Ready to Blossom

SHANGHAI — Stroll the Bund on a Sunday evening and one thing quickly becomes clear — there's money to be had here.

From the towering, ever-increasing number of skyscrapers that light up the night along the Huangpu River, to the souvenir hawkers selling post cards and film to mostly Chinese tourists, to the people, themselves, who walk Shanghai's financial district corridor with cell phones firmly planted in their ears — there's widespread evidence a middle class finally is beginning to emerge in the People's Republic of China. In fact, it's hard to go anywhere in this country without seeing new roads, world-class hotels, housing — even shopping malls — under construction. In a nutshell, China soon may be more Motown than Mao.

And that's good news for the world's automakers, which already are jockeying for position in what some analysts predict rapidly could become the third largest car market in the world.

The big drawing card is China's soon-to-come absorption into the World Trade Organization, an event some say could happen before year's end. In a word, what the WTO will give carmakers is freedom — not complete freedom, but enough room to cut more lucrative joint venture deals, make more sensible vehicle and parts sourcing decisions and for the first time allow them to reach out and touch consumers with their finance arms.

Once it joins the WTO China will have to begin lowering import car tariffs to 25% in 2006. Tariffs on parts will fall to an average of 10% by then and quotas on imported vehicles — which have restricted foreign cars to only about 35,000 units annually — should increase 10-fold almost immediately and disappear altogether in 2005. Government quotas on local content also will become void, and foreign-owned companies eventually will be able to import, retail and offer after-sales service.

This opening up of China comes at the same time a full-fledged market economy is beginning to emerge. Any fears China's central government would reverse position and tighten the reins on this country's cautious creep toward capitalism were eased in June when President Jiang Zemin called for Communist Party membership to be opened up to private business owners. And although politics is a concern — tensions between the U.S. and China do flare at times — political stability is not.

“China has a political stability that's not present in Russia, for example,” says John Cleary, an executive with Johnson Controls Inc. in China. “And you saw what happened to the economy there. A lot of pitfalls Russia saw I don't anticipate here.”

China's whole motivation for joining the WTO is to keep the economic ball rolling. Driven by massive foreign investment — second only to the U.S. in the dollars it draws — China has seen its gross domestic product grow a healthy 8% per annum in recent years. Average income is $700, and critical mass needed to spark a full-fledged auto market won't be reached until that hits $4,000, some analysts believe. But there's already a consumer corridor forming along a crescent-shaped beltline that runs from Beijing south to Shanghai and on to Guangzhou in which personal incomes average $2,000 to $2,500. There's currently a fairly substantial pool of 1 million potential automotive consumers in China, and that's growing 20% per year, says Michael Dunne, president of Automotive Resources Asia Ltd.

That makes the car market poised for takeoff in China's biggest metropolises, industry insiders insist. Barring an economic bubble burst, auto sales are on pace to continue doubling every eight years, they say. That would take the domestic market from 2.1 million vehicles today to 4 million by 2010 and to a U.S.-like 16 million by 2025.

All this has executives at General Motors China antsy as they hurry to put strategic pieces in place for what is sure to be a highly competitive, high-stakes chess match for control of this potentially lucrative market.

For now, companies like GM, Volkswagen AG and Honda Motor Co. Ltd., already active with car assembly joint ventures in China, appear to have the jump on competition. But that is expected to change quickly. Ford Motor Co. recently got the nod to start building small cars with Chongqing Chang'an Automotive Co. Ltd. Toyota Motor Corp. is set to launch the Yaris with Tianjin Automotive Group. BMW AG will build 3-series cars with Chinese Brilliance Group Co. Ltd. And Nissan Motor Co. Ltd. is closing in on a deal to build small cars with Dongfeng Automobile Group.

GM execs say they remain confident, however, that they have the strategies and pieces in place to not only survive, but prosper. “Every market is competitive, and we know we have to compete,” says GM China Group Chairman and Chief Executive Philip F. Murtaugh, brushing aside the coming competition.

The biggest ammunition in GM's arsenal is its Shanghai-GM Corp. Ltd. joint venture here with Shanghai Automotive Industry Corp., a sprawling, mostly self-contained 220,000 sq.-m (2.4 million sq.-ft.) state-of-the-art plant that in June launched its third distinct model in three years.

But GM also is positioning itself for the emerging light truck market with another JV in Shenyang, and it is pursuing a tie-up for mini-vehicle production with partner SAIC and another local manufacturer.

In addition, it has its finance arm, General Motors Acceptance Corp., prowling around for a local partner, ready to begin offering consumer loans the minute the gun sounds signaling China's entry into the WTO. And S-GM's engineering center, Pan Asia Technical Automotive Center (PATAC), is growing in size and gaining stature within the industry.

GM may indeed have the jump on the competition with the launch of the new Opel Corsa-based Buick Sail 4-door sedan at its S-GM JV. The Sail, priced at RMB100,000 to RMB125,000 ($12,000 to $15,000), is China's first “modern” car aimed at the masses, GM says. Derived from the Brazilian version of the Corsa but having undergone more than 100 — mostly cosmetic — changes for China, 70% of new Sail sales are expected to go to private buyers. That's the reverse of what is seen with higher-priced executive cars, such as the S-GM built line of Buick (Century) mid-luxury sedans that cost roughly $35,000 and up and mostly are sold to government officials, state-run companies and ex-pats working for multinationals in China.

Launch of the Sail is expected to go a long way toward helping S-GM get better use of its $1.5 billion plant that includes engine and transmission operations along with assembly. Although it is said to have made money each of the last two years — breakeven is pegged between 20,000 and 30,000 units — S-GM still has a long way to go to fill up capacity and earn back that initial investment. In contrast, Honda spent about $200 million to launch Accord production in Guangzhou, thanks to a less-demanding Beijing.

“If we could do it in today's environment, we wouldn't spend the money we did,” Mr. Murtaugh admits. “We know we over-invested.”

But no one's expecting a fast payback, either. “We're not looking to (quickly) repatriate profits back to GM,” says S-GM Chief Financial Officer Mark E. Newman. “Net-net we're close to our business plan.”

Sail is expected to account for half of the 60,000 to 65,000 units slated for production this year, with the larger sedan and minivan accounting for equal portions of the remaining volume. But that still leaves 40,000 units of unused capacity and insiders hint of another model — possibly a production version of the PATAC-designed, Corsa-based Quilin concept shown in 1999 or other Corsa derivative — joining the mix. A restructured loan package that gives S-GM access to $500 million in credit makes that easier, because the automaker no longer needs prior approval from 39 separate banks to tap into the funds.

The second piece in GM's puzzle is its revived Jinbei-GM Automotive Co. Ltd. JV with Brilliance-controlled Jinbei Automotive Co. Ltd, where launch of Chevrolet Blazer and S-10 crew cab production is under way. This is the second go-around for GM and Jinbei, having abandoned an earlier deal to build standard S-10 pickups that proved ill-suited and too high-priced for the market. About $159.2 million was spent refurbishing and tooling an eight-year-old, never-used Jinbei facility in Shenyang (northeast of Beijing) for production of the two trucks. Parts are supplied from Brazil, but about 40% of components needed are sourced locally, with a target to bring that to 60% next year and 80% by 2003. Output is pegged at 30,000 units annually, going to 50,000 on two shifts in 2003 when employment will rise from 760 to 1,400. About 43% of sales are expected to go to private buyers.

The third component in the GM game plan is acquisition of a 34% stake in Liuzhou Wuling Automotive Co. Ltd. with partner SAIC. Wuling makes microvans based on Daihatsu Motor Co. Ltd. technology, and GM says that segment, already one of the largest in China at 300,000 units annually, will double in size by 2010. The automaker likely would help Wuling expand its lineup — via help from an Asian partner such as minicar specialist Suzuki Motor Corp. — and broaden distribution through S-GM. And although talks hit a snag when the government rejected a proposal to finance the purchase through an initial public offering, executives are confident a deal will get done.

“We have strong government support — both local and central, and we're confident of the final outcome,” says Mr. Murtaugh, who points out the acquisition plays perfectly with Beijing's desire to consolidate China's auto industry — now fragmented into 119 companies — into fewer than a dozen major players.

All this, GM executives say, puts the company in good position for what is expected to be a post-WTO market boom. Along with small van sales, seen doubling to 700,000 units annually, other hot segments between now and 2010 include small cars (reaching 600,000-plus) and low- and upper-medium sedans (1 million).

“A few years ago many Chinese, including me, couldn't imagine people owning cars,” says a veteran reporter with China's Xinhua news agency. “Today, it is unimaginable not to.”

And importantly for GMAC, more customers will begin to finance purchases. Today only about 10% to 15% are bought on time, GM says. “Most buyers walk into a dealer with a suitcase full of cash,” says Scott W. Reno, director-Financial Services for GM in China.

But financing should grow to 40% of purchases by 2005, according to projections from Automotive Resources Asia Ltd., as governmental barriers come down and customers get used to the idea of borrowing. “Traditional Chinese have an aversion to debt,” notes Mr. Reno. “We'll need to educate consumers about the advantages of credit.”

All told, GM says it is ready for the post-WTO China. Even with lower tariffs, company insiders predict, imports won't be able to compete with well-run domestic vehicle manufacturers.

“You want access to (Chinese) customers, you have to get in (China),” agrees Mr. Dunne. “Asians don't like imports. The game will be played inside (China).”

Lower tariffs on parts and an absence of local content requirements also will benefit local carmakers, enabling them to act more strategically when it comes to sourcing components. But GM also says its growing network of high-quality local suppliers — it now has 150 domestic suppliers certified to QS9000 standards — gives it a cost edge that will have newcomers to the market playing catch-up.

Under WTO “we won't have to live up to local sourcing provisions in the current contract,” says Timothy P. Stratford, vice chairman of General Motors (China) Investment Co. Ltd. “But we still have a lot of supplier relationships that give us a competitive advantage here.”

In addition, exports are on the near-term horizon, but don't expect to see Chinese cars in the U.S. any time soon. “We're working on a few opportunities now, all in the Asia/Pacific region,” says Mr. Murtaugh. “We have no plans whatsoever to export to Europe or North America. We're not (cost) competitive with cars produced in North America or Europe.”

There are two major potential stumbling blocks that could take China's auto industry off the fast track, auto insiders say: an economic hiccup and rising capacity. “For the industry to double every eight years, economic growth must be in the 7% to 8% range,” says Mr. Murtaugh. “Most economists agree that is reasonable, but if there's some cataclysmic event, then we could see some major problems for the industry.”

Mr. Dunne says the industry could be a victim of its own success. As the market becomes more lucrative, more and more carmakers will be scrambling to add to the already oversubscribed production capacity. And that quickly could erode profits and weed out the weak.

“Overcapacity equals price pressures, so anticipate an all-out battle for these customers,” he says. “It will be a war of attrition during the next 10 to 20 years.”

GM China says it's determined — and positioned — to survive.