Dual horsepower

Back in 1984, it would have been easy to understand why SAIC Motor Corp was dubious about the sales prospects for Audi. At that point, only 3.2 Chinese in every 1,000 owned a vehicle. The height of their consumer aspirations was a Lada or a Volga, since most cars in the country were being imported from the Soviet Union.

SAIC opted to manufacture Volkswagen’s Santana brand instead and the sector’s first major Sino-foreign joint venture was born that October. Over the next three decades it was a decision SAIC would come to regret, for in 1990, Volkswagen (VW) was courted by SAIC’s state-backed rival FAW Group. Together the two built VW’s luxury-car unit Audi into China’s top-selling premium brand.

More recently it seems to be Volkswagen’s turn to harbour regret about its tie-up with FAW.

The Jilin-based state firm has been hampered by some very public problems over the past few years. Its longstanding chairman Xu Jianyi was arrested in March last year and he pleaded guilty to corruption charges in September. Mired in the scandal, the long-touted restructuring of FAW’s numerous local brands has been further delayed.

Industry watchers have, therefore, not been surprised by the news this month that VW and SAIC have signed a memorandum of understanding on new cooperation on top of their existing JV, paving the way for the biggest Chinese automaker to build and sell Audi vehicles in the country as well.

FAW’s dealers, on the other hand, are furious at the move and have penned an open letter complaining their interests will be seriously damaged by the establishment of a rival sales network.

According to the Wall Street Journal, representatives from 15 dealer groups, accounting for 150 dealerships, met with Audi’s top executives in China on Monday. If the German auto firm doesn’t call off the plan to tie up with SAIC, the dealers said they would demand “tens of billions of yuan” in compensation for potential lost sales (they worry that the SAIC tie-up will lead to competing Audi dealerships selling models unavailable to them). They have also threatened to refuse to take delivery of new Audi vehicles from December, the Wall Street Journal reports.

FAW is feeling bitter too, with a company insider telling Caixin Weekly its “contribution to Audi’s success in China’s luxury car market as the number one luxury seller for such a long time cannot be overlooked.”

Yet according to the Economic Observer, Audi has its own complaints, specifically the shareholding structure of the current JV: 60% for FAW, 30% for VW, and 10% for (VW-owned) Audi. “According to the annual reports of the FAW-VW joint venture, the Audi brand contributes about Rmb20 billion in earnings every year. But it could only get a 10% profit split… There has long been discontent on Audi’s side,” Economic Observer reports.

This explains why Audi reached out to SAIC. According to EO, there is no guarantee that the automaker will get a 50-50 split in the JV with SAIC, but the German firm is likely to get better than 40-60.

A delegation led by SAIC Chairman Chen Hong arrived in Germany early this month to fine tune the “investment scale, stock ratios and technology platforms,” according to EO. It says Chen issued a gagging order within SAIC “for fear of how FAW would receive the news”.

Since then, however, the potential partnership – discussions about which began in mid-2015 – has been widely reported in Chinese newspapers.

Audi decided to cooperate with SAIC because of the positive outlook for China’s luxury car market, CBN reports, citing CEO of Volkswagen’s China unit, Jochem Heizmann.

“Audi seeking a new partner will not harm FAW Group Corp at all… On the contrary, the new cooperation will strengthen the business of FAW,” Heizmann tells CBN, noting that the two already had a long track record of working together. According to the newspaper, SAIC is well positioned to handle Audi since the chassis for the VW Phideon, which SAIC already manufactures, is closely related to the Audi A6 sedan.

Audi remains China’s biggest luxury car brand. But it looks more than a coincidence that the German firm’s overtures to SAIC began shortly after Audi suffered its first monthly sales decline after 26 years in China. In May 2015, it reported a 1.4% year-on-year drop in sales.

Audi’s position has been under threat from BMW and a resurgent Mercedes Benz. In 2014, Mercedes’ sales were just under half of Audi’s in China. That gap has been rapidly closing. In the first nine months of 2016, Mercedes sold 344,791 cars to Audi’s 440,233. Its growth trajectory has remained strong, with sales rising 29.5% year-on-year compared to Audi’s 6.2%.

The improvement is in line with broader market trends. Thanks to a government tax incentive promoting small engines, China’s automobile market roared back to life in 2016. Between January and October, 19 million cars were sold, up 15% year-on-year.

Ironically, Mercedes has partly attributed its greater success to merging two separate distribution channels, enabling it to “speak to its sales network with one voice”. It remains to be seen how Audi will be able to manage two sales channels run by rival companies that may try to undercut each other, although Economic Observer notes that the parent firm VW has already handled such a situation before as it has been making VW vehicles with both SAIC and FAW.

In the short term, Audi’s rival Mercedes has a new and more pressing issue to worry about. Executives are likely to be extremely nervous about a consumer backlash following a road rage incident last weekend involving Rainer Gartner, the President and CEO of sister company Daimler Trucks and Buses.

After getting into an altercation over a parking space at a residential compound in Beijing, he is said to have shouted, “I’ve been in this country one year and the first thing I learned is that all Chinese people are bastards.”

The face-off rapidly went viral. One netizen says the German also pepper-sprayed an onlooker who tried to intervene.

Gartner has not commented publicly on the quarrel. Given that neither Daimler nor the police in Beijing have shared details of the incident, it is impossible to know whether the German agrees with the description of events that has been reported in the Chinese media. However, a Daimler official tells Sixth Tone, a news website, that Gartner has now been replaced. “Such an incident in no way reflects the values of Daimler AG and we sincerely apologise for the concerns raised by this matter,” a statement reads.

But as we reported in WiC343, a simple apology may not be sufficient – something that Samsung Electronics has recently been learning to its cost. Chinese consumers are becoming increasingly nationalistic and know the potency of their growing spending power. They threatened to boycott the South Korean company’s products after a perceived snub over China’s initial omission from the global recall of exploding Galaxy Note 7 smartphones.

Likewise, Sixth Tone says Mercedes now faces a similar backlash from disgruntled Chinese. It quotes one netizen: “I just decided to buy a car, but based on the company’s attitude to the issue, Benz will be excluded from my list.”

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