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China and Autos
decentralization and competition in an exploding market
Spring 2007, Shanghai
Washington & Lee University Study
Abroad Trip
© Michael Smitka 2007
Two tasks
• Teach you more about China
• Prepare you to ask a real expert good
questions (Alyssa Webb)
(Maybe teach a little economics, too)
© Michael Smitka 2007
Projections, June 2004
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PwC Autofacts
© Michael Smitka 2007
Reality, 2006 surpassed 2011 projections
China Total Market
number of vehicles
7,000,000
6,000,000
5,000,000
4,000,000
Cars
Buses
Heavy Trucks
Light Commercial
3,000,000
2,000,000
1,000,000
0
1997 Smitka
1998
© Michael
2007
1999
2000
2001
2002
2003
2004
2005
2006
US
China
India
Japan
Mexico
Korea
Russia
Germany
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Brazil
France
UK
© Michael Smitka 2007
Italy
Political economy + Industrial Organization
• Early auto industry: ford's position
– Monopoly!
• Then GM, Chrysler
– Oligopoly
• Now Toyota, Honda, Nissan
– And imports, all with multiple models
• Monopolistic competition
– Zero (economic) profits, excess capacity, high
distribution costs (advertising, inventory)
– Choice is costly…
© Michael Smitka 2007
So how about China?
• What do you see on the road in Shanghai?
– When you got into a taxi, what make was it?
• A VW Santana, right?
• So how many car producers under Mao?
– Initial single Soviet plant in Manchuria ca. 1958
• But then decentralization
– Entering modern period =
• 119 firms!
• Each part of a local monopoly
© Michael Smitka 2007
Excess entry
• Initially one Soviet plant in Manchuria
– Based on a Fiat plant
– But also regional military plants from late 1940s
• But extreme decentralization under Mao
– "3rd Front" policy put production in remote areas in
case Russia invaded
• Party rewarded output
– Industry counted (but not quality!)
• services didn't
• agriculture was grain first
© Michael Smitka 2007
All 30-odd provinces had plants
• Trucks of course were primary
– But also cars
– Motorcycles, motorbikes
– Various tractor-like 2-, 3- and 4-wheelers
• How was that possible
– Look at Shanghai's roads:
• VW Santana still large share
– Look at Beijing's roads
• Even though it is the #1 vehicle in China
• You'll see almost no VW Santanas!
© Michael Smitka 2007
Political Success from output
• Not efficiency!
• Local protectionism
– Huge employment levels in the aggregate
• By that measure, China is #1 in world
• Productivity began improving in the 1990s
– But still pressure to buy local
• And military / government demand too
– Plus not (yet) at international efficiency levels
– Big jump since 2000
• Economies of scale -- more later
© Michael Smitka 2007
So how many firms now?
• No good count! But … in all likelihood more!
– So 120+ firms
• Why no exit?
– Growth allows all to survive
• For now…! With help by local governments and banks
– Compare that to the US market entering WWI, smaller than
China's market yet dozens of firms
– Role of suppliers: assemblers, well, assemble!
• And market
• And (sometimes!) design
• Contrary to central government policy!
– Which has long and unsuccessfully pushed consolidation
© Michael Smitka 2007
However…
• A few success stories developing
– VW but lots of Buicks in Shanghai
– Guangdong significantly richer
• Honda and Nissan and now Toyota
– 4 domestics stand out
• Chery, Brilliance, Geely, SAIC
• Three delta regions (my sense)
– Pearl River (south), Yangtze (mid), Yellow (north)
– Sichuan as a potential 4th region
• But everyone else trying, Anhui doing well!
© Michael Smitka 2007
Market structure shifting
• Trucks and luxury vehicles at start
– Chauffeured vehicles
• Now mid-sized a big share, plus minivans etc
(especially corporate use)
• New segment: compacts at $7000-$10,000
– Still a luxury, but lots of rich Chinese
• Sales are now greater so do China's middle/upper class
families outnumber Japan's population!?
• regional producers with small, cheap vehicles
• Also inexpensive
© Michael Smitka 2007
Market remains fragmented
Firms
© Michael Smitka 2007
Projected sales over 100,000
Utility Vehicle
GM
Changan
330,000
325,000
SUV
Great Wall
135,000
Basic
Tianjin FAW
Chery
Honda
GM
140,000
152,000
145,000
144,000
Small
GM
Hyundai
VW
Nissan
BYD
259,000
154,000
150,000
120,000
100,000
Region x segment
• Fragmented market! - only 2 firms have
a double-digit share
• 20 non-Chinese firms
• 29 substantial Chinese firms
• 49 firms total!
– 14 have sales over 100,000 units
– 6 have sales over 250,000
• VW, GM, Honda, Chery, Hyundai, Toyota
– 1 has sales over 500,000: VW
exit, yes, but still new entry
© Michael Smitka 2007
QuickTime™ and a
TIFF (Uncompressed) decompressor
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© Michael Smitka 2007
Some adjustment already
• No longer does everything sell
– Obscene initial monopoly prices gone
– Profit margins were 30%!!
• Now prices down 20% for many models
• VW as representative monopolist
– No new models
– Indifferent quality
– Slow to respond when market changed
• But in general capacity constraints
• Which won't last forever
© Michael Smitka 2007
Sustainable?
• Some exit over time
• Some already … Fiat venture up for sale?
• M&A strategy (maybe) to consolidate regionals?
• 6.15 million units in 2006 and growing
• US at 16-17 million still much larger
• But Germany Japan France all smaller
• Fragmentation!
• New models at roughly 1 per week
– But still less than US with 650 models?
• Yet industry benefits from economies of scale
• So a contradiction?
© Michael Smitka 2007
Many will survive
• Fierce competition, will be surprising
successes
– For now hard to fail, will have many producers
• Compare to Big Six in US, plus Little Six, plus imports
– Some will end up in bad niches / mismanage JVs
• Much will hinge on government policy
– Environment!
– Auto industry an easy political target
everywhere
• Unique strategies echoing 1910s in US
© Michael Smitka 2007
Assembly is not all
• Everwhere…
– Parts employment at least 2x assembly
• Assemblers assemble
– Parts producers make
– Parts producers engineer
– Parts producers enjoy economies of scale
• Outside China, Magna may adopt same
– Looking to buy Chrysler!
© Michael Smitka 2007
Parts production
• Key to the industry
– All the major players are here
• 75 of top 100 global firms
• 1,200 foreign and joint-venture plants total!
– Can have 100% subsidiaries, unlike assembly
– Delphi has 500+ engineers
– More than some car assemblers!
• Experience & capacity growing rapidly
© Michael Smitka 2007
Industrial geography
• Asia needs parts producing capacity
– Duh, Chinese market up 20+% in Q1 of 2007
• India, ASEAN (Assoc Southeast Asian Nations) growing too
• You have to add capacity somewhere!
• Implicit rule of thumb:
• Assemble where you sell, make parts nearby
• But a long transition to accomplish that!
• China not low cost for labor intensive parts!
• Nor is it always low cost against existing plants
– But it beats a new plant in Japan or Korea!
– Not to mention Germany and
© Michael Smitka 2007
Other ancillary industries
• In aggregate 3x manufacturing
– Repairs and service
• A big segment
–
–
–
–
old & poor quality vehicles
Hard use on rough roads
NO info … but maybe you can find some?
Yellow Hat of Japan seeking to enter?
– Dealers
• Largely ignorant about those in China
– But will meet Infiniti people
– Lots of consultants, professional marketing
• Dealerships can be a real estate play, too
© Michael Smitka 2007
Policies
• Lots of imports at different points in time (Kia!),
but now small share of market (250,000)
• Strong pressure for joint ventures
– Constant tensions
• Some Chinese firms have multiple subsidiaries
– More than one foreign partner
– Ambitions to launch vehicles on their own
• Barriers (perceived & real) encouraged entry
Probably too successful for own good
© Michael Smitka 2007
Autos and Energy
• Energy demand rising at +2.3% per year
– Hence doubles in 30 years
– No growth 1996-2000
["rule of 72"]
• Why so low?
– After all, GDP growth is huge!
• 7%-11% implies economy doubles in
– ≈ 10 years at 7%
– < 7 years at 11%
– Old rule of thumb: elasticity ≥1.0
© Michael Smitka 2007
["elasticity"=?]
Nature of energy demand
• Less heavy industry
– New firms use higher quality energy sources
• Less crude sources by households & others
• More urban
– more energy efficient than rural
– But (duh!) more autos
• So weight of petroleum up
– China now a net importer
• 1979 exports ==> big push development strategy failed
• Cf. perestroika in USSR … parallels & contrasts
© Michael Smitka 2007
Why poor link?
• Legacy of planned economy
– Prices are administered
– Starting efficiency levels abysmal
• 80% poor quality coal in 1980
– Still 56%
• Electricity, petroleum
– 13% and 24% respectively
© Michael Smitka 2007
Now transition over?
• Initial economic reforms (as in USSR)
premised on energy exports
– Petroleum and coal
• Former never panned out, now latter nil
• So net importer
– Petroleum up 15% to 20% pa
– Small share of world total at 3.5%
• But with low growth elsewhere, large share of
incremental demand
© Michael Smitka 2007
How will change?
• Better quality coal
– will be source for electricity
• Motor vehicles petroleum for next 2 decades
– Electric vehicles in urban, low-distance areas
• Fits China?!
– Hydrogen a long ways away?
• But no existing gasoline infrastructure so sensible?
• Government policies can push easier than in US / EU
– Hybrids not viable
• Silly to put 2 power plants and battery in a small vehicle
© Michael Smitka 2007
Autos and Pollution
• 16 of world's 20 most polluted cities
– SO2, NO2 , CO, ozone, PM (particulate matter)
• In a short breath, smog
– Est. 590,000 excess deaths a year!
• Tianjin health impact 3.7% GDP (US$1.1bil)
– Even though pollution cut by 10+%
• Source 50-80% from motor vehicles
– Additional congestion time losses
• Only recent switch to unleaded fuel
– Additional hidden costs from brain damage
© Michael Smitka 2007
Energy: sum
• Motor vehicles will account for about
– 60% of demand in 2020
– Improving efficiency even 1% has impact!
– Easy political target
© Michael Smitka 2007
Big push for electric cars
• Good for within-city transport
• Uses night-time generating capacity
– Peak load is daytime
– So electricity providers have huge strategic
& management challenge that this helps
• Technically feasible in short-run
• But government also favors hybrids
– Maybe irrationally so
© Michael Smitka 2007
Is it good policy?
• Maybe … shifts location of emissions away
from urban areas
– Key for smog, as in LA (electric plants downwind in NV)
– Maybe not be lower overall emissions
• depending on details
• Electricity can potentially be cleaner
• May not save energy or cut CO2
• Lots of waste across entire electricity chain
• But electric engines pretty efficient
• Batteries an issue; government can mandate
© Michael Smitka 2007
Political salience
• Consumers "understand" cars
– Not technical electric power grid issues
• Few producers so administratively easy
– Though China stretches the definition of "few"
more than anyone!
• Also licenses etc etc make policy easier to
implement
– Autos are a sexy industry
– Sex is OK in politics
– but fouls up decision making (a polite 4-letter "f" word)
© Michael Smitka 2007
Lessons?
1 of 2
• Legacy of extreme decentralization
– Interesting strategy issues
• Entry game with lots of players
– long-run reality of monopolistic competition
– Until then, really profitable
- for some
• Extreme competition
– Survivors may have unusual skills and strategies
• 35% of GM's advertising is for internet chat rooms
© Michael Smitka 2007
Lessons?
2 of 2
• Political economy
– Auto industry everywhere politicized
– At least in post-WWII era
• Lots of externalities but
• Direct auto policies not always best
– Biggest sector (parts!) escapes attention
• Sheer diversity makes regulation hard
© Michael Smitka 2007
Conclusion
• Transport as a positive externality
– Without transport, markets can't function
– Motor vehicles offer flexibility trains don't
• Without transport, poverty
– Poor rural residents vastly outnumber urban poor
• Transport is ONE element of development
– A necessary (but not sufficient) component
• Assignment
– judge the infrastructure you encounter
• Vehicles (making selling servicing) isn't the issue!
© Michael Smitka 2007
QuickTime™ and a
TIFF (Uncompressed) decompressor
are needed to see this picture.
© Michael Smitka 2007