Long March Ahead for China's Automakers

The 2009 Shanghai Auto Show feels a step away from chaos. Waves of visitors beat against the displays, grabbing recyclable bags filled with product literature as models drape themselves over show cars, their smiles somewhere on a continuum between vacant and sultry. Over the constant roar of the crowd, automakers vie for attention with hyperkinetic video displays and pounding electronic music.

Many of the loudest and busiest displays belong to Chinese brands, and they threaten to overwhelm themselves. A piano and violin duet next to domestic maker Geely's new GE luxury concept car appears to be miming its performance. Short seconds of relative quiet allow a few bars of Teresa Teng's The Moon Represents My Heart to break free before being drowned out by a renewed sonic deluge.

"This is about showing that we are able to create innovative designs, to show that China is able to compete in the luxury segment," shouted a Geely floor representative in response to questions from China Economic Review.

The questions had been about Geely's GE, but the response—that China's automakers have arrived, and that they are read y to compete in new arenas—was not confined to Geely's booth.

"If you compare the same auto show three years ago with today, it was apparent three years ago what the Chinese automakers were," said Michael Dunne, managing director of research firm J.D. Power in Shanghai. "This time around...they were right in amongst [global automakers] and holding their heads high."

Highly visible throughout the show were the fruits of that confidence: new domestic marques, new models and new technologies. Foreign automakers had unveilings, too, but the focus was clearly on domestic firms.

"This goes perfectly in line with the development of the Chinese market," said Klaus Paur, director of automotive research at TNS China. "We are at a stage where everything is about brands."

All about the brand

Industry observers are encouraged by the brand building trend among domestic automakers. These firms are at the beginning of a transformation that should ultimately see them dominate their own market and perhaps gain a significant foothold overseas as well. They are being helped in this process by increasingly choosy consumers and targeted government policies. Despite much fanfare, however, there is still a long drive ahead.

That is not to say that Chinese brands have been unsuccessful. From a nonexistent base 10 years ago, the three largest local brands, Chery, BYD and Geely, captured 16% of the auto market—which includes trucks and buses—in the first four months of 2009. Between 2000 and 2007, small, cheap cars served local firms well. But as the local market grew only 6% in 2008, its slowest rate in a decade, that rapid growth came to an equally rapid halt.

"Most of the Chinese automakers grew only by single digits [in 2008]...and as a group for the first time since 2000, they lost market share in China," said J.D. Power's Dunne. "You start to wonder, is it sustainable, this strategy to go on price alone? As a result...we're seeing some bold moves to break out of that box."

Bold moves they may be, but domestic automakers are forging strikingly similar paths. Geely's GE—unmistakable in its Rolls-Royce aspirations—may be the most noticeable sign of a move into a higher market segment, but it is by no means the only one. In addition to the GE, Geely recently introduced a premium brand, Shanghai Englon, alongside Emgrand and Gleagle, two mass-market brands. That puts it in good company with Chery, which in April introduced new brands Riich, which targets higher-end consumers, and Rely, a line of mid- to high-end minivans for business use. Shanghai Automotive Industry Corporation (SAIC), meanwhile, sought to boost its premium Roewe brand with the introduction of a second model, the 550, to accompany its flagship 750 sedan.

Domestic makers are also eager to put their plans for alternative energy vehicles such as hybrids and electric cars on display. In addition to BYD's fully electric passenger car, the E6, planned for release later this year, Chery, Geely and SAIC are among the domestic automakers with high-profile alternative energy plans.

Purveyors of quality

Taken together, the decisions to enter higher price points and develop alternative energy vehicles represent a strategy of brands trying to position themselves as purveyors of advanced, high-quality automobiles, while taking into consideration the needs of two key domestic audiences: consumers and the government. The next step is making that strategy a reality.

"Having a car to show and selling that car on the street are two very different concepts," said Gerwin Ho, head of regional autos coverage at Citi in Hong Kong. "The question is: How far are we from execution? I think from that standpoint there's still quite a gap."

Certainly, previous attempts to move into the premium segment failed miserably, as have plans to sell into mature overseas markets. A widely publicized series of European crash tests—in which Jiang-ling Motors' Landwind SUV and Chery sedans performed very poorly—damaged Chinese brands' international reputations. Geely was also humbled when an earlier premium venture stalled.

"We tried to launch a premium brand called Maple. We just used a different brand, hoping it would help us to achieve a higher price, [but] we didn't change the other things that much," said Lawrence Ang, executive director of Geely Automobile Holdings. "And the experience tells us that it doesn't work."

Foreign players in the premium segment are keen to highlight the challenges that lie in wait for the likes of Geely.

"It takes enormous engineering resources to produce a top-of-the-line premium automobile," said Trevor Hale, a Beijing-based spokesman for Daimler. "As the inventors of the car, it's something we have learned to do pretty well over the last 120 years, but it is not easy."

Perhaps the best-known example of an automaker successfully moving from the mainstream into the luxury segment is Toyota, which introduced its Lexus brand internationally in 1989 after gradually developing a name for itself as a maker of quality passenger cars. The approach being adopted by Chinese manufacturers, analysts say, is far less methodical.

"Chinese, a little bit like Americans, prefer a home run," said J.D. Power's Dunne. "They ask, do we have to go through this tedious process? Aren't we smarter than that? Can't we use a different technology?"

The automakers themselves cast the move in a different light.

"We just had our one-millionth car roll off the production line. It was a watershed, a new starting point for our company," said Wang Chao, a spokesman for Chery. "So we decided to develop a new generation of medium and high-end [models] to explore the more lucrative segments of the automobile [market]."

Oozing confidence

Observers' doubts notwithstanding, domestic automakers who spoke to China Economic Review were unanimous in their confidence about moving into higher-end models.

Stressing that his company's strategy is to broaden its product range rather than compete only in the premium segment, Geely's Ang noted that the success of higher-priced cars would help the development of cheaper models. That is an important consideration for a business that Ang says saw 90% of its cars in 2008 feature small-displacement engines of 1.6 liters or less.

Still, the focus on premium vehicles with larger and more powerful engines may appear counter-intuitive given recent passenger car sales figures in China.

In January, as part of its measures to encourage economic growth by stimulating domestic demand, Beijing halved the purchase tax of new cars with engines of 1.6 liters or less, from 10% to 5%. That led to a sharp increase in sales of the small-engine cars that are the bread and butter of domestic automakers.

Foreign auto brands like Toyota, which had enjoyed continued growth despite the slump of 2008, saw their sales plummet. In Toyota's case, a failure to forecast demand for small-engine cars from its domestic joint venture led to a 17% year-on-year decline in first-quarter sales. A rare spot of good news came from General Motors (GM), which makes microvans—common to rural areas and smaller cities— through its Wuling joint venture. Microvans and other small-engine cars pushed GM's unit sales up 50% in April over an already high base.

According to a recent J.P. Morgan report, 1.41 million passenger vehicles with engines of 1.6 liters or less were sold in the first quarter of 2009, accounting for more than 70% of total passenger vehicle sales. The increase in sales volumes for these small vehicles was 21.93% year-on-year, 14 percentage points higher than the industry average. Domestic makers capitalized on the trend, pushing BYD, Chery and Geely to respectively become the sixth, seventh and ninth-largest producers of sedans in the country.

But as Citi's Ho points out, selling a lot of cars doesn't necessarily equate to making a lot of money.

"It's not just the unit sales, it's the profitability," said Ho. "[Premium cars] are a better way to make money, a more sustainable way to make money...If you're stuck at the low end, there are always competitors all around you and it's just like [being] stuck in the muck."

Going green

With the effect of the tax policy boost likely to wear off in the second quarter, according to Yale Zhang, an analyst with CSM Worldwide, another government initiative may therefore be vastly more important in the long term.

In January, Beijing introduced subsidies for hybrid, electric and alternative fuel vehicles in 13 cities. A KPMG report recently noted that, for now, the subsidies primarily target public transport and government vehicles. However, along with the purchase-tax cut, it is seen as a sign of broad government support for fuel-efficient and alternative energy vehicles, and an indicator of policies to come.

The rollout of electric and hybrid models shows that domestic carmakers have embraced the initiative. Yet while government assistance is important, it doesn't fully explain the rush towards new technology. The key, again, is branding.

"To a certain extent, it is definitely about marketing," said TNS's Paur. "It is not easy, but it is feasible to present a concept at an auto show. The next step, to say ‘I am capable of delivering mass-produced hybrid technology and bring it into the market,' is another question."

It's not simply about building up brand cachet among consumers as a producer of environmentally friendly cars; a TNS survey found that only 23% of Chinese consumers were even aware of electric vehicles and 22% aware of hybrids. Nor is it only about being seen to align with government priorities, though J.D. Power's Dunne notes that rapid growth in alternative energy vehicles would be impossible without Beijing's backing. It is, analysts and industry insiders say, a chance for domestic brands to take advantage of technologies still not fully developed in mature auto markets.

"They're all looking for how can they distinguish themselves from existing global players, and [alternative energy] would be one way to do so," said Dunne.

Belief in batteries

BYD, in particular, believes its background as a battery maker will help it clear the technological hurdles that have stymied attempts by international automakers to build electric and hybrid cars able to compete with gasoline-powered vehicles on price and performance. BYD spokesman Paul Lin said that the firm plans to release an advanced hybrid version of its F6 premium sedan at the end of 2009 along with its E6 electric car.

It is unclear, however, if technology alone will help BYD and other manufacturers to quickly build well-respected brands. Sales of hybrid cars remain low—Citi's Ho notes that BYD's F3DM model, in production since last year, doesn't even show up in industry figures.

Foreign automakers have remained cool to the idea of alternative energy vehicles in China. At the Shanghai Auto Show, GM's Chevrolet Volt, the advanced hybrid that the automaker has said is key to its future success as a company, sat in one of the few quiet corners of the show floor, ignored by most visitors. A floor representative told China Economic Review that the Volt would go on sale in China in 2011, but said GM was more interested in highlighting its existing products than future concepts.

Too much, too soon

As with premium cars, a risk with alternative energy is that manufacturers may be trying to do too much, too soon.

"BYD may have good hybrid technology or EV technology, but as they are not really seen as a credible car manufacturer, [consumers] don't believe they are capable of producing a really good green car," said TNS's Paur. Success with alternative energy cars, he says, requires success with conventional technology.

BYD's Lin downplays those concerns. "As a Chinese company, we have our strategy, and we have our culture, and we have our full understanding of the China market in a different way."

It is a message echoed by other automakers, who also reject suggestions that moving into new segments represents an exit from their traditional markets.

"Just because you launch a car this year, it doesn't mean it will be a big part of your sales. You need time, it takes a few years," said Geely's Ang.

A Chinese market dominated by local brands will not happen overnight, but it is generally agreed that some degree of success is assured. Equipped with varied product portfolios, they can showcase low-priced brands in second- and third-tier cities, where demand is growing rapidly, and aim their premium products at larger cities. Government policies, meanwhile, may well help automakers to compete more effectively with international brands. Lasting success, however, will require hard work.

"On paper, [domestic automakers] shouldn't even be in the game," said J.D. Power's Dunne. "Why am I optimistic? Because in my experience it just strikes me that Chinese never give up."

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