Tuning Up A Chinese Clunker

FAW, China's giant carmaker, is trying to rev up

It has a police station and health clinics. It has its own newspaper and television station, brick apartment blocks housing tens of thousands of people, and 23 schools, from kindergartens to three colleges. Little wonder the 20 million-square-meter home of First Auto Works, China's oldest and biggest carmaker, is popularly known as "First Auto City."

The scale and breadth of the FAW complex in the northeastern smokestack city of Changchun has impressed visitors ever since it was developed in the 1950s with Russian help. But under the harsh competitive climate taking shape in China, such size is now a huge liability. Due to Beijing's economic reforms, FAW, producer of everything from 16-ton Liberation trucks to Volkswagen sedans, has been under pressure for several years to slash its workforce, social welfare programs, and debt. Now, with China promising to cut auto tariffs from 100% to 25% in five years to enter the World Trade Organization, FAW's challenges will intensify. "The entire auto industry is under attack from the WTO," says China Automobile Industry Assn. Vice-Chairman Teng Bole.

But don't consign FAW to China's socialist scrap heap just yet. With a zeal unseen in more than a decade of halting state-enterprise reform, management is racing to trim its 150,000-strong workforce by one-third. Everything from schools to parts factories is being sold off. And an overhaul of management, long dominated by Communist apparatchiks, has cut the average age of top executives from 53 years to 45.

"SHARPER FOCUS." The burst of energy already is showing results. FAW's sales jumped by 24%, to $4.8 billion, in 1999, compared with a 15% increase in auto sales nationwide. Analysts credit better marketing and distribution, plus the 1998 launch of a line of Jetta sedans, produced with VW, starting at $15,000. "They've got terrific momentum and a sharper focus on the market and customers," says Michael Dunne, president of Beijing-based consulting firm Automotive Resources Asia Ltd. "That has to do with the younger leadership."

Guiding FAW's makeover is one of the youngest executives in the Chinese automotive world--38-year-old President Zhu Yanfeng. A former FAW technician, Zhu was appointed after Beijing decided last year to install new blood in each of its major carmakers. Previous FAW chief Geng Zhaojie also had a frosty relationship with Premier Zhu Rongji.

FAW's toughest challenge is streamlining labor. Firing workers outright is still hard in China, especially in the ailing Rust Belt. So Zhu is using early retirement and programs to retrain workers so they can be assigned to other companies. To better motivate those who stay, he is ditching the egalitarian compensation system. Increasingly, pay is tied to performance. And some highly skilled employees will make up to 15 times more than assembly workers. "We must reform our pay system according to the market economy," Zhu says.

Another sign that FAW is moving far beyond the lip service of previous reform drives is Zhu's restructuring strategy. FAW is selling the least-productive of its 33 factories. It is abandoning the old devotion to vertical integration by dumping inefficient component ventures. Only profitable units that enjoy economies of scale, such as those producing wheels and castings, will remain. Zhu says FAW will also consider outsourcing parts to foreign vendors--a departure from government industrial policy that has long stressed local content. It has even worked with local governments to create new units to provide health care and education that used to be offered in-house. "It's a dramatic turnaround from a few years ago," says consultant Dunne.

DEBT CONVERSION. Zhu also is making progress with one of the most intractable problems hobbling state enterprises--their onerous debts. Taking advantage of a new Beijing policy, FAW has begun to convert debt into equity. In November, FAW shed $950 million by giving equity stakes to four state-owned commercial banks--the biggest such swap to date in China. In the process, FAW's debt shrank from 75% of total equity to less than 50%, freeing up cash it now can use to modernize.

The stronger finances mean FAW is better positioned to launch more popular models that can compete with the expected flood of cheap Korean and Japanese cars when tariffs fall. Known largely for the Red Flag, a staid, normally black sedan long used by Party officials, FAW already has scored with the Jetta. FAW turned around what had been lackluster sales of the four-door sedan by aggressively courting China's huge taxi fleets, jawboning dealers, and pricing it under the rival $15,000 Santana, made by another VW joint venture in Shanghai that then accounted for half the passenger car market. Jetta became the most popular car in many cities. Last year, Jetta sales leapt 27%, to 75,000 units, enabling FAW to grab 15% of the car market, compared with 10% in 1998.

Of course, heavy government spending on public works in 1999 helped FAW by doubling sales of its new nine-ton truck. Beijing also juiced demand by allowing new consumer auto finance schemes, pushing taxi fleets to buy new cars, and easing limits on government car purchases. That helped sales of still-popular Red Flags, especially after FAW released a $22,300 economy version.

Such intervention won't work indefinitely in a country where some 120 vehicle makers still fight for an annual market of 1.6 million units. So Zhu hopes FAW can distance itself from the pack by focusing on quality. With VW's Audi division, early this year it will launch an Audi A-6, a luxury model starting at $44,500. Within two years, FAW and VW plan to assemble the Bora sedan, aimed at the middle class. Says Zhang Suixin, VW's chief Beijing representative: Zhu "has totally new ideas about the development of FAW."

Growing competition means FAW would have to make such moves anyway. VW has big plans to strengthen its venture with Shanghai Automotive, which plans to introduce a Passat sedan in China, followed by the low-priced Polo. General Motors' Shanghai-produced $38,000 Buicks now sell so briskly that GM plans to boost output this year by 35%, to 50,000 units. And Honda Motor Co. is selling all the $36,000 Accords it can produce in Guangzhou.

The real test begins when imports force prices to plunge. FAW has no choice but to "restructure all of our enterprises to make them more lean," Zhu says. Instilling that sense of urgency in state factories was exactly what Beijing's reformers had in mind when they began China's WTO push. Doses of real competition, it turns out, may succeed where years of reform campaigns and slogans have failed.

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