Too many cars are being made by too many companies in China. Margins once enjoyed by big players like General Motors and Volkswagen back in 2002 With the domestic market saturated, the pressures mount on foreign carmakers in China to export, but quality remains a roadblock and 2003 are only bittersweet memories now as the slowdown in domestic sales pulls down prices and leaves a glut in sales lots.
Demand is slowing, and Deutsche Bank projects oversupply in the China market of 23% this year. But still, foreign carmakers are expected to invest US$13bn between now and 2010 to bring annual capacity to 6m units.
Given that, one might think everyone would start looking at exports. But despite recent changes of leadership at the China operations of both GM and Volkswagen-GM's Phil Murtaugh quit in March and VW's Bernd Leissner retired three months later-both companies insist they remain focused on China's domestic market.
It starts with parts
Quality seems to be the hitch, and China's production processes won't get up to international standards for at least five years, said Graeme Maxton, an auto industry analyst at the Economist Intelligence Unit (EIU). "Car companies are in China to serve the market in China," he said. "They don't want their Chinese factories to compete with plants in other markets-there is plenty of capacity in those markets already."
Not until quality is up to par, anyway. But what then? Why would carmakers buck the lower-cost off-shoring route that so many other industries have taken? If cars are cheaper to make in China than in the US or Europe, where employee benefits packages are driving automakers into the ground?
Indeed, the migration of production to China is already showing up in car parts. GM, VW and others constantly seek ways to cut costs at their mainland plants by increasing local sourcing of parts. VW currently sources 90% of local content for its Santana and Jetta models, but still imports up to 60% of parts for others, one insider said. Soon, he added, VW will be sourcing engines from two China plants now under construction.
Meanwhile, Ford and GM have been turning up the pressure on their North American suppliers to match a world price? that is increasingly set in China-or, better still, build their factories in China.
Moving to China also opens up the possibility of scoring supply deals with new customers, be they other automakers or other parts makers sourcing bits for the parts they sell. They also get to export back to their home markets, snagging business from higher-priced parts makers who refused to move to cheaper costs centers.
That trends are moving in one direction is clear: GM now says its top-selling models in China are 85% built from local parts. Shifting the whole auto process to China is going to happen anyway, said John Wormald, co-founder of UK-based consulting company Autopolis.
"GM is trying to restructure its whole approach to the world, with much stronger central control," Wormald said. "It might see China as a major low-cost production base." But a major production shift, he added, "will depend on each maker's product and market footprints across the world, and on how they organize and run their network of assembly plants."
And again, there is the quality issue. "When costs and quality are better, then we can look at [exports]," said a Beijing-based VW official. Right now, the company is putting on a very domestic face: even though VW has seen its China sales tumble 60.5% in 2004, it is spending an extra US$3bn improving capacity and R&D to double production in China to 1.3m units by 2007. That, the company insists, is purely for filling local needs. "At the moment we have no plans to export from China to any of our main markets," the official said.
Getting the mix right
Foreign automakers are waiting to get their product mix right at their China plants before exporting, said Wormald. Overseas plants, he explained, tend to export either surplus standard products or special category vehicles – like VW using its South African plants to supply right-hand-drive Golfs. He said he considered Volkswagen's output of China-built cars niche products for the local market, not standard or special category vehicles that might fill an export bill.
But the pressure to export will only grow, and the final push could come from China's own producers. The EIU's Maxton said GM and VW could face competition from low-cost Chinese marques invading their home markets-companies like economy carmaker Chery Automobile which recently signed a pact with American auto entrepreneur Malcolm Bricklin to import US$15,000 China-made sedans to the US from 2007.
Bricklin, the man behind Subaru's successful US launch (but also a disastrous Canadian venture that produced a limited run of a car bearing his own name), promises to set prices 30% below those of comparable GM and Ford cars. "Chery's plan sounds a bit ambitious," said Maxton. "but they're getting pretty well prepared in design and distribution."
If Bricklin succeeds, it could force the big players to rethink their production cost models as drastically as they have been rethinking their parts supply chains. But success is by no means assured. Chery and other Chinese carmakers seeking to crack the US market could be thwarted by patent infringement problems, Maxton said.
Chinese carmakers have other short-term problems: with other manufacturing and cost issues to sort out first, they don't have the capacity to compete abroad, said Paul Gao, a partner at consultants McKinsey and Co China. "China's carmakers need to innovate," he said. "They have achieved sales growth, but not profitability."
Exports will only happen if carmakers are desperate to use up China capacity or "Because there's a genuine desire to do so," said Maxton. "Before that, the big automakers will talk about wanting to develop exports because it's what the Chinese government really wants to hear."
But China's enthusiasm for auto exports could create "Huge trade problems" down the road, Maxton warned, "especially in the context of a slowing US economy-when Ford and GM are on their knees and looking for a way out."
On the other hand, analyst Wormald observed, tax and other incentives to coax the China operations of major automakers into exports might "Hurry boardroom decisions."
As might a crack of the whip from their shareholders.