Fiat Focuses on China

Is there a harder-working CEO in the auto business than Fiat's Sergio Marchionne? Fresh from acquiring Chrysler and bidding—amid competition from Canada's Magna International and China's Beijing Auto—for General Motors' Opel unit, the Italian automaker has inked a deal to form a joint venture with Guangzhou Automobile Group.

The agreement, signed in Rome on July 6 in the presence of Chinese President Hu Jintao and Italy Prime Minister Silvio Berlusconi, is another step toward turning Fiat into a global automotive giant. Targeting the growing China auto industry, Fiat will invest $559 million in the venture, which plans to begin production in China's Hunan Province in the second half of 2011. The facility will initially have the capacity to make 140,000 cars and 220,000 engines per year, and may later increase to maximum of 250,000 cars and 300,000 engines per year. The first model to roll off the production line will be the Linea sedan.

Industry watchers welcomed the deal, calling it vital if Fiat is to match with Marchionne's ambition. The Fiat chief reckons that the Turin automaker needs to increase its global production capacity from 2 million today to more than 5.5 million—a size that surely necessitates a large presence in what will soon become the world's biggest car market. Guangzhou Auto operates successful—and profitable—partnerships with Toyota (TM) and Honda (HMC), both of which have factories in Guangdong, which neighbors Hunan. Sales of Honda Accords and Toyota Camrys made at the plants are both hot sellers, especially in southern China. "[It is a] good move by Fiat," says Michael Dunne, managing director at J.D. Power (MHP) in Shanghai.

Long a Laggard

Whether it will be enough to go beyond kick-starting Fiat's Chinese operations, though, is harder to say. Fiat is a laggard in China after previous attempts to manufacture in the Middle Kingdom didn't work out. In 2007, Nanjing Automobile pulled out of another joint venture agreement (JVs are a requirement for foreign automakers to make cars in China) amid weak sales. In the final year of the partnership, Fiat sold fewer than 20,000 cars, and the factory was eventually sold off to Volkswagen. That left Fiat with a tiny foothold in the market, exporting barely 4,000 cars a year from Europe.

A route back via a partnership with Chery Automobile, China's biggest independent carmaker, didn't get off the ground. The two automakers planned to make and sell 175,000 Alfa Romeo, Fiat, and Chery branded cars in China with production due to start this year. In addition, Chery was to supply Fiat with engines for sale outside of China. "This is also a good basis for studying further cooperation with Chery in the automotive industry," Marchionne said when the deal was announced in 2007. But in March Fiat and Chery canceled the deal, blaming the global downturn.

That excuse rings a little hollow now, although the Chinese auto market has recovered beyond most expectations this year. At the start of the year, many automakers were projecting a flat year at best, but the market, buoyed by tax breaks and other incentives, is up 20% over 2008. Further into the future, China's high economic growth rates and huge population suggest demand for autos will continue to outstrip the developed markets of Europe, Japan, and the U.S.

For all the opportunities, though, Fiat must overcome some serious hurdles if it is to succeed in China. For one thing, Fiat can't afford another misstep. "The Guangzhou relationship appears to be Fiat's last chance to create a meaningful presence in China," says Ashvin Chotai, managing director of London consultants Automotive Intelligence Asia. He warns, though, that Fiat's brand image in China is poor and that, with production still over two years away, it's unlikely the business will add to the company's bottom line inside five years.

Fierce Rivals

Meanwhile, catching up with foreign rivals, many of which are also investing heavily in China, won't be easy. At Volkswagen, the biggest foreign automaker in China, sales rose 12.5% in 2008, to 1 million. Automotive Intelligence Asia reckons VW will grow by a further 30% by 2015. Meanwhile, Toyota, Honda, GM (GM), and Hyundai all recorded annual sales in excess of 400,000 vehicles in 2008. (In GM's case, the figure rises to over 1 million if its roughly one-third stake in a commercial minivan joint venture with Wuling and Shanghai Auto is included.)

Just as daunting for Fiat, its strengths are in producing small and midsize cars. This low-cost segment, while experiencing high demand, is perhaps the most competitive area of the market. Indeed, while foreign automakers have much of the higher end to themselves, low-cost Chinese automakers are much tougher rivals for smaller vehicles.

The segment also offers the thinnest margins. Speaking at the Shanghai show in April, Jae Man Noh, president of Hyundai Motor's Chinese operation, estimated that while operating margins are down from double-digit levels in 2002-03, to between 5% and 6% overall, for vehicles below $15,000 the profitability is wafer-thin. To make a success of its business in China, Fiat will have to strike a difficult balance. "They key will be to offer products that, at once, carry European appeal while remaining attractive to Chinese consumers on price," says J.D Power's Dunne. "Chinese do not mind paying a premium for brands, [but] Fiat must establish itself as a cut above other large-scale manufacturers."

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