Auto Industry

Failing their driving test?

Industry expert discusses challenges facing China carmakers

Hopes were high for BYD but recent sales have disappointed

“It’s like opium. Once you’ve had it you will get addicted forever,” ruminated He Guangyuan, a former machinery and industry minister, earlier this month.

Recent history (at least it’s recent history as far as the Chinese are concerned) means references to opium can be politically-charged. And the opium He is referring to in this particular case is the reliance of China’s leading state-owned car firms on foreign partners such as Volkswagen and GM. The fear is that this has emasculated the domestic players, who have found it easier to grow their businesses through their joint ventures rather than go it alone.

“So many years have passed and we don’t even have one brand that can be competitive in the auto world,” the former minister lamented. “I feel red-faced.”

Strip out the sales from their foreign JVs, and China’s top six state-owned car enterprises account for just 2% of the local market.

The enduring influence of the foreign firms is also a key theme explored in Designated Drivers: How China Plans to Dominate the Global Auto Industry, published this summer. The author is Greg Anderson, a specialist in finance and Chinese political economy. This week Anderson talked to WiC about why foreign car firms have such an embedded presence in the Chinese market and how state policy in the sector hasn’t always worked out as intended.

What’s the background to your book Designated Drivers?

The book is based on the research I undertook in China for my Ph.D. at UCLA. I started out with a broader question which I think is on the minds of many people nowadays: if heavy state involvement in the economy is such a bad thing, why has it worked so well for China? I then chose the auto industry as a way to get my hands around business-government relations from top to bottom.

Part of your approach is to identify four core policies and then look to see if they have been achieved?

Yes. The oldest objective in state automotive policy was consolidation. Back in 1988 the idea of a ‘big three, small three’ strategy was first articulated, based on three ‘big’ enterprises (First Auto, Dongfeng and Shanghai Auto) and three ‘smaller’ joint ventures (Beijing-Jeep, Guangzhou-Peugeot and Tianjin-Auto). But at my last count there still seemed to be at least 115 Chinese carmakers, so there hasn’t been anything like the kind of consolidation that the central planners have wanted.

The reasons are generally well known. Production of cars by these small firms contributes to local GDP, spilling over into a range of support industries and creating jobs. So the local authorities worry about the impact on growth if factories in their town or province are closed. This is also part of how their own performance is measured, so they fight to protect sub-standard automakers from closure.

The push for consolidation is still going on. The latest rule I saw suggested was that companies who don’t make more than a thousand cars a year should have their licences revoked. In principle that’s not a bad idea: my estimate would be that at least 70 of China’s automakers are too small to achieve any kind of scale. But would this policy work? My guess is that the smaller firms would just make their thousand-car minimums and stay in business.

How about another policy focus: creating Chinese champions?

Sales growth in the overall Chinese market has been strong but Chinese firms have had to share profits with their foreign partners. They’d do better if they could sell more Chinese-branded models. But the problem is that Chinese consumers still believe that the foreign brands are of higher quality. Even though industry surveys suggest that the actual quality gap is closing, consumer perception isn’t narrowing to the same degree.

In fact, market share for Chinese brand passenger cars fell last year and is continuing to decline this year. So the mood is different from two years ago, when it looked like the Chinese brands were starting to catch up, following market share gains in 2009 and 2010. But that surge was triggered by consumer subsidies offered as part of the nationwide stimulus campaign. When the incentives came to an end, growth slowed. And now the surge in sales back then has left a hole in demand for homegrown brands today.

What about exports? Are Chinese cars selling in overseas markets?

Chinese brands having been making more progress in Latin American countries like Brazil, as well parts of the Middle East and Africa. In these markets they have a decent value proposition as cars with 80-90% of the quality of their international peers, but at 50-60% of the price.

Of course, many of China’s own consumers aren’t convinced by the same proposition, especially those who are more well-off. Sales to developed markets have also been slow to materialise. Chery and Great Wall have been exporting to Australia, although a recent asbestos scare may prove a setback. Great Wall has also opened a factory in Bulgaria, which could give it an opportunity to sell in the rest of Europe. But generally, Chinese brands haven’t made inroads in markets in Western Europe or North America. On a positive note, I think it is only a matter of time before they do.

Why haven’t Chinese brands made more of a breakthrough?

The leading Chinese manufacturers – large SOEs like Shanghai Auto and FAW Group – are making much of their money from their joint ventures with overseas partners, where they make cars like Buicks, Chevrolets and Audis. That reduces some of the incentive to develop locally derived models and brands.

Similarly, the bosses at the big state-owned automakers are not necessarily focused on the types of long-term investment and R&D decisions needed to get Chinese brands into a stronger position. Traditionally the guys running the big firms don’t stay long before moving on to other roles, perhaps as provincial governors or vice-ministers. They’re not expecting a commercial career over the longer term. But they do know that their future prospects will be judged by how they have contributed more immediately to local economic growth. In that context, the joint ventures look like the easiest, safest way to keep sales growing. It’s not a surprise that this is the direction usually taken.

It’s ironic that the foreign automakers have become so embedded in the market. This wasn’t the idea at the beginning: the planners wanted Chinese firms to learn from the foreign partners, then dominate the industry themselves. In fact, Japan and South Korea had similar ideas when they started their own car industries. At first, both those countries sought to launch state-owned automakers, but then recognised within a couple of years that their existing private automakers were more competitive, so they privatised their state-owned ventures and never looked back.

Japan and Korea also made greater demands on their foreign partners, keeping the joint ventures on short contract terms and insisting that technology was licensed to the domestic party. But the Japanese and the South Koreans were also beneficiaries of the politics of the Cold War period. The Americans saw both countries as allies and were more tolerant of their protectionist demands, like the high tariffs used to keep foreign cars out of their domestic markets. By the time that these walls came down, Japanese and Korean brands had built up loyal customer followings. By comparison, China has it much tougher in starting out in the WTO era, when similar protection is unavailable.

But at least China’s prospects look better for new energy vehicles?

This is another area where state policy has been explicit: China sees new energy vehicles (NEVs) as a chance to leapfrog its rivals. You could argue too that the Chinese were ahead of their time mentioning NEVs, as an eventual industry priority as early as 2001. Only Toyota and Honda had hybrids on the market at that time.

But the achievements on the ground have been less impressive. When I asked industry executives what kind of lead their companies enjoyed in new energy cars, they all told me: “None. China doesn’t have any advantages in the sector!”

However, most Chinese automakers are working on NEV projects. A handful even have production models out on the road, with most of the progress coming from the private sector. But very few sales have been made.

Nor do they have an obvious technological edge. BYD Auto is worth mentioning here. Three years ago the hype was that it was on the verge of a breakthrough in hybrid vehicles. Warren Buffett had also invested, which added to the buzz. But BYD was making all of its money selling gasoline-powered cars, not new energy ones.

Shortly afterwards, BusinessWeek magazine even made BYD the first Chinese company to feature at the top of its global technology rankings. How preposterous! Even in its best year, when BYD sold close to 500,000 passenger cars, all but a few hundred were traditional gasoline-powered cars modelled on an old Toyota Corolla design. It was hardly groundbreaking technology.

So technology transfer isn’t happening?

It depends on the relations between the partners. Shanghai GM [General Motors and Shanghai Auto] seems to be a closer partnership than most and my impression is that GM might be more open than its peers to technology sharing, perhaps because it sees the China joint venture extending beyond China.

For instance, Shanghai GM is already producing in India. GM is contributing brands and technology, while Shanghai Auto provides more of the funding.

But to my knowledge none of the other joint ventures are looking outside China yet. And less likelihood of this kind of wider cooperation means that the foreign side may keep a tighter grip on its technology.

Even so, GM is being careful about what it shares. I spoke recently to a manager at GM back in the United States who assured me that, while GM is sharing some of its Chevy Volt technology in China, it is keeping its next-generation hydrogen fuel cell technology in Detroit.

So that sounds like a bleak outlook for the fourth policy goal: indigenous innovation?

Right now, it’s hard to claim that the Chinese automakers are innovators. Their approach, for 30 years, has been about learning how to do what their foreign partners are doing. The focus is on trying to close the gap and learning to copy better. For instance, I talked to someone recently who had gone through China’s leading automotive engineering programme at Tongji University in Shanghai. He told me that there is a course called reverse engineering in which students are given components and expected to copy them.

But that’s how everybody started out, not just the Chinese. Look at industrial history: the Germans learned how to copy the British, and then the Americans did the same to the Europeans. The problem for the Chinese is that they are trying to do so today at a time in which there are global institutions intended to keep it from happening! This is unfortunate for them, and, one could argue, a little unfair.

The bigger question is whether the domestic environment will offer the right conditions for Chinese companies to get ahead, once they have caught up with their international rivals. Do they have the right climate for genuine innovation, not just in copying technology more efficiently but also in bringing about new, innovative ideas?

My sense is that the answer is no, especially if the state-owned enterprises continue to dominate. If the incentives stay similar to today, there is little reason to expect their current behaviour to change. And I think that this leads back to the same conundrum for policymakers. While the state continues to dominate the sector, it seems that there will always be a place for foreign technology and foreign brands in the industry.


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