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Driven Are China’s car manufacturers ready to compete in the US and Europe? An Economist Intelligence Unit briefing paper Sponsored by Roland Berger Strategy Consultants

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DrivenAre China’s car manufacturers readyto compete in the US and Europe?

An Economist Intelligence Unit briefing paperSponsored by Roland Berger Strategy Consultants

Paper size: 210mm x 270mm

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Roland_Berger_cover_final_outline.pdf 9/26/2006 2:08:29 PMRoland_Berger_cover_final_outline.pdf 9/26/2006 2:08:29 PM

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© The Economist Intelligence Unit 2006 1

DrivenAre China’s car manufacturers ready to compete in the US and Europe?

Contents

3 Preface

4 Executive summary

6 Introduction

7 China’s carmakers: state of play

11 How will China’s carmakers compete?

21 The push and the pull to go international

23 The road ahead: up and down

26 Conclusion

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2 © The Economist Intelligence Unit 2006

DrivenAre China’s car manufacturers ready to compete in the US and Europe?

© 2006 Economist Intelligence Unit. All rightsreserved. All information in this report is verifiedto the best of the author’s and the publisher’sability. However, the Economist Intelligence Unitdoes not accept responsibility for any loss arisingfrom reliance on it.

Neither this publication nor any part of it maybe reproduced, stored in a retrieval system, ortransmitted in any form or by any means,electronic, mechanical, photocopying, recordingor otherwise, without the prior permission of theEconomist Intelligence Unit.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

Preface

Driven: Are China’s car manufacturers ready tocompete in the US and Europe? is a briefing paperby the Economist Intelligence Unit and sponsoredby Roland Berger Strategy Consultants (RBSC). Thereport is based on interviews in May and June 2006with car manufacturers and suppliers, consultants,and Chinese and joint-venture carmakers, as wellas analyses of China’s standing in the globalautomotive industry.

The findings and views expressed in this reportare those of the Economist Intelligence Unit aloneand do not necessarly reflect those of the sponsor.The Economist Intelligence Unit’s editorial teamconducted the interviews, wrote and edited thereport. The co-authors of the report are KatherinePeavy Sima and Graeme Maxton. The projectmanager and editor was Bina Jang.

Our sincere thanks are due to the intervieweesfor their time and insights. We would also like tothank Vivian Zheng, Wim van Acker, Christian Pauland John Shen at RBSC for their contribution tothe research.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

Executive summary

China’s car manufacturers may not have taken theworld by storm yet, but will they soon be competingsuccessfully in the US and Europe markets? TheChinese automotive industry has the political andfinancial support of its government, which isencouraging automakers to develop a made-in-Chinavehicle and take it international. The governmentwants the industry to contribute strongly to theeconomy by 2010, and envisages a robust increase invehicle exports from 2005 onwards that wouldtranslate conservatively to about US$1.2bn in exportsales. China also wants China-made vehicles to hold10% of worldwide automotive trade by 2020-35.

Quick to spot an opportunity, European andAmerican auto dealers have begun to promoteChina’s cheap cars in the US and Europeanmarkets, much to the alarm of US and Europeanautomakers, many of which are already fending offinexpensive imports from Eastern Europe or SouthKorea. But is it possible for China’s carmakers totake on their muscular Western, Japanese andSouth Korean rivals in the highly competitive andhighly regulated markets of the US and Europe?

No—not yet, say automotive industry analysts,manufacturers, suppliers and consultants interviewedfor Driven: Are China’s car manufacturers ready tocompete in the US and Europe?, a briefing paper by theEconomist Intelligence Unit (EIU) sponsored byRoland Berger Strategy Consultants (RBSC).

The EIU report puts this opinion in perspective.Among the findings: • China belongs to the “autarkic” group of

countries, according to one analysis. This group,which includes Malaysia, Iran, India and China,has under-developed automotive sectors that arestriving to become fully integrated. The analysismaintains that it will take around 10-15 years for aChinese auto manufacturer to become a serious

threat to domestic producers in North Americaand Europe. The research adds that developing afully integrated automotive manufacturingenterprise will take longer than Chinese industryexecutives and government officials think.

• China’s automotive industry is in the“intermediate” stage of development. At thispoint, China is considered an “intermediate”country in terms of production, with a lowpercentage of vehicle ownership, saysautopolis, an auto industry strategyconsultancy. Autopolis charted the automotiveindustry by country based on the number ofvehicles produced relative to population, andfound that to succeed in the automotivebusiness a country needed a population of atleast 50m, a GDP of at least US$500bn and aproduction output of at least 2m units a year.China makes the grade by those measures, butthis is only because of the production volumesof foreign-owned firms. To succeed, China needsdomestic firms to produce at least 2m units peryear, and to have a band of independent mass-market automakers that own their technology.

• China’s cars will initially enter the US andEurope on low prices, but they will behamstrung by poor quality and safetystandards. Industry experts believe thatChina’s carmakers will initially enter the USand Europe markets with a price play in allsegments—offering a low-cost car of doubtfulquality just to get a foot in the door. Westernconsumers are used to this strategy throughtheir previous dealings with Japanese andSouth Korean carmakers. But price alone willnot be sufficient, and China’s cars willincreasingly have to compete on brand, and toradically improve quality and safety standards.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

• China’s carmakers are likely to focus onvalue and engines. China’s main domesticcarmakers are developing a range of vehicles,in different segments, all with low prices—often so low that international rivals cannotmatch them. Chinese firms are also keen todevelop hybrid and fuel cell vehicles, and theyhave the backing of the government to do so.All are working on new engine types and thegovernment has a clear plan for their gradualimplementation over the next 15 years.Building better engines will require China’scarmakers to ramp up their research anddevelopment (R&D) abilities and technology.Most have already begun to do so. ShanghaiAutomotive Industry Corporation (SAIC), forone, has a venture in the UK with RicardoEngineering, a UK-based design andengineering firm, where it develops enginesand trains a number of its engineers. SAIC alsohas access to a top-of-the-line developmentcentre through its venture with Volkswagenand General Motors.

• China’s carmakers must develop a strategy tobecome fully integrated automakingenterprises. Chinese companies own very littletechnology and rely mainly on reverseengineering. However, a few have moved awayfrom reverse engineering and begun to partnerwith global design and engineering consultants.The intellectual property rights (IPRs) that resultare then the property of the Chinese company.Domestic carmakers also are not shy aboutpicking up management and technological skillsfrom their European, US and Japanese joint-venture partners. In the short term, this willassist carmakers to bring a vehicle to market. Butin the long term, the reliance on outsideassistance could delay the development ofindigenous design and engineering expertise.

• It is essential to build or buy a brand. While

companies like SAIC may have the courage andmoney to develop their own brands, some ofChina’s carmakers are choosing a quickerstrategy to enter Western markets by buyingexisting brands and using them as a base to buildupon, as Nanjing Automobile has done with MGRover of the UK. This strategy encourages thebuying of distressed assets (such as MG Rover),especially as several Western automotive andauto-parts companies are ailing. Acquisitionwould give China’s carmakers access not only toa target-company’s products, but also to itstechnical knowledge, technology and customer-base. But such overtures by China’s carmakersmight also provoke a political backlash in thetarget companies’ countries of origin.

• The Chinese government has put its politicaland financial might behind automotiveexports. The central government wants autoexports to increase substantially from 2005,and China’s share of the global vehicle trade toclimb to 10% between 2020 and 2035. Towardsthat end, it is helping automakers withfunding—for example, by giving low-interestloans to Nanjing Automobile and SAIC to buyshares in the assets of MG Rover. Thegovernment is also introducing beneficialpolicies—for example, it will requireautomakers to apply for export licences fromJanuary 2007 onwards. This is intended toprevent undercutting on prices as China’sdomestic automakers export their vehiclesbecause of over-production at home.

• Foreign investors and dealers are puttingtheir money on China’s cars. The Chinesegovernment’s support is being augmented byfinancing from foreign investors keen toimport Chinese-made cars to Western markets.Chery’s entry into the US is being championedby American auto dealer Malcolm Bricklin andreportedly by American investor George Soros.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

Introduction

Ask a European or an American about a QQor a Hongqi, and the chances are theywould never have heard of these Chinesecars. Why should they? China’s

automotive industry is nascent, and its brandslargely unknown. But two years ago China becamea net exporter of vehicles, and in 2005 sold a totalof 172,639 units overseas, according to China’sMinistry of Commerce. And the country’s policymakers have even grander dreams—the 11th Five-Year Plan expects vehicle exports to jump by 40%per year between 2005 and 2010; and the NationalDevelopment and Reform Commission expects theindustry to grow in production capacity to anestimated 9m units in 2010, from an estimated6m-7m units currently.

This growth has been fuelled in part by stronggovernment support to the automotive industry inthe form of financing and policy initiatives. Thesizzling pace has prompted some auto dealers inthe US and Europe to predict that Chinese cars willform the next wave of cheap imports to compete inthe US and Europe—the two world’s oldest, largestand toughest markets for cars. Indeed, industryexperts, manufacturers, suppliers and consultantsinterviewed by the Economist Intelligence Unit forthis report say it is not a matter of if, but when,Chinese companies will make their presence felt inthe US and Europe.

At home private car sales have been spurred onby China’s newly wealthy urban elite. They are aneager market for the trendy, cheap vehiclesoffered by provincial and private upstarts likeChery Motor (owned by the Anhui provincialgovernment) and Zhejiang Geely Holding (aprivate company that listed on the Hong Kongstock exchange in 2003). The three big state-owned enterprises (SOEs)—First Automotive

Works, now known as the FAW Group, ShanghaiAutomotive Industry Corporation (SAIC) andDongfeng Motor—have been caught flat-footed bythis trend. Although the three SOEs are stillstrong, thanks mainly to robust partnerships withmajor US, European and Japanese automakers,they are being nudged into ratcheting up theirdevelopment activities.

The good news for the SOEs (as well as theprivate companies) is that the Chinese governmenthas put its might behind the domestic automotiveindustry. China’s automakers have been officiallyencouraged to develop a true made-in-Chinavehicle and to plunge head first into global waters.The goal is for China-made vehicles to hold 10% ofworldwide vehicle trade by 2020-35.

Whether that goal is realistic or not, Europeanand American auto dealers have begun to takenotice. Looking for the next Japan or South Koreaof the global automotive industry, they havestarted to tout China’s inexpensive cars to the USand European markets. This has begun to worry USand European automakers, many of which areriddled with financial and operational problems,and are already beleaguered in their home turf bycheap imports from Eastern Europe.

Should they fret over Chinese vehicles taking abite out of their market share? Or is the China autoinvasion just so much sales talk? If not, whenshould they reasonably expect inexpensiveChinese vehicles to compete with them in the USand Europe? Driven: Are China’s manufacturersready to compete in the US and Europe?, a briefingpaper by the Economist Intelligence Unit,sponsored by RBSC, aims to address thesequestions and to examine what China’s automotivemanufacturers will offer, and when, in the US,Europe and at home.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

China’s carmakers: state of play

Who are China’s key automakers? State-owned enterprises such as FAW, SAICand Dongfeng are undoubtedly amongthe leaders, along with a clutch of joint

ventures with foreign multinational companies suchas FAW-Volkswagen, Shanghai Volkswagen, TianjinToyota, Beijing Hyundai, Guangzhou Honda andShanghai General Motors. Then there are the fast-moving, quick-to-spot-trends Chery and Geely. Addto this group provincial-level SOEs such as BeijingAutomotive Industry Holding, Nanjing Automobileand Chang’an Automobile. Together theseautomakers create a market that is diverse andcompetitive, at least at home.

Of these, Chery and Geely depend on design andengineering consulting firms to bring models tomarket. The bigger automakers rely on their jointventures, like FAW and SAIC, for example, withVolkswagen and General Motors (GM), respectively.Indeed, China’s automakers have yet to design andbuild a car from the ground up. Prior to theestablishment of the first Sino-foreign automotiveventure between SAIC and Volkswagen in 1984,China’s automakers sourced their designs from theCommunist bloc countries. Not much has changedon that front. In fact, China’s auto companies faceadditional hurdles of intellectual property rightsand inadequate technological skills.

On the positive side, government support countsfor a lot in the automotive industry—just ask theJapanese and the South Koreans. China’sautomakers also do not have to deal with the legacyissues of the US carmakers nor the need to lay offstaff as do the European manufacturers. Moreover,as the domestic automotive market grows, Chinesecompanies can benefit from economies of scale andproduce even cheaper vehicles.

But these developments will take time. China is

still considered an intermediate country in terms ofproduction, with a low percentage of vehicleownership, according to autopolis, an auto industrystrategy consultancy. By charting the automotiveindustry by country based on the number of vehiclesproduced relative to population (see chart, Forecastsfor the global automotive industry), autopolis foundthat to succeed in the automotive business a countryneeds a population of at least 50m, a GDP of at leastUS$500bn and a production output of at least 2munits a year. By those standards, China clearly makesthe grade—but only because of the productionvolumes of foreign firms. Until the output volumes oflocal firms break the 2m mark, and until the countrydevelops successful independent scale-driven massmarket manufacturers with their own technology,China will be classed as “intermediate”.

Consider the numbers. In 2005 the leadingautomakers in terms of sales were joint ventures.In the elite club were FAW’s joint ventures withToyota (Tianjin-FAW Toyota) and Volkswagen(FAW-Volkswagen), which together produced asales volume of 983,000 units, according to theChina Association of Automobile Manufacturers.For their part, SAIC’s joint ventures withVolkswagen and General Motors sold 918,000units. Other top automakers in terms of sales:Dongfeng Motor, Chang’an Automobile andBeijing Automotive Industry Holdings (popularlyknown as Beiqi). By contrast, purely domesticautomakers—Hafei Motor, Chery, Anhui JianghuiAutomobile and Geely—together posted sales ofjust 724,000 units. This is less than half theamount needed to push China’s automotiveindustry out of autopolis’ categorisation as anintermediate player (see chart, China’s top tenautomotive manufacturers, by sales volume).

The trend looks set to continue for 2006, but

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

with joint ventures competing more aggressively.For example, Beiqi’s joint venture with Hyundai isgrabbing market share with its Elantra model,which sold 85,400 units from January to June2006, according to the China Association ofAutomobile Manufacturers.

But is it possible for a youthful company likeChery (barely 10 years old) or a staid company likeSAIC (that for 20 years has depended heavily onforeign partners for its production and marketgrowth) to compete anytime soon against biggerinternational players in the hyper-competitive,highly regulated auto markets of the US and Europe?

Industry experts, manufacturers, suppliers andconsultants interviewed for this paper say no. True,billionaire American investor George Soros may beputting millions into Chery and SAIC, like otherdomestic companies in China, may be reaching outto the stockmarket to pick up much-needed fundingfor expansion. But even with injections of funds,and the best of intentions, the 11th Five-Year Plan’sambition for China’s automotive exports to jump by40% per year between 2005 and 2010 looks wildlyoptimistic under current conditions.

More possibly, it will be between 2012 and 2015that Chinese vehicles will start to become a force

10,000

1,000

500

100

10

10 50 100 Total population (m)

GDP (US$bn)

Forecasts for the global automotive industry, 2004

Source: autopolis

1,000

= independent mass market manufacturers

= branch operations

= intermediate

= 2m units

Hungary

Czech

Sweden

BelgiumAustralia

Canada

France

South Korea

Malaysia

Romania

Poland

Argentina

South Africa Iran

Thailand

TurkeyRussia

BrazilIndia

China

Mexico

UK

Spain

Italy

Germany

Japan

US

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

0

20

40

60

80

100

0

20

40

60

80

100

120

China’s top ten automotive manufacturers, by sales volume: in the fast lane

China First

Automotiv

e Work

s

Shanghai Auto

motive

Industr

y Corp

oratio

n

Dongfeng Moto

r

Chang’an Auto

Beijing Auto

mobile

Works (

Beiqi)

Source: China Association of Automobile Manufacturers

Guangzhou Auto

mobile

Industr

y Gro

up (Guangqi)

Hafei Moto

r

Chery Auto

mobile

Anhui Jianghuai

Automobile

98.3

91.8

72.9

63.159.7

23.7 2318.9

15.4

Geely Holding Gro

up

15.126.1

31.1

21.320.1

17.3

5.9 7.5 7 4.6 5.2

%

Growth, Jan-March 2006,right axis

10,000 unitsGrowth, 2005,right axis

Sales volume, 2005, left axisSales volume, Jan-March 2006, left axis

Automotive strategies of countries: highs and lows

Core countries (Examples: US, Germany, France, Japan)

Fully integrated companies, producing vehicles 100% designed, manufactured, distributed, marketed in-house

Solid branding and after-sales service programmes

Limited government support

Automotive industry accounts for 10.5% of GDP, and health of industry is considered an economic indicator.

Peripheral countries (Examples: Canada, Turkey, Australia, Mexico)

Large industries, but companies involved are controlled by companies from the core group.

National policy does not control the fate of the industry

Automotive industry accounts of an estimated 9-10% of GDP

Networked countries (Examples: Indonesia, Thailand, South Africa)

Industry adds value to blueprints of the core countries, but is not manufacturing

Automotive industry accounts for an estimated 5-7% of GDP

Autarkic countries (Examples: China, India, Malaysia, Iran, South Korea)

Government takes active role in development of the industry via subsidies, loans, preferential policies

Companies ultimately owned by the government of car industry seen as a national patriotic goal as well as an economic incentive

Automotive industry accounts for an estimated 7-8% of GDP

Source: Time for a Model Change, Maxton Wormald, Cambridge University Press 2005

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

in the advanced export markets. That is, it seemsmore likely that Chinese firms will follow thepattern of the Japanese and South Koreancarmakers. They will launch an assault ondeveloped markets in the next few years, meetfierce resistance (even trade barriers) or find alukewarm response from consumers, think againand then come back with much more competitiveproducts or some way around any political hurdlesseveral years down the road.

In their 1994 book, Time for a Model Change: Re-engineering the Global Automotive Industry,Graeme Maxton and John Wormald explain thatthe government’s heavy hand in the automotiveindustry is just one strategy countries take inmanaging an industry that accounts for asignificant portion of GDP and becomes anadvertisement for the nation in overseas markets.

Countries broadly are divided into fourcategories—core, peripheral, networked andautarkic (see chart, Automotive strategies ofcountries). Core countries are those that have afully integrated auto industry. They have all thetechnologies needed, as well as their own mass-market manufacturers selling under their ownbrands with the capability to cover the entire valuechain. After 100 years of the industry there areonly a few countries in this group: the US, Japan,Germany and France. It arguably might containItaly and South Korea, too. Ten years ago itcontained Sweden and the UK, but these countrieshave now been dropped, says Mr Maxton, who isnow regional director of the EconomistIntelligence Unit’s Corporate Network, and adirector of autopolis.

The second group, the peripheral countries,often have very big auto industries—countries likeCanada, Spain, Mexico and Brazil. But they are allsatellite manufacturing operations controlled byfirms in the core countries. The carmakers in Braziladd little brand, technological or intellectual

value.The third group, the networked countries, are

like the peripheral ones except that they add somevalue. They build particular sorts of vehicles orhave their own designs, but still depend almostentirely on the companies in the core markets.This group includes countries like Thailand, whichspecialises in pick-ups; Indonesia, which hasdeveloped the Kijiang commercial cars; and SouthAfrica, which focuses on the production of right-hand drive vehicles.

The final group is the most interesting, theautarkic countries. These have under-developedauto sectors but intend to become core. Thesecountries want to join the elite club of countriesthat have a fully integrated auto sector—countriessuch as Malaysia, Iran, India and, of course, China.This group arguably still contains South Korea, asthe country remains dependent on foreigntechnology and may yet be squeezed from theindustry as lower-cost producers move intoHyundai’s territory. The question for the nextdecade is which of these countries will succeed intheir goal and which will be relegated to beingperipheral or networked.

Looking at this group, it is not too difficult toimagine which countries could make a leap intothe group of core countries. Nor is it difficult tosee that it will take time. South Korea, even withgovernment assistance, has taken 30 years just tohave its brands recognised in the US and Europe.

Based on their research, Mr Maxton and Mr Wormald suggest that India might succeed, butthat “China will clearly become a core country”.But they also believe that it will take around 10-15years for a Chinese auto manufacturer to become aserious concern to domestic enterprises in NorthAmerica and Europe. Developing a fully integratedautomotive manufacturing enterprise will takelonger than Chinese companies think, theypredict.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

So what must China’s carmakers do tocompete in the US and Europe with any realchance of success? Looking to the Japaneseand South Koreans for tips on entering the

US and European markets will only help a little. Thisis because both markets today are fundamentallydifferent from when they were first assaulted by theJapanese or South Korean car companies. Then, themarkets were growing but competitively stable.Today, they are mature and competitively volatile,and a battleground for some of the biggest namesamong US and European carmakers, many of whichare struggling to survive. As such, there is likely tobe a political backlash against Chinese (and other)carmakers driving into their markets. If companieslike Ford and GM of the US are on the edge (or over)of filing for Chapter 11 and Chinese carmakers startcutting their share further, Washington may becompelled to intervene.

The US and Europe will be tough markets forChina’s carmakers—tougher than the domesticmarket where many consumers are buying theirfirst car. China’s carmakers in the US and Europewill compete against mature competitors andmature consumers for a piece of a finite pie. This isa different exercise from exporting to the MiddleEast, Russia, Africa and South-east Asia, thecurrent destinations of China’s cars. Consumers inthe current export markets, like those in China,see price as an important factor in the buyingdecision. (Value is important in the US, but not toquite the same extent.) Moreover, unlike the US orEurope, most of these export markets have nointrinsic automotive industry, and have lowernational regulations on quality and safety.

To make headway in the developed markets,China’s carmakers will need to grow quickly andhave internationally competitive marketing,

How will China’s carmakers compete?

branding and customer service. They will also needto cater to the different buyer needs in eachmarket—consumers in Europe tend to value brandmore than their US counterparts. Stephen Clarke,Shanghai-based executive vice-president of RicardoEngineering, believes Chinese carmakers are awareof the challenges of the US and Europe, and willdevelop their position by first exporting to Russia,the Middle East and South-east Asia for a few years.

Selling at low prices is first stepAs they advance, the Chinese are likely to focus firston two things: value and engines. The intertwinedissues of quality, brand and technology shouldfollow. The main indigenous carmakers in China aredeveloping a range of vehicles, in differentsegments, all with low prices—often so low thatinternational rivals cannot match them. Despitetheir lack of economies of scale, the carmakersappear to be defying the laws of automotiveeconomics, which suggests that there is at leastsome sort of cross-subsidisation going on.Shanghai Maple, for example, is selling cars for lessthan the market value of the steel that goes intothem. Competition is most likely to come fromSouth Korean firms, which also seem able to sellcars below cost; from companies like Renault withits low-cost Logan model; and from other Chinesefirms. However, China’s carmakers do not expectmuch competition in the US or Europe from theircounterparts from India—another “autarkic”country. The reason? Cheap Indian-made cars—such as the Tata group’s US$2,500 model, which isto be launched in 2008 and will be engineered tothis price, not subsidised, will be targeted atconsumers in India and other developingeconomies. They are not likely to meet US orEuropean safety or emissions regulations.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

PricingChery. It made its name on the low-priced,economy subcompact QQ model. But it alsomakes economical sedans for the Chinamarket and commissioned the design of asports car from Italian design firm Bertone.Yet, even Chery’s biggest supporter in theUS, Malcolm Bricklin, has said that Chinaprices will not translate to the US. He saidthat safety and quality upgrades would putChery cars in the same price range asHyundai models (US$10,000-16,000).

Shanghai Automotive IndustryCorporation. SAIC will likely enter foreignmarkets with a mid-priced brand of quality,but perhaps in 15-20 years’ time, says TangWeiyan of the Shanghai Automotive TradeAssociation. Industry insiders familiar withSAIC say the company is not interested ingoing the “cheap” route, and it is not clearyet if the Rover models will be the basis forSAIC’s own brand.

Shanghai Maple. New carmakers, likethis Geely subsidiary, apparently can breakeven by selling only 8,000 units per year.Perhaps the lack of legacy costs for thesenew players will give them a helping hand.But without experienced staff, they wouldlag in research and development.

BrandingChery. Mr Bricklin told interviewers thathis strategy is to upgrade the interiors andengines to compete with the BMW3 andBMW6 series, but at a much lower price. Ifinteriors and engines alone can make thebrand, then Mr Bricklin might have a for-mula. For its part, Chery is said to be stilltrying to understand the US and Europeanmarkets. The company has ventures start-ing up in Malaysia and Russia, which wouldgive Chery cars a firmer footing in theinternational market.

Nanjing Automobile. It plans to cashin on the power of the MG Rover brand, butthe extent of the brand's decline is yet tobe determined. Nanjing Automobile says ithas a strategy to re-launch the brand, buthas not released any details as yet.Reviving an old, beleaguered brand couldbe more expensive and difficult thanestablishing a new one.

First Automotive Works, SAIC andDongfeng Motor. For these three, thestakes are higher in entering foreignmarkets because their brands are well-established at home. Any failure in theinternational markets could affect thebrands at home. By comparison, the

international markets have no frame ofreference for these brands, which alreadyhave a long history.

QualityMost of the domestic carmakers havestarted sourcing from multinational sup-pliers in order to upgrade their quality.Herbert Qi of Altair Engineering, a productdesign and engineering consultancy, saysa number of domestic manufacturers areusing his company’s software and consult-ing services to enhance their R&D capabil-ity. Key Safety Systems began supplyingairbags to Chery earlier this year, and ispurported to have other domestic enter-prises on their customer list.

FAW, SAIC and Dongfeng Motor arelikely to have learned the most in terms ofquality control and R&D through their jointventures. SAIC still cooperates closely withits joint-venture partners, Volkswagen andGeneral Motors, and two decades ofengineers have come through the rankswith positions in these two companies.They are bringing that experience to SAIC’sown vehicles.

Snapshot of some of China’s carmakers

Neither will most of China’s cars. Industryexperts believe that China’s carmakers will initiallyenter the US and Europe markets with a price playin all segments-offering a low-cost car ofquestionable quality just to get a foot in the door.Western consumers are used to this strategythrough their previous dealings with Japanese andSouth Korean carmakers.

Moving forward, however, China’s carmakers willnot be able to rely on price advantage alone. For a

start, they risk a political backlash in the US andEurope if they sell below cost (if they are subsidisedas indeed they may be). Moreover, depending onthe price range, China-made cars will also becompeting with used cars from establishedautomakers. Consumers can choose between a newcar of unknown brand and quality, or a used Toyotaor Volkswagen—both known for their good valueand long life. China’s carmakers will increasinglyhave to compete on brand, and therefore on quality

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and technology. John Humphrey, managingdirector of the Asia-Pacific operations of JD Power,puts it clearly: “Price alone will fail.”

Building better enginesSome of China’s manufacturers may have come tothe same conclusion. Despite its rather stodgyimage, FAW seems to have kept pace with thegreen-friendly trend by developing a hybridengine for its Hongqi brand. Another FAW vehiclein May 2006 moved stealthily into the US marketwith 60 units of a zero-emission electric car. TheFAW-Hongta MPV has been built by FAW-HongtaYunnan Automobile Manufacturing, a FAWsubsidiary, and is reportedly being marketed in theUS by Miles Automotive Group.

Chinese firms are keen to develop hybrid andfuel cell vehicles and have the backing of thecentral government, provincial governments anduniversities. All are working on new engine typesand the government has a clear plan for theirgradual implementation over the next 15 years.This is being done for two reasons. First, it allowsChina to limit the amount of oil it has to import.Second, it offers the chance for Chinese firms toleap-frog some of the global companies who havelagged in the development of these technologiesdespite the rhetoric put out by their public-relations departments.

Industry experts point out that certainmanufacturers in Europe and the US (Volkswagen,GM and Ford, for example) have developed fuelcells, hybrid engines and all-electric engines, butthey have realised that it will require too manychanges in their traditional markets to use the newtechnologies cost-effectively. Moreover, they havea vested interest in maintaining the status quo,having invested so much in traditionaltechnologies. China does not have the sameissues. Since its automotive infrastructure is lessingrained than those in the US and Europe, the

leap to a new technology can be less burdened bylegacy issues for the long term.

Building better engines requires China’scarmakers to ramp up their research anddevelopment (R&D) capabilities and technology.Most have already begun to do so. SAIC has aventure in the UK with Ricardo Engineering, a UK-based design and engineering firm, where itproduces engines and trains a number of itsengineers. SAIC also has access to a top-of-the-line development centre through its venture withVolkswagen.

Chery has reportedly purchased premium-quality equipment, software and hardware for itsR&D facility. Meanwhile, Nanjing Automobile hasthe support of the Jiangsu provincial governmentto develop its R&D centre based on the Roverproduction line, with former Rover staffoverseeing training and quality. NanjingAutomobile's president, Yu Jianwei, says thecompany expects to spend Rmb2bn (US$250m) ona five-year programme to kick-start R&D.

That’s not a whole lot of financing, consideringthe design, engineering, testing and tooling of aprototype costs an average of US$500m. About80% of a vehicle’s cost is determined in the phasesprior to production, notes John Humphrey,managing director of the China operations of JDPower and Associates, a leading US automotiveresearch company. This may be money that China’scarmakers are neither prepared nor able to spendpre-production.

Hence the Landwind affair. Jiangling Motors, aJiangxi-based automotive producer tried to exportits SUV model to Europe in 2005, the Landwind, viaa Belgian dealer. German authorities put thevehicle through a required safety test that it failedmiserably. Herbert Qi, who is based in theShanghai office of Altair Engineering, a productdesign and engineering consultancy, speculatesthat Jiangling may not have been able to finance

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the expensive safety test itself, and had hopedthat the vehicle would pass muster. Safety testscost hundreds of thousands of dollars, and China’scarmakers, under no obligation to conduct thetests at home, may not do so, if only to containcosts. If they are to develop a vehicle with a qualityacceptable to international consumers, China’scarmakers need to invest in pre-production, butthis is an issue most have not wanted to face.

Chinese companies own very little technology—they usually rely on reverse engineering or“borrowed” intellectual property (IP). Cherry Chu,

vice-president of Jiangyin Venture InteriorSystems, a Shanghai-based designer and producerof interiors for automobiles, says China’scarmakers lack attention to detail, have noconcept of intellectual property rights and want toreverse engineer everything. Still, there are a fewcompanies that have moved away from reverseengineering and begun to partner with globaldesign and engineering consultants. Theintellectual property rights created then becomethe property of the Chinese company. In fact,many China-built cars destined for overseas

It may still be half under construction butShanghai Maple’s car plant, about twohours’ drive from Shanghai, is a hive ofactivity. Cars roll off the production linesteadily, while machines grind parts andtrucks deliver steel sheets and tyres.

Part of the independent Geely group, thecompany was only formed in 1999. Itlaunched its first car less than two years agoand annual sales reached 25,400 cars in2005, up 143% on the previous year. Mapleplans to more than double that in 2006 andneeds to expand. With three different carmodels, a hybrid in the pipeline and aclaimed breakeven point of only 8,000 carsa year, Maple is already making money, itsays. With such progress, could Maple teachthe mighty Toyota a thing or two about theeconomics of carmaking?

Maple’s new Hysoul 305, launched atthe end of 2005, certainly seemsimpressive. With air-conditioning, leatherseats, power steering, anti-lock brakes, anda 1.8-litre Maple-designed petrol engine, itcosts just Rmb70,000 (US$8,750) in China.It even comes with a two-year warranty.The company also boasts a research

institute with Shanghai Jiaotong Universitywhich is looking into hybrids, and enteredits cars into the Shanghai stage of theNational Rally in 2004, taking first andsecond place. The cars drive well and thewell-qualified workforce is highly dedicatedand ambitious, determined to move thecompany forward.

Of course, experienced China-watcherswill scent the whiff of counterfeiting inMaple’s meteoric rise. French carmakerCitroën is currently suing the company forinfringing the design of its chassis andwhen asked where the production linecame from, one senior executive from thecompany told us that “it is based on aFrench production system”. The newengine also had to be developed afterToyota sued the company for intellectualproperty rights (IPR) infringements overthe previous one. Toyota has also been indispute with Maple’s parent Geely over theuse of its logo.

Maple says that it has put the IPRproblems behind it and that its latestvehicles are entirely self-developed. Asproof it offers its small but growing export

volumes. After all, say the company’smanagers, who would be mad enough toexport vehicles if they encroach onanother firm’s IPR and would invite theirwrath in countries where IPR laws arestronger? Maple exported 800 cars in2005, mostly to the Middle East where theHysoul sells for just US$6,500. Thecompany’s export manager says that this isonly the beginning and that it plans toraise the volume quickly. But he alsopoints out, sensibly, that Maple wants tomove carefully and learn the ropes, notrush in and blow its chances. It will take afew more years before they are ready forthe main markets, he says. These wouldpresumably include the US and Europe.

The Maple story is not just remarkablefor the pace of development or thecompany’s determination to succeed,however. If it is able to make money withsuch small production volumes, sell themfor such low prices and do that overseastoo, Maple appears to be changing therules of the game—that a carmaker has tobe big to succeed and that cars can't bemade at such prices.

Shanghai Maple: going places

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Fuelled by ample money, ambition andgovernment support, Shanghai Automo-tive Industry Corporation (SAIC), one ofChina’s biggest automotive companies, isstriving aggressively to achieve globalcompetitiveness.

The company is hoping to enter theinternational markets by leveraging majorwell-known, though ailing, brands. Itwants to start domestic production with,and later export, major automotive brands.Towards this end, it has bought a majoritystake in Ssangyong of South Korea and therights to the MG Rover car in the UK. WillSAIC’s strategy succeed?

Certainly both deals have facedproblems right from the start. Theagreement to produce Ssangyong sportsutility vehicles (SUVs) in Shanghai fellthrough, although SAIC exports othervehicles through its shareholding inSsangyong.

Moreover, soon after SAIC increased itsshareholding in Ssangyong to 51.33% inJuly 2006, the latter’s workers went onstrike for two months to protest at anarrangement in which SAIC paid onlyUS$26m to license technology fromSsangyong. SAIC hired Phil Murtaugh, aformer head of General Motors China, tolead international development. His briefincluded sorting out financial and labourissues at the SUV manufacturer, along withdriving SAIC’s outward push.

Deal with MG RoverThe deal with MG Rover was also compli-cated. Although SAIC obtained the designand property rights for the Rover 25 andRover 75 in early 2005, it subsequently

lost out to Chinese carmaker NanjingAutomobile in a bidding war for the use ofthe MG Rover name and production facili-ties (see case study, Nanjing Automobile:was buying MG Rover a bold or foolishmove?). SAIC’s plan to buy the Roverbrand name from BMW has come unstuck,as Ford, which purchased the Land Roverbrand about a decade ago, announced inSeptember that it would exercise itsoption to buy the Rover brand nameinstead.

It appears less likely now that SAIC willbe able to use the brand name as thiswould require getting permission for use orlicensing from Ford. Nevertheless, eachstep brings SAIC closer to rolling its ownbrand off the manufacturing lines-SAIC'sRover 75-based model is expected to hitthe streets in China, and possibly in theUK, by late 2007 or 2008.

By that yardstick, SAIC seems to be in astrong position. The company’s jointventures with General Motors andVolkswagen have given its engineers andmanagers exposure to internationalquality and design capabilities. Additionalexposure comes through a companystarted by UK engineering consultancyRicardo to work with SAIC to developengines and drive trains for the Rovermodels.

Nonetheless SAIC faces certainobstacles. Tang Weiyan, a former SAICengineer and current secretary of theShanghai Automotive Trade Association(SATA, a SAIC subsidiary), says thecompany's weaknesses include a lack ofresearch and development skills andinternational sales experience. But SAIC is

in no rush, he says: “We want to go to theinternational market with a good producteven if it takes longer than companies likeChery and Geely.”

It is also unclear how much SAIC willbenefit from the Rover brand. The Rovername may still have some cachet in China,but the brand’s value has taken a beatingin the UK. Building and reviving the brandname will require sales and marketingexperience and savvy-areas in which SAICis weak.

It also lacked executives withinternational experience, although that isnow changing. For example, SAIC has hiredMr Murtagh and as vice-president WangDazong, a former chief engineer anddesigner with General Motors who wasborn in China but educated in the US.Moreover, SAIC’s president, Chen Hong,speaks fluent English and some German.

Trying hardBut while the joint ventures with GeneralMotors and Volkswagen have broughtmoney and exposure to internationalmanufacturing and management, SAIC hassome way to go. In the short term, Mr Mur-taugh’s first task is to help turn around theSsangyong brand, rather than assist in thedevelopment and marketing of a SAIC-branded automobile. In fact, the companyhas yet to decide on a brand-name,although it did have its own Shanghaibrand before 1949.Asks SATA’s Mr Tang:“Wouldn't you like to drive a Shanghaibrand car?” It may be some time before EUand US consumers get the chance torespond, but it seemingly won't be forwant of trying on the part of SAIC.

SAIC: in top gear?

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In the UK, Rover is a popular name for adog. It is also the name of one of the coun-try’s most famous carmakers, MG Rover. In2005, after years of strife, the companyfinally went bankrupt and many of itsassets were sold to China’s Nanjing Auto-mobile (Group) for £53m or US$93m atcurrent rates (some reports say the sellingprice was £67m).

It was a controversial sale, hampered bybattles over production rights, brands andproperty. Despite all this, Rover’s newowners think they have made a wiseinvestment. Can Nanjing Automobile finallyturn this old “dog” into a viable business?

Yu Jianwei certainly thinks so. Aspresident of Nanjing Automobile, he hasconvinced his state-owned company’sshareholders that they should invest in astate-of-the-art factory on a 300,000-square-metre greenfield site in Pukou, onthe outskirts of the city. Production ofcars, using Rover technology, is due tostart in mid-2007 and within a few yearsthe plant hopes to churn out up to 200,000vehicles annually, as well as 250,000engines and 100,000 gearboxes.

Nanjing Automobile will export half, ormore, of these cars while others will beassembled in the UK in order to retain thebrand’s claim to British-ness (theprototypes, currently driving aroundNanjing’s streets, still sport the British flagon a small panel by the rear doors).

Mr Yu’s well-tailored suit, good Englishaccent and unflinching enthusiasm make it

easy to believe that he can make NanjingAutomobile succeed with Rover, whereRover itself and BMW (which once ownedthe long-struggling business) have failed.Only Mr Yu’s closely bitten finger nails giveaway the perilous nature of his undertaking.

Nanjing Automobile has been inbusiness since 1947 and is the leadingvehicle producer in China’s Jiangsuprovince. With assets of US$1.4bn, itcurrently has the capacity to build 180,000vehicles a year under three brands: NanjingYuejin, Nanjing Iveco and Nanjing Fiat.Output will be about 130,000 units in 2006and the product line-up is broad. With morethan 400 models, the company buildspassenger cars, light-duty trucks andbuses, cross-country vehicles, small-sizedpassenger/cargo transportation vehiclesand special-purpose vehicles, as well asvarious types of chassis. Like every otherforeign vehicle joint venture in China, theNanjing Iveco and Nanjing Fiat businessesare 50:50 operations, which were formed in1996 and 1999 respectively.

Why Nanjing Automobile bought RoverThe Rover acquisition is therefore a step,but not too big a step, for the company.Rover was roughly similar in size and usedtechnology that was more advanced, butnot much more advanced, than NanjingAutomobile. It is the plans Nanjing Auto-mobile has for the business that make themove so bold. By taking over the Britishcompany, Nanjing Automobile’s expects to

triple its own sales to more than US$2.5bnover the next three years by tripling out-put. Why does it want to bother, though,in this tough global business, where thereis so much over-capacity and so few com-panies making money?

Mr Yu is quite clear why. He has beenexplaining why in great detail for manymonths, to convince his shareholders tostump up the money. He says it is because,like everyone else, Nanjing Automobile cansee the size of the market opportunity. Itcan see the growth prospects that the carsector offers in China. Moreover, he thinksthat the growth potential for cars is muchbetter than the company's main markettoday. The bulk of Nanjing Automobile’scurrent sales come from small trucks soldto farmers.

But why not work more closely with Fiatof Italy, its partner in the car sector for thelast seven years? Surely, that would havebeen a lot easier than taking on a bankruptBritish firm? Mr Yu is polite enough not topoint out that, after so long a workingarrangement with Fiat, sales of its carshave barely reached 45,000 units a year—in a market with potential for 2.6m. Heexplains, instead, the company’s desire togo it alone. “When you are in a marriage, itis always necessary to consult yourpartner,” he says. Nanjing Automobilewanted control of its business and with thepurchase of Rover has now got it.

There were other reasons, he explains.This is a tough business and Nanjing

Nanjing Automobile: was buying MG Rover a bold or foolish move?

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Automobile lacked scale and technology.There has been pressure from theauthorities in Beijing for the Chinese autosector to consolidate. If NanjingAutomobile had not bought Rover, it mighthave had to close. The option was to eitherinvest or die. Rover was analysed verycarefully, says Mr Yu, and its platforms andtechnology looked at. Rover offeredvehicles and technology in severalsegments as well as engines. They boughtit, not because it was the only car companyavailable, but because Rover's capabilitiesmatched those of Nanjing Automobile.“Now,” says Mr Yu, “we are big enough togrow and survive.”

Nanjing Automobile fought hard forthis. Until recently there had beenpressure from the central government forthe company to be consolidated intoShanghai Automotive Industry Corporation(SAIC), easily China's strongestautomaker. To avoid this, NanjingAutomobile’s shareholders were changed,with the ownership of Nanjing Yuejintransferred to the Jiangsu provincialgovernment. This made the widelyanticipated merger “almost impossible”,according to Jia Xinguang, an analyst withthe China National Automobile IndustryResearch Institute.

But it may also have made SAIC morehostile. Before Nanjing Automobileacquired Rover, SAIC had bought the rightsand plans to build the Rover 75 model.When Nanjing acquired the business itacquired the tooling and productionequipment for the same model. This meant

that both firms would be able to producethe same car and sell it under differentbrands, locally and overseas. This has ledto even greater friction between SAIC andNanjing and to the threat of court action.SAIC has even demanded that Beijing forceNanjing Automobile to merge with it, to noavail so far.

Will Rover-based cars sell?Somewhat bizarrely, neither firm hasacquired the rights to use the Rover branditself. This was retained by BMW when itsold the business to Phoenix, the manage-ment buy-out team which first acquiredMG Rover and then sold it to Nanjing Auto-mobile.

Regardless of the brand, will Rover-based cars sell? The MG7 will usetechnology that is already almost ten yearsold. When it was withdrawn from the UK in2005, it was viewed as an ageing andincreasingly unremarkable car, with salesdeclining as rivals launched contemporarydesigns. Yet the build-quality was good,remarkably for MG Rover, as every other carit produced lay near the bottom of theAutomobile European league tables.

Still, Nanjing Automobile will need toinvest. It plans to spend Rmb2bn(US$250m) over the next five years toupgrade products. It is building atechnology centre where it will developnew models. It is hiring internationallyand has transferred 20 staff fromLongbridge, the UK, to Nanjing, includingMG Rover’s director of quality. It will alsoseek more international co-operation to

access technology and designs, forexample, with Ove Arup of the UK.Components will come initially from theoriginal suppliers in the UK as well as in-house. These will be upgraded steadily,with parts increasingly sourced from manyof the international OEMs (originalequipment manufacturers) that haveestablished factories in China.

Risks and opportunitiesWill Mr Yu achieve his goals? That is diffi-cult to say. Nanjing Automobile has comea long way in understanding the complex-ity of the car industry and the needs of for-eign buyers in a very short time. Butdoubts remain. The Rover 75 model, by farthe newest in the line-up, is old and noamount of face-lifts will hide that. TheRover brand is also badly tarnished. Thedealer network has mostly gone and, giventhe company's history, few dealers arelikely to show much enthusiasm to sign upagain.

Before it went bankrupt MG Rover hadachieved an almost comic status in itshome market and had been forgottenelsewhere, often with a sigh of relief.Labour problems, financial problems,antiquated technology, outdated designsand poor quality had dogged the businessfor the best part of 30 years before it wentbelly-up.

It is a tough call. Nanjing Automobilemight have found the fast track for successin its purchase of Rover. But it might alsohave bitten off a lot more than it can chew.

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markets have been designed by either Pininfarinaor Bertone, with engineering firms like Ricardoproviding support on the engine and powertrain.So what is being billed as a Chinese car is moreaccurately an product of co-operation amongItalian, British and Chinese companies.

Domestic carmakers are not shy about picking upmanagement and technological skills from theirEuropean, US and Japanese joint-venture partners,as FAW, SAIC and Dongfeng have done. All threecompanies have multiple partnerships with globalcompanies from different countries that have notonly given them a chance to learn, but have alsoexposed them to international automotive-industryconsultants, and to engineering and design firmslike Ricardo, and Pininfarina and Bertone of Italy.Phil Murtaugh, former chief executive of the GMChina Group, says Chinese companies “have atremendous capacity to learn”. Mr Murtaughrecently took a position with SAIC as executivepresident of overseas manufacturing.

In the short term, manufacturers can bring avehicle to market in this manner. But in the longterm, the reliance on outside assistance coulddelay their own development in design andengineering. To move into the group of corecountries, China’s manufacturers must develop astrategy to become fully integrated originalequipment manufacturers (OEMS).

Building or buying a brandThat includes building a brand. In this aspect, Ms Chu considers SAIC to be “very smart” and tohave “the guts, money and exposure to developtheir own brand”. Tang Weiyan, executive vice-chairman of the Shanghai Automotive TradeAssociation, an industry lobby group connected toSAIC, hints that SAIC will maintain a low profile andobserve other companies, even as it develops itsown brand.

Another (quicker) strategy to enter Western

markets has been to buy existing brands, and usethose as a base to build upon, as NanjingAutomobile has done with MG Rover of the UK (seecase study, Nanjing Automobile: was buying MGRover a bold or foolish move?). Although NanjingAutomobile has not acquired the rights to the MGRover brand (that is still retained by BMW, see casestudy) it will be able to use this and other brands.The products to be re-launched in 2007 will all besold with the MG brand initially. The Rover 75 willbe re-born as the MG7, for example. But thecompany also has the rights to use the Wolseley,Austin, Morris, American Austin, Princess andSterling brands, as well as Vanden Plas outside theUS and Canada. The company could also use itsown Yuejin and Soyat brands.

As far as Nanjing Automobile is concerned, itbelieves it already has access to the MG Rovermarket and intends first to target the 150,000people who bought Rover cars in the year before MGRover went bankrupt. “If we don't get [this market]now, we will lose it,” says Yu Jianwei, NanjingAutomobile’s president. This market is 90% in theUK. The question is: how will traditional Roverbuyers—mostly middle-aged, middle-Englanders—respond to a Rover made in China? Mr Yu points tothe brand’s 100-year history, adding that this isalso the reason behind Nanjing Automobile’sdecision to keep an assembly operation running inthe UK. Even if it is making small numbers of carsand most of the components come from China, hebelieves that this will be enough for the company tosustain the claim to its British heritage. “Of course,”he says, “quality and service will need to be morecompetitive than before.” But he thinks it ispossible to retain MG’s brand values with the rightlevel of customer support.

Other playsThe buying of distressed OEM assets (such as MGRover) is a trend that is likely to continue, especially

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Chery Automobile, China’s largest whollydomestic carmaker, is believed at hometo be the one most likely to succeed. Cer-tainly of China’s carmakers it hasattracted the most international atten-tion. In June 2006, the buzz in the auto-motive industry was that George Soros,the American billionaire investor,planned to invest US$200m in a jointventure with Chery to manufacture vehi-cles in China and distribute them in theUS. At the time of printing, neither MrSoros nor Chery had commented on areport to this effect carried in AutomotiveNews, a specialist publication.

Mr Soros’s millions, if they areforthcoming, should give a fillip toChery’s much-talked-about proposedexports to the US. Chery already has a2005 deal with Visionary Vehicles, anauto-distribution company led by USentrepreneur Malcolm Bricklin, to import250,000 Chery vehicles into the US. Thestarting date keeps changing, however.Initially set at mid-2007, the deadline hasnow been reportedly pushed back tosometime in 2008.

Chery has not commented on thedeadline, but also in June 2006 issued astatement that it hoped to keep a lowprofile on its globalisation strategy. “Wethink we are still at a very, very initial stageof establishing overseas capability. We donot even know the potential risks on thatroad clearly. Therefore Chery managementis not willing to talk publicly,” thestatement said. “The recent reports aboutChery are completely released by ourpartners or potential partners in the US,which are not from our will [sic].” Cherydeclined an interview with the Economist

Intelligence Unit on the issue.How realistic are Chery’s supposed

export ambitions? In a June 2006interview with New Capital News, a Beijing-based newspaper, Yin Tongyao, Chery’sgeneral manager based in Anhui province,said he expected Chery to export about10% of its overall sales in 2006, or about20,000 vehicles. It would be a huge leapfor Chery in the next few years to export250,000 cars to the US (as Mr Bricklin hasclaimed) from such a small export base.Moreover Chery’s annual productioncapacity is only 350,000 vehicles. Lastyear, the company exported a mere 18,000units, mainly to Egypt, Malaysia and Syria(its largest export destination). It appearsunlikely that Chery will rush into moredeveloped markets before the companydeems itself ready. Mr Yin outlined thecompany's growth strategy as focusinginitially on Russia, the Middle East andLatin America before tackling the US andEastern Europe. But he did say plans havenot changed to enter the US market.

It is evident why Mr Bricklin and MrSoros (and other investors) could beattracted by Chery-it has shown meteoricgrowth in its home market. But Cheryenjoys a favourable climate in China.Regulations on emissions and quality arelax, and price-conscious customers don'tmind a lower quality if they can get a lowerprice. Chery would not be unable toreplicate its popularity at home with themore demanding consumers in the US andEurope. Keep in mind that for 85% ofChina’s car buyers, this is their firstpurchase of a car. As such, Chery remainsuntested in terms of customerexpectations.

Industry executives in China are keenlyaware of the initial failure of Japanese andSouth Korean automakers’ exports to theUS and Europe, and of the spectacularfailure of the Yugo, a much malignedmade-in-Yugoslavia car that Mr Bricklinimported to the US in the 1980s. China’sautomakers would hardly risk taking anysteps that would relegate their brands tothe same historical heap as the Yugo.“Chinese companies are well aware ofwhat's at stake,” says John Humphrey,managing director of the China operationsof JD Power and Associates, a leading USautomotive research company.

Indeed, despite Chery’s ambitiousplans, it is still developing sales and after-sales service knowledge in the domesticmarket, and has not really tackledinternational service standards yet. Mr Yintold New Capital News he expects Chery torank seventh in sales in China in 2006 andthird by 2007. It expects to do this bykeeping prices low-the strategy by which ithas increased market share by double digitsover the past three years. However, indeveloped markets like the US and Europe,“price alone will fail,” notes JD Powers' MrHumphrey. Customers in those marketswould demand more from their carmakers,including customer service, warranties,reliability, safety and gas mileage to namea few. China’s carmakers are way behind insuch aspects-for example, customerwarranties in China are typically only fortwo years, a far cry from the warranties offive and ten years expected by customers inthe US. Chery has not been required to dealwith these issues yet, but it will have to dobetter than a low price to compete in thedeveloped markets.

Chery on top?

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

as several US and European automotive and auto-parts companies are looking wobbly. There are a fewpossibilities: Fiat in Italy, Ford in the US, Lada inRussia and Proton in Malaysia. For China’s carmakers,acquisition would give them access not only to thetarget-company's products, but also to its technicalknowledge, technology and customer-base. Theproblem is that overtures by China's carmakers to buystakes in these (and other) companies could arousepolitical ire in their countries of origin.

Where to get the money?Building a prototype, building a brand, competingin overseas markets—all these require financing.Fortunately for China's automakers, most of whichare state-owned, the central government is givinga strong push to the industry, and is helping withfinance (see section, The push and the pull to gointernational). Both SAIC and Nanjing Automobile(which plans to spend Rmb2bn over the next fiveyears on product upgrades) received low-interestloans from the government to buy their shares inthe assets of MG Rover of the UK. The smaller Geelyhas also benefited from government sponsorship—the town of Cixi, in Zhejiang, where Geely islocated, approved a US$2.4m loan for the carmakerto build a 200,000-units per year plant nearby.

Financing has also come from foreign investorswilling to import Chinese-made cars. There's talk ofAmerican billionaire George Soros' investment in a

joint venture with Chery to produce vehicles in Chinaand distribute them in the US (see case study, Cheryon top?). Chery already has an agreement withVisionary Vehicles, owned by Malcolm Bricklin, acontroversial American entrepreneur who is hopingto lead Chery’s charge into the US. The agreementbetween Visionary Vehicles and Chery, rumoured toinvolve investment of US$200m, provides for annualsales of up to 250,000 Chery cars to the US by late2007 or early 2008.

Besides these avenues, China’s carmakers canturn to the stockmarket for funding. For example,SAIC has plans for an overseas listing in late 2006or early 2007. Its subsidiary, Shanghai AutomotiveCompany, is already listed on Shanghai's stockexchange. Getting access to global qualitystandards is also an avenue increasingly open toChinese carmakers in their efforts to develop, asglobal parts companies ramp up production locally.Global manufacturers report that sourcingmaterials and components in China has provedcostlier than expected and so they welcome theadditional volumes that Chinese carmakers offer.The presence of foreign Tier one and Tier twosuppliers in China provides an opportunity, as theycan leverage the technology and skills of thesesuppliers to improve areas in their own production.Suppliers like Arvin Meritor of the US and MagnetiMarelli of Italy reportedly have also begun tosupply to Chinese automakers including Chery.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

The push and the pull to go international

At first glance, moving forward seems easyfor China’s automakers. Exports aregrowing rapidly (although admittedlyfrom a low base) and production capacity

is estimated to reach 9m vehicles in 2010. Thecentral government expects the automotiveindustry to become a pillar of the economy by2010, and envisages exports to climb 40%annually from 2005 onwards. On the low end, thatcould mean at least US$1.2bn in export sales.There’s more—between 2020 and 2035, thegovernment expects China's share of the globalvehicle trade to swell from the current 1% to 10%.

Push from the governmentTo propel the automotive industry along, thegovernment is helping with finance in the form ofsubsidies and low-interest loans. Adding hardpolicy to hard cash, the Ministry of Commerce inlate June 2006 said it would establish a system byJanuary 2007 requiring automobile exporters toapply for licences. Analysts say the export licencesare intended to prevent a price war among China’sdomestic automakers, which are looking to exporttheir vehicles because of a production glut. Thelicences would also permit a check on badly madeexports, which could damage China’s automotivereputation overseas. An official from the Ministryof Commerce was recently quoted in a newspaperas saying that China’s carmakers did not makeadjustments to suit the rules and regulations ofimporting countries. The comments were areference to the Landwind situation.

The government nonetheless wants its home-grown automakers to make a name abroad.Towards that end, the Ministry of Commerce plansto construct an information platform for China’sautomotive exporters and manufacturers that will

detail regulations and requirements of overseasmarkets. The ministry’s overseas economic andcommercial offices have been charged withputting the information together. Such assistancemay seem excessive, but remember thegovernment is the ultimate shareholder of mostautomakers in China.

Pull from foreign dealersWith government support and cash behind them,it is not surprising that China’s automakers areaggressive and willing to take risks at home andoverseas. This is made even easier by the foreigninvestors also willing to take risks by importingChinese-made cars. Mr Soros has not commentedon a report in Automotive News, a specialistpublication, that he will invest in Chery. But he isknown to be a savvy investor, and if he’s puttinghis money on a Chinese carmaker, it is likely thatothers will follow.

Chery’s February 2006 agreement withVisionary Vehicles startled many observers, whowere unprepared for a possible onslaught in theUS of made-in-China automobiles. But almost assoon as the deadline was set, it began to shift. InJune 2006 Chery engineers were quoted inAutomotive News as saying that 2009 would be amore likely date when their company’s cars couldcompete on quality and safety in the US market.This is probably sound strategy, as the Landwindfiasco badly hurt not only the image abroad ofJianglin, but also that of China's automotiveindustry.

China’s car manufacturers all know that a flopby one Chinese-made car will damage thereputation of the others. As a result, they are notlikely to fall for distributors pushing them tooearly into competitive markets where reputations

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

take years to recover. Chinese manufacturers havelearnt from Japanese and South Koreanmanufacturers the hazards in launching sub-standards cars in the US and Europe.

Prolific productionAnother reason for Chinese carmakers to gooverseas is prolific production. Their output hasalready reached 5% of global production,according to the National Development andReform Commission, and by 2010 is estimated to

reach 9m units. EIU forecasts are moreconservative—at just over 5m new vehicleregistrations in 2010—but even the lower figure isworrying. China’s automotive industry alreadysuffers from excessive production capacity,estimated by the commission at about 2.2m unitsin 2005. Over-capacity has already dragged downthe prices of Chinese cars on the China market, andwith the forecast that capacity will stand at almost4m units in 2010, the economic pressure onChina’s carmakers to export is intense.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

The road ahead: up and down

So when can China’s automakersrealistically begin to compete in the USand Europe? Graeme Maxton and JohnWormald would argue that Chinese

carmakers are up to 10 years behind their EU andUS counterparts. Phil Murtaugh, now executivevice-president of SAIC, also believes it will takeonly a decade for the catch-up. For his part, JDPower’s John Humphrey believes that it will takeanother generation of vehicles before some ofChina’s carmakers can master technology to asufficient level. If developing technological anddesign skills will take another generation of cars,and about five models make up a generation, thena 10-year timeframe seems reasonable to developa car that is technologically and aestheticallyacceptable to picky US and European consumers.The timeframe is based on it taking about threeyears to bring a set of models to market, andanother two to three years to get consumerfeedback.

Why would it take China's automakers 10 yearsto establish their brands on the US and Europeanmarkets, when it took the Japanese and SouthKoreans 30 years and 20 years, respectively? Partof the reason is that China’s automakers aresoaking up skills and technology from theirforeign joint-venture partners and suppliers, oroutsourcing design and engineering to firms likeRicardo or Pininfarina or Bertone. They are alsolargely copying rather than developing modelsfrom the bottom up as carmakers in India aredoing. The first indigenous model was produced byChery only in 1999/2000.

Quality and safety conceptsDespite their strengths of access to financing, andability to sell at low prices, China’s manufacturers

still have to work out quite a few bugs in their carsbefore they can truly be ready for internationalmarkets. For a start, they do not seem to fullygrasp the concepts of quality and safety.

According to the 2005 Initial Quality Study byJD Power and Associates, Chinese cars are far frombeing competitive in the US market in terms ofquality. In the compact-car market, for example,China's industry average is 454 problems per 100(PP100) cars. In the US and Europe, buyers ofcompact cars would want only 118 problems per100 cars—the worldwide industry average. (Totheir credit, in the JD Power study, two Chinesecars appeared in the top three in China’s compact-car sector in terms of quality: Chery’s QQ andTianjin First Auto Works’ Xiali Charade.)

The 2005 study also found that overall initialvehicle quality in China averaged 236 PP100, an11% improvement over the previous year, and asubstantial 50% improvement since 2000. But thisis still a long way from the expectations of US andEuropean consumers. The Landwind kerfuffle wasjust one manifestation of the swirling criticism ofsafety and emission standards of Chinese cars,which trail international norms. For example,China-made automobiles are required by theChinese government to follow Euro II emissionsstandards, but the EU has already advanced to EuroIV standards. China plans to get there only by 2010.

“There needs to be a paradigm shift for [US andEuropean] export markets to accept Chinese cars.There also needs to be a shift on the Chinese[carmakers’] side in terms of quality,” saysJiangyin Venture Interior’s Cherry Chu. The Chinesegovernment is making an effort to push thingsalong. It recently passed a regulation on the size ofan engine relative to the size of a car that willreduce emissions and increase fuel efficiency. But

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

How does the China compact segment compare with the US market compact segment?

Top 110 aatrributes ((China) Top 110 aattributes ((US)

Overall rating of transmission Overall rating of transmission

How quickly the air-conditioner can cool the interior Engine performance during rapid acceleration

Ability of the air-conditioner to keep the interior cool Engine smoothness during hard acceleration

Passing power at highway speeds Sound of engine while idling

Engine smoothness during hard acceleration Driving range between fuel stops

Exterior color choices available Rating of vehicle’s overall fuel economy

Front end styling (headlight/grill area) Vehicle ground clearance

Sound of the engine while idling Stability when driving fast on winding roads

Engine performance during rapid acceleration How easily you can open/close side door

Appearance of exterior paint Appearance of the wheels/rims

Source: JD Power and Associates

Top three vehicles per segment in initial quality: J.D. Power Asia Pacific 2005 China Initial Quality StudyNote: Lower score reflects better quality performance

296391

424454

147153

159231

130134

145177

70109110

141

106151

183298

Compact car segmentChevrolet Spark

Chery QQTianjin Xiali

Compact Car Segment

Toyota ViosHonda Fit

Volkswagen PoloEntry Midsize Car Segment

Toyota CorollaNissan Sunny

Volkswagen BoraMidsize Car Segment

Toyota CamryMazda 6

Honda AccordPremium Midsize Car Segment

Honda OdysseyBuick GL8

Dongfeng FutureMPV Segment

Problems per 100 vehicles

Entry midsize car segment

Midsize car segment

Premium midsize car segment

MPV segment

Note: No official rankings are published for the premium compact car, entry luxury car, luxury car and SUV segments due to an insufficient number of models in the sample.

Source: JD Power Asia Pacific 2005 China Initial Quality Study, JD Power Asia Pacific

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

emission and quality requirements in China are stilla long way behind those in the US and Europe.

Safety standards, too, lag in China. The countryrecorded 517,889 automotive accidents in 2004, ofwhich 107,077 resulted in fatalities. This is thehighest per-population accident rate in the world,according to an industry insider, who declined tobe named. China only began requiring front-impactcrash tests in 2004, which resulted in a number ofdomestic made mini-vans being taken off themarket. Side and rear-impact standards and crashtests came into effect from July 1st 2006. It’s likelythat more domestic cars will be forced to retire withthese new standards. By contrast, EU and US safetyregulations are stringent, and in future would eveninclude limits on the number of airbags permittedin a vehicle. The Chinese government expects toimprove safety standards only by 2010. Until then,it seemingly will be difficult to convince EU and USconsumers to buy from China.

Brand and intellectual property They are also likely to be put off by copycatbehaviour from Chinese carmakers, several ofwhom have been accused of violating theintellectual property rights of internationalcompanies. If they take cars or parts which haveinfringed copyright to the US or Europe they arelikely to be sued by local rivals—which will createendless bad press. There certainly may be a case toanswer. GM sued Chery in 2004 for allegedlycopying the Chevrolet Spark to create Chery’s best-selling QQ. The Chinese government advised GM toseek mediation and the two companies eventuallysettled out of court. There are many otherexamples. Nissan has taken Great Wall to court;Toyota and PSA are doing the same to ShanghaiMaple. Volkswagen also settled out of court withChery over mass production of a car using one ofVolkswagen’s own plants.

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DrivenAre China’s car manufacturers ready to compete in the US and Europe?

Conclusion

China’s carmakers are beginning to getnoticed. Whether they become biggerstars will depend on the strategies theyadopt to grow and to overcome

weaknesses. It is expected that the initiatives willbe varied, from the slow, calculated moves of SAICto the versatile aggression of Chery. The threatsfacing them are likely to apply to all. Among themis the possibility of a political backlash in the US orEurope, or rivalry from a low-cost competitor likeIndia. The latter could be challenged throughsavvy marketing and branding, but Chineseautomakers are weak in those areas. Indeed, itappears that China carmaker’s intrinsicweaknesses pose more of a threat to theirdevelopment than outside threats. According tothe industry experts, consultants and carcompanies we interviewed for this report, China’scarmakers suffer from the following:• Lack of brand recognition in overseas markets• Low quality (perceived or real)• Low expenditure on research and development• Little intellectual property • Shortage of technological and engineering

skills• Weak international-level management skills• Lack of attention to safety standards• Stiff competition to sell low-priced cars

But China’s carmakers also have certainstrengths, not least government support andfinancing. They also have few management legacyissues, and are able to sell cars cheap. How quicklythey leverage these strengths to overcome theirweaknesses will ultimately determine whetherthey are able to crack the developed markets of theUS and Europe in 10-15 years’ time.

Meanwhile, they can ease domesticoverproduction by selling their low-cost vehiclesto developing countries in South-east Asia, theMiddle East and Africa. They can also formalliances in transitional markets in Eastern Europeand South America. Going for the unexpected,Chinese automakers could attempt to enter themore developed markets with niche products suchas SUVs, hybrid cars or a quirky design. With“traditional” cars, China’s automakers do not havea big advantage in the developed markets againstother low-cost producers like the Japanese andSouth Koreans, who have established brands therewith a reputation of value for money.

The global automotive landscape 10-15 yearsfrom now is hardly clear. Changes in US andEuropean manufacturers’ fortunes may open upopportunities for Chinese carmakers in thosemarkets. In mid-2006 the mature, staid markets inthe West look tough nuts for a new entrant to crack.