,300 ($3,000). Like its competitor, Changan, Geely too has been forming technological alliances with the likes of Germany’s Rucker. It has also been cheating a little by recruiting top executives from Chinese auto giants like FAW-VW, BMW, and Dongfeng. However unlike these large Western-backed corporations, Geely has inevitably suffered quite a bit in the last economic slide and is now looking abroad to raise finance.

Chung believes that Asians are quite nationalistic and as homegrown products reach the standard of imports, national brands are becoming more popular. “They are leveraging these patriotic feelings towards their purchases,” he notes. He thinks in a year or so you will see a reflection of that in the overall sales.

“As the Chinese market is historically susceptible to copying you will see an acceleration of quality,” says Chung. Like Toyota we may eventually see them finding their own design language once they have mastered quality, and conquered markets.

A reality game

China’s ambitions are not as far fetched as all that. Just 30 years ago, the Japanese entered the US market as the world sneered-on with open scepticism. Toyota is now virtually number one globally. Korea was soon to follow and Hyundai is right on the heals of Toyota, especially in the US market. So it is absolutely plausible that the Chinese should have a go. But will China become the next Korea?

“The Chinese government has set out an agenda so that by 2010, 50 per cent of its volume sales, sold in China, will be by localised brands,” says Chung. By this they mean not the OEMs who are in collaboration, but the likes of Chery and FAW, on their own. As a result we should expect to see a whole lot of vehicles developed with this in mind.

The Chinese market has already stalled and isn’t growing to the extent that everyone was hoping for. On the other hand all these global giants have invested heavily in the region and the capital has to be utilised. They need to find export markets to use that capacity. “Therefore China will have to become a major export base,” Stevenson concludes. There will still be imports from high-end prestige brands like Bentley and Rolls Royce, but all the major volume brands will be able to make their cars in China.

The likes of GM have announced a substantial increase in production capacity. “It will take a very long time for Chinese demand to catch up with that capacity,” says Stevenson. It seems that the West has made the same mistake with overcapacity in China as some other parts of the developing world. This is why prices have dropped in China and will do further as consumers stand by waiting for a better deal. “China was a very profitable market for the likes of VW, it is a short-term erosion and will come back, but it’s a question of whether we will experience the profitability we have in the rest of the world,” he says.

On the other hand, the Chinese are savvy consumers. Larger cities like Shanghai and Beijing are littered with designer labels and you don’t have to be a genius to see that they will not settle for second best. VW may been selling its second-rate Sontanas for twenty years, but the new Chinese middle class will not settle for second-best. Sales have sharply dropped and the brand has suffered intensely because of this short sight

Chung thinks that in the future we will see the likes of Changan, Chery and Geely coming up with more adventurous products, whereas the more established carmakers will stick to a more traditionally Western interpretation of vehicle design. There is not such a thing as Asian design but there are certain features that have to be included to suite Asian life, so perhaps these companies will be more sympathetic towards these needs. Additionally, global interest will mean that these carmakers are less likely to copy design as they have been doing so far.

Stevenson believes that there will clearly be a need to fill the niche for an entry-level vehicle. “I think China has the opportunity to access that marketplace,” he says for both internal consumption and export. But where will that export car go? “It maybe that it is more destine towards the developing markets rather than the mature markets, but I think there will be a flow of cars into both markets.

So what will become of China? It will no doubt become the world’s largest market in the next two decades, but will not necessarily become a major exporter like Japan and Korea, like some experts have predicted. The cars will be largely sold to developing markets, especially India, where the bulk of car volume growth will be in the next 10 or 15 years and an entry-level car may be the ticket to these nations. Talking of India, it is possibly the next place to look out for, lagging behind China by only five years.