Auto Industry, Talking Point

Screeching to a halt?

Some of the world’s biggest carmakers are probed by Chinese regulators

Troska, Daimler board member responsible for greater China, attends a world premiere ceremony for the new Mercedes Benz C-Class Long Wheelbase at Auto China 2014 in Beijing

Mercedes is among the foreign automakers that has dropped prices in response to the probe

As a self-professed “nut on China” (“When I’m talking to GE managers, I talk China, China, China, China, China”), General Electric’s boss Jeff Immelt was a trifle embarrassed when a less positive remark leaked out four years ago.

“I really worry about China,” he told a private gathering of business executives in Italy. “I am not sure that in the end they want any of us to win, or any of us to be successful” (see WiC68).

The media storm soon passed – the comments were off-the-record and taken out of context, Immelt insisted – but the underlying premise that Beijing is prepared to play nasty with multinational companies operating on Chinese soil has taken longer to dispel. Indeed, the theme is back in vogue this summer, as a series of international firms wrestle with price-fixing probes and antitrust cases.

Where is the current focus for regulators?

Most of the latest investigations are targeting the international carmakers. Earlier this month the National Development and Reform Commission (NDRC) said it would be punishing Audi and Chrysler for price-fixing, while Xinhua reported on Sunday that Jiangsu province’s price bureau has found further evidence of anti-competitive practices at Mercedes-Benz dealerships in a number of Chinese cities. General Motors has confirmed that it is in dialogue with the NDRC on similar claims, while several Japanese car part makers are under the regulatory microscope for their pricing of auto components and bearings.

Beyond the auto sector investigators also raided Microsoft’s offices at the end of July, while the NDRC has confirmed that a probe into chipmaker Qualcomm for breaching anti-monopoly rules on its patent fees has reached its final stages.

The same agency has been examining pricing policies at various pharmaceutical firms too after a slew of bribery allegations against foreign drug makers prompted another major investigation last year.

What are the charges against the carmakers?

The latest cases have cited what regulators are calling “vertical monopolies”, or situations in which car owners are required to buy parts at high prices from the ‘4S’ shops (sales, spare parts, service and survey) that serve as authorised dealerships for the leading foreign brands.

“It is a typical case of a vertical monopoly in which the carmaker uses its leading position to control the prices of its spare parts, repair and maintenance services in downstream markets,” Zhou Gao, head of the antitrust investigation into Audi in Jiangsu, told Xinhua.

The costs of servicing and repairs for premium cars has been troubling the state media for a while, especially when the price of replacing all the parts of a Mercedes C-class sedan was estimated to be 12 times greater than buying a new vehicle, according to calculations made by a group of Chinese insurance and repair companies earlier this year.

Frustration then boiled over in the city of Wuhan when Audi increased repair costs at dealerships by as much as three times their originally contracted levels, the Economic Observer reports. Local insurance companies baulked at the hike, refusing to cover the additional bills and leaving at least 400 cars parked up at repair outlets. Eventually Audi backed down. But the row made national news, drawing attention to the discrepancy between repair costs at Audi shops and those of third parties.

“To replace a tyre for the Audi A8L at the 4S stores in Hankou costs more than Rmb7,000 ($1,138),” one owner complained to the newspaper. “But the independent repair shops charge less than Rmb 3,000.”

In a separate announcement at the start of August the NDRC has confirmed that 12 Japanese component makers accused of price-fixing will also be fined. Targeted for monopolistic activity in what 21CN Business Herald refers to as “front end” manufacturing, the companies were cited for colluding on the prices of items like control panels, airbags, steering wheels and windscreen wipers.

The implication is that the Japanese carmakers have deliberately restricted their purchase of key parts to a very small number of component manufacturers. The car firms say that these arrangements create a stable supply chain, improving product quality and encouraging long-term investment and innovation. But the regulators believe that the carmakers are fostering a “closed kingdom” in which third party providers are pointedly frozen out. “The Japanese side has many parts companies which are wholly-owned or joint-ventured,” a dealership boss told 21CN. “As long as they raise the prices of parts, they can get much higher profits than the Chinese side in the overall production process.”

But foreign firms feel that they are being targeted?

International carmakers usually counter that the higher prices for their vehicles in China – especially the imported ones – are primarily due to local taxes. They also point out that Chinese customers are prepared to pay more for foreign brands because they are much more convinced of their quality and design than homegrown cars. Hence pricing policies are a little different to those used elsewhere in the world – companies are simply charging what that the market is willing to bear.

Despite this, the European Union Chamber of Commerce in China has complained this month that some of its members feel subjected to “intimidation tactics” by local officials, amid concerns that the investigations seem designed to “impel companies to accept punishments and remedies without full hearings”.

Another gripe is that the authorities have told foreign firms “not to challenge the investigations, bring lawyers to the hearings or involve their respective governments or chambers of commerce.” It was also noted that it is the international car brands that face scrutiny, and not their Chinese joint-venture partners. But an editorial in Xinhua denied that foreign firms were being singled out for tougher treatment, claiming that “no company is allowed to break laws with impunity in China, be it Chinese or foreign, state-owned or private.”

Other commentators made a similar point. “If we take a review over the past six years… regulators have investigated more domestic companies than foreign companies,” Wang Xiaoye, an antitrust law expert at the Chinese Academy of Social Sciences, told the China Daily, while an accompanying theme in the local media is that the largest antitrust punishments have been levied against local firms, not foreign ones. In February last year baijiu maker Kweichow Moutai was fined $40 million for insisting that retailers sell its spirits above a minimum price, for instance, while Wuliangye Yibin was fined $30 million for the same practice.

Why the campaign against the carmakers now?

The authorities may have felt pressured to act because consumers are becoming more aware that they are paying more than their peers in other markets. Millions of Chinese are travelling overseas, while consumer rights shows on TV at home have been focusing on the aggressive pricing strategies of some foreign brands (on the same theme: reports have come out that Apple fans pay $470 for an iPad mini at home when they could buy the same item for $399 in the US; and that Starbucks generates operating margins of 35% in China, but only 9% in Europe).

In fact, more than a thousand investigations are currently being pursued, Wang Xiaoye told the China Daily, although he also felt that the implementation of the anti-monopoly laws, which were introduced six years ago, has not been strict enough.

“You hear complaints all the time from consumers,” he told the newspaper, “and it is important that the agencies enforce the law.”

Elsewhere there was media applause that the antitrust bodies are getting their act together, although the China Daily wondered whether regulators were actually struggling with the more complicated cases, and if a shortage of qualified manpower was hampering many of the investigations.

Another explanation for the burst of activity is that it has been triggered by an internal turf war. China’s anti-monopoly effort is split up across three different agencies with the NDRC ruling on unfair pricing, the Ministry of Commerce approving mergers and acquisitions, and the State Administration for Industry and Commerce (SAIC) overseeing the other aspects of competition law. That may be leading to competition among the agencies to deliver the biggest scalps. The New York Times has also suggested that the NDRC – traditionally the top economic planning agency – is losing influence in Chinese President Xi Jinping’s administration, so it has been trying to shore up its position with a more vigorous implementation of the pricing rules.

For others, the price-fixing cases signal a long-overdue levelling of the competitive playing field, following years of leniency for foreign firms including relatively lax oversight on their pricing policies. That’s the view of Bo Zhiyue, a research fellow at the National University of Singapore. “In the past China tended to give a little favour to foreign companies,” he told Bloomberg. “Foreign firms now have to unlearn what they have learned. They have to relearn how to make it work in China.”

The commentary from the People’s Daily was more uncompromising, with a view that “imperfect legal regulations” have resulted in “double standards” for multinational groups, encouraging them to discriminate across different markets.

“Foreign firms have been enjoying special treatment in China for too long, which is a major cause of monopolies in the market,” the newspaper complained.

But Greg Anderson, a specialist in finance and Chinese political economy, and author of Designated Drivers, a study of the development of China’s auto industry, told WiC this week that the practices of the foreign carmakers are largely consistent with their behaviour in most other countries.

“There is no ‘monopoly’ in the Chinese auto market,” Anderson suggests. “The most intense competition is actually among the foreign brands, but Beijing’s ‘China versus the world’ view blinds them to this fact.”

The crucial difference, he believes, is that viewed through Beijing’s eyes, the foreign automakers collectively seem to be approaching monopoly status simply because they are taking an ever-growing chunk of market share.

Nonetheless, Anderson acknowledges that the spate of price-fixing cases marks the latest phase in the struggle for spoils in a crucial market for carmakers everywhere.

“Part of the motivation of the foreigners may be to make up for the fact that (in most JVs) half of the profits are essentially going to the Chinese partner who brings little of substance to the table,” he explains.

“But the primary motivation of the foreign automakers is simply to make as much money as they can for as long as they can in an uncertain political environment. They have long been aware of the risks of doing business in China – one being that they operate at the pleasure of the Party – and that this could change at any minute. So I doubt that any of them is surprised that the hammer is beginning to fall. The writing has been on the wall for years,” concludes Anderson.

So Chinese companies are going to benefit, not just China’s consumers?

Certainly, some Chinese firms will hope to secure lower prices from their international suppliers. “Those lodging the complaints are Chinese businesses,” Marc Waha, a partner at Norton Rose, a law firm, told Dow Jones in Hong Kong earlier this month. He predicted that firms like smartphone maker Huawei could profit if Qualcomm is forced to lower prices for its chips and components. China Mobile might prosper as well, as it builds out the new domestic network for 4G.

In the auto sector, there is also the question of economic nationalism, and the view that regulators want to help China’s carmakers wrest control of the market back from the foreign brands (local marques account for about a fifth of car sales and the percentage is declining, according to official data).

But for Chinese carmakers like Chery, Great Wall and Geely, the upside looks more limited. “Significant price reductions on foreign cars would only put greater pressure on domestic manufacturers, which compete primarily on price,” warns David Yang, an analyst at market intelligence provider IHS. “Likewise, price reductions on foreign milk powder, eyeglasses and other consumer products will put even greater pressure on domestic brands.”

Greg Anderson’s perspective is similar. “These investigations will simply make foreign-branded cars more affordable in China. Chinese brands, whose primary competitive advantage has heretofore been lower prices, will see that advantage somewhat minimised. I would even go so far as to say that the NDRC’s nationalist view is blinding them to the potential harm they can do to China’s automakers.”

What happens next?

Current legislation allows for fines of up to 10% of a company’s Chinese revenues. More likely is that the offenders will pay smaller penalties, but show appropriate remorse by offering immediate reductions in prices. This is what happened with the milk firms last year when six infant formula makers including Mead Johnson and Danone were cited for compelling distributors to maintain minimum sales prices. The six companies were fined $110 million but also announced that formula prices would fall. The first of the latest round of fines was unveiled on Thursday when 12 Japanese parts makers wered fined a total of $202 million, the biggest aggregate antitrust penalty ever imposed by the NDRC. Sumitomo Electric was hardest hit with a $47 million fine, which is equivalent to 6% of its annual revenue from China.

Sure enough, carmakers have been scrambling to announce price reductions for their after-sales services over the last few weeks. Mercedes reduced average prices for its parts by 15% last month. Audi has done the same, acknowledging publicly that it will accept any penalties levied by the NDRC. BMW has followed suit, with Chrysler, Toyota and Honda also cutting prices since the probes were announced.

“We welcome the active price reduction of some companies,” a government spokesman nodded curtly in response. “But if some firms persist in refusing to admit or rectify their behaviour at the end of the investigation they will be punished more severely.”

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