China's entry in the WTO has brought about a gradual opening of the Chinese automotive market. The growing participation of global automotive majors has resulted in some important trends, which will have a far-reaching impact on the industry. This article discusses some of these trends.
Market OverviewThe Chinese automotive industry has become one of the big success stories of the country's booming economy. Spurred by growing domestic demand, the industry is expected to be one of the world's largest markets by 2008. The growth potential has attracted the attention of global majors that are keen to profit from the opportunities lying ahead. China is now internationally known for its low-cost automotive manufacturing. Keen to drive home the advantage, several global automotive companies have invested in China. China's entry into the World Trade Organisation (WTO) in 2001 has also come at an opportune time. Global companies can look forward to operating in a more liberalised environment and competing with domestic participants on an equal footing. The government is also keen to make the automotive industry as one of the pillars of future economic growth. In 2003, the total industry comprising sales of new vehicles and component parts was $92.80 billion constituting more than 5 per cent of the gross domestic product (GDP). There were close to 2,400 organised manufacturers of automotive vehicles and components in this market, employing almost 1.9 million people. At the end of 2002, over 600 joint venture companies were operating in China with overseas partners from more than 20 countries. The total foreign investment amount was more than $22.00 billion in 2002. Until the early 1990s, the truck segment dominated the Chinese four-wheeler industry. However, the passenger car segment drove the recent boom in the industry. This has been as a result of a rise in private purchases due to rise in disposable income levels, declining prices, easier availability of credit, and new model launches. Sensing the opportunity, global industry leaders such as General Motors, Ford, Hyundai, Toyota, and Honda have entered the market in the past few years.
This has increased the competition in the car market. A fast track strategy of infrastructure development has also paid dividends. Greater passenger and freight movement has resulted in demand for trucks and buses rising smartly. Rising demand from rural and semi-urban areas have seen motorcycle sales crossing the 12 million mark. China's accession to the WTO is one of the key industry developments. Under WTO, China is committed to reducing import tariffs and eliminating non-tariff barriers including quotas and licences by 1st January 2006. Laws regulating market entry will also be liberalised along with local content and technology transfer norms. All disparities between state and provincial laws are also expected to be eliminated. Under the Trade Related Intellectual Property (TRIP) agreement, China would need to tighten its intellectual property (IP) laws. This is likely to be an important step, given the large number of disputes relating to IP issues. The government has already shown its intention by beginning to crack down on the counterfeit business. The Chinese automotive market is a very dynamic one. For participants to succeed, it requires a greater understanding of the issues relevant to the market. These include various challenges facing market participants, demand drivers and restraints, competitive scenario, and market and regulatory trends.
Automotive Vehicle MarketThe Chinese automotive market can be classified into the following segments:
▪ Passenger cars
▪ Buses
▪ Trucks (including automatic unloading vehicles)
▪ Motorcycles
▪ Agricultural vehicles
▪ Tractors
In 2003, the Chinese automotive industry (including cars, buses, trucks, motorcycles, tractors, and agricultural vehicles) grew by 24.3 per cent to reach 25.5 million unit shipments. Sales of passenger cars touched 2 million for the first time, with significant rises in sales of economy grade cars (cars up to 1.6 litres engine capacity). This was largely driven by rising disposable incomes in urban areas, lower unit prices, and higher penetration of credit schemes.
Improved road infrastructure helped push up truck sales by 15 per cent to 1.25 million units in 2003.
Higher passenger mobility (migration from rural to urban areas) and replacement demand drove bus sales by 11 per cent to 1.2 million units (2003). Rising demand from rural and semi-urban areas helped motorcycle sales to touch 12.9 million units (2003). Sales of tractors have stagnated in the past few years due to lower farm output prices and a decline in sown area. A similar trend has also been witnessed in the agricultural vehicle market.
Market DriversThe key factors driving growth in the Chinese vehicle market are:
▪ Growing disposable income levels
▪ Declining car prices
▪ Introduction of new passenger car models
▪ Easier credit availability and lower interest rates
▪ Infrastructure development
▪ High replacement demand for light and mini trucks in rural areas
▪ Higher replacement demand for buses
▪ Industrial development
▪ Development of tourism.
Market RestraintsThe major demand restraints for the Chinese vehicle market include:
▪ High cost of vehicle ownership
▪ Rising sales of used cars restraining demand for two-wheelers
▪ Decreasing grain output and changing food habits restrain demand for tractors
▪ Local protectionism
▪ Poor pollution norms reducing replacement
China is expected to be one of the fastest growing markets in the world. Frost & Sullivan expects the total automotive industry to grow at a compound annual growth rate (CAGR) of 5.3 per cent in unit terms over the period 2002 to 2008. Rising prosperity levels and higher replacement demand are likely to induce greater demand for cars in the future. Passenger car sales are likely to register the highest growth rate with a CAGR of 22.0 per cent during the period 2002 to 2008. Backed by continuing investment in road building projects, freight movement is expected to shift to this sector at the expense of waterways.
Truck sales are likely to rise at a CAGR of 12.8 per cent during the period 2002 to 2008. Better road connectivity is also likely to help the bus segment. Frost & Sullivan expects bus sales to rise at a CAGR of 9.2 per cent over 2002 to 2008. Motorcycle sales are likely to grow at a slow pace of 2.7 per cent per annum in the forecast period. This has to do with the fact that penetration rates are already high in China with yearly sales of around 13 million units. In addition, there are restrictions on motorcycle sales in urban areas. Sales of tractors and agricultural vehicles are also likely to witness a slow growth phase.
Trends :
Growing Levels of Individual ConsumptionTill about four years ago, automobile consumption in China was largely driven by demand from government institutions. With increasing economic growth, personal disposable incomes rose, which led to higher consumption by individuals and families. In 2003, 50 per cent of passenger cars brought were by individuals. If one was to go by previous experiences in developed countries, private cars begin to be popular only when per capita GDP reaches $1,000. In 2003, China's per capita GDP was around $1090. However, there exist huge regional differences in China. Per capita GDP in developed provinces (having a population of about 300 million) is around $4,000. Shanghai, for example, has a per capita GDP of close to $4,500. Thus, in the current scenario, the target market for cars would be developed urban areas.
Increasing Price Competition in the Passenger Car IndustryChina is committed to a gradual reduction in tariffs on passenger cars to 10 per cent by July 2006. Meanwhile, import quotas will also need to be totally eliminated by then. The government has also removed controls on domestic pricing of cars. These measures have led to growing price competition in the segment.
Price competition is an elementary tool of market competition. It may be argued that price competition is a competition at the very basic level and results in shrinking profits for market participants. However, for most products, price competition is a kind of a mechanism that compels enterprises to improve management, technology, and service levels. This is true for the automotive industry. Volkswagen's 'Santana' has been selling well in the Chinese market for the past 20 years, making a good deal of profit for the company. This was only possible as there was no competition of any kind until recently. Due to its dominance in the market, the company did not see the need to keep prices competitive and introduce new technology. Early this year, when sales of Santana were under pressure, the company launched a variant with better features but at the existing price.
Pricing strategy is an important part of the overall strategy of multinational corporations in China. It has helped them to penetrate new regional markets and capture market share from their competitors. Hence, higher price competition is not necessarily bad for the Chinese market. In the long run, price competition, will help eliminate weaker market participants while leaving the field for more competitive producers.
Price competition works well in the development stage of an industry. However, as the market opens out to competition and market shares become stable, participants would need to think of other strategies to succeed in the market. Competition will then expand to cover other factors such as marketing, services and so on.
Transformation of State-owned Automobile Enterprises from Market Leaders to Market FollowersMultinational corporations came into China flushed with funds and armed with the latest technology and management practices. They formed several joint ventures with domestic firms. These JVs have already occupied the leadership position in the passenger car segment. Foreign JVs will also try and extend their hold in other segments too, notably trucks and buses. Unless independent state-owned firms acquire or develop advanced technologies and seek new opportunities in the growing market, they would soon lose out to global majors.
State-owned enterprises also face competition from domestic private sector firms. With investment norms getting liberalised, the industry has attracted significant amount of private capital. These private enterprises have initially targeted certain niche markets. For example, Anhui Chery Automatic Co Ltd and Zhejiang Geely Group have focused on the economy car segment and have succeeded in making a good impact. Although their product quality, performance, and after-sales services are still not competitive compared with those of foreign JVs and state-owned firms, their low priced products have managed to appeal to the customer.
Global majors have indicated a marked preference to ally with privately owned domestic enterprises rather than state-owned ones. Administrative interference prevents state-owned firms from taking timely decisions limiting their ability to respond to changing market conditions. There is also an important question of managing cultural differences between the two entities. However, in the current scenario, private capital spending is yet to take off in a big way in China. In the future, when the situation changes, the market is likely to see more number of alliances between private sector and MNCs. This will further queer the pitch for state-owned corporations.
Large Scale Setting up of Production CapacitiesThe continued growth in the domestic car market in China has resulted in companies rolling out plans to increase production capacities. With growing incomes, consumer preferences will get diversified and higher production capacities will help companies to target a large number of market sub-segments. Higher capacities will also help companies to achieve economies of scale in an increasing price competitive market.
However, there is also a flip side. Increasing competition in the market will result in frequent launches of models, which necessarily mean shorter product life cycles. The success of a product will not be guaranteed and any such failure will mean a waste of resources for the company. Thus, higher production capacities could lead to higher fixed costs, which can prove detrimental to the overall profitability of the firm. Currently, too, some car manufacturers are laden with over capacities. For example, Dongfeng-Citroen already has a capacity of 150,000 units, although it produces and sells just around 50,000 units.
ConclusionRising living standards, improvement in transportation infrastructure, and reduction in automobile related taxes and fees will drive expansion in the Chinese automotive market. Apart from the thriving domestic market, the export market is also set to grow as China is being seen as a low-cost manufacturing base. The entry into the WTO has signaled far reaching regulatory changes in the future. Foreign joint venture companies will be able to operate in a more open environment without adhering to localisation and licensing norms. Non-tariff barriers are also to be gradually done away with. Stricter emission norms such as Euro-II are expected to entail investment in technology for local firms. These changes are likely to help create a level playing field for foreign JVs in relation to domestic companies. This is likely to result in a round of consolidation in the market with several smaller manufacturers either being acquired or exiting the market.
The entry into the WTO will also impact the fortunes of the Chinese auto component industry. The development has created a more favourable environment for foreign participants to invest in the industry. Global component manufacturers can leverage their tie-ups with multinational automakers that already have or will have manufacturing facilities in China to facilitate their market entry into China. This presents both challenges and opportunities for the domestic industry participants. The most affected will be the large number of unorganised players who subsist on small volumes, low technology and low quality products. They are likely to face pressure from cheaper imported parts and would need to enhance technology and quality benchmarks for catering to OE clients. This will result in an inevitable shakeout in the industry. Given the growth potential in the Chinese automotive industry, global market participants cannot ignore this opportunity.
The growth in the Chinese automotive market has brought in its wake certain market trends, which will shape the way the industry develops in the future. Industry participants would need to keep a close track on these developments and develop appropriate strategies to deal with the resulting scenario. Long-term success in this market would depend on several factors. These include a comprehensive understanding of the needs of automotive buyers by offering a good price-value mix and stable partnerships with domestic companies.
