Friday, October 12, 2012

Which cars do chinese entrepreneurs buy?

Not all Chinese entrepreneurs can afford a Mercedes-Benz, but most of them still prefer foreign brands to domestic ones. Volkswagen and General Motors sold the greatest number of vehicles in China in 2011, the world’s largest car market, followed by Nissan, Hyundai and Kia. All domestic car makers combined captured only about 30% of their home market, the lowest proportion of any major economy.

The auto industry has been gradually opened to foreign investment over the past two decades, as Beijing allowed foreign car makers to form joint ventures with domestic partners. But the goal was always to help Chinese manufacturers acquire the technologies and expertise necessary to build their own strong brands, an outcome that eludes the industry.

As markets in the US and Europe stagnate, the focus of the auto industry has shifted to China. This has made Chinese government’s efforts to build a strong global brand and profit from its own growth boom all the more urgent. It aims to help Chinese companies capture about 50-60% of the market by 2015, but that goal appears unattainable, since Chinese cars' biggest problem continues to be brand strength, a problem which cannot be solved overnight.

State-owned car makers – such as Shanghai Automotive Industry (Group) Corporation (SAIC), First Auto Works (FAW) and Chang’an Automobile Group – have begun paying more attention to building their own brands. But it has been an uphill battle: with shorter histories, inferior technology and smaller marketing budgets, their products are mainly confined to the low-cost segment, where profits are thinner. Meanwhile, independent Chinese carmakers such as Geely, Chery, BYD and Great Wall have introduced their own low-price models, intensifying competition.

Most Chinese brands continue to trade on the China’s traditional forte: driving down manufacturing costs and making money on high volume and thin margins. In contrast, foreign car brands charge double or more and still sell far more units, all on the strength of their brand, technology and styling. The playing field has tipped farther towards foreign players in the past few years. In the first quarter of this year: overall sales of passenger cars declined 1.3% annually, while sales of Chinese passenger cars slumped 8.1%. Domestic media began reporting in May that the government is considering re-introducing supportive policies for vehicles with small engines. In the meantime, however, the drop in sales is still prompting car companies to cut prices aggressively. Foreign auto makers are offering discounts of 25-30%, while some domestic auto makers have reduced prices by up to 50%. Most Chinese companies are planning aggressive expansions in the next five to 10 years that will further increase competition. Chinese carmakers will have a very hard time: they will not be able to expand the market share on the low end much because of competition, and they have a very hard time moving up-market, where the quality and performance of the car plays a more important role.

For Chinese carmakers, the key to winning over more domestic buyers is strengthening and elevating their brands. Chinese luxury car buyers often make purchase decisions based on a car’s ability to demonstrate their status. The result is that demand in the luxury car segment in China has been “upside down” compared with other markets. In the US and Germany, sales of luxury cars decrease as the car’s price goes up, as one might expect. Mercedes’ C-Class sedan, its most affordable model, sells best, followed by the E-Class, and then the flagship S-class. Until very recently, however, this order was reversed in China: the S-class was the bestseller, followed by the E-Class and then the C-class. This changed only four years ago, when Mercedes localized production of the C- and E-Class sedans. These two models are now significantly cheaper than the S-Class because they are not subject to a 25% import duty. However, China remains the No 1 S-Class market worldwide.

When it comes to buying a car, brand is a powerful motivator: Chinese consumers’ understanding of cars has improved, but they’re still not very rational. Chinese entrepreneurs are not buying a car; they’re not buying its functions, they are buying face.

Chinese brands are understandably eager to chase this demand by moving their brands up-market. But building a luxury brand is difficult and time-consuming. However, even if the luxury segment may be off-limits, some Chinese companies have been able to move somewhat up-market. SAIC successfully entered the high-end market in the last few years with the release of “Roewe,” a brand based on intellectual property acquired when British car maker MG Rover went bankrupt in 2005. Geely, a private car maker that acquired the Swedish brand Volvo in 2010, has also won market share by gathering its high-end products together under one nameplate, “Emgrand.”

Overall, however, few Chinese carmakers have been able to establish a reputation for quality and comfort. Sometimes this is merely a matter of lagging consumer perception, but often there are still quality and technology gaps between foreign and Chinese brands. For example, many Chinese companies have yet to master the technology for building automatic transmissions (Geely is an exception, having acquired Australia’s Drivetrain Systems International, the world’s second-largest automatic transmission company, in 2009). Chinese car brands also tend to lag behind in terms of styling, marketing and after-sales service. Many Chinese companies also tend to face operational challenges: even if a company has mastered advanced technologies, they may still have trouble designing a car as a logical package, creating an efficient business model to support it, and then fitting that car into a complementary portfolio of products.

Several Chinese companies are ahead of the pack in mastering these processes. Geely and SAIC, for example, both posses strong technology and have introduced higher-end brands. And while the track record of SOEs like FAW, Dongfeng Motor and Guangzhou Auto have been unimpressive thus far. It is expected, though, that these companies will benefit in the long run from their access to foreign brands and technology they derive from their foreign joint ventures.

Overall, Chinese car companies are making progress. Most analysts acknowledge that it will just be a matter of time before they catch up. Most industry people project that Chinese carmakers will need another five to 10 years to perfect their processes and technology, and perhaps more time to solidify their brand. To make the shift, Chinese car makers will need to change their focus from quantity during the boom years to quality now.

As a result, the market share of Chinese carmakers will probably increase only gradually in the years to come and fall far short of Chinese government’s target of 50-60% market share. IHS Automotive projects Chinese manufacturers will capture 37-38% of the domestic market by 2020, up from around 30% currently.

One factor that could speed this process is outbound acquisitions. The surest way for Chinese companies to get ahead seems to be by acquiring foreign brands and technology – as Geely did with Volvo and Drivetrain Systems International, and SAIC did with MG Rover. Of course, that raises the question of whether these companies would qualify as “Chinese brands.”
Also the situation swings the other way: by setting up shop in China, multinational car makers are, to a certain extent, also becoming Chinese operations. Laprise of CLSA cited the example of General Motors, which has localized management and parts production in China, and even designs half of its worldwide platforms in Shanghai. Even Mercedes-Benz, that paramount of car quality, is localizing production of its luxury models. Its Beijing Benz joint-venture assembles and manufactures the E-Class and C-Class in China; this someday may be joined by the flagship S-Class, which are the type of cars wealthy Chinese entrepreneurs want to buy.

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