Auto Industry

Garage sale

China’s car industry begins to feel the pain

Garage sale

An electric future: But China’s car manufacturers need a boost today

Another week, another car industry bail out. As industry supplicants line up to meet their governments, China’s own car manufacturers now want a piece of the action. The China Business Times reports that domestic automakers have claimed a place as one of the 10 pillar industries in line for support this year.

The nature of this support is still taking shape. The sales tax for smaller, low emission vehicles has been halved: as an encouragement to buyers. Reuters also reports that owners of high-emission vehicles will get a share of a Rmb5 billion ($730 million) subsidy if they trade in their current car for a cleaner model. Others want the government to push a more aggressive “buy Chinese” policy, requiring officialdom to purchase models not only manufactured in China but designed there too.

Almost all analysts expect state-owned banks to lend on more favourable terms within the industry, especially to those with working capital constraints. Manufacturers are also suggesting that financing be made available directly to customers, noting that only 8% of Chinese buy their cars through vendor-financed schemes, far fewer than in other countries. If the industry could get this up to around 13% of purchases, industry-wide unit sales would increase by 4%.

This 4% rise is more significant once you understand the particular challenges facing China’s auto executives. The Detroit bailout is generally regarded as the political equivalent of easing the breathing of a terminally ill patient. The Chinese industry is a younger one – but still faces some serious problems.

So, while Detroit listens out for the faint bleeps of its life-support machine, China’s auto executives are worried about road-bumps to their industry’s sales growth. After six years of increases of more than 20% a year, the China Association of Automobile Manufacturers has reported that domestic sales were up only 6.7% in 2008, and actually fell in December by 11.6%.

CICC, a domestic investment bank, forecast that sales will fall 3.6% this year before recovering in 2010. The industry and the government want to get the annual growth rate back above 10%.

But demand is not the only major long-term problem facing the industry in China, say analysts. Supply is a challenge too. Automotive research body CSM Worldwide calculates, for instance, that car industry globally has the capacity to produce 94 million cars per year, which is 34 million more than current global demand. China is part of the glut, and many expect to see domestic consolidation. Topically enough, in the years after the Great Depression the US auto industry was whittled down to a much smaller group of manufacturers.

Rapid consolidation in China is unlikely, according to ChinaBizGov, an industry blog. Although the majority of the domestic auto industry is state-owned, only two auto firms (First Auto Works and Dongfeng) are controlled by the central government. Almost all of the rest are locally-owned state enterprises. They will fiercely resist any attempt at industry streamlining..

With dampening domestic demand, Chinese manufacturers will be hoping for more overseas sales. As Paul Gao explains in a June 2008 McKinsey study, car exports from China do have the potential to boost profits. With the world’s second largest domestic market (sales came in at a little over 9.2 million units in 2008), car companies have been able to achieve scale quickly. They also continue to enjoy cost advantages of up to 40% over international competitors.

Despite these advantages, the industry only sells a single digit percentage of its total production overseas. There are problems, says Gao, with expecting this number to grow steeply. One is that manufacturers often fail to focus on customer preferences in particular markets. No Chinese car model has iPod connectivity, for instance.

Another problem is product quality. Chinese vehicles consistently score poorly on safety and reliability in international surveys. At this week’s Detroit Motor Show two Chinese brands were showcasing their wares, but as autos analyst Nathan Spunt from Fitch Ratings told the South China Morning Post: “At this point, Chinese cars are more of an intellectual curiosity for American car buyers, against a purchase option, given the lack of products, known brands, or a dealer network. Quality concerns also linger given recently publicity about tainted goods in other categories.”

Probably as a result, export sales have tended to be strongest in developing markets, where the lowest price can trump higher performance.

Geely, one of China’s largest privately owned manufacturers, is hoping to compete on price and quality, breaking into the American market with its black taxis. These are made in joint venture with Britain’s Manganese Bronze, and are the same tried and tested vehicles that cruise London’s busy streets. Positively enough, they have met with the satisfaction of perhaps the UK’s most opinionated people: London cabbies. Geely owns 51% of the JV and reckons it can build a quality brand in America.

China’s automakers have sought other foreign alliances and acquisitions too. But this is not always working out, as SAIC Motor Corp is discovering. China’s largest automotive manufacturer is currently under pressure from the South Korean government to provide additional financial support to its ailing subsidiary, Ssangyong Motors, which went into receivership in January.

Another tactic of Chinese car manufacturers is to try a technology leapfrog – and produce next generation electric cars. These environmentally-friendly models fit the prevailing mood, and are in line with President Obama’s vision for weaning America off petrol-driven cars. Shenzen’s BYD – which is 9.9% owned by Warren Buffett – exhibited five hybrid and electric models at the Detroit car show.

GM will not launch its Volt electric car till 2010, and that leaves BYD with a head start. “We are confident of selling our electric cars in the US market in 2011,” Li Zhuhang told the China Daily. BYD’s general manager for exports added: “By 2011 our electric car will be a proven and mature product after three years of existence in China, while the Volt will only be a year old.”

That may be true, but 2011 seems a long way off. The immediate problem is selling cars today.

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