TREND #6: Hyper-Competition Across the China Automotive Market Segments

September 30, 2009

by Bill Russo

The sixth of the Eight Overarching China Automotive Trends That Are Revolutionizing the Auto Industry concerns the rapidly changing structure of the China automotive market and its impact on the competitive landscape. While many Vehicle Manufacturers have reported robust sales in 2009, what may not be understood or appreciated among those who are observing the growth in sales is that this is a market where quantity of sales should not be confused with quality of sales. The China market is now experiencing what many companies doing business in the United States have come to understand for many years: hyper-competition.

With Tremendous Growth Comes Hyper-Competition

As described in detail in Trend #2: Global Redistribution of Assets by Non-Chinese Companies to Capture China Market Growth, China’s vehicle market has more than doubled in size from 4.56 million units (in 2003) to 9.67 million units (in 2008). Global Insight has forecasted that the Asian markets represent the largest growth potential in the global auto industry - with a combined 4.7% compound annual growth rate over the next 10 years (compared with 2.9% in NAFTA). Within Asia, 54% of that growth is expected to come from China. With the promise of tremendous growth, many international firms as well as Chinese firms are encouraged to allocate resources to seize the opportunities presented by the Chinese market.

The high popularity of the April 2009 Shanghai Motor Show further illustrated the attraction of the Chinese market. The show stand covering 170,000 meters attracted over 660,000 visitors with over 900 models on display, over 300 of which were imports. Over 1500 exhibitors were present at this year’s show.

Early-movers in the China market such as Volkswagen and General Motors have enjoyed significant profit margins by occupying mid-size, full-size and MPV segments without a great deal of competition. In such a market environment, profits could be made on products such as the VW Santana and the Buick GL8 minivan – older technologies that dominated their segments with good margins. However, today’s China market no longer offers such an easy road to profitability. Virtually every major vehicle manufacturer is now present in the China market. A recent J.D. Power & Associates study has reported that many of the cars sold in 2009 were in low-end segments that are eligible for tax incentives and that many of these cars earn the manufacturers as little as $100 each.

However, hyper-competition actually began several years ago, with the onset of a phenomenon called “net negative pricing”. In fact, Global Insight reported the following net segment price declines over a four-year period (starting 2004):

• Micro (A-segment): 20.4%
• Small (B-segment): 27%
• Compact (C-segment): 32.5%
• Standard (D-segment): 26.3%
• Luxury (E/F-segment): 12.1%

The future outlook is that local brands and international brands will install more capacity in China, placing even more pressure on pricing in order to increase capacity utilization. Weak brands and older models will become the first casualties as market and competitive forces squeeze them out. The competitive battle can only be won with strong brands and contemporary models that can be delivered profitably to savvy Chinese consumers with choices that demand a competitive price.

The Problem of Overcapacity

It was reported recently in the article “China urges automakers to prevent overcapacity”, that Chen Bin of the National Development and Reform Commission has encouraged automakers to “keep their heads cool” to prevent overcapacity. With an expectation of a 28% jump in vehicle sales in 2009, many automakers are announcing aggressive expansion plans. With sales now expected to easily surpass 12 million units this year, there is every cause to be bullish about China’s future automotive market. However, China’s industry planning agency has good cause for concern as there are already many weak vehicle manufacturers in the market today, and it is unclear whether the government will extend the tax cuts and rural subsidies that expire at the end of this year into 2010.

Beyond simply adding capacity to produce more of the same type of cars, there is evidence that the competitive structure of the market will take on a new dimension in the near future. For the early stages of the development of the China market, the multi-national brands and Chinese brands were for the most part not competing directly with each other. Foreign brands enjoyed a tremendously high share of the passenger vehicle market, with overall share of more than 70% as recently as last year. Until recently, China's automotive market was largely driven by the more affluent Chinese consumers who tended to shop for foreign branded products. However, this year’s sales jump has been largely driven by first-time consumers entering the market to buy the low-displacement micro-and small-segment cars that are supported by the tax policies. These segments are for the most part served by the Chinese local brand manufacturers.

This is about to change. Attracted by the tremendous growth of these segments, many multi-national brands are expanding their product portfolio into these smaller segments. Examples include the Ford Focus Hatchback, Chevrolet Cruze, PSA 207 Hatchback, Hyundai i30, VW Polo Sport, Toyota Yaris, smart Fortwo, and Kia Soul.

Attracted by the desire to raise their brand image, and achieve higher margins, the Chinese carmakers are also expanding their product portfolio – into larger segments. Examples include Chery’s Rely V5, Riich G6, Dongfeng’s S30, BYD’s S8 and M6, Geely’s Dihao and Yinglun and the Brilliance Zunchi.

While top-down advice to cool things down may be helpful, it is rare to see any organization unilaterally opt for conservatism in the face of optimistic market forecasts. Since China has become the most attractive area to invest for growth, it seems that Chinese consumers will be enjoying even more choices and even more attractive pricing as a result of hyper-competition.

These developments will have significant implications on the global auto industry, as the installed capacity in China will increasingly be used to serve to serve demand beyond China's borders. Structurally, many vehicle manufacturers will either learn to profit in this hyper-competitive market, or will find their ability to compete here, and thereby elsewhere, compromised.

In the next posting in this series, I will describe the trend "China Vehicle Manufacturers Push to Build Brand Equity".

Click here to view the article published in GLG News

Click here to view the article published in gasgoo.com's China Automotive News

Click below to view:

TREND #7: Local Vehicle Manufacturer’s Push to Build Brand Equity