Chinese Carmakers Move Overseas
Klaus Koehler, Managing Director, Klako Group

China has reached a new stepping-stone recently, particularly in the automobile industry. In the last five years the automobile sector has undergone vast changes and will continue to do so in the future. A recent interesting direction the carmakers are taking is for example with the announcement of China First Automobile Works and its interest in buying the Chrysler Group, the division of Daimler Chrysler Group, which is making continuous losses.

Changes in the Automobile Industry

Previously governmental restrictions limited the number of carmakers to the largest and most influential companies, such as the Dongfeng Motor Corporation or Shanghai Automotive Industry Corporation. Due to high tariffs on imported cars, foreign companies were restricted from entering and therefore Chinese companies did not face any strong competition.

Although there are still regulations preventing existing companies from expanding rapidly and from newer companies entering the market, the barriers have been lowered. For example, the Ministry of Commerce has started to take action in boosting China's car and auto parts export. Auto clusters are being developed in the main cities of China such as in Jiangsu, Zhejiang or Shanghai in order to create competitive advantages.

The increase in China's economy, which, according to the National Bureau of Statistics of China, reached 10.7 percent in 2006, reflects that smaller car manufacturers are still able to benefit. The increase in prosperity for individuals has grown and as a consequence their buying power as well. As the middle class is able to afford to buy a car, it has consequently resulted in a 25 percent rise of car sales to 7.22 million automobile units in 2006, according to the China Association of Automobile Manufacturers (CAAM), whilst passenger car sales rose to 3.8 million units the same year.

Furthermore China has on average dropped the general tariff level, from 15 percent in 2001 to less than 10 percent in 2006. Especially in the car industry import tariffs have dropped significantly, (from 28 percent to 25 percent in 2006) which offers a variety of chances and risks for both Chinese and Overseas companies.

Foreign Manufacturers in China

European and American car manufacturers have intensified their investments in China through Joint Venture establishments due to the potential in the market for their products. General Motors, for example, increased sales at a level of 32 percent in 2006 after suffering from a global loss in 2005 of USD $8.6 billion. BMW's luxury brand Rolls Royce recorded a 60 percent increase in Chinese sales in 2006 compared to 2005.

The Chinese market is flooded with Chinese manufactured foreign cars, which were 15-20 percent cheaper in 2003 than before the entry in the WTO. China has a domestic market share of almost 70 percent for foreign branded cars due to the Western cars carrying a greater quality and a better image than the local brands. This however does not mean that the Chinese branded car manufacturers are at a loss. As foreign companies must establish Joint Ventures, the Chinese partners are gaining technological experience and expertise. A down-side is that the Chinese are becoming too dependent on foreign input, rather than creating independent innovations. Nevertheless Chinese-branded cars, such as Chery, Geely and Brilliance are only able to grasp a small piece of the market share. However figures show that their market share has been increasing from 5 to 30 percent in the first five months of 2006.
As a consequence, the auto manufacturers are looking for a new market to enter and are therefore starting to export outside of China.

The International Market

The international market is fiercely competitive, offering thin profit margins on low-priced cars. The strategy thus far for the Chinese manufacturers has been to undercut prices of similar car models. This approach seems to be quite plausible since they have gained expertise in joint ventures with foreign partners. The question is whether this strategy will be successful.

This approach has worked well for developing countries in Southeast Asia, the Middle East, Africa and Latin America where a majority of cars are exported to developed countries, where rapid sales growth show the lowest-price-strategy is good.

Due to this success Chinese automakers are now moving towards the American and European market. However China's auto companies will be facing obstacles when entering these markets due to the local laws and regulations of the countries.

China accounts for only 0.7 percent of the international trade of automobiles and auto parts, but aims to increase its share to ten percent within ten years, according to the country's Ministry of Commerce. With estimated Chinese automotive exports rising from $11.8 billion in 2005 to between $70 billion and $100 billion by 2010, experts predict that China will overtake the U.S. car market after 2015, causing disastrous impacts on the North American and European market.

The Minister of Commerce, Mr. Bo Xilai, has cautioned car manufacturers to move slowly into the outside world as he fears that, "If the reputation of one Chinese auto is ruined, the reputation of the whole industry of China will also be hurt seriously."

Examples of Manufacturers in Europe

Jianling Motors Landwind (SUV) is one example of a Chinese manufacturer that began its operations in Germany in November 2005. The model being produced was 50 percent cheaper than the closest rival but achieved disastrous results in an independent crash test, executed by the ADAC, Germany's biggest independent automobile club. Tests showed that a driver of the car would not have survived a frontal crash when driving at 60km/h as the passenger cab compressed. This is a perfect example of quality issues that Chinese car companies are facing.

Brilliance China Automotive Holdings Ltd went into a joint venture with German global player BMW in 2003. Plans show that more than 15,000 cars are going to be sold in Germany and Europe in 2007 and 20,000 - 25,000 the following year. Brilliance aims to successfully penetrate the European market by relying on its strengths such as its innovative ability or the quick adaptation to market conditions. But no matter how good the ambitious car manufacturer will perform in the near future, it will depend on the performance of the Chinese auto industry as a whole to prove that Chinese cars are more than reproductions and modified bestsellers.

Examples of Manufacturers in America

It is not only the European market that the Chinese car manufacturers are looking to enter. The American market also offers a great potential for cheap and high quality cars made in and by China.

At the moment negotiations and discussions are being made by Chinese companies, such as Chery and Geely with American partners. The timetable of entering this market has been halted as the Americans are uncertain regarding 'quality issues'. According to Mr. Zhang Ji, an official with the Ministry of Commerce, the Chinese companies have underestimated the quality demand in the international market. They did not properly research the special market conditions and therefore did not adapt their designs to local requirements. This has made it difficult for Chinese car manufacturers to find and establish a solid dealer base. Moreover American customers still underlie the illusion of Chinese cars as being of low quality.

Geely, for example, is an independent carmaker with its headquarters in Zhejiang. It is the only privately owned car company in China. The company has undergone a change from a refrigerator and bicycle producer into a major automaker with a dozen factories able to turn out 100,000 vehicles and 200,000 engines a year. Geely, who already sells to Yugoslavia, Ukraine and the Middle East aims high by penetrating the world's most developed automobile market. In order to achieve this they want to produce SUVs, sedans and sports coups at the highest quality with the claim of not just to deliver a product of adequate but superior quality but also at the lowest price affordable.

Given all these ambitious goals Geely still faces a lot of difficulties, particularly in quality and image. At the end of 2008 / 2009 the 7151 CK sedan will be sold for less than USD $10.000, but safety and emissions standards have still not been met. Furthermore the model lacks comfort and extra functions such as a sunroof or heated seats that foreign consumers like to add. This creates further problems in the mind of the consumer as they are already holding the idea of poor quality. A recent research conducted by J.D. Powers has revealed the setbacks Chinese car manufacturers are still facing. Results showed that on average there occurred 374 problems per 100 Chinese cars compared to 118 per 100 cars made in the U.S.
As a consequence, Geely has countered that they are able to fix the problems, make modifications and therefore meet the necessary stringent regulations of the U.S. authorities by 2008.

A successful market penetration in the US has been seen by Changfeng Motors. They represent the next level of China's automobile efforts to spread out into the global market. The company has had a long-time partnership with Japanese Joint Venture partner Mitsubishi Corp. and now they are looking to diversify and compete on the American market. The large state-owned enterprise grabbed attention already on the North American International Auto Show in 2006 by displaying its cars to an international audience. Their plans include the sale of a five-passenger SUV, the Liebao CS6, which was designed by Italy's Pininfarina and is equipped with a four-cylinder diesel engine built by Italian automaker Fiat.

As opposed to Geelys sedan, the SUVs made by Changfeng have already meet US consumer needs by having anti-lock brakes, GPS navigation system and DVD screens behind passenger heads, a sunroof and a maximum speed of 160km/h.
More importantly Changfeng Motors has managed to pass US crash and emissions tests, which allow them, according to officials, to sell into the U.S. market within three years. Unfortunately they are still looking for a trustworthy and reliable partner that is also willing to form a long-term cooperation.

A Long Step Forward

In the short-term Chinese cars are not competitive yet. Even if China's automobiles meet all technical requirements and regulations of the United States and/or Europe they are still far away from successfully establishing in these markets. Reasons for that are not only strict regulations and demanding customers on the Western side, but Chinese companies themselves have to transform and restructure their processes and structures.

A clear example is that in general spending on research and development accounts for less than 1 percent of the revenue of Chinese automakers. Exceptions include Chery, spending 13 percent and Geely spending between 6-7 percent, while companies of developed countries spend 5 times the amount on research and development.

As Chinese carmakers are now trying to establish their own techniques of manufacturing they can no longer rely on the foreign side that formally brought them the basic groundwork and a solid research and development program. As the Chinese companies are now being left on their own without foreign support they are having difficulties in the areas that the foreign companies excelled in.

But even if the market penetration should succeed, it is not likely that many Chinese companies will be able to stay in the market. Experience has shown, for example with the Japanese automakers, such as Mitsubishi, Isuzu or Daihatsu, that failures do occur. Although Chinese cars are comparable to Korean cars in terms of quality, experts predict that there is no chance for Chinese cars to be competitive in the U.S. market in the next three to five years, which is about the time of a typical product life cycle. Perhaps, however, the consumers will changes their decision-making and start purchasing these types of vehicles.

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