Competing in China’s Slower Growth Automotive Industry

Auto.Sohu.com, September 1, 2012

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By Bill Russo （罗威）

China’s automotive industry has arrived at an inflection point.  After a period of breathtaking growth and expansion, the industry is now facing a future of slower growth at a level comparable to China’s GDP growth. 

This slower growth is a function of several inter-related drivers, including:

1. The central government’s desire for a more stable and sustainable pattern of macroeconomic development
2. Elimination of purchase incentives
3. New vehicle ownership restrictions in major cities

In the aftermath of the global financial crisis, China quickly responded by launching the Automotive Industry Stimulus Plan in early 2009. This plan included specific measures designed to spark the growth of consumer demand. Measures including the reduction of sales tax for cars below 1.6L engine displacement, along with subsidies for new minibus or light truck sales for rural residents resulted in a rapid market expansion particularly in China’s lower-tier cities, helping to boost the performance of the manufacturers of these smaller vehicles.

While aggressive tax cuts and subsidies sparked demand growth in 2009 (up 46% year-over-year) and 2010 (up 32%), these incentives were eliminated in 2011.  As a result the market growth slowed significantly to 2.5% in 2011.  Looking ahead, annual car sales are expected to maintain a growth rate comparable to the growth in China’s GDP, approximately 7%, between now and 2020. 

In December 2011, Beijing government released a new policy on “Beijing Traffic Relief Initiatives” and according to the policy; Beijing will issue only 240,000 new plates in 2011, 88% for individual usage, 10% for corporate usage, 2% for commercial usage. A lottery method is adopted for all plate allocation. Similar policies could also be seen in several other big cities such as Shanghai, Chengdu, and Guangzhou.  Other large cities such as Xian and Nanjing are likely to have similar policies in the near future.

STRUCTURAL IMPLICATIONS OF SLOWER GROWTH

It can be said that the global automobile industry has been burdened by overcapacity caused by overly ambitious expectations of market growth together with excessive optimism towards new products and technologies. The same can now be said for China, which is now the most hyper-competitive market in the world, with numerous foreign as well as domestic brands competing for the business.  In China, the top 20 manufacturers account for over 90% of sales.  With over 100 manufacturers in the auto business, many sub-scale companies face severe challenges and will struggle to survive in a market dominated by established companies. Moreover, greater than two-thirds of passenger vehicles sold in China carry a foreign brand, indicating that Chinese domestic brands will struggle to remain economically viable in a market where consumers prefer international brands.

Capacity additions that are currently planned will likely exceed the vehicle demand by as much as 35% by 2015.  As a result, manufacturers will begin to experience significant margin pressure and will be forced to raise incentives to sell-down their excess inventory.  As a result, the competitive dynamics in China may begin to resemble the mature markets, where companies experience large up and down swings in annual profits, severe price-based competition, and high emphasis is placed on operational efficiency to maintain profitability.

The pressures resulting from this overcapacity development may be the catalyst for the long-anticipated industry consolidation phase.  The existence of many weak sub-scale manufacturers is understood, and the China government had articulated a plan in 2009 to consolidate the industry into 2 distinct “tiers”:  the Tier 1 group consisting of companies with an annual capacity of 2 million units that are encouraged to acquire smaller automotive companies throughout China, whereas Tier 2 consists of companies with an annual capacity of 1 million units that are encouraged to drive regional consolidation. 

However, progress toward implementing this restructuring plan has been slow during a booming growth period where all companies were expanding.  As the market slows, it is now time to accelerate industry consolidation.  This will not be easy, as many companies will resist a top-down push to restructure.  Ultimately, market forces must determine the companies that have earned their right to survive this consolidation phase.

STRATEGIES BEYOND THE INFLECTION POINT

With slower growth prospects and a fragmented landscape of manufacturers, we may be tempted to become pessimistic about China’s automotive future.  However, we must remember this is still the largest and fastest growing auto market in the world, and companies that adjust their strategies to the new growth pattern will prosper.

First, demand will become more “binary” as lower tier cities develop and grow at rates higher than the higher tier cities.  There is enormous growth potential in the lower tier cities and provinces in China.  While the wave of car buying has swept over China’s tier 1 and 2 cities, over 80% of the population lives in tier 3 and lower cities.  Compared to the higher tier cities that are confronted with the problem of market saturation as noted before, the lower tier cities have greater potential for growing demand, and consumption of automobiles in the future. Moreover, this process will be further promoted, as the Chinese government places a focus on boosting the economic development of these regions. 

Some companies have started to seize the opportunity. For example, GM’s mini-vehicle China JV (SAIC-GM-Wuling) introduced the first own-brand car (Baojun, meaning treasured horse) to target the fast-growing lower tier consumer, aiming to combine world-class quality & low ownership costs.  By becoming a pioneer in moving down the to compete in the low end market, GM-SAIC-Wuling aim to capture the shift in the growth pattern toward lower-tier cities and provinces.

Second, shifting demographics and consumer preferences can generate profit opportunities.  While growth may have slowed in certain segments, there remain tremendous and profitable growth opportunities in smaller emerging growth segments. Companies need to have good strategies to fully cater to an increasingly diverse set of customer needs.  For example, compact SUV sales grew at an annualized rate higher than 40% in 2011, and sales of premium cars remain strong resulting from the expansion of China’s upper middle-class population.

Third, companies must grow their localized capabilities in the areas that help create competitive advantage.   That involves building a deeper understanding what makes their brand competitive in China, and localizing the human resource capacity in areas such as research and development, and network development.  In an era where efficiency becomes more critical, it is especially important for companies to fully localize the volume products sold in the China market.  For example, Hyundai has achieved nearly 100% local content for Elantra, and likewise Volkswagen has achieved the same for the Lavida.  The ability to deliver highly localized cars suitable to the local market needs is a capability that will increasingly depend on localized talent.

Finally, growing profits does not simply mean selling more new cars.  With the growth of the auto market in recent years, the demand for after-sales service, maintenance, and used car sales is growing as well. In response to the slowdown, manufacturers and dealers must recapture growth by building capability across a variety of after sales services, including establishment of a sub-dealership network and heavier involvement into service delivery and innovation.

CONCLUSION

The China auto market has passed an inflection point, downshifting from double-digit annual growth to a slower and more sustainable pattern in-line with GDP growth.  In the future, we can expect to see even more intense competition among the foreign and domestic brand vehicle manufacturers as they attempt to adjust to this new pattern while maintaining profitability.  Surviving the inevitable consolidation will require automakers to adjust their strategies to this new growth pattern.

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Bill Russo, is the President and CEO of Synergistics Limited, and a Senior Advisor with Booz and Company. He lives in Beijing and has more than 25 years of experience in the automotive industry, most recently serving as Vice President of Chrysler's business in North East Asia.