Chinese Automakers Getting Better End of Bargain

By Tom Gibbs - April 19, 2012 | Tickers: FIATY.PK, F, GM, VLKAY | 0 Comments

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Growing to an annual production output of more than 18 million vehicles today from 1.5 million in 1999, China has swiftly overtaken the United States as the world’s largest auto market.  The recent and troubling slow down in the Chinese market, however, has hinted that the “If you build it, they will come” scenario that has historically characterized the competitive landscape will continue to slowly disappear as the market matures.  Foreign automakers, more so over the past several months than the past several years, are finalizing plans to secure competitive positions within the market as clear industry leaders have emerged. 

Worldwide giants Volkswagen (NASDAQOTH: VLKAY) and Ford (NYSE: F), for example, have both announced the construction of new plants within the nation this week.  The $400 million and $760 million, respectively, committed to the projects have been just two of several recent announcements by automakers intent on controlling a sizeable share of the Chinese market – Ford announced two weeks earlier a $600 million commitment for the construction of its third factory in the nation.  Ford hopes that the two new factories will boost annual production two-fold to 1.2 million units by 2015. 

This week also brings news from the nation’s volume leader in General Motors (NYSE: GM), which turned its initial $1.5 billion investment in China in 1995 from a 22,000 unit start-up to a 2.5+ million unit behemoth operation today.  The automaker has announced the augmentation of its most important Chinese joint venture with Shanghai Automotive Industry Corp. (SAIC) to give it slightly more control over the decision making behind the operation of the highly regulated market. 

General Motors, which sold a percentage of its original 50/50 agreement with SAIC during its bankruptcy restructuring in 2009, will still retain ownership of 49% of the JV’s revenues and profits and will instead gain an even control over the operational side of the agreement.  Setting the budget, making product design decisions, and management hiring powers will now be shared evenly between General Motors and its Chinese partner SAIC. 

Although the JV restructuring may seem superficially inconsequential, the change is especially crucial due to the slowing of the Chinese auto market’s growth.  With more of GM’s traditional competition making a larger presence in the space, and with domestic Chinese brands becoming very legitimate competitors, having more say in the key day-to-day activities of the operation is of utmost importance. 

The change, especially considering the state’s historic tight control over the industry, is hardly likely to only benefit the American party in the relationship.  In fact, it is the increasing power of the native Chinese brands and the emergence of the nation’s own “Big Three” (in their case, “Big Four”) that is of greater importance than GM’s slightly increased control over its JV operations. 

Chinese Shakeout

The Chinese auto market is very close to experiencing what its American counterpart went through in the early- to mid-1900s when General Motors, Ford, and Chrysler (NASDAQOTH: FIATY.PK) were the clear winners of a mass industry consolidation. 

Although four large automakers lead the domestic Chinese pack – SAIC, Chang’an, FAW, and Dongfeng – the slew of other smaller native producers that are characterized by uninspired designs and cheaper quality products are leading to a quick change of market share in favor of foreign competition.  First quarter of 2012 sales for domestic Chinese automakers slumped 8% year-over-year to 1.62 million units, and the market share of the natives shrank 3.2 percentage points to 42.9%.  

Although many of these smaller, second-tier Chinese competitors including Beijing Automobile, Chery, and Geely may inevitably experience significant consolidation, the communist state will continue to ensure that the national leaders will continue to strengthen even if foreign players like GM have the opportunity to amend JV guidelines in their slight favor.  What has SAIC received from the 15+ year-old venture with General Motors, and what will it continue to reap as it becomes a more serious competitor in the space?

• Technological Know-How: The difference in auto technology between the major Chinese brands that have and have not established successful JVs with American automakers is significant.  Many of the inner-workings of SAIC’s Roewe vehicles – its own domestic badge – are taken from GM’s Buick vehicles.
• Design Inspiration:  Many of the often humorously similar Chinese knock-offs of foreign autos are also produced by the smaller manufacturers, who lack either the design processes or motivation to create original and inspired designs.  SAIC, like others that have established JVs with foreign producers, have had the opportunity to create legitimate design centers.
• Cheaper Production: Through the sharing of design and technology trade secrets, foreign automakers like General Motors have given their Chinese teammates access to very lean production processes.  GM’s Epsilon II platform, which represents the underpinnings for vehicles like the Buick LaCrosse and the Chevrolet Malibu, has also been shared on Roewe’s 950 model.  Through the JVs, the native Chinese automakers are able to, therefore, produce very competitive cars and sell them less expensively than their foreign counterparts.  Similarly equipped Roewe 950 and Buick LaCrosse 2.4L models have a 15% price differential.
• International Expansion: Chinese automakers, even the higher volume and more successful competitors, may be experts on the local market but have historically had relatively little experience in the international space.  In exchange for a piece of the highly important Chinese market, the domestic brands are getting international exposure from foreign automakers.  The new GM/SAIC JV guidelines may give the former some additional say on the operations side of the agreement, but more importantly the latter is to receive a launch into the South American via GM’s existing operations in the market. 

GM is by no means receiving the bad end of the bargain – its Chinese JVs did produce $30 billion in revenues and $1.5 billion in profits in 2011 – but as long as the automaker does play by the rules of the state-controlled auto market, domestic brands will always have the slight upper hand.  Such an arrangement should not prove to be worrisome in the short run, as the market is still vast despite its recent slowing growth.  However, as the inevitable Chinese auto market consolidation takes place and the existing Big Four become increasingly strong on design, technology, and production frontiers, there is a very meaningful likelihood that foreign entrants including the industry leader GM will have an increasingly difficult time in competing in the market. 

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