Enjoy it while you can

GE Anderson

According to recent HSBC research, the Chinese auto market has been a lifesaver for the foreign manufacturers in offsetting weaker demand in developed economies. The Financial Times noted the corollary effect last week in production terms. Over the last five years in the US, capacity has shrunk by an average of 7% annually. But in China it has grown 17.5% a year.

Having spent much of 2009 interviewing Chinese and foreign auto company executives, I came away with a fuller picture of how important joint venture strategy has become for foreign bosses.

On the one hand, there’s the example of Shanghai Automotive (SAIC) and GM who seem to be growing fonder of each other by the day. (I had one GM executive and one SAIC executive tell me on separate occasions, and almost verbatim: “SAIC-GM isn’t a partnership; it’s a marriage.”)

But not all relationships have turned out quite as rosy. Italian carmaker Fiat is still struggling to make local inroads, for instance, having dropped out of an earlier joint venture with Nanjing Auto. Now it is reported to be slow going in a new tie-up announced with Guangzhou Auto last November. Disagreements are said to include the introduction of new models and the internal management responsibilities at the joint venture, says the China Daily.

Still, given that foreign brands occupy more than 70% of China’s market for passenger cars, it seems strange that the central government failed to even mention the existence of foreign partners (much less discuss their role) in the latest iteration of official policy in March 2009. How could they be left out? And what does it say about how long the “golden age” might last?

First we need to understand how and why foreign automakers came to be in China. Early in the reform era, China had only a few state-owned enterprises (SOEs) producing trucks, buses and the occasional limousine. Most passenger cars were imported under extremely high tariffs. By the late 1980s the SOEs began to establish joint ventures with foreign automakers, hoping that they would learn all they needed to know about auto design and manufacturing, and then stand on their own two feet.

By the late-1990s it became clear that the Chinese were not learning much from their partners beyond assembly and sales. The much hoped-for technology transfers had not happened, so policymakers changed strategy. The new push would be for the development of independent Chinese brands. Foreign manufacturers still had (and have) a very important role as generators of cash through sales from the joint ventures. But the Chinese would direct the proceeds towards independent R&D, purchases of foreign technology and the hiring of foreign talent.

Since the early nineties, Beijing has also declared the car industry to be one among a handful of “pillar” industries in which the state intends to provide strong policy guidance, in many cases remaining as a dominant player. This means that Chinese car brands will ultimately dominate their home market, and that Chinese firms are expected to be at the forefront of a revolution in green automobile technologies. On the flip side: foreign brands will command an ever-smaller share of China’s (currently fast-growing) market. Times may seem terrific now, but they’re unlikely to remain so forever.

Keep an eye out for a few signals in the years ahead. First, as the apparent quality of China’s independent brands continues to improve, more Chinese consumers will begin to choose domestic over foreign brands. Consequently, the price premium for foreign brands will begin to fall. But not disappear completely – foreign firms are still the innovators in traditional internal combustion technology. Because this technology will not be displaced by green technology anytime soon, foreign brands will probably maintain technological cachet in the eyes of Chinese consumers over the short term. However, as independent brands become more acceptable to Chinese buyers (and more consumers earn the incomes to afford them), individual SOEs will begin to achieve economies of scale with their own designs. Then they will begin to ask themselves, “Would I rather earn 50% from a joint venture car, or 100% from an all-Chinese one?” At this point, it becomes a pretty simple cost-benefit calculation.

Perhaps this is why the planners saw little need to address the role of foreign partners specifically in last year’s policy, although Beijing is due to release a new auto policy within the next few months. In fact, they may not need to fire a single shot. By pushing their own automakers to spend money on their own brands, as well as on innovation in green technology, they know that domestic firms will eventually own the market.

GE Anderson is a China specialist, former CFO and current PhD candidate. His research focuses on state-owned enterprises, corporate governance and China’s auto industry.

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