China Takes The Lead In the Automobile Industry

American tastes dominated the world's automotive market for a century, but all that's changing now. Today it's the increasingly well-to-do Chinese car-buyer that industry wants to woo and win, thanks to this incredible fact—China has, over the last three months running, surpassed the U.S. in terms of volume sales of automobiles. Ever wonder why Ford's new Fiesta has an instrument panel that looks like a cell phone? Because that's what's familiar to its target audience of

20- and 30-something Chinese. It's also why Chinese versions of the Fiesta come in sedan size, with four doors, rather than as hatchbacks, which are anathema in the Middle Kingdom.

The future of auto design was on display last week at the Shanghai Auto Show, where, in 30 football fields worth of space, international and domestic carmakers vied for the attention of Chinese consumers. The timing of the biennial event, China's oldest international auto show, was fortuitous. No one expected the Middle Kingdom to nab first place in the global auto market from America for at least another decade, but the financial crisis has had a sharp dampening effect on U.S. sales. The Chinese, meanwhile, spurred on by their government's enormous stimulus package, have kept spending. Beijing's 2009 auto sales target is 10 million units, an increase of 10 percent from 2008, and a figure that would cement its position, with an estimated 1 million more unit sales than the U.S. "No one expected China to emerge as the leading volume market this fast," says William Russo, a Beijing-based business consultant who specializes in the automotive sector. "This will give China a huge say in setting the standards and architecture for the entire industry."

If Beijing gets its way, the future will be small, green and—of course—made in China. The shock of the global financial crisis, and the resulting need to stimulate the auto sector has persuaded Beijing to dig deep into government coffers with more than $733 million to promote the rural sales of small cars and trucks (which domestic makers specialize in) and $220 million to fund and upgrade new green automotive technologies that many consider to be the wave of the future for the industry. Ultimately, Chinese planners want to create a new Detroit—a leaner, meaner, cleaner global automotive hub.

It won't be an easy road. The five top-selling brands in the country are still familiar foreign names—Volkswagen, Hyundai, Toyota, Honda and Nissan, in that order—though the top four are all joint ventures between these foreign giants and old Chinese-state run companies, like Shanghai Automotive Industry Corp. or SAIC, a behemoth that has joint ventures with both Volkswagen and GM. But muscling their way onto the scene are some brash, local rising stars—including private carmakers Chery Automobile Co., Geely Automobile Holdings and BYD Auto Co.—that have been ramping up production and sales. While most are still beginners when it comes to things like brand development, marketing and quality control, together they already represent one third of domestic sales—and Beijing's policymakers think it's time for local players to lift their profile.

The first big push toward that goal will come via stimulus-package money. In late January, domestic carmakers were thrilled to discover they would reap the lion's share of benefits from official stimulus efforts simply because they specialize in small, inexpensive cars popular in second-tier cities and towns. Government initiatives included the halving of retail taxes (from 10 to 5 percent) on vehicles with less than 1.6-liter engine displacements, and $700 million in government subsidies to entice farmers into trading their tractors and rural clunkers in for new small cars and trucks.

Local players immediately began reaping the benefits. China's fifth-biggest manufacturer, Chery, saw sales in January and February shoot up 25 percent; it's aiming for 18 percent growth in 2009. By shifting its policy support to smaller cars Beijing has upped the pressure on China's biggest manufacturers, both foreign and domestic, to scale down in vehicle size. Just by coincidence, Ford started selling its new Fiesta—with an engine displacement of 1.5 liters—in China a little more than a month after the new tax cut. Customers bought more than 4,000 in six weeks of presales transactions.

Yet smaller cars are only the first part of the government's master plan. China's stimulus package also includes $220 million for upgrading automotive technologies, especially in alternative-energy vehicles. To help offset the high cost of buying clean-energy vehicles, subsidies of nearly $8,800 are being offered to local government agencies and taxi fleets in 13 cities for each hybrid vehicle purchased. The rebate will also reportedly be offered to private car-buyers to soften sticker shock.

Such incentives helped make Shanghai's auto extravaganza last week the greenest A-list car show in history. Although none of them represent cutting-edge technologies, China's homegrown electric and hybrid vehicles were visible at every turn. Chery, China's top-selling local brand, exhibited four alternative-energy cars. The private Lifan Group, based in Chongqing, unveiled its hybrid 320 EV. And BYD Auto, a Shenzhen-based firm best known for putting batteries in one fourth of the world's cell phones, had on display its much-touted F3DM, a plug-in electric car with a backup gasoline engine, that started selling last December for around $22,000.

The company leveraged its famous battery expertise to create what it says is a safer and more environmentally friendly lithium-ion phosphate battery for the new plug-in. BYD has now leaped ahead of more established international models such as Toyota's Prius and GM's Volt to bring an affordable plug-in car to the market—BYD's model is nearly half the expected cost of the Chevy Volt.

But despite the hype, officials and consumers alike acknowledge that smaller, greener homegrown vehicles are still in their infancy. It's perhaps telling that at the Shanghai show, BYD Auto officials decided to exhibit their plug-in with genuine license plates, rather than mock-ups as is typical. "The technology is so new that some Chinese worry such cars would never even get licensed," says marketing representative Jasmine Huang. "This will reassure them." Despite the reassurances, only a few dozen F3DM's have been sold, and even then, not to individuals but to government units and banks. Private purchases are expected to begin only in June. Meanwhile BYD's target date to start selling in the U.S. market has slipped from 2010 to 2011, due to the ongoing economic crisis, says export manager Henry Li.

This underscores the many challenges facing China's domestic players. At present their ability to penetrate export markets is insignificant, partly because Chinese safety standards lag behind those in Europe and the U.S. Even at home, for example, Chery's popular QQ compact suffers from a perception of being too flimsy to be safe—especially after a photo circulated on the Internet, showing a QQ wedged between two buses, squashed like a soft-drink can.

Marketing and consumer research also remain alien concepts to domestic players. At the Shanghai Auto Show, Geely unveiled nearly two dozen new models—including a blatant clone of a Rolls-Royce Phantom, down to the winged hood ornament. Company chief Li Shufu then invited visitors to fill out suggestion forms to record their reactions to the bewildering proliferation of new products. "We're trying to get opinions from all walks of life," says Li, whose firm had to delay its entry into the U.S. market due to quality-control issues.

By contrast, Ford, for example, intensively researched China's under-30 consumers who are the new Fiesta's target audience. Its findings encouraged Ford to team up with Microsoft to develop SYNC technology so that drivers can connect their cars to their MP3 players. "We spent a lot of time talking with 25-year-old Chinese women about their tastes," says John Parker, Ford's executive VP for Asia-Pacific and Africa. "They wanted styling, fuel economy—and Internet connectivity."

Chinese auto companies still have a key competitive advantage—the fact that most are run by (and favored by) China's command-and-control government. The state can tweak policy and macroeconomic levers that virtually change the game overnight—witness Beijing's swift and successful response to the financial crisis. Compared to democratic countries where policymaking can be protracted and messy (just look at America's efforts to revamp the automotive industry), Beijing has a major leg up. They can simply decide what the future will look like, and state-owned enterprises must toe the line.

Already, Chinese leaders have signaled their determination to consolidate the country's chaotic and overcrowded auto sector, and drag it up the value chain. Of 150 entities licensed to produce vehicles, just 20 of them account for 95 percent of the market. Beijing has decided that of these 20, a globally competitive "Top Ten" will emerge (a decree which will inevitably be helped along by the fact that Beijing has less pesky unions and local and regional politicians to deal with). "We even know who eight of those 10 are," says Russo, who cites industry sources saying such numbers are guidelines only.

To speed up the process, Beijing has taken the unusual step of warning Chinese auto firms to focus on getting their own affairs in order before rushing off to buy foreign automotive assets at fire-sale prices. With prestigious names such as Volvo and Hummer on the block, "the world is for sale and looking for Chinese partners," says Eduardo Morcillo, an M&A specialist with InterChina Consulting in Shanghai. But government officials have spread the word that, as tempting as distressed foreign assets might be, they're hard to digest. "Chinese buyers [would] need to learn to deal with different management techniques, labor unions and whole new ways of thinking," warned senior planning official Chen Bin in a widely quoted interview with local media. "That can be difficult." Indeed—when China's biggest carmaker SAIC bought a 49 percent share of South Korea's Ssangyong Motor back in 2004, the venture ended in tears when Korean unions resisted Chinese cost-cutting.

These days, of course, cost-cutting is the mandate in Detroit, Seoul and Shanghai, which is the closest thing to a nerve center that China's far-flung automotive industry has, thanks to SAIC's overshadowing presence. And no one does fiscal prudence better than the Chinese, who have managed to keep growing amid the recession thanks to their $2 trillion in reserves and the ability of their autocratic system to turn on a dime to deal with whatever new economic challenge is presented. Re-creating a cleaner, leaner, meaner Detroit in the Middle Kingdom is a lofty goal indeed, but if anyone can do it, it's the Chinese.

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