China’s indigenous brand policy backfires

The Financial Times, May 5, 2014

Even the most ardent car lovers would struggle to identify some of the vehicles built by major multinational auto companies in China.

A BMW Brilliance Zinoro, an SGMW Baojun and a Dongfeng Nissan Venucia are among the “indigenous” brands that the Chinese government requires foreign-invested joint ventures to develop in return for approvals to expand production capacity in the world’s largest auto market.

SGMW – GM’s joint venture with SAIC Motor and Liuzhou Wuling Motors – embraced the dictat by developing popular Baojun sedans and mini-cars. SGMW sold more than 100,000 Baojuns in 2013, up almost 20 per cent.

Priced at just Rmb50,000 ($8,000) to Rmb70,000, Baojun’s success has come primarily at the expense of China’s struggling domestic automakers, suggesting that the policy has had at least one unintended consequence.

“After several decades in China, the earliest models introduced by the foreign joint ventures are now priced as cheaply as Chinese brands,” Liu Bo, vice-president of Chang’an Auto, said at a seminar held in conjunction with April’s Beijing car show. “Their ability to focus global R&D resources on the China market is putting a lot of pressure on us.”

March sales of Chinese brand sedans fell 12 per cent year-on-year, as local automakers lost their market lead in the segment to their German rivals led by VW. “The indigenous brand policy is really dumb because all it does is cannibalise the local Chinese brands,” said Janet Lewis, head of Macquarie Securities industrials research team in Hong Kong.

The damage that Baojun and other joint ventures’ indigenous brands, such as Nissan and Dongfeng Motors’ Venucia, are inflicting on Chinese car companies could explain why the government does not appear to be putting much pressure on multinationals who have only done the bare minimum.

BMW’s joint venture with Brilliance Auto “rebadged” the German company’s X1 and electrified it for China’s anaemic new energy vehicle market – thus avoiding confusion with its better selling conventional cars – while Ford has yet to reveal its local contribution to the market.

“Zinoro is a brand of our joint venture here in China,” Karsten Engel, BMW’s country head, said at the Beijing car show. “It’s a brand only for China. It’s based a little bit on the BMW X1.”

BMW chose not to display the Zinoro at the show, instead highlighting its premium i3 electric car. “BMW’s i3 could generate interest in China,” said Bill Russo, founder of industry consultancy Synergistics. “Zinoro doesn’t have the brand panache. Even if it’s an X1 [customers] want to be able to call it what it is.”

The Chinese government’s indigenous brand requirement is particularly challenging for Ford as it runs counter to outgoing chief executive Alan Mulally’s “one Ford” strategy, under which the company jettisoned brands such as Jaguar Land Rover and Volvo Cars to focus on a narrower portfolio.

“We were trying to be world class at so many things,” said Mr Mulally, adding that the strategy was in keeping with the vision of the company’s eponymous founder. “Henry [Ford] wanted to be part of the fabric of economic development in every country in which he operated but he didn’t know that Ford would have a different Ford in every country.”

John Lawler, the head of Ford’s China operations, insisted that the US automaker is in compliance with Chinese government policy mandates, even though it still has not rolled out an indigenous brand.

“We’re satisfying all the requirements from the government but at this point there really isn’t anything for us to announce relative to an indigenous brand or anything along those lines,” said Mr Lawler.

Additional reporting by Wan Li

Click here to read this article at FT.com

Car sales rev up to double speed in China

The Financial Times, December 15, 2013

After an uncharacteristic deceleration in 2012, the world’s largest car market is again growing at a double-digit clip, writes Tom Mitchell in Beijing.

LMC Automotive, a consultancy, estimates that sales of passenger vehicles in China from January to September increased 15 per cent to almost 12m units. That compares with expected growth of less than 8 per cent in the US for 2013, and projected year-on-year declines in Brazil, Russia, India, Germany and Japan.

China’s four richest urban centres seem to be overwhelmed with traffic congestion and related pollution issues.

But Beijing, Shanghai, Guangzhou and Shenzhen are just at the point where car ownership traditionally begins to take off – when per capita GDP reaches $10,000. According to Synergistics, another automotive consultancy, that figure in China’s “big four” regional car markets now stands at more than $12,700.

Moreover, manufacturers are turning their attention to the smaller cities where more than 80 per cent of the country’s 1.3bn people live and per capita gross domestic product is about $4,000.

“Congestion and pollution issues might have a negative effect [on growth in China’s largest cities], but [smaller cities] still have a lot of potential,” says Ray Bierzynski, executive vice-president of General Motor’s joint venture with SAIC Motor and Wuling Auto in Guangxi province. “Our expansion has got to be in those areas.”

In volume terms, GM is the second most successful multinational car company operating in China. Its joint ventures with SAIC, First Auto Works and Wuling sold 1.1m passenger vehicles over the first three quarters of this year, compared with Volkswagen’s 1.9m.

Analysts attribute GM’s and VW’s success in China to aggressive localisation of production, research and development – a tactic that automakers at the luxury end of the spectrum are also adopting.

Daimler formally opened an engine plant in Beijing in November – its first outside Germany – that will eventually export components to Europe.

Yet China has yet to emerge as a significant automotive exporter as Japan and Korea did before it, especially to the US and Europe. Over the first eight months of this year, China’s vehicle exports fell three per cent over the same period in 2012 to just 500,000 units.

Click here to read this story at FT.com

Competing in the China Truck Market - Winning in China's Mid-Market

April 1, 2013

by Bill Russo

This is the fifth installment in a series on the China Commercial Vehicles market.  

Click here to read the first installment.

Click here to read the second installment.

Click here to read the third installment.

Click here to read the fourth installment.

Most multi-national companies that aspire to be global leaders have no choice but to find a way to win in the Chinese mid-market. 

The common strategies employed by MNCs are to:

1. Ignore the risk and avoid competing in China’s mid-market altogether.
2. Offer global products and wait until China catches up to more upscale demand, which works only for a limited number of sectors.
3. Pursue a two-tier strategy with a core brand sold along with a lower-priced “good enough” brand considered. MAN is following this approach since early 2011 and Daimler trucks are considering it with their partner Foton.

Multinationals simply cannot afford to cede this mid-market to local competitors.  Instead, they must set about organizing themselves to face the emerging Chinese competitors on their own terms – with products that meet Chinese

needs, developed at Chinese cost, and which can then be taken out of China to other markets around the world. They must stop thinking about what it is they can bring to China, and instead start focusing on what China’s mid-market can offer them – what culture and structures they must adopt that will allow them to innovate at a lower cost and to deliver the goods and services that will drive the next round of global growth.

A good example can be found in the construction equipment industry. Caterpillar, which in the 1990s focused on government relationships and selling traditional, high end products to China, shifted focus after the entry of Japanese and Korean competitors in the mid-market segments, and being squeezed by lower-end local players. In the late 2000’s, Caterpillar acquired Shandong Engineering Machinery and formed local R&D centers to expand into lower end market, while optimizing its cost base to compete. Clearly, Caterpillar reasoned, there was a market segment that was here to stay and CAT’s traditional product and business model positioning wasn’t going to be adequate.

In the medical equipment sector, another good example of a mid-market innovation was General Electric’s development of ultrasound machines. From 1990 to 2000, GE served the Chinese ultrasound market with machines developed in the US and Japan, priced at $100K and upwards. While these products were successful with a narrow set of hospitals, the price point was above the affordability threshold of many. In 2002, GE’s local team in China leveraged GE global resources to develop a cheaper, portable machine, priced at $30-40K. And then in 2007, GE’s local, China organization launched a dramatically cheaper model, priced at only $15K. The result of these step-wise innovations in somewhat functionality but at dramatically lower price points, were products that saw rapidly increasing sales in China from $4M in 2002 to $278M in 2008, and at the same time, these mid-market products found new markets abroad. As it turned out, there had been latent demand for lower-priced ultrasound machines even in the world’s most developed markets, but neither GE nor its competitors had realized this or pursued this demand with relevant products.

Mid-market products are not simply lower-cost variants to global, high end products that can be delivered at lower price points.  Foreign and Chinese companies will bring very different mindsets into the battle for the middle market.

Although the competitive strategy to address the middle markets may be different, the path for both Chinese and foreign companies is the same: access the middle market growth opportunity to both extend brands and product reach with the magnitude of impact that can change the global competitive landscape.    

Ultimately, mid-market capabilities rooted in China can be leveraged to tap global markets with similar demand patterns.  

While the size and importance of the Chinese mid-market opportunity may be understood, it is often unclear how Multinationals can participate in the market.  The Chinese market is already highly fragmented, and the pathway to entry for foreign players is not obvious.  However, we believe that several market entry options exist.  It is important to understand that competing in Chinas rapidly expanding and highly competitive mid-market will require an integrated set of capabilities.

For example, MAN SE (Maschinenfabrik Augsburg-Nürnberg), in a joint venture with China’s Sinotruk, has maintained a two-tiered strategy since early 2011.  Vehicles for the Chinese market are sold under the Shandeka brand name, and those for other emerging markets across Asia, Africa, and the Middle East are sold as Sitrak.  This strategy allows MAN to sell two different vehicles at two different price points to two different markets, with separate business models.

In China’s passenger vehicle market, similar two-tiered strategies are increasingly adopted by international OEMs in the form of Joint Venture local brand development.  Starting with the Everus brand launch by Guangzhou Honda in 2010, Shanghai GM Wuling, Dongfeng Nissan, and Dongfeng Honda have each launched their respective JV local brands.  The vehicles carrying those brands are often originally branded vehicles at the end of their life cycle, which are rebranded after certain local adaptations are made to meet the taste of the Chinese consumer.  Such an approach is intended to generate higher volume through upgraded old generation vehicles without diluting the brand image of international players.

The two-tiered strategy, with separate but parallel business models, can be effective:  it enables companies to compete in mid-markets where they otherwise could not.  However, it is not a trivial task for many global producers of industrial equipment to build the capabilities needed to sell effectively to mid-market customers in China.  They must invest in Chinese (or equivalent) R&D and product development, simultaneously integrating their new operations with their old and managing intellectual property challenges. They also lack the home advantages that Chinese mid-market innovators possess: the knowledge of their market niche, access to low-cost production resources, and a deep understanding of the regulatory and operational environment.  Joint ventures such as MAN’s can help, but they also add complexity.

A small number of global companies are focusing on developing an integrated capabilities system that approaches Chinese mid-market customers and Western higher-end customers in an integrated way.  This requires a relentless focus on improving operations and product development together with regional integration.  For example, a company might migrate more parts of its value chain and innovation practices to China and other lower-cost countries — with the intent not of saving labor costs, but of gaining distinctive production and sourcing capabilities that can be put in place around the world. These new efforts can specifically target the country’s mid-market and use local engineers and research staff accustomed to more frugal ways of thinking.  It may not be obvious at first how particular product lines will be affected, but the new efforts can act as springboards for the kinds of ventures that lead to capabilities that can be leveraged around the world[1].

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[1] Edward Tse, John Jullens and Bill Russo, “China’s Mid Market Innovators”, Strategy & Business, Summer 2012, Issue 67.

Competing in China’s Slower Growth Automotive Industry

Auto.Sohu.com, September 1, 2012

Click here to read the Chinese version at auto.sohu.com
Click here to read the English version at auto.sohu.com

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.