Stuck in First Gear: Chinese Car Companies Struggle to Compete with Foreign Brands

CKGSB Knowledge, July 30, 2013

Foreign car makers are under attack in China while Chinese auto manufacturers have yet to achieve real success

Can foreign car makers in China continue to dominate the market while appeasing Chinese car companies?

CCTV, Chinaʼs powerful state-run television broadcaster, unleashed a torrent of faulty vehicle claims against foreign automakers in March. First, the network targeted Volkswagen, alleging transmission issues with some of its cars, which led to the recall of more than 380,000 vehicles at an estimated cost of $618 million. The broadcaster then attacked BMW and Daimler, who were accused of selling cars that produced harmful fumes.

The media’s indictment of foreign car makers dovetails with China’s policy to nurture indigenous players. From removing financial incentives for foreign car makers to requiring they launch Chinese car brands, Beijing has tried to curtail the seemingly endless popularity of non-local autos as domestic brands continue to cede ground to their foreign counterparts. Foreign auto manufacturers first set foot in the Chinese car market 30 years ago, fully aware that the state allowed their entry into the market on the condition that they enter into joint ventures (JVs) with domestic firms, who were expected to benefit from their technical expertise. Despite a lack of complete freedom, they’ve flourished ever since, but the latest round of government-sanctioned media criticisms may force foreign companies to change tack.

Slow Start for Chinese Cars

The Chinese car industry has grown rapidly since the nation opened its doors in 1972, shouldering past the US in 2009 to become the word’s largest. Domestic players have profited from this expansion, but their market share is receding compared to foreign car makers: the 30% portion held by Chinese car brands at the end of 2009 fell to 26% in 2012 according to financial research firm Sanford C. Bernstein.

This is not the turn of events China hoped for when it granted foreign auto manufacturers market access in 1984. Beijing knew its car makers were behind the curve on precision manufacturing, so it encouraged JVs with foreign firms to bolster domestic tech-expertise, hopefully leading to a globally recognized national champion.

“The joint venture policy towards the auto businesses in China has always been one of ‘youʼre a guest, youʼre invited and we will tell you the rules by which you must play,ʼ” says William Russo, (formerly a) Senior Advisor at consulting company Booz & Co.

In 1984, Zhao Ziyang, Chinaʼs then premier, said JVs would facilitate the consolidation of the auto market into three large and three small producers, with high levels of local content. Zhaoʼs vision has not come to pass. Different outlets give different estimates—The Wall Street Journal said there were 170 Chinese car makers as of April this year, while the International Business Times cited only 115 companies as of 2012, neither news outlet divulging the source of their information—the China Association of Automobile Manufacturers declined to confirm any specific figure. Either way, even the ballpark is well off from Zhaoʼs prescription.

Not only has consolidation not occurred, but local car makers also remain umbilically dependent on their foreign JVs for profits. Shanghai Automotive Industry Corporation (SAIC), Chinaʼs largest car manufacturer, owes 90% of its sales to its foreign JVs, according to a research paper from January this year called “Case Study: SAIC Motor Corporation” published by the US think tank Center for Strategic and International Studies (CSIS). And no Chinese car maker has managed to design and produce a single car that has won global acclaim.

In stark contrast, foreign car makers have thrived. “The Chinese car market is very orientated towards foreign brands. Three out of every four cars sold in China carry a foreign brand,” says Russo.

The China car market, now General Motorʼs (GM) largest, was the US companyʼs savior during the financial crisis, as sales in the nation helped it heave itself out of bankruptcy proceedings in 2009. Since the firm tied itself to SAIC nine years ago, it has amassed 14.7% of Chinaʼs market share, earning a profit of $1.5 billion in 2011 from its joint venture, according to GM China reports. Still confident of its position in China, GM aims to increase sales by 75% in two years to 5 million cars.

China is also Audiʼs most lucrative market. The German manufacturerʼs sales increased by 14.2% in the first quarter of 2013, to almost 103,000 vehicles and it is planning to open a new plant in Foshan, Guangdong province, which will have a manufacturing capacity of 150,000 cars annually when it opens for production at the end of this year according to state-run China Daily.

Still Second Choice

Chinese consumers are buying foreign brands over local ones, because domestic makers are finding it hard to shake off poor repute. “The challenge that Chinese car companies have is convincing their own consumers that Chinese companies in fact can make good cars,” says Russo.

A number of Chinese brand cars have failed foreign safety standards, sullying the reputation of Chinese car makers and making it difficult for indigenous brands to market themselves at home and abroad. Brilliance China Automotive, a firm tied to both Bayerische and Toyota, tried to sell its BS6 sedan in Europe in 2007, but earned only one out of five stars for safety from a German car association, which said the driver would have little chance of surviving a side collision.


(Source: Youtube, Youku video here.)

Chinese car companies find it tough to ratchet up the quality, in part because they lag on research and development spending. “Most Chinese companies are thinking five to six years out with their R&D spending and trying to compete with international companies that are already thinking 20 to 25 years out,” says Nat Ahrens, Deputy Director and Fellow of the Hills Program on Governance at CSIS.

This thrifty approach means Chinese car companies have less to spend on nurturing innovative engineering and design. Instead of creating a car from scratch, which would allow them to claim half the patent rights, Chinese JV partners take existing foreign vehicle blueprints, make a few changes and call it a new JV auto: GM and SAICʼs first JV car, Baojun 630, is built on the old Buick Excelle, while Dongfeng and Nissanʼs fi rst Venucia vehicle is fashioned after Tiida. By taking the path of least resistance, Chinese JV companies demonstrate to the consumer their reliance on foreign tech for quality, which does little to raise confidence in their own brands.

Chinese brands are gaining ground on locally made foreign brands as sales have grown steadily in 2012

Driven to Distraction
The relative success of Western brands against languid domestic ones has sparked indignation and embarrassment among Chinese commentators. In January, Communist Party mouthpiece The Peopleʼs Daily blamed foreign companies for the sluggish performance of domestic players, writing, “Most Chinese car companies involved with JVs have not received the technology they were promised.” In September last year, former machinery and industry minister He Guangyuan said JVs are “like opium” and likened Chinaʼs JV policy to a negative addiction. “So many years have passed and we donʼt even have one brand that can be competitive in the auto word,” He said.

But some feel that Chinaʼs expectations of tech transfer were too high. “I donʼt think any promises were broken, these contracts are laid out very clearly on what was going to be transferred and what wasnʼt… I donʼt think that there was any deception on the part of the foreign partners,” says Ahrens. “You canʼt force technology transfer.”

Market Remodel

As the strength of Western brands has grown, China has pushed back by trimming the incentives and freedoms of foreign automakers. In January last year, China said it would no longer promote investments from foreign car makers through preferential tax treatment and streamlined approval processes, increasing costs for foreign manufacturers.

The month after, Beijing excluded foreign car makers from a newly released list of approved vehicles for government use. While this measure will have little impact on the profits of foreign car makers such as Audi and Mercedes (brands that were included on previous lists), it signaled Beijingʼs determination to freeze out nonlocal competition. In April of the same year, Maxime Picat, the Director General of Peugeot-Citroenʼs Chinese joint venture, said Beijing was threatening to restrict the firmʼs manufacturing expansion plans unless it launched local brands.

The squeeze on foreign auto manufacturers is likely to put a strain on existing JV relationships, making the negotiation process for new deals increasingly delicate. The conflict inherent in a joint venture between two would-be competitors is clear. “A foreign companyʼs interest is not to nurture a local company so that it is as successful or more successful than itself. It will undoubtedly withhold some of its crucial technology,” says Teng Bingsheng, Associate Professor of Strategic Management at the Cheung Kong Graduate School of Business. At the same time, domestic firms are bartering with access to the largest auto market in the world at a time when foreign firms, whose own markets are drying up, can ill afford to be choosy. Under government pressure, the biggest challenge for an existing foreign JV partner will be how to relinquish enough intellectual property to placate Beijing, while at the same time, invest sufficient amounts in R&D to maintain its lead over local and other international players.

But Chinaʼs actions are not likely to wean consumers off foreign brands as the central issue is one of demand not supply. “Government policy cannot change the nature of demand. Chinese consumers will spend their money on the brands they prefer and there is very little that can be done to force Chinese consumers to buy Chinese brands,” says Russo.

This Chinese consumer preference is likely why state media reports went after foreign car makers to begin with, to damage their brand equity in hopes of restoring balance between foreign and domestic brand preference. But it will take more than a few quality-control reports to undo the brand resonance of foreign cars. Chinese brands will have to spend a significant amount of time garnering consumer confidence before they become as popular as well known international car makers.

The Chinese government’s distortion of the market may also have unintended consequences. The launch of new domestic brands by forcing JVs will add another level of competition to an already fragmented market and take business away from Chinese companies who are already struggling to build their market share. By ramping up competition, China in fact weakens the position of wholly domestic brands like Chery and BYD, thus stifling their own plans for a national champion.

“For example, if GM launches a domestic brand, customers that would otherwise be buying a Chery or BYD car will see a car coming from Shanghai General Motors [the GM joint venture with SAIC] and will buy that instead,” says Russo. “So they [the State] are going to eat their own young.”

Just a Fender Bender

Despite Beijingʼs cooling approach to foreign car makers, the countryʼs leaders are unlikely to stifle them completely. “At the end of the day, the government wants to see the domestic car industry succeed, but many of the Chinese companies depend on successful foreign joint ventures to contribute to their profitability and they wonʼt do anything to harm those companies, because that would ultimately harm the whole industry,” says Russo.

In spite of the complications, foreign car makers are finding their tie-ups beneficial in some ways. GM is using SAICʼs low-cost vehicle technology to vault into emerging Asian markets. SAICʼs technology for producing cars priced as low as $4,800 is central to GMʼs plans to plugmiddle-class needs in India and Indonesia. Also it has been reported that BMW and Chinese Brilliance brand Zhi Nuo—which roughly translates as “The Promise”—may start exporting their vehicles to Europe.

The governmentʼs latest measures to suckle a national auto champion are unlikely to seriously dent foreign makersʼ prospects in the short-term. Ultimately, consumer choice determines the winners and losers and the Chinese are increasingly buying foreign brand vehicles. Also, the structure of the market is so dependent on symbiotic JVs that separation in the near term would damage both parties.

The biggest long-term threat to foreign car makers in China is competition from increasingly sophisticated Chinese brands, whose manufacturing skills are developing steadily. Nissan and Honda, two Japanese brands known for their attention to detail, stated publicly that they now outsource heavily to local Chinese suppliers. Quintessentially precise Mercedes-Benz-manufacturer Daimler opened a trial engine production plant in China in May. A decade ago, this would have been unthinkable given the quality of production in China.

Experts draw comparisons between the fledgling Chinese car market and the early Japanese one. In the 1970s, consumers largely thought of Japanese cars as cheap machines. Now, Japanese manufacturers produce premium lines. Hyundai was originally well known for its affordably priced cars, and now makes very innovative, high-quality products. “Great Wall, Geely and Shanghai Auto are capable of making good, quality cars and give an indication that the Chinese car industry will be able to produce a globally competitive car company,” says Russo. “Itʼs a question of time.”

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An Odd Corporate Vehicle for Doing Business in China

The Financial Times, May 13, 2013

by Andrew Hill

Buick Riviera The big attraction on GM’s stand at last month’s auto show in Shanghai, the concept car is the product of a joint venture between Shanghai GM and a separate JV, the Pan Asia Technical Automative Center

In 2010, seven managers from PSA Peugeot Citroën and five from Chang’an Automobile met in Shenzhen, southern China, to lay the groundwork for a new car factory. Three years later, Capsa, a 50-50 joint venture between the French and Chinese companies, is in the final stages of preparing a 1m square metre plant for the September launch of Chinese-made premium cars under the DS brand. “Because we were beginning from a blank sheet, people wanted to make it as perfect as possible,” says Gilles Boussac, Capsa’s president, between meetings with his team of mostly Chinese managers. “So often in China, if you’re trying to rework or improve something, it takes years to achieve.”

But the people who built Capsa have not started from scratch. Their shared enterprise is based on three decades of global car companies’ experience working with Chinese partners.

International car executives are confident such ventures will continue to be the best way to reach Chinese customers, who now buy more than 20m new vehicles annually, making it the world’s largest automobile market. But their enthusiasm for these awkward corporate vehicles, with their unique management challenges, obscures the fact that the path of co-operation has been bumpy.

A shared purpose

From the outset in the 1980s, automotive joint ventures in China were built on hopes of mutual benefit, tinged with mutual suspicion. George Xue of Fudan University’s school of management in Shanghai says they are “central [to] the Chinese economy”. The nation had three main aims in encouraging them: “Developing industry, upgrading technical expertise and enhancing our management level.” International carmakers, meanwhile, were prepared to share their manufacturing technology and knowhow with Chinese state-owned partners in the hope of gaining access, initially via local government contracts, to the wider market.

The joint ventures are odd creations. The largest state-owned carmakers frequently cultivate relationships with non-Chinese rivals. SAIC Motor in Shanghai, for instance, operates 104 joint ventures, including two of the biggest – one with Volkswagen and another with General Motors – as well as its own independent carmaking operations. But these enterprises now have deep roots. Ahead of the auto show in Shanghai last month, Volkswagen celebrated with SAIC the 30th anniversary of the first Chinese-built VW Santana.

From China’s point of view, local production was revolutionised by association with the global companies. The Chinese partners grew large on the back of joint-venture production. At a roundtable at the Boao Forum for Asia last month, Hu Maoyuan, SAIC’s chairman, attributed its “development into a Fortune Global 500 company from a local small company” to the opening of the economy and opportunity to co-operate with global carmakers. The Chinese also appear to value management experience acquired via joint ventures: Mr Hu and his vice-chairman are former presidents of Shanghai GM.

Meanwhile, mutual suspicion has waned. According to G.E. Anderson’s book Designated Drivers, Peugeot’s first, failed venture, with Guangzhou Automotive Manufacturing in the 1980s, was marked by “resentment that, although the Chinese workers were being taught to speak French, there appeared to be no desire on the part of the French expatriates to learn Chinese”. The Chinese also bridled at strict French production methods, while the French did not export the Chinese-made Peugeots, as planned, lest the poor quality hurt their brand. By contrast, Capsa’s managers use English and Chinese – based in part on the fact it is easier to find Chinese-English interpreters.

Popular model: Volkswagen Santana taxis first built by the German carmaker and SAIC 30 years ago

Capsa’s Shenzhen plant is hard to distinguish from European or US car factories, though managers boast it is more compact, and therefore likely to be easier to run. It draws on lean manufacturing techniques, such as the use of modular plastic racks and trolleys along the production line. In a negotiation typical of Chinese joint ventures, the French team had to convince its Chinese counterparts such racks would be a better investment than cheaper, but rigid, metal alternatives. To pre-empt potential clashes, Capsa workers were asked to bring their tools to the first training sessions to help integrate their working methods into the planning of the plant.

Ying Zhanwang, executive vice-president, says the joint venture has developed a “one goal, one team, one process” system of production-line excellence based on best practice at Chang’an and Peugeot. It also capitalises on Chang’an managers’ and engineers’ experience working with Mazda and Ford in other joint ventures.

Shanghai GM is the longest-running example of this co-operative approach. In American Wheels, Chinese Roads, Michael Dunne writes about the critical moment, in 1998, when Phil Murtaugh, then general manager of GM’s Shanghai operations, and Mr Hu, at the time his Saic counterpart, laid out a four-point plan for a “kind of co-operation never before witnessed in China’s automotive industry”. It included the requirement that Shanghai GM staff should put the joint venture first, in contrast to the more rigid delineation between German and Chinese managers at rival Shanghai VW.

Kevin Wale, former president of GM China, says all joint ventures are moving towards Shanghai GM’s co-operative style. VW and SAIC set great store, for instance, on forging a closer common culture through initiatives such as Shanghai Volkswagen University, set up last year to train staff in areas such as product development and sales and marketing.

Mr Wale and other analysts also say there is no reason why Shanghai GM’s approach should be more successful than Shanghai VW’s and point out that relations within the GM-SAIC venture are not always harmonious.

Bob Socia, Mr Wale’s successor, says the expatriate roles at Chinese joint ventures are “not easy jobs, because you have lots of bosses”. Trying to look at problems from your partner’s perspective can be draining, Mr Wale adds: “It isn’t a natural phenomenon to always be looking behind the curtain.” As an example, both point to Saic’s insistence on – and GM’s initial resistance to – development of the Chevrolet Sail at a production cost and price level far lower than the Americans were used to.

Maturing partnerships

Since the 1980s, automotive companies have learnt how to tailor old models, and, increasingly, to design new cars to Chinese tastes. Asked what the Chinese have taught them, most expatriate managers refer to their counterparts’ determination to reduce process complexity and costs.

But have the international carmakers applied these lessons or other Chinese-led innovations to their operations in other markets? “Less than they could or should have done,” says Bill Russo, a former Chrysler executive whose Synergistics consultancy now advises companies on building cross-border partnerships.

Hu Maoyuan of Saic predicts that it will take years before Chinese-branded cars overtake joint venture models

All joint ventures are “like children growing up”, says Mr Wale. The parents have “to let them stretch where they are capable and slow them down where they need guidance and support”. The children, and their parents, are likely to face further challenges in the coming decade. John Huang, managing partner at Shanghai law firm MWE China, points out: “If competitors form joint ventures – what I call ‘sharing the same bed, with different dreams’ – sooner or later they will have problems.”

In three areas – development of Chinese-branded cars, the export of Chinese-made vehicles and the sharing of intellectual property – Chinese companies, and their political paymasters, have not achieved what they hoped for in the 1980s.

The arrangements were supposed to prompt the development of competitive homegrown models. At the Shanghai show, scores of Chinese brands were on display but non-Chinese marques have the upper hand in the market. This is partly because the Chinese are happy to reap the monetary and industrial rewards from the joint ventures, but also because the Chinese consumer has developed a taste for the international brands.

SAIC’s Mr Hu underlined at the Boao conference that the company was “working on independent research and development . . . and our independent brands are seeing long-term development, not only in terms of the technology level”. He admitted, however, it would require “the efforts of generations” for sales of Chinese-branded petrol and diesel vehicles to surpass those of joint-venture brands.

Not for export

The original joint-venture contracts also made clear that the new enterprises would eventually export their vehicles from China. But one analyst says international companies have deliberately “slow-walked” exports because they could pose a direct competitive threat to their wholly owned subsidiaries in third countries.

At the same time, with a few exceptions – including the Sail, whose intellectual property belongs to GM’s local joint ventures – international companies have been reluctant to share designs with Chinese partners. Most “new” co-owned joint-venture brands are pale versions of older models.

Chinese and foreign partners have a strong shared interest in prolonging their moneymaking ventures. But if China slows, or local brands fail, the demands on joint ventures will intensify, further complicating the management of the world’s largest, but strangest, co-operative enterprises.

In Shenzhen, Mr Boussac’s demanding production programme is on schedule: “At the last board [meeting] everyone was pleased to see that all the planets were aligned: Capsa, [Peugeot], Chang’an.”

The question for most of the automotive joint ventures in China is what will happen if and when the planets no longer line up.

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Is your joint venture really necessary?

Shanghai GKN Driveshaft, a car parts venture between GKN of the UK and SAIC, dates from 1988, making it one of the oldest in the sector. Xue Jinda, its managing director, says it combines the “successful characteristics of both Chinese and western parties” – so successful that in 2009 the partners extended it for another 50 years and have just expanded its scope.

But in other industries, where joint ventures are not mandatory, they are usually shorter-lived and, in many cases, may not even be necessary.

Richard Grams, who runs the Shanghai office of Benesch, the US law firm, says very few partnerships work after year three. Often, in that time, “the company has spent as much or more time managing the relationship with the JV partners than they have pursuing the business”.

Unlike the carmakers, which operate via larger, more rigid equity joint ventures, a growing number of international companies in China are now using flexible “contractual” or “co-operative” agreements, under which more than two partners can have different shareholdings, pay-off schedules and objectives. Non-Chinese companies may also prefer to link up selectively with specific local companies for one product or activity – for instance, distribution – rather than for the entire business.

Where there are likely to be large upfront costs, or difficult negotiations with government officials, it makes sense to use a Chinese partner. But John Huang of Chinese law firm MWE China says that since 2000, more foreign groups have set up “woofies”, wholly foreign-owned enterprises, than joint ventures. As Andy Reynolds Smith, GKN’s chief executive of automotive, points out, businesses with many customers lower down the supply chain may find it easier to serve China through a wholly owned subsidiary, as GKN does in the powder metallurgy division he also oversees.

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