The People's Carmaker in China, for Now

Zhen Zhijun is ready to buy his first car, and the 34-year-old financial adviser at Shanghai's Jubo Investment Co. likes the slick look of Volkswagen's $29,000 Passat. On a salary of $1,200 a month, the price is steep. But Zhen plans to get a 5.9% car loan, which local banks are pushing as a way to boost domestic consumption. Zhen isn't interested in any brand but VW, which goes by the name of Dazhong, or "the masses," in Chinese. "I know I'll get good after-sales service with Volkswagen, and besides, the European design looks cool," he says.

Hot models. Reliable service. VW (VLKAY ) has worked out a winning formula in China. It got in early and now has a 53% share of a rapidly growing market. Last year, car sales rose 8%, to 628,659; they are projected to increase 14.5% this year. Competition is heating up, of course, and VW probably won't hold on to that huge share. Ford is moving into Chongqing to turn out a budget car, and Toyota (TM ) will start turning out a compact in Tianjin. But with the market expanding, VW should still get its share of the booty.

REVVED UP. It didn't necessarily have to turn out this way. VW was the first foreign carmaker to set up a joint venture in China back in 1985, in Shanghai. But getting in first in China has often proved foolish: Many early joint ventures were ill-advised partnerships between overconfident foreigners and inexperienced, often greedy locals.

VW, however, played its cards right--and enjoyed a bit of luck. It hooked up with powerful local partners at a time when there was little competition but a surging demand for cars. Better yet, the government in Shanghai shielded VW from central government meddling and gave the joint venture quite a bit of business at a time when most cars were bought by institutions rather than individuals. Now, for 2001, VW's two joint ventures will turn out more than 400,000 Audis, Jettas, Passats, Santanas, and Polos. "Everybody in China knows Volkswagen," says Credit Suisse First Boston analyst Catherine Zhu.

VW can expect to remain the market leader in China for a few more years. Other carmakers will find it hard to beat VW's prices, kept lower by the fact that 90% of its cars' parts are locally produced. Competitor General Motors Corp.'s new $44,000 Buick GS sedan has only 60% of its components made in China, and its sales have been disappointing.

But imports of cheaper parts and even cheaper cars are likely to rise, which will blunt VW's edge. "With China's WTO entry, the pressure from imported cars will grow," admits Johannes Wyrwoll, executive director of finance at SAIC-Volkswagen Sales Co. Customs duties make imports cost 70% to 80% more than cars built in China, but if China enters the World Trade Organization, lower duties will boost the cost by only 25%.

To keep its advantage, VW will probably have to cut prices and offer even better after-sales service. It might even consider bringing the lower-priced Skoda brand to China. "It's imperative to strengthen our position and bring in new products," says VW board member Robert Buchelhofer. Image-conscious consumers like Mr. Zhen are waiting.

By Alysha Webb in Shanghai, with Michael Shari in Singapore

— With assistance by Michael Shari

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