China - an Emerging Automotive Superpower?

China － An Emerging Automotive Superpower?

Jian Sun, Vice President, A. T. Kearney

A few days before Chinese New Year this year, a report from the official "People's Daily" newspaper caused media fanfare by claiming that China had surpassed Japan to become the world's second largest automobile market in 2005. According to the report, China's domestic sales totaled 5.92 million new vehicles (including imports) compared with Japan's sales of 5.8 million units. Although there is still much debate about just how comparable the unit sales statistics are, it is quite clear that China is starting to live up to its billing as an automotive supermarket. It remains to be seen, however, whether China's indigenous carmakers will achieve the government's ambition to become global automotive superpowers.

For many multinational auto companies, China is both a dream market and a befuddling one at the same time. With only 24 cars per 1000 residents (compared with over 700 cars per 1000 residents in the United States and 120 worldwide on average), the China market is widely regarded as the largest growth opportunity for the new century. On the other hand, the China market remains a unique challenge to foreign investors. In this still highly regulated industry foreign OEMs must form 50:50 joint ventures to produce complete vehicles locally. Aside from regulatory obstacles, foreign OEMs face a very crowded market situation with many unfamiliar competitors - ranging from foreign competitors with which they have little interaction in their home markets, to ambitious Chinese entrepreneurs who started their own car assembly operations from scratch just a few years ago. It is not rare for foreign companies to unexpectedly face off against their own joint venture partners producing similar products under their own brands.

As is the case in many Chinese industry sectors, there are more brands or models in the Chinese auto market than in any other global market. Over 100 registered vehicle makers in China launched 104 new vehicle models last year alone, setting another record for this developing market. Not surprisingly, average profitability per unit has declined significantly in the last few years as competition intensified. However, it doesn't seem to have changed the determination of foreign players to invest in China - almost all the global OEMs have announced long term plans to double or triple their China production capacity over the next few years. Their mindset is captured by the CEO of one such OEM, who proclaimed: "Investing in China is risky, but not investing in China is even more risky!"

The year 2005 will be remembered as a turning point for the Chinese auto industry in more than one way. First, there was a fast change in market dynamics, characterized by Shanghai General Motors replacing Shanghai Volkswagen as market share leader in the passenger car segment for the first time in 20 years. Perhaps more importantly, however, was the impressive progress made by local Chinese OEMs. Local Chinese passenger car OEMs achieved a much higher growth rate than their joint venture peers in 2005. As a group, Chinese OEMs realized 53% year-on-year growth, almost double that of JV companies (20%), while the overall passenger car market grew at 24% annually. As a result, local OEM share of the passenger car market expanded to around 25%.

The rising of the Chinese automotive industry has been a hot topic in global auto circles for many years. In 2005, Chinese OEMs once again became the focus of attention. Chery, a local government-owned passenger car company, had a record year, selling over 180,000 units, including 18,000 units for export. This equated to an annual growth rate of over 100%, making Chery the 2005 national champion in the growth race. Geely, a privately owned car company located in Zhejiang province, flaunted its first self-developed passenger car products at the Frankfurt Auto Show in September and also in the Detroit Auto Show early this year - a confident move that shocked the industry. Enthusiasm was dampened somewhat in the same month of September when a German automotive association rated the Chinese-made "Landwind" SUV as "Not meeting European safety standards", causing the manufacturer to scramble to make modifications and introducing consumer doubt about potential design and quality issues with exported Chinese cars. However, Chinese OEMs still had a lot to celebrate as they exported more vehicles than they imported for the first time.

Yet, the developing Chinese carmakers face many challenges. First of all, most local OEMs lack significant product development capability. For a long time, most of the new products launched in China were simply local versions, or even copies, of existing models from outside China. Average R&D spending of local Chinese OEMs was around 1.5% of revenue, far below the global standard of 4-6%. In the past 20 years, China has relied heavily on joint venturing with global auto OEMs to develop its infant passenger car industry under a policy called "Trading The Market For Technology". It has successfully attracted investment from almost all the top ten global OEMs, who have also committed to introducing the latest models into the market. The downside of this policy is that it has discouraged local OEMs to develop new products on their own, as R&D typically requires heavy investment and long accumulation of hands-on experience.

Realizing that such JVs may not be the best way for Chinese auto makers to develop their product development capability, the Chinese government is revisiting the policy and calling for more self-developed products and self-owned technology. The government has urged the largest state-owned OEMs to lead the trend by establishing internally-driven product development as a high priority objective over the next five years. In line with this policy, the two largest state-owned automotive conglomerates, FAW and SAIC, have announced that internally-developed new products will comprise more than 50% of their portfolio by 2010.

However, it certainly will take much longer for local Chinese OEMs to fully develop their own products than it did to learn how to assemble vehicles. For example, it took Japanese and Korean OEMs, such as Toyota and Hyundai, almost 30 years