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Capability Building in China’s Auto Sector Loren Brandt Department of Economics University of Toronto [email protected] University of Michigan China Automotive Conference April 9, 2008

Capability Building in China’s Auto Sector

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Page 1: Capability Building in China’s Auto Sector

Capability Building in China’s Auto Sector

Loren BrandtDepartment of Economics

University of [email protected]

University of Michigan China Automotive ConferenceApril 9, 2008

Page 2: Capability Building in China’s Auto Sector

Outline

Historical BackgroundTrends and Driving forcesLooking Forward

Development of the auto sector in ChinaImplications outside

Page 3: Capability Building in China’s Auto Sector

Development of China’s auto sector must be viewed in context of larger process of capability-building in Chinese mfg that is affecting every sectorKey: Combination of domestic and foreign sector reforms that have encouraged FDI, increased competition, forced firms to invest incapability building, and facilitated the transfer of tech and managerial know-howProcess has integrated the Chinese economy to an unprecedented degree into the international economy for an economy of its size and population

• China has become an integral part of global supply chains;• Major importer of intermediate and capital goods;• Major exporter of mfg goods

Important role of rapidly expanding domestic market, which has become focus of increasing number of MNCsEmerging 100% Chinese owned firms in nearly every sector

Basic Message (General)

Page 4: Capability Building in China’s Auto Sector

Accelerating competition in car market having significant impact on OEMs and domestic supply chain

WTONew entry; Expansion in capacity

Rapid improvement in supply chain, but uneven Quality levels of 1st tier suppliers comparable; last few years, most noticeable among 2nd tier suppliersProductivity appears to be rising

Exports of parts and components rising rapidlyMNC …. Global supply chainsDomestic firms …. After-sales market

Rising capabilities in product development and design among some 1st

tier suppliers; often tied to strategies of the OEMs; some OEMs developing similar capabilitiesEmergence of domestic OEMs having significant impact on industrydynamics

Basic Message (Auto sector)

Page 5: Capability Building in China’s Auto Sector

Historical Background

Key Policies in 1980s and 1990sEncouragement of FDI in industry

OEMs, entry limited to that through JVs for autos; e.g BAIC, SAIC, FAWno restrictions for auto-parts

Local content rules for autosHigh protective tariff on the industry

Nurtured emerging industry, and facilitated transfer of technical and org. know-how, but

Notable failures (Beijing Jeep and Guangzhou Peugeot)

Regional heterogeneity reflecting differences in local political and economic institutions (Thun, 2006)

1999: Total Vehicles, ~ 1.8 mnPassenger car production, ~ .6 mnJVs: two-thirds of passenger car production

Page 6: Capability Building in China’s Auto Sector

Key Trends

Rapidly rising volumesDeepening supply chainRising exportsUpgrading of capabilities by both OEMs and suppliersEmerging domestic players

Page 7: Capability Building in China’s Auto Sector

Countries producing a million or more vehicles in 2006

Country 2000 2006 % change

Japan 10,144 11,484 13.21US 12,770 11,264 -11.79China 2,008 7,189 258.02Germany 5,526 5,820 5.32South Korea 2,858 3,840 34.36France 3,351 3,169 -5.43Spain 3,032 2,777 -8.41Brazil 1,671 2,611 56.25Canada 2,961 2,572 -13.14Mexico 1,923 2,046 6.4India 867 2,020 132.99UK 1,813 1,648 -9.1Russia 1,203 1,508 25.35Italy 1,738 1,212 -30.26Thailand 458 1,194 160.7

Page 8: Capability Building in China’s Auto Sector
Page 9: Capability Building in China’s Auto Sector

1. Rising incomes and increase in demand for passenger cars

2. Intense competition in final goods market →sharply falling car prices

3. Cost pressures throughout the supply chain similar to those in the West

Driving Forces?

Page 10: Capability Building in China’s Auto Sector

Competition in the final goods market

• Tariff cuts on passenger vehicles (WTO): 80% (’98) 60% (’00) 25% (’06)

• Capacity expansions: 0.95 mn (2000), 5.39 (2005); 7.30 mn (2006); 9.0 mn (2008); further expansion planned, especially by China’s Big 3 for cars under their own brand names

• Emergence of domestic firms, e.g. Chery, Geely, Great Wall, Haima, Brilliance, with improving capabilities and capacity, especially in the small car segment (1.6L or less)

• Turnover among industry leaders

Page 11: Capability Building in China’s Auto Sector

Changes in Passenger Vehicle Prices: 2001-2005

-40

-30

-20

-10

010

Cha

nge

in V

ehic

le P

rice

(Per

cent

)

2001 2002 2003 2004 2005

Change in Vehicle Prices, 2001-2005

Page 12: Capability Building in China’s Auto Sector

Top 10 Passenger Car makers in China

050,000

100,000150,000200,000250,000300,000350,000400,000450,000500,000

Shang

hai G

MFAW VW

Chery

Guang

zhou

Hond

aSha

ngha

i VW

FAW Toyo

ta

Dongfen

g Niss

anChan

gan F

ord

Beijing

Hyu

ndai

Dongfen

g PSA

Sal

es

-40-30-20-10010203040506070

% C

hang

e

Sales, Jan-Sept, 2007

Year on Year Change

Page 13: Capability Building in China’s Auto Sector

Top 10 Passenger Car makers in China, 2007

050,000

100,000150,000200,000250,000300,000350,000400,000450,000500,000

Shang

hai G

MFAW VW

Chery

Guang

zhou

Hond

a

Shang

hai V

WFAW To

yota

Dongfen

g Niss

an

Changa

n Ford

Beijing

Hyu

ndai

Dongfen

g PSA

Sale

s

-40-30-20-10010203040506070

% C

hang

e

Sales, Jan-Sept, 2007Year on Year Change

Page 14: Capability Building in China’s Auto Sector

Cost pressures in the supply chain

“As margins thin and pricing competition intensifies, an efficient and developed low-cost assembly and supply base will be essential for financial success”

Head of Purchasing, major JV

Page 15: Capability Building in China’s Auto Sector

Quality convergence with the West

• Quality level of 1st tier suppliers to JVs roughly comparable to that overseas; narrowing in gap for 2nd tier

• Latest VW and Toyota retooling brought the 2006 Jetta and Camry into China at the same time as in N.A; Nissan launching new global car in Shanghai

• Exports (JVs): Honda Fit & CR-V, Toyota engines, engines for CAMI plant in Ontario

Page 16: Capability Building in China’s Auto Sector

Product Location

2006 2003 2006 2003 2006 2003 2006 2003PPM

% % % % % % % %

< 50 58 8 60 20 30 5 19 5650-100 22 20 30 70 10 7 48 4100-300 5 21 5 5 15 8 22 20300-500 10 22 5 5 15 25 7 4500-1000 1 14 10 14 4 41000-2500 4 9 8 18 82500-5000 6 4 8 05000+ 8 15 4

Average PPM 158.5 634.5 67.5 87.5 1070 1967.5 142.75 543

Jiangsu Jiangsu Chongqing

seats

Jiangsu

exhausts brakes brakes

Defect Rates for 2nd-tier Suppliers

Page 17: Capability Building in China’s Auto Sector

Chinese Imports and Exports of Auto Parts and Components($US millions)

0

2000

4000

6000

8000

10000

12000

14000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Year

Exports of Parts andComponentsImports of Parts andComponents

Export potential is appearing

Page 18: Capability Building in China’s Auto Sector

1998 1999 2000 2001 2002 2003 2004 2005

Number of firms 2320 2349 2496 2724 2968 3605 5625 5604

Total Revenue (mn RMB) 81291.22 88518.33 108760 138783.59 185483.8 247633.1 354131.8 404419.5

Avg Revenue (mn RMB) 35.04 37.68 43.57 50.95 62.49 68.69 62.96 72.17

Export Ratio (%) 7.83 9.51 11.13 9.58 10.02 11.02 NA 14.38

Profitability 0.054 0.066 0.073 0.081 0.089 0.09 0.07 0.057

% π > 0 68.1 70.97 74.76 77.02 81.23 82.22 79.45 80.96

Profitability/>0 0.093 0.097 0.098 0.1 0.103 0.104 0.09 0.076

Summary Information for Parts and Components Firms Supplying Motor Vehicles Industry

Page 19: Capability Building in China’s Auto Sector

1998 1999 2000 2001 2002 2003 2004 2005

All Firms 7.83 9.51 11.13 9.58 10.02 11.02 NA 14.38FIE 19.27 21.13 22.86 17.71 17.75 15.95 NA 19.63 of which: WOS 76.46 69.77 61.43 38.8 36.26 27.81 NA 29.54SOE 2.83 2.53 2 1.88 2.45 3.64 NA 5.4Other 4.22 5.11 5.81 6.43 6.54 8.36 NA 10.39

FIE 64.21 68.13 71.22 65.58 64.67 58.81 NA 62.16 of which: WOS 35.11 39.3 38.18 38.28 38.6 31.16 NA 40.87SOE 8.29 5.23 2.79 3.68 3.66 2.99 NA 1.66Other 27.5 26.63 25.99 30.75 31.67 38.19 NA 36.17

Export Ratios and Contribution to Total Exports: By Ownership

Export Ratios: (Exports/Sales)*100

Contribution to Total Exports (in percent)

Page 20: Capability Building in China’s Auto Sector

China’s net exports of auto parts by region

Net Exports (M-X) Parts and Engines by Region

-2000

-1000

0

1000

2000

3000

4000

5000

Japa

nAsia

(othe

r)

NAFTA

Europe

Latin

Ameri

ca

Africa

Middle

East

Other

$US,

mill

ion 1995

20002005

Page 21: Capability Building in China’s Auto Sector

How are firms responding to these pressures?

1. Cut prices2. Improve productivity3. Bring in better products4. Localize production and supply base5. Localize development

1. Lower costs2. Reduce time to market3. Better meet consumer demand

Page 22: Capability Building in China’s Auto Sector

Localize supply chain• Can occur in a variety of ways

• Imports → Domestically sourced• In-house → Outsource• JV → 100% domestic firms

• Speed determined by OEMs• Willingness to “release” parts for localization• Ability to work with local suppliers• Size of market also important

• Often greater scope for cost reductions than by improving productivity

Page 23: Capability Building in China’s Auto Sector

OEM JV/WOS Domestic Overseas(imported)

Europe 86.0 14.0 0.0

Europe 68.3 23.8 7.9

US 57.1 14.3 24.5

US 58.5 39.6 3.8

Asia (Korea or Japan) 64.4 2.2 33.3

Asia 85.5 4.8 9.7

Asia 67.9 9.4 22.6

China 41.8 58.2 0

China 36.6 63.4 0

Average (non-Chinese OEMs) 69.7 15.4 14.5

Average (Chinese OEMs) 39.2 60.8 0

Average (all) 62.9 25.5 11.3

Sourcing by OEMs in China (% of 1st tier suppliers)

Page 24: Capability Building in China’s Auto Sector

Localization for Brakes1. Calipers: 2002, 20%; 2003, 83%; 2006, 93%;

2007, 95%

2. Actuation unit: 2005, 65%; 2006, 80%

3. ABS: 2005, 65%, 2007, 95%

Page 25: Capability Building in China’s Auto Sector

Imported Parts and Components

0

1

2

3

4

5

6

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Year

Num

ber o

f veh

icle

s (m

illio

ns)

0

500

1000

1500

2000

2500

$US

Number of vehicles produced

Value of Imported parts and engines per vehicle

Page 26: Capability Building in China’s Auto Sector

Localize design and development

• Tied to vehicle programs• More potential with domestic OEMs, but also

happening for some of the JVs • E.g. SGM• E.g. Guangzhou Honda’s new R&D Center

• Change designs for manufacturability • Long history in automotive sector

• With some localization of design, requirements of 1st

tier suppliers rising; significant investments in capabilities required to meet these demands

Page 27: Capability Building in China’s Auto Sector

5-year plan of a major JVOEM in China

Reduce production costs by 40% through

Increase local sourcing for parts and components to 90-95%Increase local sourcing of tools, die and other capital equipmentInvest heavily in local R&D/product development capabilities, and require suppliers to do the same

Page 28: Capability Building in China’s Auto Sector

Implications for North American Industry?

1. Three strategies have emerged for JVs in China

2. Domestic Chinese firms should not be ignored3. Exports from China are on their way4. OEMs (and now 1st tier suppliers) want global

suppliers

Page 29: Capability Building in China’s Auto Sector

1. Three strategies for JVs in China

Aggressive localizationCautious localizationIntegrate in global supply chain

Each means very different things for North American suppliers

Page 30: Capability Building in China’s Auto Sector

2. Domestic (Chinese) firms

Should not be ignored:Encouraged by central government; significant expansion planned, especially by the Chinese Big 3, producing under their own brandSource even more domesticallyOutsource much design work, e.g. Chery and Pinafarina

Piggy-back on supply-chain developed by JVsProvide opportunity for local capability building among 1st and 2nd tier suppliers, e.g. exhaust systems, ABS

Page 31: Capability Building in China’s Auto Sector

3. Vehicle exports are on their way

Geely was present at the Detroit Motor ShowChery has partnered up with Chrysler (they were already in the process of setting up a dealer network)SAIC (partner of VW and GM in Shanghai): Set up an independent venue for exportJiangling (Landwind) and Great Wall (Hover) have tried in Europe Honda exports the Jazz from Guangzhou

Page 32: Capability Building in China’s Auto Sector

4. OEMs (and some 1st tier suppliers) want suppliers with global reach

Nissan uses (only) the following criteria to put you in its ‘potential suppliers’ pool:

World class production quality at lowest costWorld class design and redesign capabilitiesWorldwide reach (production and design)

NA Firms: Chinese presence or partners critical100% Chinese parts suppliers: Looking overseas for M&A, e.g. Wanxiang and recent acquisition of Dana plants in North America

Page 33: Capability Building in China’s Auto Sector

Looking forward

Continued expansion and deepening of capabilities of OEMs and suppliers, but messy

Turnover in industry leadersParts sector: Consolidation, M&A mirroring developments internationally;

Success of Chinese OEMs? Parts suppliers? Will one emerge as the next Hyundai?