During the Shanghai Auto Show in late April, Volkswagen and General Motors Corp. (GM ) put on a brave face. At Volkswagen's 5,000-sq.-meter stand, car buffs could sample tropical fruit, salmon, and chocolate while ogling the new 200-horsepower Golf GTI and the Audi A6L -- a China-only version that's 10 cm longer than the standard A6 to make the back seat roomier for execs with drivers. At GM's display, models in slinky outfits posed beside the chiseled 3.6-liter Cadillac CTS, the new Chevrolet Aveo compact sedan, and -- to give Chinese buyers a taste of GM's former grandeur -- a 1959 Cadillac Eldorado.
But all the flash in the world can't hide the challenges the two companies face in China. Both came early to the mainland -- GM formed its Shanghai joint venture in 1997, while VW arrived 21 years ago -- and quickly dominated the market. But now they're getting trounced by new entrants offering smaller, cheaper cars. Led by the success of its Elantra compact, starting at $13,600, Hyundai Motor Co.'s unit sales in China soared by 156% in the first quarter over the same period last year according to market researcher CSM Worldwide. Guangzhou Honda Motor Co. (HMC ) sold 76% more cars as buyers snapped up its $10,360 Fit. And domestic champ Chery's sales climbed 42%, driven by the explosive response to its $3,600 QQ. VW, meanwhile, has seen its 2001 market share of 40% tumble to less than 20% last year, as sales plunged by nearly two-thirds in the first quarter. GM's sales from its Shanghai operation -- its biggest China venture -- dropped 35% in the quarter and its overall profits in China plummeted 80%, to $33 million.
The reason for the shift is simple. Just a few years ago most auto sales were to state-owned companies that didn't worry much about price. Today most buyers are individuals who want the best deal for their money. And rumors that Beijing is mulling a tax on vehicles with big engines are only accelerating the trend. "Now the common people are buying cars," says Yale Zhang, head of the Shanghai office of CSM. "They want affordable, small [vehicles], of good quality and with a good brand."
The problems at GM and VW, though, go deeper than just the change to more modest cars. Their woes also stem from the fact that they got to China so early. As first movers, the two benefitted from high tariffs that kept out imports and allowed them to milk the market for immense profits. But the tariffs also allowed them to avoid necessary cost-cutting. And they faced cumbersome restrictions from Beijing. Volkswagen, for example, has had to develop a separate distribution network for each of its two China manufacturing operations. It was "a mistake of the past," says Bernd Leissner, president of Volkswagen Group China. And Beijing demanded that GM focus largely on the expensive Buick Regal. Honda and Hyundai, by contrast, have been able to get into China with far less meddling from Beijing. Locals such as Chery have seen little interference from bureaucrats.
A SMOOTH RIDE
The newcomers have also done a better job of making cars Chinese consumers want to buy. Before Hyundai launched the Elantra last year, the company sent 20 engineers and marketing experts to China for three months to suss out what buyers were looking for. As a result, the Elantra sold in China has a strengthened chassis and wider tires to ensure a smooth ride on the mainland's rough roads. There's also a computer that boosts fuel efficiency, and a hands-free kit for China's mobile-phone-mad consumers. While GM and VW did their share of market research, their hands were tied by restrictions on what kind of cars they could make.
There's more competition coming, too. Capacity in China is expected to grow by as much as 30% this year. Chery showed off a range of new models at the Shanghai show including a sporty concept car called the S16, while Hyundai plans to introduce three models to China over the next year. Indeed, Hyundai sees China as a step on the way to the big leagues. It plans to invest $1.1 billion by 2008 to triple its annual production capacity, to 600,000, from this year's 200,000. Ford Motor Co. (F ) is planning a $1 billion investment in China on top of the hundreds of millions it has spent already. The money will go toward a new engine plant in Nanjing and a new production line for its four-door Focus sedan at an existing factory in Chongqing. Nissan Motor Co. (NSANY ) plans to add 250 new dealerships, to bring its total to 400, and hopes to boost sales to 350,000 cars by 2007, up from an expected 140,000 this year. "Being late or in advance doesn't matter," says Nissan Chief Executive Carlos Ghosn. "Make a good product and have good service, and you'll be successful."
In response, both GM and VW are moving to revamp their operations, most notably by replacing top management in China. VW announced in April that this summer Winfried Vahland, currently deputy chairman of the Board of Management at subsidiary Skoda Auto, will take over for Folker Weissgerber, its board member responsible for China. Country chief Leissner is preparing to retire this year. At GM, longtime China boss Philip Murtaugh, who oversaw the flagship Shanghai venture from the start, stepped down in March amid rumors of disagreement with headquarters over the pace of China growth. The company denies any conflict.
The two early leaders are also looking to beef up their offerings of smaller cars. VW already sells its $9,000 Golf and $12,000 Polo in China and is planning at least two new models annually, but declined to provide details. And GM is pushing its sub-$8,000 Chevy Spark -- a car that, GM says, Chery copied with its QQ. (Chery declines to comment on the case; a lawsuit on the issue is pending). Unit sales of the Spark tripled in the first quarter, although they remain less than 25% of QQ volumes. For its part, GM predicts double-digit sales growth this year and says its market share even inched up in the first quarter. Some doubt whether either has done enough to get back in the game. "Prices for GM and Volkswagen vehicles are still too high," cautions Jia Xinguang of the Beijing-based China National Automotive Industry Consulting & Development Corp. VW CEO Bernd Pischetsrieder counters that the company doesn't want to get into a price war that would destroy margins. "Market share [in China] is important for us, but not at any price," he told shareholders at VW's annual meeting in Hamburg on Apr. 21.
Both GM and VW have outlined ambitious cost-cutting programs in China and are urging more suppliers to start producing in the mainland as well. Competition, though, is sure to increase as ambitious newcomers keep chipping away at the early leaders. China used to be an easy game. Not anymore.
By Dexter Roberts in Shanghai, with Moon Ihlwan in Seoul, Ian Rowley in Tokyo, and Gail Edmondson in Frankfurt