Imagine a General Motors Corp. (GM) that could start from scratch. It wouldn't be saddled with billions in pension and health-care costs. Its manufacturing costs would match those of rivals like Toyota Motor Corp. (TM) and Honda Motor Co. (HMC) This GM would be something like the well-oiled machine that was building new plants and boosting its U.S. market share throughout the early 20th century. In such a world, GM wouldn't suffer from a reputation for poor-quality cars -- even moribund brand names like Buick would be held in high esteem.
That, in a nutshell, is GM in China. Chairman and CEO G. Richard Wagoner Jr. is doubling down his bet on the world's fastest-growing car market. Since launching Buick in China five years ago, GM has poured more than $2 billion into an expanded lineup of 14 cars, ranging from the $8,000 Chevrolet Spark minicar to, starting later this year, luxurious Cadillacs. Now, GM, along with its Chinese partners, plans to sink $3 billion more over the next three years into boosting production by 145%, developing new engines, and ramping up research and development in Shanghai. In time, GM plans to offer 20 new models -- a car for every Chinese purse and purpose, to paraphrase legendary GM Chairman Alfred P. Sloan.
But Wagoner is taking a big risk. He's betting that the Chinese economy will keep roaring along at its present torrid pace, at a time when many analysts believe China is set to slow, or maybe even overheat. And he's not alone at the craps table. Over the past decade, nearly every major auto company has jumped into China, the No. 3 car market, with both feet. Already, growth is slowing -- car sales were up 45% through April, off from 75% in 2003 -- amid signs of a glut. Last year, prices dropped 12% as import tariffs fell and all manner of Chinese companies, from motorcycle makers to electronics firms, piled into the car business.
For now, though, GM's investment is paying off big. Its sales in China surged 56% through the first four months of this year, giving the auto maker the No. 2 spot (behind Volkswagen) with 11% of the market, up from 9.3% last year. More important, GM hasn't had to shell out $4,000 per vehicle in incentives to lure those new buyers. The $437 million profit GM made last year in China, selling just 386,000 cars, compares with an $811 million profit made in all of North America on sales of 5.6 million autos. In the first quarter of this year, GM's total China profits quadrupled, to $162 million.
For a car giant that is still on the road to a full turnaround, that's a nice chunk of change to offset its seemingly endless losses in Europe. But if China car sales grow as Wagoner expects, the increased scale there could prove more significant, helping GM stave off the worldwide challenge from Toyota. GM predicts that China will surpass Japan as the second-largest vehicle market around 2007 -- and could pass the U.S. by 2020. By establishing its brands and seizing share now, Wagoner thinks, GM will be able to mine profits for years to come. Says Michael J. Dunne, president of Bangkok consulting firm Automotive Resources Asia Ltd.: "China may be the perfect case study for the re-creation of GM."
Even if China hits a wall, Wagoner thinks GM could still emerge in better shape than its rivals. He believes its lineup offers more variety than those of the Japanese or Europeans. GM also benefits from a solid distribution network established through its sole partner, Shanghai Automotive Industry Corp. (SAIC). Says Wagoner: "There is always risk when you're investing in an emerging market. But the bigger risk is not being there."
Indeed, for auto makers seeking relief from a global price war, China is the only game in town. With just 8 vehicles per 1,000 residents -- vs. 940 in the U.S. and 584 in Western Europe, according to J.D. Power and Associates Inc. -- there could be plenty of upside. Says Frederick A. "Fritz" Henderson, GM's group vice-president of Europe, who until recently ran the Asian operations: "The battleground for global industry leadership is China."
Besides GM's plan to boost capacity to 1.3 million vehicles by 2007, new plants and production increases are planned by VW, Nissan (NSANY), Toyota, Korea's Kia and Hyundai, DaimlerChrysler (DCX), and Ford (F). Ford now makes Fiestas, Mondeos, and a van in China. The company says it will triple production this year, albeit to just 65,000 vehicles. Says Mark A. Schulz, executive vice-president and president of Ford Asia Pacific and Africa: "Some say we're slower or behind in China. But to us it's a brand-new market. it's just starting to blossom." VW alone plans to spend $6 billion to double production over the next four years. The German carmaker, which started with almost exclusive rights to foreign car sales in the 1980s, still has a 26% share. To bolster its dated lineup, VW recently introduced vehicles such as the $80,000 Phaeton luxury sedan and will add the Golf and Skoda Octavia compact. Its Audi unit is already a powerful luxury nameplate in China.
Over the past 10 years China has seen the emergence of a middle class numbering in the tens of millions with enormous buying power -- much of that directed at big-ticket items like autos. In a market that used to be dominated by government and big-company purchases, individual buyers have rapidly become the new driving force. Unlike many emerging markets, China also has a large, wealthy entrepreneurial class. The average price of the 2.8 million passenger cars that will sell in China this year is about $20,000. The average car price in markets such as India, Brazil, and Indonesia is $6,000 to $8,000. China is BMW's biggest market for the most expensive 7-Series sedan, outstripping even the U.S. -- even though Chinese buyers pay double what Americans pay.
Even more astonishing is how many Chinese are shelling out cash for those expensive cars. Foreign lenders will get the green light to offer auto loans later this year. For now, though, GM estimates that at most a fifth of all car purchases are financed. Most buyers are like Xu Zhenyu, a 27-year-old construction contractor living in Shanghai. Xu plunked down $30,000 in cash for a new Buick Regal 2.5 GL for his family -- plus $7,000 to cover license fees and taxes. A year ago he bought a Buick Sail with cash. Says Xu: "Buick has a good price-to-quality ratio."
SEIZING AN OPPORTUNITY
GM has been working to build up its business in China since the early 1990s. Retired GM Chairman John F. "Jack" Smith Jr. had a keen interest in Asia and spent a lot of time with Japanese partners Suzuki Motor Corp. (SZKMF) and Isuzu Motors Ltd. (ISUZF). But Japan's auto market was virtually closed to Western carmakers and Smith saw China's huge population as an opportunity. He went to China in 1994 and began a year of negotiations with government officials, including then-Vice-Premier Li Lanqing and auto maker SAIC. Outbidding Ford Motor Co. (F), Smith hammered out a deal to invest an initial $1 billion to develop a plant with SAIC to build only the Regal. Production started in 1999. Government officials liked the Buick brand because it was popular in China before World War II, and they figured an expensive car would fit the market, dominated then by government officials and big-company executives. GM bet that it could later expand, as a consumer class developed. Critics laughed, pointing out that the auto maker had enough trouble just trying to sort out its home market.
With China's economy surging 9.8% in the first quarter, no one is laughing now. But can the boom last? There are serious concerns that the nation's financial institutions helped fuel overly rapid growth with loose lending practices. Many banks loaned money to unprofitable state-owned businesses, and backed expansion in industries like steel, aluminum, cement, and real estate that now have overcapacity. The People's Bank of China, the central bank, has tried to get lending under control. But there is still plenty of fear that business ventures that grew fat on borrowed capital could fail. Standard & Poor's (MHP) estimates that some 40% of business loans in China are nonperforming. The growth is also fueling inflation. "You have an economy based on easy money," says Bill Adams, Asia analyst for Austin (Tex.)-based Strategic Forecasting Inc.
If the economy slows, some auto makers may be in trouble. Morgan Stanley (MWD) forecasts that car manufacturers in China will double their plant capacity to 5.4 million vehicles by 2006. Sales need to continue to grow at 30% a year to keep everyone in the money, figures Morgan Stanley analyst Stephen J. Girsky: "If demand falls, there could be a bloodbath."
Auto makers could sop up excess production in China by exporting cars, maybe even to the U.S. Wagoner says that won't happen in the foreseeable future. Despite wage rates of 78 cents an hour at Chinese car companies, he says, Chinese production isn't cost-competitive. Many locally made parts are inferior. That's why GM and others import parts despite tariffs. Plus, GM would have big problems with the United Auto Workers if it tried to displace U.S. plants.
For now, the Chinese government is trying to head off a car glut. It's particularly worried about the many new local players entering the market. In early June, the government decreed that companies new to the market must invest a minimum of $240 million in manufacturing facilities and $60 million more for an R&D center. The government also is mulling emissions and safety regulations that could be tough on weak competitors.
Analysts assume that many local carmakers -- which now hold some 20% of the market -- will fall by the wayside. But that will leave stronger Chinese players, such as Chery and Geely, which have doubled their sales annually the past couple of years. They have thrived partly by copying popular brands: GM griped to the Chinese government that a new model from Chery, the QQ, is a knockoff of the Spark. And Toyota sued Geely for copying its logo but lost in a Chinese court. However, both Chery and Geely are improving their quality and are likely to survive.
GM's biggest advantage in China, though, is its unsullied reputation. In the U.S., it still struggles to convince many young and middle-aged drivers that it is past the production gaffes and dull styling that marked the '80s and '90s. But newly minted Chinese executives equate Buick with prestige and quality. Hu Zhilong, 50, who runs the Shanghai Yongda Auto Puxi Sales & Service Co., says his best-seller is the Regal: "It is a symbol of one's status and very luxurious." Hu, who has an executive MBA degree from China's People's University in Beijing, hopes to become become a Cadillac dealer later this year as well.
AN OPEN ROAD?
Indeed, nothing captures GM's ambitions for China more than the rapid rollout planned for its luxury brand. On June 7, it staged a glitzy launch ceremony, with dancers and models, some in futuristic-looking costumes, a vintage 1948 Cadillac and a 1,000-horsepower "Sixteen" concept car, in Beijing's 584-year-old Imperial Ancestors' Temple. The first Cadillac CTS's will roll off ships this fall, followed by the SRX sport sedan, and the XLR roadster. All will start as imports. But soon after, assembly will begin in Shanghai -- the first Caddies ever to be built outside the U.S. "China will become Cadillac's second-largest market, and this will happen very quickly," says Mark LaNeve, the brand's general manager.
GM execs see an open road ahead in their fastest-growing market. They're stepping on the gas -- even if there's no telling what waits beyond the next curve.
By David Welch in Detroit, with Dexter Roberts in Beijing and Gail Edmondson in Frankfurt