In China, hybrids can't seem to sell without a lustrous nameplate

Nikkei Asian Review, December 19, 2013

A Lexus ES300h on display at a dealership in Shanghai.(Mark Andrews)

SHANGHAI -- Hybrid cars haven't been a big hit in China.
   
Shanghai rolled out 350 Buick LaCrosse Hybrids for use as taxis for the green-themed World Expo in 2010, but the cars disappeared soon after the exhibition ended.

Toyota infamously sold only one of its world-leading Prius models in China during the same year.

Sales of the utilitarian Prius have rebounded slightly but are still slow. Imported Honda gasoline-electric cars, meanwhile, have been faring worse.

Hybrids, however, are making inroads at the premium end of China's car market.

Toyota's luxury Lexus division is on track to sell close to 20,000 hybrids in China in 2013. Last year, it unloaded 16,000 of the things, leaving Prius sales way behind at 2,434.

Lexus last month pointedly unveiled the revamped CT200h model at the Guangzhou Auto Show rather than at shows going on at the same time in Tokyo and Los Angeles. Mercedes is also finding a welcome for its hybrid S-class sedans, though it isn't giving out figures.

"It is easy to sell these cars," a sales manager at a Shanghai Lexus dealership said, gesturing at the CT200h hybrid and other models. "We firstly emphasize the six-year warranty and secondly that it saves fuel."

Indeed, fuel economy has not been a strong selling point in China, where most car buyers are first-time purchasers.

Said Boni Sa, an automotive analyst at consultancy IHS Automotive: "For these first-time buyers, they have more to consider, like brand, vehicle size, features or safety. In an emerging market like China, to spend money on a better brand or larger model is much more reasonable than spending money on better fuel consumption."

Price is a key factor even for repeat buyers. In Chengdu, where the Prius is produced, businessman Jimi He recently bought his third car, a Volkswagen Tiguan crossover.

"I'd love a hybrid," He said. "It is more environment-friendly and more energy-saving. However, the price is the key issue that stops me from getting one."

The argument that buyers will recoup the higher upfront cost of a hybrid through fuel savings is not so convincing in China. To recover the 12,000 yuan ($1,976) price premium on the hybrid version of SAIC Motor's locally developed Roewe 750 sedan, for example, would require driving the car at least 100,000 kilometers.

Some automakers had campaigned for Beijing to begin subsidizing gas-electric hybrid purchases this year. They argued this could be more effective in addressing pollution concerns than the government's generous subsidies for pure electric cars and plug-in hybrids, which have not generated significant sales. Instead, China in September renewed the existing subsidies.

So the carmakers are finding other ways to close the price gap. Toyota announced at the Guangzhou show that it will localize production of batteries and hybrid motors for the Prius and Camry Hybrid. These components are now imported and slapped with high duties. As it stands, for the price of a Prius, a Chinese buyer can get a much larger family car.

This is why hybrids are attracting buyers for whom price is less of an issue.

"Some customers are buying a Lexus SUV or a Mercedes-Benz S-class rather than hybrid vehicles," Sa said. "Hybrids' inflated costs can be ignored by these customers."
   
At the premium end, hybrids can be positioned as high-tech and top-of-the-range rather than fuel-saving and environmentally friendly.
   
A new Mercedes E400 hybrid is to offer a more powerful engine with better acceleration than that of the standard model.
   
"Premium carmakers have a higher chance of success in the area of hybrid vehicles, mainly because premium autos are not purchased by price-sensitive consumers" said Bill Russo, president and chief executive of automotive consultancy Synergistics in Beijing. "It is still a small market but will grow as more automakers slowly introduce more models."
   
The long wheel-base E-class Mercedes will be the first premium hybrid to be produced in China. Infiniti is set to begin producing cars in China 2014, and Lexus is a possibility.

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Daimler Opens First China Engine Plant

Bloomberg TV, August 27, 2013

Synergistics President & CEO Bill Russo discusses how luxury car makers are trying to tap into the largest growth market in the world. He speaks with Zeb Eckert on Bloomberg Television's "First Up." (Source: Bloomberg)

Infant Industry: Why Chinese Car Brands Are Struggling to Compete

China Economic Review, June 2012

Like many Chinese, Zong Zhaoxiang wishes nothing but the best for the Chinese car industry – yet he won’t be buying a Chinese car anytime soon.

The 52-year-old chairman of a Shanghai chemical company, Zong said he expects Chinese-branded cars to have bright prospects. However, he loves the comfort, quality and image projected by his black Mercedes-Benz S-class, and he said he may buy another Mercedes-Benz model or a BMW in the future. “If Chinese-made cars were better designed and could demonstrate your status, more people might buy them,” Zong said.

Not all of Zong’s compatriots can afford a Mercedes-Benz, of course. But most of them still prefer foreign brands to domestic ones. Volkswagen and General Motors sold the greatest number of vehicles in China in 2011, the world’s largest car market, followed by Nissan, Hyundai and Kia. All domestic carmakers combined captured only about 30% of their home market, the lowest proportion of any major economy.

This is not what Beijing intended. In contrast to other “strategic” industries like telecom and banking, the auto industry has been gradually opened to foreign investment over the past two decades, as Beijing allowed foreign car makers to form joint ventures with domestic partners. But the goal was always to help Chinese manufacturers acquire the technologies and expertise necessary to build their own strong brands, an outcome that eludes the industry.

As markets in the US and Europe stagnate, the focus of the auto industry has shifted to China. This has made Beijing’s efforts to build a strong global brand and profit from its own growth boom all the more urgent. “The sun of the automobile world is clearly shining in Asia and specifically in China,” said Geoff Broderick, Asia-Pacific general manager at auto industry consultancy J.D. Power & Associates. “[China] is clearly going to be the sales leader for the foreseeable future.”

Beijing aims to help Chinese companies capture about 50-60% of the market by 2015, but that goal appears unattainable. Chinese cars are variously accused of problems with quality, safety and styling, but their biggest problem continues to be brand strength – a conundrum that can- not be solved overnight.

“China is the world’s largest market, but it doesn’t make any of the world’s leading brands,” said an employee of Guangzhou’s Chang’an Auto who asked not to be named because he is not approved as a company spokesperson. “We’re hosts, not leaders.”

Race to the Bottom

State-owned car makers – such as Shanghai Automotive Industry (Group) Corporation (SAIC), First Auto Works (FAW ) and Chang’an Automobile Group – have begun paying more attention to building their own brands, at Beijing’s urging.

It’s been an uphill battle. With shorter histories, inferior technology and smaller marketing budgets, their products are mainly confined to the low-cost segment, where profits are thinner. Meanwhile, independent Chinese carmakers such as Geely, Chery, BYD and Great Wall have introduced their own low-price models, intensifying competition.

Most Chinese brands continue to trade on the China’s traditional forte: driving down manufacturing costs and making money on high volume and thin margins. In contrast, foreign car brands charge double or more and still sell far more units, all on the strength of their brand, technology and styling.

The playing field has tipped farther towards foreign players in the past few years. First, Beijing ended a tax break on cars with engines smaller than 1.6 liters last year. “The companies with smaller vehicles tend to be Chinese-branded carmakers. So they benefited most from the stimulus and were hurt the most by the removal of the stimulus,” said Bill Russo, a senior advisor at consultancy Booz & Co and the former head of Chrysler Asia.

The policy had helped overall vehicle sales to grow 46% year-on-year in 2009 and 32% year-on-year in 2010 – unsustainable rates of expansion, Russo said.

The termination of the tax break triggered both a slowdown in overall sales and a reduction in the market share of Chinese brands in 2011. Growth in sales of domestic cars fell to a 13-year low. The beating continued in the first quarter of this year: Overall sales of passenger cars declined 1.3% annually, while sales of Chinese passenger cars slumped 8.1%.

This drop in sales has prompted car companies to cut prices aggressively. Foreign auto makers are offering discounts of 25-30%, while some domestic auto makers have reduced prices by up to 50%.

Most Chinese companies are planning aggressive expansions in the next five to 10 years that will further increase competition.

“Overall profitability is strongly under pressure with the slowdown in the market,” said Ivo Naumann, managing director at consultancy AlixPartners.

“Going forward I think [Chinese car- makers] will have a very hard time. They will not be able to expand the market share on the low end much because of competition, and they have a very hard time moving up-market, where the quality and performance of the car plays a more important role.”

Holy Grail of the premium market

For Chinese carmakers, the key to winning over more domestic buyers is strengthening and elevating their brands. As luxury car owners like Zong Zhaoxiang attest, Chinese buyers often make purchase decisions based on a car’s ability to demonstrate their status.

Since cheap public transportation is widely available in Chinese cities, most Chinese buyers view cars as a luxury purchase, rather than a necessity, said Scott Laprise, an analyst at CLSA. “You get a lot of people in China who just never want to even buy a car until they can get a BMW.”

The result is that demand in the luxury car segment in China has been “upside down” compared with other markets, auto analyst Michael Dunne writes in “American Wheels, Chinese Roads: The Story of General Motors in China.”

In the US and Germany, sales of luxury cars decrease as the car’s price goes up, as one might expect. Mercedes’ C-Class sedan, its most affordable model, sells best, followed by the E-Class, and then the flagship S-class.

Until very recently, however, this order was reversed in China: the S-class (Zong Zhaoxiang’s chosen ride) was the bestseller, followed by the E-Class and then the C-class. This changed only four years ago, when Mercedes localized production of the C- and E-Class sedans. These two models are now significantly cheaper than the S-Class because they are not subject to a 25% import duty, said Dunne. However, “China remains the No 1 S-Class market worldwide, and it still makes a powerful statement when it pulls up in front of the Portman Ritz Carlton or Shanghai Links Country Club.”

Shang Yugui, a vice president and spokesman at Chinese SUV maker Great Wall, agreed that brand is a powerful motivator. “Chinese consumers’ under- standing of cars has improved, but they’re still not very rational. Chinese consumers are not buying a car; they’re not buying its functions. They are buying face. That’s very obvious in big cities.”

Chinese brands are understandably eager to chase this demand by moving their brands up-market. But building a luxury brand is difficult and time-consuming – perhaps even impossible, said Philippe Houchois, an auto analyst at UBS.

The last brand to rise into the luxury segment was Lexus in the 1980s in North America, he said. Outside of North America, however, Lexus is often still not recognized as a premium brand. “I think brands exist or they don’t, but you don’t make new [luxury] brands anymore. They’re very historic, and it’s difficult to create new ones,” Houchois said.

Slow going

The luxury segment may be off-limits, but some Chinese companies have been able to move somewhat up-market.

SAIC successfully entered the high-end market in the last few years with the release of “Roewe,” a brand based on intellectual property acquired when British car maker MG Rover went bankrupt in 2005. Geely, a private carmaker that acquired Swedish brand Volvo in 2010, has also won market share by gathering its high-end products together under one nameplate, “Emgrand.”

Overall, however, few Chinese car- makers have been able to establish a reputation for quality and comfort. Sometimes this is merely a matter of lagging consumer perception (see chart on page 36), but often there are still quality and technology gaps between foreign and Chinese brands.

For example, many Chinese companies have yet to master the technology for building automatic transmissions (Geely is an exception, having acquired Australia’s Drivetrain Systems International, the world’s second-largest automatic trans- mission company, in 2009). Chinese car brands also tend to lag behind in terms of styling, marketing and after-sales service.

“The fact is that the quality is not yet completely there,” said Naumann of Alix- Partners. “[Chinese manufacturers] have made great progress over the last seven to eight years, but they are not yet there.”

Analysts said many Chinese companies also tend to face operational challenges. Even if a company has mastered advanced technologies, they may still have trouble designing a car as a logical package, creating an efficient business model to support it, and then fitting that car into a complementary portfolio of products.

“Improving technology is no longer the problem. The problem is now how to turn technology into a widely competitive product,” the Chang’an employee said. “How to transform first-rate technology into classic products, how to transform classic products into best-selling products – that’s not just a question of technology, but of marketing and management.”

Long road ahead

Several Chinese companies are ahead of the pack in mastering these processes. Geely and SAIC, for example, both posses strong technology and have intro- duced higher-end brands. And while the track record of SOEs like FAW, Dongfeng Motor and Guangzhou Auto have been unimpressive thus far, Scott Laprise of CLSA said he expects them to benefit in the long run from their access to foreign brands and technology they derive from their foreign joint ventures.

Many analysts are also bullish about Great Wall, an independent brand that concentrates on SUVs and pick-ups.  Laprise praises the company for its strong exports, good brand recognition, quality and cash position. State-owned carmaker Chery has also introduced some competitive models, like the Riich and the Regal, though Huaibin Lin of consultancy IHS Automotive cautioned that the company has had problems with management and cost control.

Overall, Chinese car companies are making progress. Most analysts acknowledge that it will just be a matter of time before they catch up. “The Chinese brands will clearly have the same level of quality and styling as the foreign ones do [in the future],” said Broderick of J.D. Power & Associates. “And as soon as their brand equity catches up, then I think you will see more of a growth rate of Chinese brands.”

Unfortunately, this could take a long time. Most industry people project that Chinese carmakers will need another five to 10 years to perfect their processes and technology, and perhaps more time to solidify their brand. To make the shift, Chinese car makers will need to change their focus from quantity during the boom years to quality now, said Luo Lei, deputy secretary-general of the China Automobile Dealers Association.

As a result, the market share of Chinese carmakers will probably increase only gradually in the years to come and fall far short of Beijing’s target of 50-60% market share. IHS Automotive projects Chinese manufacturers will capture 37-38% of the domestic market by 2020, up from around 30% currently.

“Some voices are still casting doubt on the development of independent brands ... Consumers just need to be a little patient – we’ll mature and progress,” said the Chang’an employee.

Spend money to make money

One factor that could speed this process is outbound acquisitions. The surest way for Chinese companies to get ahead seems to be by acquiring foreign brands and technology – as Geely did with Volvo and Drivetrain Systems International, and SAIC did with MG Rover.
“I think, left alone, nothing changes.

Chinese auto makers ... wouldn’t make much progress,” said Michael Dunne, the author of “American Wheels, Chinese Roads.” “But they have enough political will that they could start acquiring more brands. Volvo’s already there, there was an effort to buy Saab. You could see, for example, Chrysler or Dodge or Fiat or Hugo or Citroen or weaker global brands get acquired.”

Of course, that raises the question of whether these companies would qualify as “Chinese brands.” Would Beijing accept an acquired foreign brand as the domestic champion that it has been searching for? Perhaps China’s central planners can take heart in the fact that the situation swings the other way. By setting up shop in China, multinational car makers are, to a certain extent, also becoming Chinese operations. Laprise of CLSA cited the example of General Motors, which has localized management and parts production in China, and even designs half of its worldwide platforms in Shanghai. “What is GM in China? A Chinese carmaker or a foreign carmaker? I mean that philosophically,” he said. “You’re paying all these people in local salaries; you’re reinvesting a vast majority of your profits into the local entity. What is not Chinese about Shanghai GM?”
  Even Mercedes-Benz, that paramount of car quality, is localizing production of its luxury models.  Its Beijing Benz joint-venture assembles and manufactures the E-Class and C-Class in China; someday this may be joined by the flagship S-Class.

Perhaps the next time Shanghainese businessman Zong Zhaoxiang buys a Mercedes-Benz, it will be a little more “Chinese” than the last time.

Ghosn’s Infiniti Targeting Audi-Lexus Drivers in China

Bloomberg Business Week, August 17, 2011

Aug. 17 (Bloomberg) -- Nissan Motor Co. plans to quadruple Infiniti’s share of the Chinese luxury-auto market within five years as it rushes to make up a “ridiculous” amount of time lost to Volkswagen AG’s Audi and Toyota Motor Corp.’s Lexus.

Chief Executive Officer Carlos Ghosn has set a target of winning at least 8 percent of the luxury segment in the world’s largest auto market by 2016. Infiniti has 2 percent now. Market leader Audi has 34 percent while Lexus has 8 percent, according to industry researcher J.D. Power & Associates.

Nissan’s strategy to boost sales includes doubling the number of Infiniti dealers this year, adding five product lines over five years and airing its first TV commercials in a nation where primetime audiences can exceed 500 million. The Yokohama, Japan-based company is also considering production in China to eliminate tariffs of 25 percent on imported cars.

“We entered the China market even later than Taiwan and South Korea, and that’s very ridiculous to anybody who has a bit of knowledge about the industry,” Allen Lu, who left Ferrari SpA to become managing director of Infiniti’s China unit last year, said in an interview in Beijing. “But, it’s like running a marathon -- you can’t tell who will win after just 10 kilometers.”

Nissan, Japan’s second-largest automaker, aims to more than triple worldwide Infiniti sales to 500,000 a year by March 2017, taking about 10 percent of the global luxury-car market. China became Infiniti’s second-biggest market after the U.S. last year, according to Lu. The brand isn’t sold in Japan.

‘Good Momentum’

“We have a good momentum in China and we should continue,” Ghosn said July 26 in Beijing, where Nissan unveiled its mid-term China business plan.

Infiniti trails Audi, Munich-based Bayerische Motoren Werke AG and Daimler AG’s Mercedes-Benz in China. BMW has a 22 percent share of the luxury-car market and Stuttgart-based Mercedes has 14 percent, according to J.D. Power.

Infiniti’s China sales were 11,513 last year, doubling from the year before, though still only 5 percent of Audi’s. Lexus sales rose more than 55 percent to 52,933 units in 2010, according to Toyota, Japan’s largest automaker.

Audi also ranked first in a new-vehicle sales satisfaction survey released Aug. 15 by J.D. Power. Nissan’s Chinese venture Dongfeng Motor Co. came second. The survey was based on responses from 11,496 owners and covered 57 passenger-vehicle brands.

‘Real Challenge’

“The real challenge for Infiniti is to get on the consideration list for luxury-auto shoppers in China,” said Bill Russo, a senior adviser at consulting company Booz & Co. in Beijing.

China has more than 1.1 million millionaires and an economy that expanded at 9.5 percent in the second quarter, so “it should be possible for Infiniti to carve out a piece of this expanding pie,” he said.

Toyota declined to comment on the challenge posed by Infiniti, saying in an e-mail that “we respect all competitors.”

Honda Motor Co., Japan’s third-largest automaker, is preparing several new Acura luxury models for the U.S. and Chinese markets, Chief Financial Officer Fumihiko Ike said in June.

Late Start

Infiniti got a late start in China, entering the market in 2007, about three years after Lexus opened its first dealerships there and more than a decade after Audi began local production. The two Japanese luxury units don’t have plants in China, which means customers pay import duties that boost prices.

The Infiniti M25 sedan starts at 498,000 yuan ($78,000) and a Lexus ES350 costs from 545,000 yuan, according to pricing data compiled by Sina.com. That compares with 355,000 yuan for an Audi A6 and 418,600 yuan for a BMW 5-series, both of which are assembled in China.

“Brand loyalty in China is not strong,” Lu said. “Everyone in China made their wealth in the past 20 or 30 years, and when people have all this money and don’t know where to spend it, that’s a great opportunity.”

The success of Infiniti may hinge on manufacturing vehicles in China, said Klaus Paur, Shanghai-based managing director for Greater China at Synovate Motoresearch.

Local Production

Ghosn said in June that Nissan plans to make Infiniti cars in either the U.S. or China. Ghosn and Lu declined during separate interviews last month to comment on whether Infinitis will be made in China.

“The visibility of Infiniti-branded cars has to be increased,” Paur said. “This requires higher volumes that can only be achieved with local production.”

Ghosn is counting on growth in China to help make Nissan Japan’s most profitable automaker for the first time since at least 1992. The carmaker’s Dongfeng venture, which makes Nissan- brand cars, has announced plans to invest 50 billion yuan by 2015 with the aim of raising annual auto sales to more than 2.3 million from 1.3 million.

Infiniti has stepped up its marketing in China, airing its first TV commercial last September and participating in more than 50 local auto shows, Lu said. Sebastian Vettel, the Formula One champion, drove a 5.0-liter V8 Infiniti FX50 and a 3.7-liter V6 Infiniti G37 around a test track in Shanghai in April as part of Infiniti’s sponsorship deal with the Red Bull team.

The number of Infiniti dealers will double to 50 this year, with a five-year target of 150 covering all major cities, according to the company. Five new product lines will augment the current QX, FX, EX, M and G-series vehicles, and department heads drive Infiniti cars to meetings instead of other brands.

“You eat your rice mouthful by mouthful,” Lu said. “We’re going to take it step by step.”

--With assistance from Makiko Kitamura in Tokyo. Editors: Chua Kong Ho, Michael Tighe

To contact the Bloomberg News staff on this story: Tian Ying in Beijing at ytian@bloomberg.net

To contact the editor responsible for this story: Chua Kong Ho at kchua6@bloomberg.net

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