Future of China’s Auto Industry Clouded by Push Toward Consolidation

China’s automotive market is roiled these days by two different government objectives, one long range and the other short term.

Recovery from the global financial crisis, already under way, is the top priority of Beijing leaders and likely to be relatively quick and simple. Their push for an autonomous Chinese auto industry, however, is far more complex and harder to achieve.

The building blocks for both are in place, and changes are coming.

Neither the Chinese economy nor the domestic vehicle market were as badly hurt by the global meltdown and recession as those in the U.S. and Europe. The world’s third-largest economy is on track to grow close to 8% in 2009, Deputy Central Bank Governor Yi Gang says at a recent meeting in Beijing. Tokyo University Professor Tomoo Marukawa agrees. “China will be a leading force in the world economy this year, with around 7% to 8% growth in gross domestic product, a slow rate for China but high compared to the rest of the world.”

Chinese exports, driven by demand in the U.S. and Europe, are still weak and not expected to recover much momentum this year. But a 2-year, RMB4 trillion ($586 billion) stimulus plan –roughly 7% of GDP – announced last November and focused mainly on infrastructure projects, is providing a new spur to the economy.

Giving a hearty boost to vehicle sales are a reduction from 10% to 5% in the purchase tax on cars with 1.6L or smaller engines and subsidies to owners who trade in high-emissions cars for more fuel-efficient models.

In the year’s first four months, J.D. Power Asia Pacific reports total vehicle sales in China rose 10% to 3.93 million units, with minivehicles, compacts and subcompact passenger cars accounting for six out of every 10 vehicles sold.

“Most people are buying cars with 1.6L (or smaller) engines,” says John Zeng, a senior analyst with IHS Global Insight in Shanghai. “Without the subsidies, the market would not have recovered so quickly. The first subsidy was worth around RMB5 billion ($732 million), and the government has added more.”

Zeng estimates these subsidies will deliver additional sales this year of 500,000 to 800,000 cars and mini cars

Chery’s top-of-line Riich G6.

For the full calendar year, industry analysts are upbeat, expecting light-vehicle sales to climb 9% or 10% to as much as 9.6 million units. Light-vehicle deliveries, alone, are forecast to rise 7% to about 6.3 million. J.D. Power reports the seasonally adjusted annualized selling rate for April reached 11 million units.

The halcyon days of huge double-digit annual sales gains may be over, but China already has passed Japan to become the world’s second-biggest automotive market and undoubtedly will continue to grow briskly.

However, the future shape of the automotive industry is clouded by Beijing’s plans for reorganization and consolidation.

Although the timing and details are not yet clear, the central government wants to consolidate auto makers into four large groups and five or six smaller groups. The number of vehicle producers, still more than 100, most of them small, presumably will be sharply reduced to eliminate excessive competition, strengthen the survivors and advance ambitions for autonomy.

But there are doubts as to how necessary or successful the proposed changes would be.

“I don’t know why there is a push now for consolidation,” says Tim Dunne, director, Asia-Pacific Market Intelligence, J.D. Power and Associates.

“Who does the selecting? Based on what criteria? The provinces have a stake in the automobile business now. The turning point that helped drive China’s economic development was decentralization in the early 1980s.”

Today, the industry is divided into two different kinds of vehicle producers, independent and dependent.

China’s Big Three in terms of sales are dependent on joint ventures with foreign partners for most of their profits, as well as design, engineering, new technology, up-to-date production know-how and other topical inputs.

Geely’s brand image problem for jump into premium segment, analyst says.

Along with JV partners Volkswagen AG and General Motors Corp., Shanghai Automotive Industry Corp. Group led the country in sales last year with 1.72 million units.

First Automotive Works Group Corp., with partners Volkswagen and Toyota Motor Corp., sold 1.53 million vehicles, followed by Dongfeng Motor Co. Ltd, which has JVs with Honda Motor Co. Ltd., Nissan Motor Co. Ltd. and PSA Peugeot Citroen.

All of the Chinese Big Three, as well as other large Chinese producers wedded to JVs with foreign auto makers, have been slow to develop their own Chinese-brand passenger vehicles. More numerous are smaller, up-and-coming independent producers, such as Chery Automobile Co. Ltd., Geely Automobile Holdings Ltd., BYD Auto Co. Ltd. and Great Wall Motor Co. Ltd. All are owned or supported by provincial or municipal governments, unaffiliated with the major players and led by aggressive, ambitious entrepreneurs. Until recently, they competed on price. “We want to compete with locally made foreign brands,” Chery Chairman Yin Tongao said this spring at the launch of the auto maker’s top-of-the-line Riich G6, priced at RMB200,000-RMB300,000 ($29,300-$43,900).

Great Wall and Geely reportedly plan 3.0L sedans to compete in the RMB300,000-range, as well. “We have changed our strategy now,” Geely Chairman and founder Li Shufu recently said on state television. “We want to make good, quality cars.”

Can these independent producers successfully make and market upscale, national brands as well as smaller, cheaper models for the masses? Do they have the talent and experience in-house to build globally competitive vehicles? There is no consensus among industry experts. “All Chinese auto makers still need outside help,” IHS Global Insight’s Zeng says. “None are at an independent stage yet. The brand image of Chery, Geely and Great Wall will be a big problem for any jump into the premium-market segment.”

Dunne is more optimistic. “China’s local producers have bright, young, energetic people who learned on the job and have already shown they can successfully start a car company from scratch. And don’t forget the Chinese are fast learners. But they will need more time to become globally competitive.”

Marukawa is a skeptic. “Geely and Great Wall have even less chance than Chery to move up-market,” he says. “Chinese auto makers do not seem to nurture talent and experience. They all seem to have difficulty keeping good people in-house. After watching the Chinese auto industry for several years, I even doubt whether any independent Chinese auto maker can survive in China in the future.”

The share of the passenger-car market held by domestic brands last year was 26.6%, down from 27.2% in 2007, but climbing to 30% in the first four months of 2009. That figure is expected to stay the same through the end of the year.

Zeng expects domestic share “to grow bigger and bigger,” in the future, but J.D. Power forecasts a decline to 28% in 2013, suggesting a peak already may have been reached.

A hard look at market-share numbers indicates a shakeout is badly needed, either by natural attrition or consolidation.

Dunne notes the local brands of 25 independent producers accounted for virtually all of the 27% to 30% share of China’s passenger-car market, while the top-five independent producers have snagged more than 83% of the total.

“The rationale for consolidation is that stronger players must have a chance to flourish,” he says. “But the counter argument is China needs people with the ingenuity and energy to make things happen. And who can say small companies, backed by their own provincial or municipal governments, can’t succeed?”

Near-term, Marukawa warns, “All the foreign companies making cars in China will try to recover in China the sales they lost in the U.S. and other countries, and Chinese auto makers will face even harder competition this year.”

If and when the reorganization and consolidation details are worked out, where will the maneuvering leave foreign auto makers?

The short answer seems obvious: firmly seated in their JVs, albeit willingly or unwillingly continuing to assist Chinese partners in their attempts to make appealing Chinese local brands.

“Winding down the operations of foreign auto makers would be difficult,” Dunne says. “Consumer demand for foreign brands is tremendous and, politically, I doubt Beijing wants to (discontinue that).” Marukawa says foreign auto makers will remain major players in the domestic passenger-car market because Chinese consumers do not trust the quality of Chinese brands.

“Beijing’s policy is clear, but much depends on how the (auto makers) respond,” Zeng says. “It takes a long time to build a strong car company.”

Foreign auto makers remain upbeat about their prospects in China, with no signs of waning interest.

Zeng reports Fiat Auto Group and Guangzhou Automobile Industry Group have signed an agreement to form a RMB4.3 billion ($627 million) JV to build 140,000 vehicles and 220,000 engines annually beginning in 2011.

“It is now up to the central government, which has an automotive policy that says new projects will be for local brands only.”

In early June, China’s Xinhua government news agency quoted GM Group President and Managing Director Kevin Wale as saying, “Domestic sales of vehicles by GM China and our joint ventures continue to be strong, rising 33.8% year-on-year in the first five months. We intend to remain an industry leader in China.”

Wale also confirmed talks are continuing with FAW for a JV to build commercial vehicles.

An autonomous Chinese auto industry remains the long-range dream Chinese leaders are pursuing, and foreign auto makers in China may be living on borrowed time. But, for the foreseeable future, it appears Beijing is willing to settle for a global mix of foreign and domestic producers.