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Driven Are China’s car manufacturers ready to compete in the US and Europe?

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An Economist Intelligence Unit briefing paper Sponsored by Roland Berger Strategy Consultants Driven Are China’s car manufacturers ready to compete in the US and Europe?

Contents

3 Preface 4 Executive summary 6 Introduction

7 China’s carmakers: state of play 11 How will China’s carmakers compete? 21 The push and the pull to go international 23 The road ahead: up and down

26 Conclusion

© 2006 Economist Intelligence Unit. All rights reserved. All information in this report is verified to the best of the author’s and the publisher’s ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Economist Intelligence Unit.

2 © The Economist Intelligence Unit 2006 Driven Are China’s car manufacturers ready to compete in the US and Europe?

Preface

Driven: Are China’s car manufacturers ready to compete in the US and Europe? is a briefing paper by the Economist Intelligence Unit and sponsored by Roland Berger Strategy Consultants (RBSC). The report is based on interviews in May and June 2006 with car manufacturers and suppliers, consultants, and Chinese and joint-venture carmakers, as well as analyses of China’s standing in the global automotive industry. The findings and views expressed in this report are those of the Economist Intelligence Unit alone and do not necessarly reflect those of the sponsor. The Economist Intelligence Unit’s editorial team conducted the interviews, wrote and edited the report. The co-authors of the report are Katherine Peavy Sima and Graeme Maxton. The project manager and editor was Bina Jang. Our sincere thanks are due to the interviewees for their time and insights. We would also like to thank Vivian Zheng, Wim van Acker, Christian Paul and John Shen at RBSC for their contribution to the research.

Executive summary

China’s car manufacturers may not have taken the threat to domestic producers in North America world by storm yet, but will they soon be competing and Europe. The research adds that developing a successfully in the US and Europe markets? The fully integrated automotive manufacturing Chinese automotive industry has the political and enterprise will take longer than Chinese industry financial support of its government, which is executives and government officials think. encouraging automakers to develop a made-in-China • China’s automotive industry is in the vehicle and take it international. The government “intermediate” stage of development. At this wants the industry to contribute strongly to the point, China is considered an “intermediate” economy by 2010, and envisages a robust increase in country in terms of production, with a low vehicle exports from 2005 onwards that would percentage of vehicle ownership, says translate conservatively to about US$1.2bn in export autopolis, an auto industry strategy sales. China also wants China-made vehicles to hold consultancy. Autopolis charted the automotive 10% of worldwide automotive trade by 2020-35. industry by country based on the number of Quick to spot an opportunity, European and vehicles produced relative to population, and American auto dealers have begun to promote found that to succeed in the automotive China’s cheap cars in the US and European business a country needed a population of at markets, much to the alarm of US and European least 50m, a GDP of at least US$500bn and a automakers, many of which are already fending off production output of at least 2m units a year. inexpensive imports from Eastern Europe or South China makes the grade by those measures, but Korea. But is it possible for China’s carmakers to this is only because of the production volumes take on their muscular Western, Japanese and of foreign-owned firms. To succeed, China needs South Korean rivals in the highly competitive and domestic firms to produce at least 2m units per highly regulated markets of the US and Europe? year, and to have a band of independent mass- No—not yet, say automotive industry analysts, market automakers that own their technology. manufacturers, suppliers and consultants interviewed • China’s cars will initially enter the US and for Driven: Are China’s car manufacturers ready to Europe on low prices, but they will be compete in the US and Europe?, a briefing paper by the hamstrung by poor quality and safety Economist Intelligence Unit (EIU) sponsored by standards. Industry experts believe that Roland Berger Strategy Consultants (RBSC). China’s carmakers will initially enter the US The EIU report puts this opinion in perspective. and Europe markets with a price play in all Among the findings: segments—offering a low-cost car of doubtful • China belongs to the “autarkic” group of quality just to get a foot in the door. Western countries, according to one analysis. This group, consumers are used to this strategy through which includes Malaysia, Iran, India and China, their previous dealings with Japanese and has under-developed automotive sectors that are South Korean carmakers. But price alone will striving to become fully integrated. The analysis not be sufficient, and China’s cars will maintains that it will take around 10-15 years for a increasingly have to compete on brand, and to Chinese auto manufacturer to become a serious radically improve quality and safety standards.

4 © The Economist Intelligence Unit 2006 Driven Are China’s car manufacturers ready to compete in the US and Europe?

• China’s carmakers are likely to focus on companies like SAIC may have the courage and value and engines. China’s main domestic money to develop their own brands, some of carmakers are developing a range of vehicles, China’s carmakers are choosing a quicker in different segments, all with low prices— strategy to enter Western markets by buying often so low that international rivals cannot existing brands and using them as a base to build match them. Chinese firms are also keen to upon, as Nanjing Automobile has done with MG develop hybrid and fuel cell vehicles, and they Rover of the UK. This strategy encourages the have the backing of the government to do so. buying of distressed assets (such as MG Rover), All are working on new engine types and the especially as several Western automotive and government has a clear plan for their gradual auto-parts companies are ailing. Acquisition implementation over the next 15 years. would give China’s carmakers access not only to Building better engines will require China’s a target-company’s products, but also to its carmakers to ramp up their research and technical knowledge, technology and customer- development (R&D) abilities and technology. base. But such overtures by China’s carmakers Most have already begun to do so. Shanghai might also provoke a political backlash in the Automotive Industry Corporation (SAIC), for target companies’ countries of origin. one, has a venture in the UK with Ricardo • The Chinese government has put its political Engineering, a UK-based design and and financial might behind automotive engineering firm, where it develops engines exports. The central government wants auto and trains a number of its engineers. SAIC also exports to increase substantially from 2005, has access to a top-of-the-line development and China’s share of the global vehicle trade to centre through its venture with Volkswagen climb to 10% between 2020 and 2035. Towards and General Motors. that end, it is helping automakers with • China’s carmakers must develop a strategy to funding—for example, by giving low-interest become fully integrated automaking loans to Nanjing Automobile and SAIC to buy enterprises. Chinese companies own very little shares in the assets of MG Rover. The technology and rely mainly on reverse government is also introducing beneficial engineering. However, a few have moved away policies—for example, it will require from reverse engineering and begun to partner automakers to apply for export licences from with global design and engineering consultants. January 2007 onwards. This is intended to The intellectual property rights (IPRs) that result prevent undercutting on prices as China’s are then the property of the Chinese company. domestic automakers export their vehicles Domestic carmakers also are not shy about because of over-production at home. picking up management and technological skills • Foreign investors and dealers are putting from their European, US and Japanese joint- their money on China’s cars. The Chinese venture partners. In the short term, this will government’s support is being augmented by assist carmakers to bring a vehicle to market. But financing from foreign investors keen to in the long term, the reliance on outside import Chinese-made cars to Western markets. assistance could delay the development of Chery’s entry into the US is being championed indigenous design and engineering expertise. by American auto dealer Malcolm Bricklin and • It is essential to build or buy a brand. While reportedly by American investor George Soros.

Introduction

sk a European or an American about a QQ Works, now known as the FAW Group, Shanghai or a Hongqi, and the chances are they Automotive Industry Corporation (SAIC) and would never have heard of these Chinese Dongfeng Motor—have been caught flat-footed by cars. Why should they? China’s this trend. Although the three SOEs are still Aautomotive industry is nascent, and its brands strong, thanks mainly to robust partnerships with largely unknown. But two years ago China became major US, European and Japanese automakers, a net exporter of vehicles, and in 2005 sold a total they are being nudged into ratcheting up their of 172,639 units overseas, according to China’s development activities. Ministry of Commerce. And the country’s policy The good news for the SOEs (as well as the makers have even grander dreams—the 11th Five- private companies) is that the Chinese government Year Plan expects vehicle exports to jump by 40% has put its might behind the domestic automotive per year between 2005 and 2010; and the National industry. China’s automakers have been officially Development and Reform Commission expects the encouraged to develop a true made-in-China industry to grow in production capacity to an vehicle and to plunge head first into global waters. estimated 9m units in 2010, from an estimated The goal is for China-made vehicles to hold 10% of 6m-7m units currently. worldwide vehicle trade by 2020-35. This growth has been fuelled in part by strong Whether that goal is realistic or not, European government support to the automotive industry in and American auto dealers have begun to take the form of financing and policy initiatives. The notice. Looking for the next Japan or South Korea sizzling pace has prompted some auto dealers in of the global automotive industry, they have the US and Europe to predict that Chinese cars will started to tout China’s inexpensive cars to the US form the next wave of cheap imports to compete in and European markets. This has begun to worry US the US and Europe—the two world’s oldest, largest and European automakers, many of which are and toughest markets for cars. Indeed, industry riddled with financial and operational problems, experts, manufacturers, suppliers and consultants and are already beleaguered in their home turf by interviewed by the Economist Intelligence Unit for cheap imports from Eastern Europe. this report say it is not a matter of if, but when, Should they fret over Chinese vehicles taking a Chinese companies will make their presence felt in bite out of their market share? Or is the China auto the US and Europe. invasion just so much sales talk? If not, when At home private car sales have been spurred on should they reasonably expect inexpensive by China’s newly wealthy urban elite. They are an Chinese vehicles to compete with them in the US eager market for the trendy, cheap vehicles and Europe? Driven: Are China’s manufacturers offered by provincial and private upstarts like ready to compete in the US and Europe?, a briefing Chery Motor (owned by the Anhui provincial paper by the Economist Intelligence Unit, government) and Zhejiang Geely Holding (a sponsored by RBSC, aims to address these private company that listed on the Hong Kong questions and to examine what China’s automotive stock exchange in 2003). The three big state- manufacturers will offer, and when, in the US, owned enterprises (SOEs)—First Automotive Europe and at home.

6 © The Economist Intelligence Unit 2006 Driven Are China’s car manufacturers ready to compete in the US and Europe?

China’s carmakers: state of play

ho are China’s key automakers? State- still considered an intermediate country in terms of owned enterprises such as FAW, SAIC production, with a low percentage of vehicle and Dongfeng are undoubtedly among ownership, according to autopolis, an auto industry the leaders, along with a clutch of joint strategy consultancy. By charting the automotive Wventures with foreign multinational companies such industry by country based on the number of vehicles as FAW-Volkswagen, Shanghai Volkswagen, Tianjin produced relative to population (see chart, Forecasts Toyota, Beijing Hyundai, Guangzhou Honda and for the global automotive industry), autopolis found Shanghai General Motors. Then there are the fast- that to succeed in the automotive business a country moving, quick-to-spot-trends Chery and Geely. Add needs a population of at least 50m, a GDP of at least to this group provincial-level SOEs such as Beijing US$500bn and a production output of at least 2m Automotive Industry Holding, Nanjing Automobile units a year. By those standards, China clearly makes and Chang’an Automobile. Together these the grade—but only because of the production automakers create a market that is diverse and volumes of foreign firms. Until the output volumes of competitive, at least at home. local firms break the 2m mark, and until the country Of these, Chery and Geely depend on design and develops successful independent scale-driven mass engineering consulting firms to bring models to market manufacturers with their own technology, market. The bigger automakers rely on their joint China will be classed as “intermediate”. ventures, like FAW and SAIC, for example, with Consider the numbers. In 2005 the leading Volkswagen and General Motors (GM), respectively. automakers in terms of sales were joint ventures. Indeed, China’s automakers have yet to design and In the elite club were FAW’s joint ventures with build a car from the ground up. Prior to the Toyota (Tianjin-FAW Toyota) and Volkswagen establishment of the first Sino-foreign automotive (FAW-Volkswagen), which together produced a venture between SAIC and Volkswagen in 1984, sales volume of 983,000 units, according to the China’s automakers sourced their designs from the China Association of Automobile Manufacturers. Communist bloc countries. Not much has changed For their part, SAIC’s joint ventures with on that front. In fact, China’s auto companies face Volkswagen and General Motors sold 918,000 additional hurdles of intellectual property rights units. Other top automakers in terms of sales: and inadequate technological skills. Dongfeng Motor, Chang’an Automobile and On the positive side, government support counts Beijing Automotive Industry Holdings (popularly for a lot in the automotive industry—just ask the known as Beiqi). By contrast, purely domestic Japanese and the South Koreans. China’s automakers—Hafei Motor, Chery, Anhui Jianghui automakers also do not have to deal with the legacy Automobile and Geely—together posted sales of issues of the US carmakers nor the need to lay off just 724,000 units. This is less than half the staff as do the European manufacturers. Moreover, amount needed to push China’s automotive as the domestic automotive market grows, Chinese industry out of autopolis’ categorisation as an companies can benefit from economies of scale and intermediate player (see chart, China’s top ten produce even cheaper vehicles. automotive manufacturers, by sales volume). But these developments will take time. China is The trend looks set to continue for 2006, but

with joint ventures competing more aggressively. Industry experts, manufacturers, suppliers and For example, Beiqi’s joint venture with Hyundai is consultants interviewed for this paper say no. True, grabbing market share with its Elantra model, billionaire American investor George Soros may be which sold 85,400 units from January to June putting millions into Chery and SAIC, like other 2006, according to the China Association of domestic companies in China, may be reaching out Automobile Manufacturers. to the stockmarket to pick up much-needed funding But is it possible for a youthful company like for expansion. But even with injections of funds, Chery (barely 10 years old) or a staid company like and the best of intentions, the 11th Five-Year Plan’s SAIC (that for 20 years has depended heavily on ambition for China’s automotive exports to jump by foreign partners for its production and market 40% per year between 2005 and 2010 looks wildly growth) to compete anytime soon against bigger optimistic under current conditions. international players in the hyper-competitive, More possibly, it will be between 2012 and 2015 highly regulated auto markets of the US and Europe? that Chinese vehicles will start to become a force

Forecasts for the global automotive industry, 2004 GDP (US$bn) 10,000

Japan

Germany France UK China

Canada Italy 1,000 Mexico Brazil Spain India 500 Belgium Australia South Korea Russia Turkey Poland Sweden Malaysia Argentina Thailand = independent mass market manufacturers 100 Czech South Africa Iran = branch operations Hungary Romania = intermediate

= 2m units

10 50 100 Total population (m) 1,000

Source: autopolis

8 © The Economist Intelligence Unit 2006 Driven Are China’s car manufacturers ready to compete in the US and Europe?

China’s top ten automotive manufacturers, by sales volume: in the fast lane 10,000 units % Sales volume, 2005, left axis Growth, 2005, 100 98.3 Sales volume, Jan-March 2006, left axis right axis 120 91.8

Growth, Jan-March 2006, 100 80 right axis 72.9

63.1 80 59.7 60

40 40 31.1 23.7 23 26.1 18.9 20 21.3 15.4 15.1 20 20.1 17.3 5.9 7.5 7 4.6 5.2 0 0

omobile omobile China First Hafei Motor omobile Chang’an Auto Aut Dongfeng Motor Works (Beiqi) Chery Automobile Anhui Jianghuai Beijing Aut Automotive WorksShanghai Automotive Geely Holding Group Industry Corporation Guangzhou Aut Industry Group (Guangqi)

Source: China Association of Automobile Manufacturers

Automotive strategies of countries: highs and lows

Core countries (Examples: US, Germany, France, Japan) Fully integrated companies, producing vehicles 100% designed, manufactured, distributed, marketed in-house Solid branding and after-sales service programmes Limited government support Automotive industry accounts for 10.5% of GDP, and health of industry is considered an economic indicator. Peripheral countries (Examples: Canada, Turkey, Australia, Mexico) Large industries, but companies involved are controlled by companies from the core group. National policy does not control the fate of the industry Automotive industry accounts of an estimated 9-10% of GDP Networked countries (Examples: Indonesia, Thailand, South Africa) Industry adds value to blueprints of the core countries, but is not manufacturing Automotive industry accounts for an estimated 5-7% of GDP Autarkic countries (Examples: China, India, Malaysia, Iran, South Korea) Government takes active role in development of the industry via subsidies, loans, preferential policies Companies ultimately owned by the government of car industry seen as a national patriotic goal as well as an economic incentive Automotive industry accounts for an estimated 7-8% of GDP

Source: Time for a Model Change, Maxton Wormald, Cambridge University Press 2005

in the advanced export markets. That is, it seems value. more likely that Chinese firms will follow the The third group, the networked countries, are pattern of the Japanese and South Korean like the peripheral ones except that they add some carmakers. They will launch an assault on value. They build particular sorts of vehicles or developed markets in the next few years, meet have their own designs, but still depend almost fierce resistance (even trade barriers) or find a entirely on the companies in the core markets. lukewarm response from consumers, think again This group includes countries like Thailand, which and then come back with much more competitive specialises in pick-ups; Indonesia, which has products or some way around any political hurdles developed the Kijiang commercial cars; and South several years down the road. Africa, which focuses on the production of right- In their 1994 book, Time for a Model Change: Re- hand drive vehicles. engineering the Global Automotive Industry, The final group is the most interesting, the Graeme Maxton and John Wormald explain that autarkic countries. These have under-developed the government’s heavy hand in the automotive auto sectors but intend to become core. These industry is just one strategy countries take in countries want to join the elite club of countries managing an industry that accounts for a that have a fully integrated auto sector—countries significant portion of GDP and becomes an such as Malaysia, Iran, India and, of course, China. advertisement for the nation in overseas markets. This group arguably still contains South Korea, as Countries broadly are divided into four the country remains dependent on foreign categories—core, peripheral, networked and technology and may yet be squeezed from the autarkic (see chart, Automotive strategies of industry as lower-cost producers move into countries). Core countries are those that have a Hyundai’s territory. The question for the next fully integrated auto industry. They have all the decade is which of these countries will succeed in technologies needed, as well as their own mass- their goal and which will be relegated to being market manufacturers selling under their own peripheral or networked. brands with the capability to cover the entire value Looking at this group, it is not too difficult to chain. After 100 years of the industry there are imagine which countries could make a leap into only a few countries in this group: the US, Japan, the group of core countries. Nor is it difficult to Germany and France. It arguably might contain see that it will take time. South Korea, even with Italy and South Korea, too. Ten years ago it government assistance, has taken 30 years just to contained Sweden and the UK, but these countries have its brands recognised in the US and Europe. have now been dropped, says Mr Maxton, who is Based on their research, Mr Maxton and now regional director of the Economist Mr Wormald suggest that India might succeed, but Intelligence Unit’s Corporate Network, and a that “China will clearly become a core country”. director of autopolis. But they also believe that it will take around 10-15 The second group, the peripheral countries, years for a Chinese auto manufacturer to become a often have very big auto industries—countries like serious concern to domestic enterprises in North Canada, Spain, Mexico and Brazil. But they are all America and Europe. Developing a fully integrated satellite manufacturing operations controlled by automotive manufacturing enterprise will take firms in the core countries. The carmakers in Brazil longer than Chinese companies think, they add little brand, technological or intellectual predict.

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How will China’s carmakers compete?

o what must China’s carmakers do to branding and customer service. They will also need compete in the US and Europe with any real to cater to the different buyer needs in each chance of success? Looking to the Japanese market—consumers in Europe tend to value brand and South Koreans for tips on entering the more than their US counterparts. Stephen Clarke, SUS and European markets will only help a little. This Shanghai-based executive vice-president of Ricardo is because both markets today are fundamentally Engineering, believes Chinese carmakers are aware different from when they were first assaulted by the of the challenges of the US and Europe, and will Japanese or South Korean car companies. Then, the develop their position by first exporting to Russia, markets were growing but competitively stable. the Middle East and South-east Asia for a few years. Today, they are mature and competitively volatile, and a battleground for some of the biggest names Selling at low prices is first step among US and European carmakers, many of which As they advance, the Chinese are likely to focus first are struggling to survive. As such, there is likely to on two things: value and engines. The intertwined be a political backlash against Chinese (and other) issues of quality, brand and technology should carmakers driving into their markets. If companies follow. The main indigenous carmakers in China are like Ford and GM of the US are on the edge (or over) developing a range of vehicles, in different of filing for Chapter 11 and Chinese carmakers start segments, all with low prices—often so low that cutting their share further, Washington may be international rivals cannot match them. Despite compelled to intervene. their lack of economies of scale, the carmakers The US and Europe will be tough markets for appear to be defying the laws of automotive China’s carmakers—tougher than the domestic economics, which suggests that there is at least market where many consumers are buying their some sort of cross-subsidisation going on. first car. China’s carmakers in the US and Europe Shanghai Maple, for example, is selling cars for less will compete against mature competitors and than the market value of the steel that goes into mature consumers for a piece of a finite pie. This is them. Competition is most likely to come from a different exercise from exporting to the Middle South Korean firms, which also seem able to sell East, Russia, Africa and South-east Asia, the cars below cost; from companies like Renault with current destinations of China’s cars. Consumers in its low-cost Logan model; and from other Chinese the current export markets, like those in China, firms. However, China’s carmakers do not expect see price as an important factor in the buying much competition in the US or Europe from their decision. (Value is important in the US, but not to counterparts from India—another “autarkic” quite the same extent.) Moreover, unlike the US or country. The reason? Cheap Indian-made cars— Europe, most of these export markets have no such as the Tata group’s US$2,500 model, which is intrinsic automotive industry, and have lower to be launched in 2008 and will be engineered to national regulations on quality and safety. this price, not subsidised, will be targeted at To make headway in the developed markets, consumers in India and other developing China’s carmakers will need to grow quickly and economies. They are not likely to meet US or have internationally competitive marketing, European safety or emissions regulations.

Neither will most of China’s cars. Industry start, they risk a political backlash in the US and experts believe that China’s carmakers will initially Europe if they sell below cost (if they are subsidised enter the US and Europe markets with a price play as indeed they may be). Moreover, depending on in all segments-offering a low-cost car of the price range, China-made cars will also be questionable quality just to get a foot in the door. competing with used cars from established Western consumers are used to this strategy automakers. Consumers can choose between a new through their previous dealings with Japanese and car of unknown brand and quality, or a used Toyota South Korean carmakers. or Volkswagen—both known for their good value Moving forward, however, China’s carmakers will and long life. China’s carmakers will increasingly not be able to rely on price advantage alone. For a have to compete on brand, and therefore on quality

Snapshot of some of China’s carmakers

Pricing Branding international markets have no frame of Chery. It made its name on the low-priced, Chery. Mr Bricklin told interviewers that reference for these brands, which already economy subcompact QQ model. But it also his strategy is to upgrade the interiors and have a long history. makes economical sedans for the China engines to compete with the BMW3 and market and commissioned the design of a BMW6 series, but at a much lower price. If Quality sports car from Italian design firm Bertone. interiors and engines alone can make the Most of the domestic carmakers have Yet, even Chery’s biggest supporter in the brand, then Mr Bricklin might have a for- started sourcing from multinational sup- US, Malcolm Bricklin, has said that China mula. For its part, Chery is said to be still pliers in order to upgrade their quality. prices will not translate to the US. He said trying to understand the US and European Herbert Qi of Altair Engineering, a product that safety and quality upgrades would put markets. The company has ventures start- design and engineering consultancy, says Chery cars in the same price range as ing up in Malaysia and Russia, which would a number of domestic manufacturers are Hyundai models (US$10,000-16,000). give Chery cars a firmer footing in the using his company’s software and consult- Shanghai Automotive Industry international market. ing services to enhance their R&D capabil- Corporation. SAIC will likely enter foreign Nanjing Automobile. It plans to cash ity. Key Safety Systems began supplying markets with a mid-priced brand of quality, in on the power of the MG Rover brand, but airbags to Chery earlier this year, and is but perhaps in 15-20 years’ time, says Tang the extent of the brand's decline is yet to purported to have other domestic enter- Weiyan of the Shanghai Automotive Trade be determined. Nanjing Automobile says it prises on their customer list. Association. Industry insiders familiar with has a strategy to re-launch the brand, but FAW, SAIC and Dongfeng Motor are SAIC say the company is not interested in has not released any details as yet. likely to have learned the most in terms of going the “cheap” route, and it is not clear Reviving an old, beleaguered brand could quality control and R&D through their joint yet if the Rover models will be the basis for be more expensive and difficult than ventures. SAIC still cooperates closely with SAIC’s own brand. establishing a new one. its joint-venture partners, Volkswagen and Shanghai Maple. New carmakers, like First Automotive Works, SAIC and General Motors, and two decades of this Geely subsidiary, apparently can break Dongfeng Motor. For these three, the engineers have come through the ranks even by selling only 8,000 units per year. stakes are higher in entering foreign with positions in these two companies. Perhaps the lack of legacy costs for these markets because their brands are well- They are bringing that experience to SAIC’s new players will give them a helping hand. established at home. Any failure in the own vehicles. But without experienced staff, they would international markets could affect the lag in research and development. brands at home. By comparison, the

12 © The Economist Intelligence Unit 2006 Driven Are China’s car manufacturers ready to compete in the US and Europe?

and technology. John Humphrey, managing leap to a new technology can be less burdened by director of the Asia-Pacific operations of JD Power, legacy issues for the long term. puts it clearly: “Price alone will fail.” Building better engines requires China’s carmakers to ramp up their research and Building better engines development (R&D) capabilities and technology. Some of China’s manufacturers may have come to Most have already begun to do so. SAIC has a the same conclusion. Despite its rather stodgy venture in the UK with Ricardo Engineering, a UK- image, FAW seems to have kept pace with the based design and engineering firm, where it green-friendly trend by developing a hybrid produces engines and trains a number of its engine for its Hongqi brand. Another FAW vehicle engineers. SAIC also has access to a top-of-the- in May 2006 moved stealthily into the US market line development centre through its venture with with 60 units of a zero-emission electric car. The Volkswagen. FAW-Hongta MPV has been built by FAW-Hongta Chery has reportedly purchased premium- Yunnan Automobile Manufacturing, a FAW quality equipment, software and hardware for its subsidiary, and is reportedly being marketed in the R&D facility. Meanwhile, Nanjing Automobile has US by Miles Automotive Group. the support of the Jiangsu provincial government Chinese firms are keen to develop hybrid and to develop its R&D centre based on the Rover fuel cell vehicles and have the backing of the production line, with former Rover staff central government, provincial governments and overseeing training and quality. Nanjing universities. All are working on new engine types Automobile's president, Yu Jianwei, says the and the government has a clear plan for their company expects to spend Rmb2bn (US$250m) on gradual implementation over the next 15 years. a five-year programme to kick-start R&D. This is being done for two reasons. First, it allows That’s not a whole lot of financing, considering China to limit the amount of oil it has to import. the design, engineering, testing and tooling of a Second, it offers the chance for Chinese firms to prototype costs an average of US$500m. About leap-frog some of the global companies who have 80% of a vehicle’s cost is determined in the phases lagged in the development of these technologies prior to production, notes John Humphrey, despite the rhetoric put out by their public- managing director of the China operations of JD relations departments. Power and Associates, a leading US automotive Industry experts point out that certain research company. This may be money that China’s manufacturers in Europe and the US (Volkswagen, carmakers are neither prepared nor able to spend GM and Ford, for example) have developed fuel pre-production. cells, hybrid engines and all-electric engines, but Hence the Landwind affair. Jiangling Motors, a they have realised that it will require too many Jiangxi-based automotive producer tried to export changes in their traditional markets to use the new its SUV model to Europe in 2005, the Landwind, via technologies cost-effectively. Moreover, they have a Belgian dealer. German authorities put the a vested interest in maintaining the status quo, vehicle through a required safety test that it failed having invested so much in traditional miserably. Herbert Qi, who is based in the technologies. China does not have the same Shanghai office of Altair Engineering, a product issues. Since its automotive infrastructure is less design and engineering consultancy, speculates ingrained than those in the US and Europe, the that Jiangling may not have been able to finance

the expensive safety test itself, and had hoped vice-president of Jiangyin Venture Interior that the vehicle would pass muster. Safety tests Systems, a Shanghai-based designer and producer cost hundreds of thousands of dollars, and China’s of interiors for automobiles, says China’s carmakers, under no obligation to conduct the carmakers lack attention to detail, have no tests at home, may not do so, if only to contain concept of intellectual property rights and want to costs. If they are to develop a vehicle with a quality reverse engineer everything. Still, there are a few acceptable to international consumers, China’s companies that have moved away from reverse carmakers need to invest in pre-production, but engineering and begun to partner with global this is an issue most have not wanted to face. design and engineering consultants. The Chinese companies own very little technology— intellectual property rights created then become they usually rely on reverse engineering or the property of the Chinese company. In fact, “borrowed” intellectual property (IP). Cherry Chu, many China-built cars destined for overseas

Shanghai Maple: going places

It may still be half under construction but institute with Shanghai Jiaotong University volumes. After all, say the company’s Shanghai Maple’s car plant, about two which is looking into hybrids, and entered managers, who would be mad enough to hours’ drive from Shanghai, is a hive of its cars into the Shanghai stage of the export vehicles if they encroach on activity. Cars roll off the production line National Rally in 2004, taking first and another firm’s IPR and would invite their steadily, while machines grind parts and second place. The cars drive well and the wrath in countries where IPR laws are trucks deliver steel sheets and tyres. well-qualified workforce is highly dedicated stronger? Maple exported 800 cars in Part of the independent Geely group, the and ambitious, determined to move the 2005, mostly to the Middle East where the company was only formed in 1999. It company forward. Hysoul sells for just US$6,500. The launched its first car less than two years ago Of course, experienced China-watchers company’s export manager says that this is and annual sales reached 25,400 cars in will scent the whiff of counterfeiting in only the beginning and that it plans to 2005, up 143% on the previous year. Maple Maple’s meteoric rise. French carmaker raise the volume quickly. But he also plans to more than double that in 2006 and Citroën is currently suing the company for points out, sensibly, that Maple wants to needs to expand. With three different car infringing the design of its chassis and move carefully and learn the ropes, not models, a hybrid in the pipeline and a when asked where the production line rush in and blow its chances. It will take a claimed breakeven point of only 8,000 cars came from, one senior executive from the few more years before they are ready for a year, Maple is already making money, it company told us that “it is based on a the main markets, he says. These would says. With such progress, could Maple teach French production system”. The new presumably include the US and Europe. the mighty Toyota a thing or two about the engine also had to be developed after The Maple story is not just remarkable economics of carmaking? Toyota sued the company for intellectual for the pace of development or the Maple’s new Hysoul 305, launched at property rights (IPR) infringements over company’s determination to succeed, the end of 2005, certainly seems the previous one. Toyota has also been in however. If it is able to make money with impressive. With air-conditioning, leather dispute with Maple’s parent Geely over the such small production volumes, sell them seats, power steering, anti-lock brakes, and use of its logo. for such low prices and do that overseas a 1.8-litre Maple-designed petrol engine, it Maple says that it has put the IPR too, Maple appears to be changing the costs just Rmb70,000 (US$8,750) in China. problems behind it and that its latest rules of the game—that a carmaker has to It even comes with a two-year warranty. vehicles are entirely self-developed. As be big to succeed and that cars can't be The company also boasts a research proof it offers its small but growing export made at such prices.

14 © The Economist Intelligence Unit 2006 Driven Are China’s car manufacturers ready to compete in the US and Europe?

SAIC: in top gear?

Fuelled by ample money, ambition and lost out to Chinese carmaker Nanjing in no rush, he says: “We want to go to the government support, Shanghai Automo- Automobile in a bidding war for the use of international market with a good product tive Industry Corporation (SAIC), one of the MG Rover name and production facili- even if it takes longer than companies like China’s biggest automotive companies, is ties (see case study, Nanjing Automobile: Chery and Geely.” striving aggressively to achieve global was buying MG Rover a bold or foolish It is also unclear how much SAIC will competitiveness. move?). SAIC’s plan to buy the Rover benefit from the Rover brand. The Rover The company is hoping to enter the brand name from BMW has come unstuck, name may still have some cachet in China, international markets by leveraging major as Ford, which purchased the Land Rover but the brand’s value has taken a beating well-known, though ailing, brands. It brand about a decade ago, announced in in the UK. Building and reviving the brand wants to start domestic production with, September that it would exercise its name will require sales and marketing and later export, major automotive brands. option to buy the Rover brand name experience and savvy-areas in which SAIC Towards this end, it has bought a majority instead. is weak. stake in Ssangyong of South Korea and the It appears less likely now that SAIC will It also lacked executives with rights to the MG Rover car in the UK. Will be able to use the brand name as this international experience, although that is SAIC’s strategy succeed? would require getting permission for use or now changing. For example, SAIC has hired Certainly both deals have faced licensing from Ford. Nevertheless, each Mr Murtagh and as vice-president Wang problems right from the start. The step brings SAIC closer to rolling its own Dazong, a former chief engineer and agreement to produce Ssangyong sports brand off the manufacturing lines-SAIC's designer with General Motors who was utility vehicles (SUVs) in Shanghai fell Rover 75-based model is expected to hit born in China but educated in the US. through, although SAIC exports other the streets in China, and possibly in the Moreover, SAIC’s president, Chen Hong, vehicles through its shareholding in UK, by late 2007 or 2008. speaks fluent English and some German. Ssangyong. By that yardstick, SAIC seems to be in a Moreover, soon after SAIC increased its strong position. The company’s joint Trying hard shareholding in Ssangyong to 51.33% in ventures with General Motors and But while the joint ventures with General July 2006, the latter’s workers went on Volkswagen have given its engineers and Motors and Volkswagen have brought strike for two months to protest at an managers exposure to international money and exposure to international arrangement in which SAIC paid only quality and design capabilities. Additional manufacturing and management, SAIC has US$26m to license technology from exposure comes through a company some way to go. In the short term, Mr Mur- Ssangyong. SAIC hired Phil Murtaugh, a started by UK engineering consultancy taugh’s first task is to help turn around the former head of General Motors China, to Ricardo to work with SAIC to develop Ssangyong brand, rather than assist in the lead international development. His brief engines and drive trains for the Rover development and marketing of a SAIC- included sorting out financial and labour models. branded automobile. In fact, the company issues at the SUV manufacturer, along with Nonetheless SAIC faces certain has yet to decide on a brand-name, driving SAIC’s outward push. obstacles. Tang Weiyan, a former SAIC although it did have its own Shanghai engineer and current secretary of the brand before 1949.Asks SATA’s Mr Tang: Deal with MG Rover Shanghai Automotive Trade Association “Wouldn't you like to drive a Shanghai The deal with MG Rover was also compli- (SATA, a SAIC subsidiary), says the brand car?” It may be some time before EU cated. Although SAIC obtained the design company's weaknesses include a lack of and US consumers get the chance to and property rights for the Rover 25 and research and development skills and respond, but it seemingly won't be for Rover 75 in early 2005, it subsequently international sales experience. But SAIC is want of trying on the part of SAIC.

Nanjing Automobile: was buying MG Rover a bold or foolish move?

In the UK, Rover is a popular name for a easy to believe that he can make Nanjing triple its own sales to more than US$2.5bn dog. It is also the name of one of the coun- Automobile succeed with Rover, where over the next three years by tripling out- try’s most famous carmakers, MG Rover. In Rover itself and BMW (which once owned put. Why does it want to bother, though, 2005, after years of strife, the company the long-struggling business) have failed. in this tough global business, where there finally went bankrupt and many of its Only Mr Yu’s closely bitten finger nails give is so much over-capacity and so few com- assets were sold to China’s Nanjing Auto- away the perilous nature of his undertaking. panies making money? mobile (Group) for £53m or US$93m at Nanjing Automobile has been in Mr Yu is quite clear why. He has been current rates (some reports say the selling business since 1947 and is the leading explaining why in great detail for many price was £67m). vehicle producer in China’s Jiangsu months, to convince his shareholders to It was a controversial sale, hampered by province. With assets of US$1.4bn, it stump up the money. He says it is because, battles over production rights, brands and currently has the capacity to build 180,000 like everyone else, Nanjing Automobile can property. Despite all this, Rover’s new vehicles a year under three brands: Nanjing see the size of the market opportunity. It owners think they have made a wise Yuejin, Nanjing Iveco and Nanjing Fiat. can see the growth prospects that the car investment. Can Nanjing Automobile finally Output will be about 130,000 units in 2006 sector offers in China. Moreover, he thinks turn this old “dog” into a viable business? and the product line-up is broad. With more that the growth potential for cars is much Yu Jianwei certainly thinks so. As than 400 models, the company builds better than the company's main market president of Nanjing Automobile, he has passenger cars, light-duty trucks and today. The bulk of Nanjing Automobile’s convinced his state-owned company’s buses, cross-country vehicles, small-sized current sales come from small trucks sold shareholders that they should invest in a passenger/cargo transportation vehicles to farmers. state-of-the-art factory on a 300,000- and special-purpose vehicles, as well as But why not work more closely with Fiat square-metre greenfield site in Pukou, on various types of chassis. Like every other of Italy, its partner in the car sector for the the outskirts of the city. Production of foreign vehicle joint venture in China, the last seven years? Surely, that would have cars, using Rover technology, is due to Nanjing Iveco and Nanjing Fiat businesses been a lot easier than taking on a bankrupt start in mid-2007 and within a few years are 50:50 operations, which were formed in British firm? Mr Yu is polite enough not to the plant hopes to churn out up to 200,000 1996 and 1999 respectively. point out that, after so long a working vehicles annually, as well as 250,000 arrangement with Fiat, sales of its cars engines and 100,000 gearboxes. Why Nanjing Automobile bought Rover have barely reached 45,000 units a year— Nanjing Automobile will export half, or The Rover acquisition is therefore a step, in a market with potential for 2.6m. He more, of these cars while others will be but not too big a step, for the company. explains, instead, the company’s desire to assembled in the UK in order to retain the Rover was roughly similar in size and used go it alone. “When you are in a marriage, it brand’s claim to British-ness (the technology that was more advanced, but is always necessary to consult your prototypes, currently driving around not much more advanced, than Nanjing partner,” he says. Nanjing Automobile Nanjing’s streets, still sport the British flag Automobile. It is the plans Nanjing Auto- wanted control of its business and with the on a small panel by the rear doors). mobile has for the business that make the purchase of Rover has now got it. Mr Yu’s well-tailored suit, good English move so bold. By taking over the British There were other reasons, he explains. accent and unflinching enthusiasm make it company, Nanjing Automobile’s expects to This is a tough business and Nanjing

Automobile lacked scale and technology. that both firms would be able to produce access technology and designs, for There has been pressure from the the same car and sell it under different example, with Ove Arup of the UK. authorities in Beijing for the Chinese auto brands, locally and overseas. This has led Components will come initially from the sector to consolidate. If Nanjing to even greater friction between SAIC and original suppliers in the UK as well as in- Automobile had not bought Rover, it might Nanjing and to the threat of court action. house. These will be upgraded steadily, have had to close. The option was to either SAIC has even demanded that Beijing force with parts increasingly sourced from many invest or die. Rover was analysed very Nanjing Automobile to merge with it, to no of the international OEMs (original carefully, says Mr Yu, and its platforms and avail so far. equipment manufacturers) that have technology looked at. Rover offered established factories in China. vehicles and technology in several Will Rover-based cars sell? segments as well as engines. They bought Somewhat bizarrely, neither firm has Risks and opportunities it, not because it was the only car company acquired the rights to use the Rover brand Will Mr Yu achieve his goals? That is diffi- available, but because Rover's capabilities itself. This was retained by BMW when it cult to say. Nanjing Automobile has come matched those of Nanjing Automobile. sold the business to Phoenix, the manage- a long way in understanding the complex- “Now,” says Mr Yu, “we are big enough to ment buy-out team which first acquired ity of the car industry and the needs of for- grow and survive.” MG Rover and then sold it to Nanjing Auto- eign buyers in a very short time. But Nanjing Automobile fought hard for mobile. doubts remain. The Rover 75 model, by far this. Until recently there had been Regardless of the brand, will Rover- the newest in the line-up, is old and no pressure from the central government for based cars sell? The MG7 will use amount of face-lifts will hide that. The the company to be consolidated into technology that is already almost ten years Rover brand is also badly tarnished. The Shanghai Automotive Industry Corporation old. When it was withdrawn from the UK in dealer network has mostly gone and, given (SAIC), easily China's strongest 2005, it was viewed as an ageing and the company's history, few dealers are automaker. To avoid this, Nanjing increasingly unremarkable car, with sales likely to show much enthusiasm to sign up Automobile’s shareholders were changed, declining as rivals launched contemporary again. with the ownership of Nanjing Yuejin designs. Yet the build-quality was good, Before it went bankrupt MG Rover had transferred to the Jiangsu provincial remarkably for MG Rover, as every other car achieved an almost comic status in its government. This made the widely it produced lay near the bottom of the home market and had been forgotten anticipated merger “almost impossible”, Automobile European league tables. elsewhere, often with a sigh of relief. according to Jia Xinguang, an analyst with Still, Nanjing Automobile will need to Labour problems, financial problems, the China National Automobile Industry invest. It plans to spend Rmb2bn antiquated technology, outdated designs Research Institute. (US$250m) over the next five years to and poor quality had dogged the business But it may also have made SAIC more upgrade products. It is building a for the best part of 30 years before it went hostile. Before Nanjing Automobile technology centre where it will develop belly-up. acquired Rover, SAIC had bought the rights new models. It is hiring internationally It is a tough call. Nanjing Automobile and plans to build the Rover 75 model. and has transferred 20 staff from might have found the fast track for success When Nanjing acquired the business it Longbridge, the UK, to Nanjing, including in its purchase of Rover. But it might also acquired the tooling and production MG Rover’s director of quality. It will also have bitten off a lot more than it can chew. equipment for the same model. This meant seek more international co-operation to

markets have been designed by either Pininfarina markets has been to buy existing brands, and use or Bertone, with engineering firms like Ricardo those as a base to build upon, as Nanjing providing support on the engine and powertrain. Automobile has done with MG Rover of the UK (see So what is being billed as a Chinese car is more case study, Nanjing Automobile: was buying MG accurately an product of co-operation among Rover a bold or foolish move?). Although Nanjing Italian, British and Chinese companies. Automobile has not acquired the rights to the MG Domestic carmakers are not shy about picking up Rover brand (that is still retained by BMW, see case management and technological skills from their study) it will be able to use this and other brands. European, US and Japanese joint-venture partners, The products to be re-launched in 2007 will all be as FAW, SAIC and Dongfeng have done. All three sold with the MG brand initially. The Rover 75 will companies have multiple partnerships with global be re-born as the MG7, for example. But the companies from different countries that have not company also has the rights to use the Wolseley, only given them a chance to learn, but have also Austin, Morris, American Austin, Princess and exposed them to international automotive-industry Sterling brands, as well as Vanden Plas outside the consultants, and to engineering and design firms US and Canada. The company could also use its like Ricardo, and Pininfarina and Bertone of Italy. own Yuejin and Soyat brands. Phil Murtaugh, former chief executive of the GM As far as Nanjing Automobile is concerned, it China Group, says Chinese companies “have a believes it already has access to the MG Rover tremendous capacity to learn”. Mr Murtaugh market and intends first to target the 150,000 recently took a position with SAIC as executive people who bought Rover cars in the year before MG president of overseas manufacturing. Rover went bankrupt. “If we don't get [this market] In the short term, manufacturers can bring a now, we will lose it,” says Yu Jianwei, Nanjing vehicle to market in this manner. But in the long Automobile’s president. This market is 90% in the term, the reliance on outside assistance could UK. The question is: how will traditional Rover delay their own development in design and buyers—mostly middle-aged, middle-Englanders— engineering. To move into the group of core respond to a Rover made in China? Mr Yu points to countries, China’s manufacturers must develop a the brand’s 100-year history, adding that this is strategy to become fully integrated original also the reason behind Nanjing Automobile’s equipment manufacturers (OEMS). decision to keep an assembly operation running in the UK. Even if it is making small numbers of cars Building or buying a brand and most of the components come from China, he That includes building a brand. In this aspect, believes that this will be enough for the company to Ms Chu considers SAIC to be “very smart” and to sustain the claim to its British heritage. “Of course,” have “the guts, money and exposure to develop he says, “quality and service will need to be more their own brand”. Tang Weiyan, executive vice- competitive than before.” But he thinks it is chairman of the Shanghai Automotive Trade possible to retain MG’s brand values with the right Association, an industry lobby group connected to level of customer support. SAIC, hints that SAIC will maintain a low profile and observe other companies, even as it develops its Other plays own brand. The buying of distressed OEM assets (such as MG Another (quicker) strategy to enter Western Rover) is a trend that is likely to continue, especially

Chery on top?

Chery Automobile, China’s largest wholly Intelligence Unit on the issue. Industry executives in China are keenly domestic carmaker, is believed at home How realistic are Chery’s supposed aware of the initial failure of Japanese and to be the one most likely to succeed. Cer- export ambitions? In a June 2006 South Korean automakers’ exports to the tainly of China’s carmakers it has interview with New Capital News, a Beijing- US and Europe, and of the spectacular attracted the most international atten- based newspaper, Yin Tongyao, Chery’s failure of the Yugo, a much maligned tion. In June 2006, the buzz in the auto- general manager based in Anhui province, made-in-Yugoslavia car that Mr Bricklin motive industry was that George Soros, said he expected Chery to export about imported to the US in the 1980s. China’s the American billionaire investor, 10% of its overall sales in 2006, or about automakers would hardly risk taking any planned to invest US$200m in a joint 20,000 vehicles. It would be a huge leap steps that would relegate their brands to venture with Chery to manufacture vehi- for Chery in the next few years to export the same historical heap as the Yugo. cles in China and distribute them in the 250,000 cars to the US (as Mr Bricklin has “Chinese companies are well aware of US. At the time of printing, neither Mr claimed) from such a small export base. what's at stake,” says John Humphrey, Soros nor Chery had commented on a Moreover Chery’s annual production managing director of the China operations report to this effect carried in Automotive capacity is only 350,000 vehicles. Last of JD Power and Associates, a leading US News, a specialist publication. year, the company exported a mere 18,000 automotive research company. Mr Soros’s millions, if they are units, mainly to Egypt, Malaysia and Syria Indeed, despite Chery’s ambitious forthcoming, should give a fillip to (its largest export destination). It appears plans, it is still developing sales and after- Chery’s much-talked-about proposed unlikely that Chery will rush into more sales service knowledge in the domestic exports to the US. Chery already has a developed markets before the company market, and has not really tackled 2005 deal with Visionary Vehicles, an deems itself ready. Mr Yin outlined the international service standards yet. Mr Yin auto-distribution company led by US company's growth strategy as focusing told New Capital News he expects Chery to entrepreneur Malcolm Bricklin, to import initially on Russia, the Middle East and rank seventh in sales in China in 2006 and 250,000 Chery vehicles into the US. The Latin America before tackling the US and third by 2007. It expects to do this by starting date keeps changing, however. Eastern Europe. But he did say plans have keeping prices low-the strategy by which it Initially set at mid-2007, the deadline has not changed to enter the US market. has increased market share by double digits now been reportedly pushed back to It is evident why Mr Bricklin and Mr over the past three years. However, in sometime in 2008. Soros (and other investors) could be developed markets like the US and Europe, Chery has not commented on the attracted by Chery-it has shown meteoric “price alone will fail,” notes JD Powers' Mr deadline, but also in June 2006 issued a growth in its home market. But Chery Humphrey. Customers in those markets statement that it hoped to keep a low enjoys a favourable climate in China. would demand more from their carmakers, profile on its globalisation strategy. “We Regulations on emissions and quality are including customer service, warranties, think we are still at a very, very initial stage lax, and price-conscious customers don't reliability, safety and gas mileage to name of establishing overseas capability. We do mind a lower quality if they can get a lower a few. China’s carmakers are way behind in not even know the potential risks on that price. Chery would not be unable to such aspects-for example, customer road clearly. Therefore Chery management replicate its popularity at home with the warranties in China are typically only for is not willing to talk publicly,” the more demanding consumers in the US and two years, a far cry from the warranties of statement said. “The recent reports about Europe. Keep in mind that for 85% of five and ten years expected by customers in Chery are completely released by our China’s car buyers, this is their first the US. Chery has not been required to deal partners or potential partners in the US, purchase of a car. As such, Chery remains with these issues yet, but it will have to do which are not from our will [sic].” Chery untested in terms of customer better than a low price to compete in the declined an interview with the Economist expectations. developed markets.

as several US and European automotive and auto- joint venture with Chery to produce vehicles in China parts companies are looking wobbly. There are a few and distribute them in the US (see case study, Chery possibilities: Fiat in Italy, Ford in the US, Lada in on top?). Chery already has an agreement with Russia and Proton in Malaysia. For China’s carmakers, Visionary Vehicles, owned by Malcolm Bricklin, a acquisition would give them access not only to the controversial American entrepreneur who is hoping target-company's products, but also to its technical to lead Chery’s charge into the US. The agreement knowledge, technology and customer-base. The between Visionary Vehicles and Chery, rumoured to problem is that overtures by China's carmakers to buy involve investment of US$200m, provides for annual stakes in these (and other) companies could arouse sales of up to 250,000 Chery cars to the US by late political ire in their countries of origin. 2007 or early 2008. Besides these avenues, China’s carmakers can Where to get the money? turn to the stockmarket for funding. For example, Building a prototype, building a brand, competing SAIC has plans for an overseas listing in late 2006 in overseas markets—all these require financing. or early 2007. Its subsidiary, Shanghai Automotive Fortunately for China's automakers, most of which Company, is already listed on Shanghai's stock are state-owned, the central government is giving exchange. Getting access to global quality a strong push to the industry, and is helping with standards is also an avenue increasingly open to finance (see section, The push and the pull to go Chinese carmakers in their efforts to develop, as international). Both SAIC and Nanjing Automobile global parts companies ramp up production locally. (which plans to spend Rmb2bn over the next five Global manufacturers report that sourcing years on product upgrades) received low-interest materials and components in China has proved loans from the government to buy their shares in costlier than expected and so they welcome the the assets of MG Rover of the UK. The smaller Geely additional volumes that Chinese carmakers offer. has also benefited from government sponsorship— The presence of foreign Tier one and Tier two the town of Cixi, in Zhejiang, where Geely is suppliers in China provides an opportunity, as they located, approved a US$2.4m loan for the carmaker can leverage the technology and skills of these to build a 200,000-units per year plant nearby. suppliers to improve areas in their own production. Financing has also come from foreign investors Suppliers like Arvin Meritor of the US and Magneti willing to import Chinese-made cars. There's talk of Marelli of Italy reportedly have also begun to American billionaire George Soros' investment in a supply to Chinese automakers including Chery.

The push and the pull to go international

t first glance, moving forward seems easy detail regulations and requirements of overseas for China’s automakers. Exports are markets. The ministry’s overseas economic and growing rapidly (although admittedly commercial offices have been charged with from a low base) and production capacity putting the information together. Such assistance Ais estimated to reach 9m vehicles in 2010. The may seem excessive, but remember the central government expects the automotive government is the ultimate shareholder of most industry to become a pillar of the economy by automakers in China. 2010, and envisages exports to climb 40% annually from 2005 onwards. On the low end, that Pull from foreign dealers could mean at least US$1.2bn in export sales. With government support and cash behind them, There’s more—between 2020 and 2035, the it is not surprising that China’s automakers are government expects China's share of the global aggressive and willing to take risks at home and vehicle trade to swell from the current 1% to 10%. overseas. This is made even easier by the foreign investors also willing to take risks by importing Push from the government Chinese-made cars. Mr Soros has not commented To propel the automotive industry along, the on a report in Automotive News, a specialist government is helping with finance in the form of publication, that he will invest in Chery. But he is subsidies and low-interest loans. Adding hard known to be a savvy investor, and if he’s putting policy to hard cash, the Ministry of Commerce in his money on a Chinese carmaker, it is likely that late June 2006 said it would establish a system by others will follow. January 2007 requiring automobile exporters to Chery’s February 2006 agreement with apply for licences. Analysts say the export licences Visionary Vehicles startled many observers, who are intended to prevent a price war among China’s were unprepared for a possible onslaught in the domestic automakers, which are looking to export US of made-in-China automobiles. But almost as their vehicles because of a production glut. The soon as the deadline was set, it began to shift. In licences would also permit a check on badly made June 2006 Chery engineers were quoted in exports, which could damage China’s automotive Automotive News as saying that 2009 would be a reputation overseas. An official from the Ministry more likely date when their company’s cars could of Commerce was recently quoted in a newspaper compete on quality and safety in the US market. as saying that China’s carmakers did not make This is probably sound strategy, as the Landwind adjustments to suit the rules and regulations of fiasco badly hurt not only the image abroad of importing countries. The comments were a Jianglin, but also that of China's automotive reference to the Landwind situation. industry. The government nonetheless wants its home- China’s car manufacturers all know that a flop grown automakers to make a name abroad. by one Chinese-made car will damage the Towards that end, the Ministry of Commerce plans reputation of the others. As a result, they are not to construct an information platform for China’s likely to fall for distributors pushing them too automotive exporters and manufacturers that will early into competitive markets where reputations

take years to recover. Chinese manufacturers have reach 9m units. EIU forecasts are more learnt from Japanese and South Korean conservative—at just over 5m new vehicle manufacturers the hazards in launching sub- registrations in 2010—but even the lower figure is standards cars in the US and Europe. worrying. China’s automotive industry already suffers from excessive production capacity, Prolific production estimated by the commission at about 2.2m units Another reason for Chinese carmakers to go in 2005. Over-capacity has already dragged down overseas is prolific production. Their output has the prices of Chinese cars on the China market, and already reached 5% of global production, with the forecast that capacity will stand at almost according to the National Development and 4m units in 2010, the economic pressure on Reform Commission, and by 2010 is estimated to China’s carmakers to export is intense.

The road ahead: up and down

o when can China’s automakers still have to work out quite a few bugs in their cars realistically begin to compete in the US before they can truly be ready for international and Europe? Graeme Maxton and John markets. For a start, they do not seem to fully Wormald would argue that Chinese grasp the concepts of quality and safety. Scarmakers are up to 10 years behind their EU and According to the 2005 Initial Quality Study by US counterparts. Phil Murtaugh, now executive JD Power and Associates, Chinese cars are far from vice-president of SAIC, also believes it will take being competitive in the US market in terms of only a decade for the catch-up. For his part, JD quality. In the compact-car market, for example, Power’s John Humphrey believes that it will take China's industry average is 454 problems per 100 another generation of vehicles before some of (PP100) cars. In the US and Europe, buyers of China’s carmakers can master technology to a compact cars would want only 118 problems per sufficient level. If developing technological and 100 cars—the worldwide industry average. (To design skills will take another generation of cars, their credit, in the JD Power study, two Chinese and about five models make up a generation, then cars appeared in the top three in China’s compact- a 10-year timeframe seems reasonable to develop car sector in terms of quality: Chery’s QQ and a car that is technologically and aesthetically Tianjin First Auto Works’ Xiali Charade.) acceptable to picky US and European consumers. The 2005 study also found that overall initial The timeframe is based on it taking about three vehicle quality in China averaged 236 PP100, an years to bring a set of models to market, and 11% improvement over the previous year, and a another two to three years to get consumer substantial 50% improvement since 2000. But this feedback. is still a long way from the expectations of US and Why would it take China's automakers 10 years European consumers. The Landwind kerfuffle was to establish their brands on the US and European just one manifestation of the swirling criticism of markets, when it took the Japanese and South safety and emission standards of Chinese cars, Koreans 30 years and 20 years, respectively? Part which trail international norms. For example, of the reason is that China’s automakers are China-made automobiles are required by the soaking up skills and technology from their Chinese government to follow Euro II emissions foreign joint-venture partners and suppliers, or standards, but the EU has already advanced to Euro outsourcing design and engineering to firms like IV standards. China plans to get there only by 2010. Ricardo or Pininfarina or Bertone. They are also “There needs to be a paradigm shift for [US and largely copying rather than developing models European] export markets to accept Chinese cars. from the bottom up as carmakers in India are There also needs to be a shift on the Chinese doing. The first indigenous model was produced by [carmakers’] side in terms of quality,” says Chery only in 1999/2000. Jiangyin Venture Interior’s Cherry Chu. The Chinese government is making an effort to push things Quality and safety concepts along. It recently passed a regulation on the size of Despite their strengths of access to financing, and an engine relative to the size of a car that will ability to sell at low prices, China’s manufacturers reduce emissions and increase fuel efficiency. But

Top three vehicles per segment in initial quality: J.D. Power Asia Pacific 2005 China Initial Quality Study Note: Lower score reflects better quality performance Problems per 100 vehicles Compact car segment Chevrolet Spark 296 Chery QQ 391 Tianjin Xiali 424 Compact Car Segment 454 Entry midsize car segment Toyota Vios 147 Honda Fit 153 Volkswagen Polo 159 Entry Midsize Car Segment 231 Midsize car segment Toyota Corolla 130 Nissan Sunny 134 Volkswagen Bora 145 Midsize Car Segment 177 Premium midsize car segment Toyota Camry 70 Mazda 6 109 Honda Accord 110 Premium Midsize Car Segment 141 MPV segment Honda Odyssey 106 Buick GL8 151 Dongfeng Future 183 MPV Segment 298

Note: No official rankings are published for the premium compact car, entry luxury car, luxury car and SUV segments due to an insufficient number of models in the sample. Source: JD Power Asia Pacific 2005 China Initial Quality Study, JD Power Asia Pacific

How does the China compact segment compare with the US market compact segment?

Top 10 atrributes (China) Top 10 attributes (US) Overall rating of transmission Overall rating of transmission How quickly the air-conditioner can cool the interior Engine performance during rapid acceleration Ability of the air-conditioner to keep the interior cool Engine smoothness during hard acceleration Passing power at highway speeds Sound of engine while idling Engine smoothness during hard acceleration Driving range between fuel stops Exterior color choices available Rating of vehicle’s overall fuel economy Front end styling (headlight/grill area) Vehicle ground clearance Sound of the engine while idling Stability when driving fast on winding roads Engine performance during rapid acceleration How easily you can open/close side door Appearance of exterior paint Appearance of the wheels/rims

Source: JD Power and Associates

emission and quality requirements in China are still Brand and intellectual property a long way behind those in the US and Europe. They are also likely to be put off by copycat Safety standards, too, lag in China. The country behaviour from Chinese carmakers, several of recorded 517,889 automotive accidents in 2004, of whom have been accused of violating the which 107,077 resulted in fatalities. This is the intellectual property rights of international highest per-population accident rate in the world, companies. If they take cars or parts which have according to an industry insider, who declined to infringed copyright to the US or Europe they are be named. China only began requiring front-impact likely to be sued by local rivals—which will create crash tests in 2004, which resulted in a number of endless bad press. There certainly may be a case to domestic made mini-vans being taken off the answer. GM sued Chery in 2004 for allegedly market. Side and rear-impact standards and crash copying the Chevrolet Spark to create Chery’s best- tests came into effect from July 1st 2006. It’s likely selling QQ. The Chinese government advised GM to that more domestic cars will be forced to retire with seek mediation and the two companies eventually these new standards. By contrast, EU and US safety settled out of court. There are many other regulations are stringent, and in future would even examples. Nissan has taken Great Wall to court; include limits on the number of airbags permitted Toyota and PSA are doing the same to Shanghai in a vehicle. The Chinese government expects to Maple. Volkswagen also settled out of court with improve safety standards only by 2010. Until then, Chery over mass production of a car using one of it seemingly will be difficult to convince EU and US Volkswagen’s own plants. consumers to buy from China.

Conclusion

hina’s carmakers are beginning to get But China’s carmakers also have certain noticed. Whether they become bigger strengths, not least government support and stars will depend on the strategies they financing. They also have few management legacy adopt to grow and to overcome issues, and are able to sell cars cheap. How quickly Cweaknesses. It is expected that the initiatives will they leverage these strengths to overcome their be varied, from the slow, calculated moves of SAIC weaknesses will ultimately determine whether to the versatile aggression of Chery. The threats they are able to crack the developed markets of the facing them are likely to apply to all. Among them US and Europe in 10-15 years’ time. is the possibility of a political backlash in the US or Meanwhile, they can ease domestic Europe, or rivalry from a low-cost competitor like overproduction by selling their low-cost vehicles India. The latter could be challenged through to developing countries in South-east Asia, the savvy marketing and branding, but Chinese Middle East and Africa. They can also form automakers are weak in those areas. Indeed, it alliances in transitional markets in Eastern Europe appears that China carmaker’s intrinsic and South America. Going for the unexpected, weaknesses pose more of a threat to their Chinese automakers could attempt to enter the development than outside threats. According to more developed markets with niche products such the industry experts, consultants and car as SUVs, hybrid cars or a quirky design. With companies we interviewed for this report, China’s “traditional” cars, China’s automakers do not have carmakers suffer from the following: a big advantage in the developed markets against • Lack of brand recognition in overseas markets other low-cost producers like the Japanese and • Low quality (perceived or real) South Koreans, who have established brands there • Low expenditure on research and development with a reputation of value for money. • Little intellectual property The global automotive landscape 10-15 years • Shortage of technological and engineering from now is hardly clear. Changes in US and skills European manufacturers’ fortunes may open up • Weak international-level management skills opportunities for Chinese carmakers in those • Lack of attention to safety standards markets. In mid-2006 the mature, staid markets in • Stiff competition to sell low-priced cars the West look tough nuts for a new entrant to crack.