China's Green Car Sales in 2012

Just a few years ago, pretty much everyone (except Chinese auto industry insiders whom I interviewed) thought China was about to take ownership of the global green car market. (Here's just one example from the excitable Tom Friedman of the New York Times.)

In 2009 China's industrial planners announced plans to have 500,000 green cars ("New Energy Vehicles" or "新能源汽车" -- a combination of electrics and hybrids) on Chinese roads by the end of 2011. That obviously didn't happen, so last year, that same target of 500,000 was pushed out to 2015.

So how did green car sales fare in 2012? Overall, hybrids plus electrics grew a respectable 52 percent.

So while sales grew pretty well in percentage terms, it is clear that overall numbers are still inconsequential when you consider that 19.3 million vehicles were sold in China last year. 

How do these numbers compare to the US?  Green car sales in the US grew 73 percent to over 440,000 in 2012.  (Includes electrics, hybrids and plug-in hybrids.) So China's aim of 500,000 sales may still be a bit ambitious when you consider that not even the world's largest market for green cars has reached that number yet. Nevertheless, just as China has eclipsed the US in overall vehicle sales since 2009, China can probably be expected eventually to eclipse the US in green vehicle sales too.

One thing that we can surmise from these numbers is that China has clearly yet to become the global green car powerhouse it had aspired to become. The reason is simple, and it also explains why China's auto industry -- despite having been relaunched over 30 years ago -- has yet to produce a globally-competitive home-grown brand. (Investigation of this question consumes a major portion of my book, Designated Drivers: How China Plans to Dominate the Global Auto Industry.)

The state-dominated structure of Chinese industry does not provide the proper incentives for innovative leadership. China has private automakers, but they continue to be marginalized in terms of state support and access to funding. The big state-owned enterprises (SOEs) continue to receive every benefit that central and local governments can hand out, yet they are still led by politicians who have no incentive to take risks or invest for the long term.

The green technologies being used in Chinese EVs and hybrids are, for the most part, purchased, licensed or copied from foreign automakers. This is not a recipe for ownership of a global market.


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Green car sales data sources:
2010, 2011, 2012

GM is getting its 1% back, and it won't be cheap

Back in January, GM announced it wanted to buy back the 1% it had sold to its partner, Shanghai Auto (SAIC). In the post I wrote at that time, here was my prediction:

The only way I can see this happening is if GM were to agree to set up the sales organization that SAIC had first proposed, which may be possible now that the US government is no longer a majority owner in GM (though still technically the controlling owner).

As it turns out, this is exactly what is happening.  According to an article (free registration required) from Automotive News China:

Company CEO Dan Akerson told the Journal that the partners plan to split Shanghai GM into two units: sales and operations.

General Motors would have a 50 percent share of the operations unit, which would make product decisions. SAIC would retain a 51 percent share of the sales unit, which would allow the Chinese automaker to book the joint venture's revenue.

The remaining question, which the partners have not yet answered, is what consideration is changing hands. How much is GM paying to SAIC for the 1% of the manufacturing operation?

As for the ongoing implications, GM once again presumably has an equal say in SAIC-GM board meetings.  This is good for GM because they will have leverage in charting the direction of the firm, appointing executives, and planning production.

However, this new sales organization, of which SAIC will now own 51%, will funnel a bit more cash toward SAIC for the foreseeable future.  What's that worth?  According to my very rough, back-of-the-envelope math, possibly as much as $150 million a year in sales -- that's every year in perpetuity.*

If my math is even close to correct -- cut my figure in half and assume $75 million a year in sales -- that will very quickly add up to a lot more than the $85 million or so GM originally got for selling that 1% to SAIC in 2009.

Of course, SAIC and GM could just tell us what this will cost and people like me wouldn't have to do voodoo math. I'm sure GM's shareholders would like to know.

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* My back-of-the-envelope math.  According to the WSJ, GM gets about $30 billion in revenue a year from China.  Last year, SAIC-GM sold 1.2 million vehicles and SAIC-GM-Wuling sold 1.3 million (data here).  Again, very roughly, taking GM's 49% of SAIC-GM and GM's 44% of SAIC-GM-Wuling reveals that about 52% of GM's China revenue came from SAIC-GM.  Even more roughly, 52% of GM's $30 billion is $15.6 billion and 1% of that is $156 million.

Is GM handing China another win?

General Motors announced today that it has signed a memorandum of understanding with the China Automotive Technology and Research Center (CATARC) in which CATARC will reportedly...

...manage GM’s fleet of demonstration Volts and will assist GM China in meeting certain objectives.

These [objectives] will include gaining the support of key decision makers crafting vehicle electrification policy in China.

Who is CATARC?  From their English website:

China Automotive Technology and Research Center (CATARC) was established in 1985 response to the need of the state for the management of auto industry and upon the approval of the China National Science and Technology Commission. It is now affiliated to SASAC.

As a technical administration body in the auto industry and a technical support organization to the governmental authorities, CATARC assists the government in such activities as auto standard and technical regulation formulating, product certification testing, quality system certification, industry planning and policy research, information service and common technology research.

CATARC is "affiliated to SASAC" (State-owned Assets Supervision and Administration Commission) which is essentially the organization that holds the shares of central state-owned enterprises.  CATARC is also a major regulatory organization in that all automobiles need to be tested by CATARC before they may be certified for the road in China.

Since part of GM's purpose is to gain influence over policymakers, this relationship with an organization that is part of the central government cannot hurt.  But there is more to CATARC than meets the eye.

Not only is CATARC an auto industry regulator that is essentially owned by the central government, but it is also a competitor of GM's through its ownership in the Tianjin Qingyuan Electric Vehicle Company (Qingyuan).  According to Qingyuan's website, the company both develops and produces clean energy vehicles and components, which sounds remarkably like something that GM does.

Qingyuan's "principal shareholder" is CATARC, and another of Qingyuan's shareholders is the Tianjin Lishen Battery Company, a producer of lithium-ion batteries for electric vehicles, which is, of course a competitor of LG Chem, the manufacturer of the battery in the Chevrolet Volt.  (Lishen, incidentally, makes the li-ion battery for the Coda electric car.)

So what does all of this mean?  Am I saying that GM has handed its intellectual property over to CATARC so they may copy at will?  Not exactly.  CATARC, after all, also has a reputation to protect, so I am doubtful that they would so blatantly copy GM's Volt technology.  But how certain can GM be that its technology will not find its way, through CATARC, into the hands of Qingyuan, or Lishen, or any of the dozens of Chinese automakers who bring their cars to CATARC for testing?

GM is no stranger to having its IP copied in China.  Back in 2003, GM discovered that Chery had somehow obtained the plans to the Chevrolet Spark, and used them to develop the QQ which Chery got to market several months ahead of the Spark.  And when GM went to its partner, Shanghai Auto, to complain about this miscreant that had been copying its technology, only then did GM learn that Shanghai Auto was also a part owner of Chery.  (Long story short, GM sued, then settled out of court with Chery, which admitted no wrongdoing, and Shanghai Auto got rid of its shares in Chery.)

In all honesty, I find it hard to blame Chinese automakers for copying foreign technology and designs.  After all, this is what all developing countries do when they are trying to catch up.  All developed countries -- including the US -- at one time or another, copied other countries' technologies with reckless abandon.

I do, however, blame foreign automakers (and manufacturers in pretty much any industry) for sometimes naively risking their shareholders' valuable IP for a share of the Chinese market.  The goal of the Chinese automakers is to win -- as it should be.  But foreign automakers need to understand that the ultimate goal of China's automakers is to no longer need them.  When Chinese partners say their aim is for a "win-win," this means they get to win twice.*

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* I don't know for certain whether I was the first person to say this about the concept of "win-win", but I had not heard it before I tweeted it from my hotel room in Shanghai in January of 2010 (as documented by @rudenoon on his blog).  :)

Time for a Shakeout in China's Auto Industry?

Yesterday China Bureau Chief of Automotive News, Yang Jian posted an interesting article (free registration reqd.) speculating as to possible consequences of a recent slowdown in auto sales in China.  In the first two months of 2012, auto sales decreased four percent, year-on-year – and this comes on the heels of (for China) a rather anemic 2011 in which sales only grew about 2.5% and Chinese-branded passenger vehicles gave up nearly two percentage points in market share to the foreign brands.

In short, Yang Jian's point is that, should this drop in sales become a trend that lasts through 2012, some of the weaker players in China's auto industry could be forced into bankruptcy or possibly out of business altogether.

From the perspective of China's central government, which has been begging and pleading for this heavily fragmented industry to consolidate itself for nearly three decades, this wouldn't be such a bad thing.  (Of course it would be a bad thing for the employees of those companies that went out of business.)  There are still well over 100 vehicle manufacturers operating in China (compared to only 24 in the United States), and this fragmentation prevents the industry as a whole from becoming more competitive vis-à-vis the foreign automakers.

So what is the likelihood that a decline in sales could lead to a shakeout of the weaker players?  Well, let's take a look at what happened the last time China's auto industry experienced a slowdown in sales growth.  After enjoying annual sales growth of anywhere between 14% and 37% since 2001, the onset of the Great Recession in 2008 caused China's growth rate to drop to a horrifyingly low 7%.  (Yes, the word “horrifyingly” should be interpreted sarcastically.)

I remember talking to a lot of auto industry insiders in China in the spring of 2009 when some of them lamented the fact that the much hoped-for shakeout didn't happen back then.  (And it seems like Yang Jian himself may have been among those who expressed such sentiment to me then.)

Why didn't the shakeout happen?  

The central government rode to the rescue with a far-reaching stimulus program that not only prevented another year of miserably low sales growth, but that, for the first time ever, launched China into position as the world's single largest market for automobiles in 2009.  Hence the lamentations from some of my interviewees at the time.  As Yang Jian hopes today, many of them also hoped soft sales growth would kill off some of the weaker players in 2009.

So will the central government ride to the rescue again this year? 

I think it is less likely.  With large cities in China already limiting the number of cars that can be sold and driven on their streets, and with the central government clamping down on overcapacity in the industry, AND now that China is already the number one auto market in the world (they can't go any higher), a rescue is probably not in the cards.

Does that mean a shakeout will occur? 

I wouldn't bet on that either.  Among the top-10 automakers, Chang'an, Chery and BYD each experienced sales declines in 2011, which doesn't look good for them.  Except that Chang'an is among China's “Big 4” and Chery is among China's “Small 4.”  What this means is that the central government has designated these automakers to be among those remaining after the industry consolidates.  And BYD is privately-owned (its shares are traded in Hong Kong), and, though it hasn't sold as many EVs and hybrids as it had hoped to by now, it is probably China's best chance of having an automaker who can compete in this space.

Will a shakeout then occur among the dozens of tiny, inefficient and unprofitable automakers scattered around the country? 

I think this is the best hope, but whether the downturn will be deep enough and long enough to outlast local governments' ability to prop up these firms remains to be seen.  Local governments tend to be rather fond of their automakers -- even the ones that lose money.

Book Talk at USC

Several weeks ago I gave a talk related to my forthcoming book at the University of Southern California.  Watch as I attempt to summarize four years of research and a 300-page book in less than an hour.  :)

Volvo is Geely, and Geely is Volvo

It was only a matter of time.

The privately-held Chinese automaker Geely has announced that it will be forming a joint venture with its subsidiary Volvo.  As you may remember, Geely’s owner, Li Shufu conducted a high-profile purchase of the Swedish automaker Volvo from Ford in 2010.

The concern at the time had been that Geely simply wanted to strip away Volvo’s intellectual property for itself, but Li Shufu assured observers that the two entities would remain separate: “Volvo is Volvo, and Geely is Geely.”  And indeed, the purchase was structured so that both the Hong Kong-listed Geely Motors and Volvo are both subsidiaries of a holding company controlled by Li Shufu.  (In other words, Geely doesn’t own Volvo, technically, Li Shufu does.)

So why is Geely now forming a JV with Volvo?  Because it has to in order to build cars in China.  China’s rules require that any “foreign” automaker that wants to assemble cars in China may only do so through a joint venture with a Chinese automaker, and the foreign entity may hold no more than 50 percent of the JV.  Since Volvo is still headquartered in Sweden, it is considered foreign.

The icing on the cake for China here is that, like all other foreign automakers who have sought permission from Beijing for expansion or establishment of a new venture anytime during the past two years, Volvo is also being required to “assist” Geely in building a Chinese-branded car.

Until now, this has only applied to state-owned enterprises because only state-owned enterprises had joint ventures with foreign automakers (with the exception of a small JV between BYD and Daimler to develop electric vehicles).  The assumption had been that the SOEs, which had been dragging their feet in terms of developing their own brands, would be “given” slightly out-of-date technology by their foreign partners.  They would then produce cars under a Chinese brand name using the foreign technology and designs.  (I have previously written about this phenomenon, which I refer to as "sub-brands" or “JV Brands.”)

What is interesting here is that Geely, unlike the SOEs cannot be accused of “dragging its feet” in developing Chinese brands.  Indeed, Chinese brands are all Geely has ever made!

So what does this mean for Volvo?  What it means is that Volvo will simply be handing over technology onto which will be slapped a Geely-owned Chinese brand name.

Perhaps Li Shufu would now like to change his quote to, “Volvo is Geely, and Geely is Volvo.”

GM's Kevin Wale on Innovation in China

The consulting firm McKinsey published on its website an interview with Kevin Wale, president and managing director of General Motors China.  The whole interview is worth a read if you are interested in the state of innovation in China, but here are a few of the more revealing excerpts with a little of my own commentary.

Kevin Wale: When the Chinese get an idea, they test it in the marketplace. They’re happy to do three to four rounds of commercialization to get an idea right, whereas in the West companies spend the same amount of time on research, testing, and validation before trying to take products to market.

This is both scary and admirable.  Scary, because the Chinese are, at least according to Mr Wale, willing to put products into the market before they are fully tested as a means of development.  When you think about it, this is pretty much what Apple does with its products.  The first iPhone wasn't fully ready, but it was ready enough.  Feedback from customers helped them to improve on subsequent iterations.

What's scary about this is that driving a car that has been put into the market on an experimental basis doesn't sound like something I would want to do.  If my iPhone blows up, I would probably survive.  I'm not sure I could survive my car blowing up.  While I would hope that GM is able to prevent its partner, Shanghai Auto, from putting dangerous vehicles on the market, I wonder whether other Chinese auto companies are quite as careful.

The Buick LaCrosse, partially designed in Shanghai

The Chinese system supports the idea that it’s OK to fail if you fail in a government-sponsored direction. It’s OK to make mistakes as long as you’re moving forward. They’re quite OK to get out there, do something, find out it’s not perfect, but quickly adapt it and move forward. There’s no recrimination internally for doing that if that’s the direction the country wants to move in.

It's a great thing that people feel comfortable to experiment within the boundaries set by the state, but the opposite of Mr. Wale's statement is that they do not feel comfortable experimenting outside the boundaries set by the state.  But what if a worker has an idea that's not in “the direction the country wants to move in.”?  Too bad.

This, in my view, is precisely why China will always be a step behind.  Governments have historically been quite bad at charting an unknown course in terms of picking winners and losers.  In China, true technical innovation will always have to come from outside until people feel free to make mistakes in all areas of business, not just those approved by the geniuses in Beijing.

McKinsey Quarterly: Do you source innovation from outside GM China?  Kevin Wale: The answer depends on whether you’re talking about joint ventures or GM. In our joint ventures, we’re happy to take innovation from suppliers any day of the week.

This is more interesting for what Mr Wale doesn't say.  When asked whether GM gets innovation from outside, Mr. Wale assumes the question is about whether GM sources innovation from its joint ventures in China.  From his answer, it seems pretty clear that they don't.

Let's be honest here, the technology is still only flowing in one direction, and that's from GM to its Chinese partners.  At what point will GM's partner have enough technology that it doesn't need GM anymore?

Chinese-branded cars lost market share in 2011

In early 2009 China's government released a fairly comprehensive policy for the auto industry called the "Automobile Industry Adjustment and Stimulus Plan (汽车产业调整和振兴规划)." 

Among the major targets included in this plan was for an increase in market share of China's home-grown auto brands (also known as 自主品牌). One of the targets was for Chinese-branded  passenger cars (轿车, aka, sedans) to increase domestic market share to 30 percent in three years' time (by the end of 2011).  (Up from about 26 percent at the end of 2008.)

China's auto industry enjoyed robust sales growth of 48 percent in that very year, giving the Chinese brands a 29.7 percent market share by the end of 2009.  And just in case the leaders weren't satisfied with rounding up to 30, Chinese brands achieved a 30.9 percent market share by the end of 2010.

Unfortunately, the tide turned against manufacturers of Chinese-branded cars in 2011, causing them to lose market share for the first time. Though the absolute number of Chinese-branded cars sold increased, foreign-branded car sales grew at a faster rate, dropping the domestic brands to a 29.1 percent market share -- just in time to miss the target that had been set out for them three years earlier.

And this came in a year during which luxury automakers enjoyed enviable sales growth in China: Audi-37%, BMW-37%, JaguarLandRover 61%, Cadillac-73%.

Why did Chinese cars suddenly lose market share to the foreign brands?

Did quality decline? Not at all!  In fact, Chinese brands have been closing the quality perception gap with the foreign automakers.

What happened was that another provision in the "Adjustment and Stimulus Plan" of 2009 distorted sales growth in 2009 and 2010.  The plan included a 50 percent cut in auto sales taxes for vehicles with engine sizes of 1.6 liters or less -- in other words, small cars.

The stimulus really worked! In 2009 sales of cars in the 1.6 liter and below segment grew 71 percent while sales in all other passenger car segments grew by "only" 23 percent. And the beauty of this stimulus plan was that, at the time of its introduction, fully 85 percent of the market for 1.6 liter and under cars was occupied by Chinese brands.  This was none other than a plan to stimulate sales of Chinese brands.

The stimulus also worked in 2010, but it was later halved to only a 25 percent sales tax cut, and then, by the end of 2010, the stimulus was lifted completely -- resulting in disappointing performance in 2011.

Of course, we can't blame it all on lifting of the stimulus because, once the stimulus was enacted in 2009, foreign automakers scrambled to enter the 1.6 liter and below segment as quickly as possible.

Still, this does illustrate well the distorting effects of government schemes on markets. And it is somewhat ironic that the same plan that brought such growth in 2009, took it away once the stimulus provision was allowed to expire.

GM Wants its 1% back. Good luck.

GM announced yesterday (again) that it wants to repurchase a one percent stake in its joint venture with Shanghai Auto (SAIC) that it sold for a handful of magic beans a few years ago.

Back in December of 2009, GM and SAIC announced a major change to their partnership which involved GM selling one percent of the SAIC-GM joint venture (JV) to SAIC for $85 million.  This announcement also included details on a new Hong Kong-registered joint venture through which GM and SAIC would partner to conduct business in other countries, primarily India.

The net result was that GM and SAIC were no longer 50:50 owners in the main China JV.  With the one percent transfer, SAIC became the majority owner with a 51 percent stake.  On paper at least, GM had been reduced to the role of junior partner.

At the time, GM management explained that the purpose of the one percent transfer was in consideration of some future help from SAIC.  And though it wasn't explicitly stated, GM statements sort of hinted that SAIC's help may come in the form of help with future funding.

Early speculation was that GM needed the money.  And since GM had emerged from bankruptcy only a few months earlier, that seemed to make sense, except that, in the whole scheme of things, $85 million didn't really seem like a lot of money.  At year-end 2009, the company had over $14 billion in cash on its balance sheet, so it wasn't cash poor.  And with a current ratio (current assets/current liabilities) of 1.13, it wasn't facing an impending liquidity crisis.

Since I happened to be in Shanghai only a few weeks after this announcement was made, and since I was fortunate enough to land an interview with a senior SAIC executive who was integral to the negotiations with GM, I asked the SAIC executive to explain why GM would give up any leverage it had over the JV for a measly $85 million.  His explanation made a little more sense.

In short, SAIC wanted to be able to consolidate the top-line revenues of the JV into its parent company income statement, and under accounting rules, it could only do this if it owned more than 50 percent of the company.  Chinese companies were (and are) under a great deal of pressure from Beijing to move up in the rankings of the Global Fortune 500, and since the Fortune list looks at sales, not profits, SAIC needed to make its sales number bigger.

Does this sound ridiculous?  It did to me too.  But it's also the truth, as this particular executive, on two different occasions, emphasized to me the importance of moving up the list of the Fortune 500.

So what did GM get for handing over control?  According to the SAIC executive, GM wanted desperately to continue expanding its global footprint, but was facing two hurdles.  First, as GM had recently exited bankruptcy, the terms it could receive on bank lending were highly unfavorable.  Second, still being majority owned by the taxpayers of the US, GM was restricted in its ability to fund any activity that didn't somehow create American jobs or shore up the US-side of its business.

And this is where SAIC came in.  Through this partnership, SAIC, with its stellar credit rating, not to mention being a major state-owned corporation with access to favorable loan terms from both state-owned mainland banks as well as Hong Kong banks, would be able to help GM out with its funding needs overseas.

The SAIC executive did suggest that GM and SAIC could have entered into an agreement whereby the two companies would create an entirely separate sales JV to which all vehicles manufactured would be sold.  Then SAIC would own 51 percent of the sales JV, also allowing it to consolidate revenue into the parent company's income statement.  (SAIC and its other major partner, Volkswagen have a similar arrangement.)

However, this particular arrangement didn't work for GM either as, once again, GM's government minders in Washington were not interested in entering into any arrangements that didn't serve the interests of the US.

Fast-forward a couple of years, and now GM wants its one percent back.  The only way I can see this happening is if GM were to agree to set up the sales organization that SAIC had first proposed, which may be possible now that the US government is no longer a majority owner in GM (though still technically the controlling owner).

Of course, since the time of that transaction, GM has been very vocal about the importance of the China market to the company's future.  In fact, GM now sells more vehicles in China than in the US (2.6 million vehicles in China vs 2.5 million in US in 2011.)

One wonders how eager SAIC will be to give up the majority control it has enjoyed for more than two years.  Furthermore, given the importance of its China JV, GM can probably expect to pay considerably more than $85 million for the return of its one percent.

End of the Road for Foreign Automakers in China?

Last week a story emerged that China's industrial planner, the National Development and Reform Commission (NDRC), has announced that it will stop supporting foreign investment in its auto industry. (News stories may be found here, here and here.)


This bit from a China Daily article explains a little about why these restrictions were being put in place:

China...has removed industries from the list of those it encourages foreign companies to invest in. No longer part of that group are automakers, large coal-to-chemical operations and manufacturers of polycrystalline silicon.

"The restrictions generally apply to industries that have excessively large capacities and that pollute the environment," said Zhang Xiaoji, senior researcher at State Council's development research center. (emphasis added)

My take on this story is that the NDRC actually has no real intention of restricting foreign investment in its auto industry. To understand why this is so, one needs only a limited understanding of the history of foreign involvement in China's auto sector, which I lay out in an op-ed in today's Asian Wall Street Journal.

In short, I make the claim that:

... the NDRC's announcement is more about improving Chinese leverage in negotiations with foreign automakers so Chinese automakers can more quickly overcome their innovation deficit.

For the rest of the op-ed at the WSJ site, click here.

And for all of the stories behind the main story of business-government relations in China's auto sector, my book, Designated Drivers: How China Plans to Dominate the Global Auto Industry, will be published by Wiley and Sons this year.

Coming to a bookstore, mailbox or e-reader near you in Spring 2012. Stay tuned!

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EDIT:
I was just notified that my article was also picked up by WSJ's US op-ed page. It will run in Thursday's edition. (January 5)

Hold on to your lugnuts! It's time for a Trade War!

The Wall Street Journal is reporting today that China is preparing to levy duties on certain autos imported from the US. This would be on top of the 25 percent duties that China is still allowed to levy under its WTO commitments.

China's Ministry of Commerce said in a statement late Wednesday that it will levy antidumping and antisubsidy duties on imports from the U.S. of some vehicles with engine capacities above 2.5 liters beginning on Thursday and lasting through the next two years. ...

The ministry said several U.S. companies, including General Motors Co., Chrysler Group LLC and the U.S. arm of Honda Motor Co., engage in dumping and subsidizing. The statement said the move would also affect cars made by the U.S. arms of Mercedes-Benz and BMW AG, though it said their level of dumping was smaller.

Note that China's Commerce Ministry singled out not only the traditional US automakers GM and Chrysler, but also the US arms of Honda, Mercedes and BMW.

While China could have plausibly argued that GM and Chrysler benefit from government subsidies due to the bailouts these two companies received, they instead chose to make this about all cars with engines larger than 2.5 liters made in the US (but not in Japan or Germany!).

Does anyone think the US Congress will choose to view this as any less than an attack on the livelihoods of American workers -- and in an election year no less? Of course, Congress cannot portray themselves as innocents in all of this as Congress has already singled out China's solar panel industry for US-imposed tariffs. Then again, Congress can point to China's currency...

And on and on it goes. One thing I learned in grad school about wars (the kind in which people shoot at each other) is that it is nearly impossible to identify who started it. No matter which incident one side points to, the other side can go further back in history to identify another.

If we look at this incident only with regard to China's auto industry, it is also easy to see a kind of pattern here. Back in 2009, when China launched the stimulus heard round the world, they chose to subsidize consumer purchases of vehicles with engines smaller than 1.6 liters.

Why 1.6 liters? Because the foreign automakers that were dominating China's auto market had very little to offer in the small car segment. That subsidy was intended to boost sales of Chinese-branded cars.

Of course, the foreign automakers didn't stand still. Many of them already had small cars in the pipeline, so they got them to market faster -- just in time for China to cancel the subsidy toward the end of 2010.

Why are the import duties now focused on 2.5 liters? Because this is an area in which the foreign automakers pretty much own the market. This effort to make these imports more expensive may ideally (from China's point-of-view) accomplish two things: 1) make Chinese consumers more likely to consider a less expensive Chinese-branded car, and 2) make foreign automakers consider moving more assembly of their larger models to China.

In reality China's new tariff may not accomplish either purpose. For one, the Chinese consumers who are more interested in these larger cars (as the WSJ article points out) are less price sensitive anyway. They are already interested in these large foreign brands because they perceive them to have higher quality. In addition, because the volume of these larger cars in China is still comparatively small, it is highly doubtful that much, if any, of their production would be moved to China. (Perhaps that second one is a straw man argument.)

So what does China really stand to gain? Not much, really. In the end, China will get the trade war that it has been warning us about for years, and its home-grown automakers will still face a quality gap with their foreign partners/competitors.

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In case you're wondering where the picture at the top came from:

A legitimate beef with China

A leader in this week's Economist, concerning the US Senate's passage of a bill intended to punish China for currency manipulation, warns that, however right the Senate may be about currency manipulation, passage of the bill would risk an unnecessary trade war.

The Economist goes on to say that America does have "legitimate beefs with China, but this bill is the wrong way to address them. It is legally flawed, economically dangerous and unnecessary." If passed, China would surely have a legitimate claim against the US through the WTO, and would almost certainly retaliate with its own trade-limiting measures.

While I understand the value of this measure as a political tactic for Senators who are part of the most hated US Congress in history, the fact is that there are better ways for America to get what it wants (not that Congress even cares).

While the WTO mechanisms designed to facilitate open trade are slow to work, China recognizes them as legitimate and has generally adhered to their judgments in the past. Although, as The Economist admits, currency manipulation is not addressed in WTO rules, America indeed has "legitimate beefs" with China that could be addressed under the WTO. Yet, for some reason, the US Congress chooses to focus on currency, and the Obama administration apparently chooses to look the other way when it comes to some of China's real WTO violations.

While I haven't cataloged all of China's violations, I know that there are several going on in the auto industry that no one seems to think are worth calling China on. For example, a couple of key measures in China's WTO accession agreement forbid China from conditioning investment in China on technology transfer and local content requirement. (This agreement dates back to 2001, by the way, so it's nothing new.)

As for the tech transfer part of the rules, China's ability to apply pressure to foreign automakers to transfer technology in exchange for permission to expand in the country has been well-documented. (A couple of example articles are here and here.)

The latest attempt by the Chinese to adhere to the letter of the law while blatantly violating its spirit includes holding off on investment approval until the foreign company "voluntarily" offers to contribute technology toward establishing a Chinese brand with its (state-owned) Chinese partner. Peugeot's CEO was quoted by the Financial Times as saying that, cooperating on building a Chinese brand is now "part of the deal."

And the automakers involved in this attempted extortion have no incentive to complain about it for fear of losing their access, all the while knowing that their competitors are all doing the same thing.

Okay, you may say, perhaps China's violations in this case would be too difficult to prove under the WTO's mechanisms. After all, the foreign automakers all appear to be "voluntarily" contributing technology in these cases, and anyway, none of them is complaining. Perhaps.

Then how about a more obvious violation of the rules? In this case, it involves the imposition of illegal local content requirements.

This actually surfaced a few weeks ago, and I commented about it on twitter, but only my friend @alexwoods5 seemed to think it was an issue worth being concerned about. The issue in question arose from a recent Wikileaks cable in which an employee of Ford in China revealed to US diplomatic personnel that Ford's operation in China is subject to a 40 percent local content requirement. This is the relevant section:

¶9. (SBU) All of Ford's parts suppliers must meet the Chinese Government's rules of minimum 40 percent local content by value, Chuang explained.

Does that not sound like a local content requirement? Could this have been a condition for Ford's recent investment in new factories in China?

I even emailed an acquaintance of mine at Ford, twice, seeking some sort of explanation or confirmation. The fact that he has yet even to respond with a "no comment" tells me that this may be worth investigating.

But is the Obama administration investigating it? If not, why not?

I know that the administration, or at least certain individuals in it, understand that the currency bill passed by the Senate would do great harm to both global trade and to America's relationship with China. But if they want to avoid such unpleasantness, why not at least make an effort to make China follow the agreements it has signed?

Who cares about IPR, what about innovation in China?

The Wall Street Journal reports on a brief debate that took place yesterday between US Ambassador to China, Gary Locke and an advisor to the People's Bank of China, Li Daokui. The exchange took place during a panel discussion at the World Economic Forum meeting currently taking place in Dalian, China.



The apparently civil discussion surrounded a disagreement as to the repercussions of China's difficulties in enforcing intellectual property rights (IPR) protections. In short, Locke expressed his view that lack of IPR enforcement would stifle Chinese innovation. Li, on the other hand, merely expressed his disagreement and noted that China's policy focus instead needed to be on supporting entrepreneurs and removing barriers to their success. (Notice how Li cleverly took Locke's cue and changed the topic from IPR to innovation?)

So who is right about innovation? Where should China focus its policy in order to better support innovation? Should it beef up IPR enforcement, or should it focus on removing barriers to the private sector? Which would give it the biggest bang for its policy buck? (Not that this is necessarily an either/or proposition -- China is big and rich enough now to do both -- but humor me on this.)

Some of my readers may be surprised to learn that I think Li Daokui was right. While Locke was certainly carrying out his duty as Ambassador by saying that China needs to improve IPR protection, the truth is that IPR protection has very little to do with innovation in a developing country like China. In fact, history tells us that, since the dawn of the Industrial Revolution, every subsequent country to jump on the development bandwagon has copied those who came before.

...every country that became economically great began by copying: the Germans copied the British; the Americans copied the British and the Germans, and the Japanese copied everybody.*

This is not to excuse the Chinese companies that blatantly copy foreign products and the government that often chooses to look the other way, but since Locke chose to introduce innovation into the discussion, the issue deserves a closer look.

My research on China's auto industry reveals that the most innovative among China's automakers are the private and independent automakers, not the massive state-owned enterprises (SOEs) with their foreign joint venture partners. While private players have yet to introduce any real breakthrough innovation, their progress in developing new energy vehicles and unique Chinese brands is ahead of the SOEs. The reason for this (and you'll have to take my word for it until my book comes out) is twofold.

First, leadership positions in SOEs are essentially political positions. The men who run these companies have their eyes on their next job, which will be a political appointment to run an association or a local government, or even to become a Vice Minister or Minister in the central government. In order to better assure themselves of a good position, they tend to be risk-averse in their decision making.

Second, because these guys have short-term investment horizons, "wasting" money on R&D is not high on their agendas. R&D spending only helps the next guy. It is much easier to rake in profits building and selling foreign branded cars. They simply lack the career incentives to take the kind of risks that result in significant innovation.

(Here is another story today about how "JV brands" have not resulted in the innovation that the central government had been hoping for. Why? Again, forcing foreign partners to hand over technology does not translate into innovation, especially when leadership incentives are not changed. I previously wrote about this "JV brands" or "sub brands" issue several months back.)

So while Li Daokui seemed to be changing the subject above, he was actually addressing Locke's point about innovation. And if China's auto industry is any kind of indication for China as a whole, the central government would do well to follow Li's advice and remove the barriers that continue to marginalize private business in China.

Of course, as an American, I would like to see the home team do well, so if China continues to insist on a preponderance of state control over all of its major industries, I believe that will ultimately be to the advantage of China's competitors. And they need every advantage they can get.

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* William Kingston, “An Agenda for Radical Intellectual Property Reform,” in International Public Goods and Transfer of Technology Under a Globalized Intellectual Property Regime, ed. Keith E. Maskus and Jerome H. Reichman (New York: Cambridge University Press, 2005), 658.

American Wheels, Chinese Roads: a review

For several months I have been eagerly awaiting the arrival of Michael J. Dunne's new book, American Wheels, Chinese Roads: The Story of General Motors in China (Singapore: John Wiley & Sons Asia, 2011).


If you have read any news stories covering China's auto industry over the past decade, you have almost certainly read quotes from Mike Dunne. Until recently he was in charge of J.D. Power's China unit, and now he runs his own consulting company.

There are few people more qualified than Mike Dunne to write about China's auto industry. He grew up in Detroit, worked at GM, and earned his MBA from the University of Michigan. He has also spent over two decades of his life living and working in China.

American Wheels, Chinese Roads is a more-or-less chronological telling of the experience of General Motors in China, but at appropriate points, Dunne interjects relevant stories about other auto companies and their experiences in China. And it is a pretty quick read because the story is so entertainingly told.

The stories are all fascinating because many reveal lessons that GM learned along the way and often contain fly-on-the-wall details about negotiations between Chinese and foreign automakers. Dunne makes these stories even more interesting (and demonstrates his China credentials) by weaving in little Chinese language lessons and references to Chinese philosophers and historical figures. He doesn't just lay the lessons on us; he often delves deeper into why things are the way they are in China.

At a few points, GM is portrayed almost as a naive victim, caught off guard by the machinations of the government or GM's competitors. For example, when GM inked its deal with Shanghai Auto (SAIC), it was promised a monopoly in the luxury vehicle segment only to be surprised a few months later that Shanghai Auto's other partner, Volkswagen was being allowed to introduce a competing vehicle.

Dunne also retells the story about how Chery Auto managed to beat GM to market with the QQ, a copy of the Chevrolet Spark, adding new details that I had not seen elsewhere.

GM's curious sale of one percent of its joint venture to Shanghai Auto in 2009 is also covered here, though little is said about the possible motivation of SAIC. (But you will be able to find SAIC's side of the story in my forthcoming book on China's auto industry.)

In the penultimate chapter, Dunne sums up the experiences, not only of GM, but most foreign companies attempting to succeed in China:

While placing their bets, companies must never forget that to be dealt a hand in the game of electric cars -- or almost any business in China -- you will need to get approval for a license.

And get a partner.

Once those are secured, you will begin to compete with both the house and the player. The ones making the rules are also playing the game -- and they're determined to triumph.

This nicely sums up much of my own research on China's auto industry. Getting into China is hard, and once there, you will only be there as long as the Chinese find you useful.

In terms of the details, I was very pleased to find that Dunne's take on China's auto industry largely agrees with my own -- not that it has to, but having spent several years researching this industry in which Dunne is an expert, I am happy to note that my own research was not off-base. This is not always the case when two writers tackle the same topic in relation to China: it often depends on which part of the elephant one is touching.

As enjoyable as this book was to read (it is truly a page-turner!), as a researcher, I often wished to see footnotes to support certain quotes, figures or other claims. For some reason, the non-academic world has an aversion to footnotes. From the point-of-view of a researcher, footnotes make a particular work more attractive as a documentary source, and ensures that the book is cited more frequently. More citations will very likely translate into more sales. (And if you're the kind of reader who hates footnotes, you may also be happy that the book comes in a Kindle edition.)

My sense in this case is that many of the quotes come from Dunne's first-hand experience, although I would not have minded his saying so in the text. There seems to be a trend toward increasing acceptable use of the first person in non-fiction nowadays, a trend that I fully support: if you did the work, conducted the interview, etc., I think you should feel free to say so.

But this minimal criticism only reflects my personal preference, and in no way does it detract from this book as both an entertaining work of non-fiction and a source of wise advice on the pleasures and pitfalls of doing business in China.

In the conclusion, Dunne leaves no doubt as to where he stands in his own assessment of the business environment for foreigners in China. His parting shot takes the form of a fictitious memo from a foreign auto executive in China to the US Auto Task Force. His final recommendations aren't delivered in anger; they are a matter-of-fact assessment of a playing field on which foreign businesses have been forced to face down the entire Chinese government all on their own for far too long.

Finally, some good news for BYD

Last October I wrote about a situation in which BYD, the private automaker from Shenzhen, was punished for attempting to build a factory on farmland near Xi'an.

In short, BYD was fined about $435K and had seven buildings, on which it had already begun construction, confiscated and ordered destroyed. In addition 14 local officials in Shaanxi province were also punished for violating rules forbidding the use of arable land for non-farming purposes. Ouch. And this came in a tough year for BYD whose sales only grew 16 percent in 2010 (compared to China's auto industry as a whole which enjoyed 32 percent growth).

The story surfaced a few days ago that BYD was preparing to restart construction in Xi'an. According to an earlier story in the Economic Observer, the land has been "legalized" (合法化) and rezoned as industrial land. BYD was allowed to bid for the land in a public auction, and -- surprise! -- BYD won the auction. (There was no word on whether anyone else bid for the land.)

Even though BYD didn't get all of the land it had secured before, it still got most of the land, and, most conveniently, it got the part of the land on which its unfinished construction already stood. Back in October, the announcement from the Ministry of Land and Resources said BYD's buildings would have to be destroyed, but, fortunately for BYD, no one had got around to destroying them yet.

This strikes me as quite a miraculous turnabout for BYD. The problem that led to BYD's punishment was (and is) that China, despite being a huge country, has precious little of the arable land it needs to feed 1.3 billion people. The central government has recently become quite serious about preserving arable land.

But not that serious apparently.

In the months following BYD's punishment last October, Local officials in Xi'an had begun to complain that they had been deprived of a major source of local income -- sales of land use rights. The Economic Observer quoted a local official as saying that Shaanxi's annual demand for industrial land is running at about 400,000 mu (67,000 acres) per year, but they are only able to supply about 150,000 mu.

I was initially happy to see the central government finally taking a stand last fall by supporting their own laws forbidding illegal use of arable land. For once, it wasn't just about the money. At the time, I took this as a positive sign that rule-of-law was actually starting to mean something in China.

It's amazing to me how a scarce resource such as arable land could have been so quickly and easily "rezoned" as industrial. Apparently it really was about the money.

Creating 'Chinese' brands now 'part of the deal' for foreign automakers

Last December I wrote about a trend among Chinese-foreign automotive joint ventures in which the foreign partner gives technology to the JV to sell under a Chinese brand. Some of the English language China auto blogs refer to these as "sub-brands."

For example, Honda contributed the design of an outdated City vehicle it no longer makes to its JV with Guangzhou Auto. The JV now sells it under the Chinese brand Linian.

At the time I noticed this trend among several automakers (Guangzhou Honda, Dongfeng Nissan, Shanghai-GM), my assumption was that this was an attempt on the part of the Chinese automakers to wean Chinese consumers away from foreign brands. Chinese consumers still overwhelmingly prefer foreign brands (if they can afford them), because they perceive them to have higher quality.

Now several other foreign automakers including Volkswagen and PSA Peugeot-Citroen are discussing similar arrangements with their Chinese partners. PSA Peugeot-Citroen's CEO told the Financial Times that helping their partner to develop a local brand is now "part of the deal".

Last December I speculated that this may have been under central government coordination, but I had no evidence of that. Today, evidence seems to have surfaced in this report from the Financial Times.

The story quotes Mike Dunne, formerly of JD Power in China, who now has his own consulting company:

Nothing is written down, but when automakers go to apply for capacity expansion, in their application it’s clear that they should have a plan for an indigenous brand with jointly owned product rights and some provision for new energy vehicles. Foreigners want more capacity; China is saying: ‘We want more own brands’.

Back in 2001, when China joined the WTO, they gave up the right to demand technology transfer as a condition for approval of foreign investment. Of course, this new rule did nothing to change China's appetite for foreign technology.

The new demand, rather than for "technology transfer", appears to be: if you want to expand capacity, then X% needs to be devoted to Chinese-branded cars.

The foreign automakers now have a choice. They can pour precious R&D money into joint development of cars that compete directly with their own, or they can just hand over technology they already have.

The technology the foreigners are now handing over may be slightly outdated, so the foreigners aren't being forced to hand over their latest and greatest innovations. But again, it seems to me that these foreign-designed, Chinese-branded cars that the central government is now forcing the JVs to sell will fill the perceived quality gap between Chinese- and foreign-branded cars.

China's central government fully intends that its largest state-owned automakers will be global contenders, and they are patiently finding ways to make that happen. The WTO will not stand in the way. Wherever there's a rule, there's a way around it.

How fragmented is China's auto industry?

For anyone wondering where I've been for the past several months, I've been right here at my desk. But instead of posting to this blog, I've been in a push to complete a full first draft of my dissertation by the end of March -- which is beginning to look like a real possibility.

For now, here's a quick post of some numbers I've been looking at for the past few days on market shares in China's auto industry.

Probably the most consistent component of China's auto policy since the mid-80s has been the insistence of the central government on consolidation in the industry. Just looking at the raw numbers, I think most people would agree that this demand has been completely justified.

In 1978, the year that Deng Xiaoping launched the first experimental market reforms in China, there were 55 auto assemblers. The number peaked at 124 in the mid-90s, and by 2008 (the latest numbers available) there were still 117 -- clearly, way too many.

But just how fragmented is China's auto industry? Here is a quick comparison with the US.

This chart compares cumulative 2010 market shares for the top five auto companies in the US and China.








If China were to take the US as its example, then it would seem to have already achieved a fair amount of consolidation. China’s largest auto group has a slightly larger share of its market than does the largest automaker in the U.S., and the top five in both markets are practically even.

Of course, we already know that the US market is somewhat less concentrated than it used to be. In 1980, for example, the Detroit Three held 76 percent of the US market. But I think few people would argue that less concentration in the US market has not been good for consumers.

So while it would appear that China is starting to see some solid growth out of the players at the top of its auto industry, the problem lies with all of those tiny companies at the bottom that, for some reason, refuse to go away.

Who are these small players? Quite a few are small, locally-owned automakers that lack any kind of scale to be profitable. In any given year, they probably break even on a cash flow basis, which means that the local government is absorbing their cost of capital. If exposed to true market competition, these small firms would quickly disappear.

So why haven't they? Local governments don't want them to. They employ anywhere from a few dozen to maybe even a few hundred local people, and local governments are not inclined to create any more of an unemployment problem than they have to.

Of course, the central government, through the NDRC or MIIT, could force these local enterprises to close, but why would they? The central government is no more interested in putting people out of work than are the local governments.

So if we simply accept that some of these small players are part of a welfare system that keeps people gainfully employed, then China's leaders should at least be satisfied that, at the top of its auto industry, it appears to have the makings of an increasingly strong and competitive industry. Right?

I don't think so, and this next chart reveals why.

Here we have the top five companies in both the US and China along with their respective market shares.









What I notice about this chart is that each of the companies on the US side also corresponds with a brand, but each of the companies on the Chinese side is just a big old state-owned enterprise that assembles cars for foreign companies.

SAIC makes most of its money selling VW and GM cars. Dongfeng sells Nissan and Citroen. FAW sells Toyota and VW. Chang'an sells Ford, Mazda and Suzuki. BAIC sells Hyundai and Mercedes.

Yes, each of these companies also sells some cars under its own brand, but the numbers are comparatively small. Overall, only 30.9 percent of sedans sold in China in 2010 were of local brands -- up only slightly from 30 percent in 2009.

And therein lies the problem. China's central government wants its biggest SOEs to get bigger so that they can compete with the foreign multinationals. For now, they would just like to dominate in their own market, but eventually, they want to compete in overseas markets as well.

The problem is that, while these SOEs are indeed developing their own brands, it's just so easy to sit back and rake in profits while the foreigners contribute all of the intellectual property.

Designing your own stuff is hard.

*UPDATED* - Who is Li Shufu's "Associate"?

UPDATE below...
_______________________

From the corporate governance files...

Geely is probably best known as the Chinese auto company that bought Volvo from Ford last year. It is also known as China's largest "private" automaker. I put the term "private" in quotation marks because, in China, the meaning of the word is not quite the same as in most developed countries.

As is generally well-known among China watchers, the government -- particularly local governments -- have influence on private businesses that goes beyond mere regulation. And the larger the "private" business, the greater the government's influence.

At a minimum, the local state is everyone's landlord. At the extreme, a local government can force private businesses to sell out to state owned businesses, as has been done with alarming frequency in the coal industry, or local officials can demand an ownership share.

On the positive side, not all governments necessarily seek to own or control private businesses, and many even provide help to private businesses in startup mode such as tax breaks, free or cheap land and utilities, access to bank loans, etc.

But the question that this kind of help often raises is, what does the government expect in return? Is it enough to be a successful business that employs people and pays its taxes on time, or do local officials expect more?

Because we always hear that Geely is a "private" business, I decided to try to find out exactly how "private" Geely is -- at least in terms of legal ownership. Geely is listed on the Hong Kong Stock Exchange, so its audited financial statements and accompanying notes are made available on the HKSE website. Geely's latest annual report (2009) is available here (pdf).

In an effort to determine who exactly owns Geely, I constructed the following partial org chart from information available in the annual report. The listed company is in the purple box. About 48 percent of the Geely Auto Holdings is held by public shareholders, and the remaining majority of shares are owned by a company named Proper Glory Holdings which is incorporated in the British Virgin Islands.

According to the annual report, Proper Glory is ultimately controlled by Geely's Chairman "Mr. Li Shufu and his associate," but for some reason it does not say who this "associate" is. (Here I am referring to the yellow box at the top of the diagram.)

Looking back over the years, this "associate" did not begin to be mentioned as an owner until 2008, but he, she or it seems to be pretty important. If you do the math, this anonymous "associate" could potentially control up to 35 percent of the listed company. And if "associate" owns as little as 75 percent of Zhejiang Geely Holding Group Ltd, he, she or it would be the listed company's largest single shareholder with a 26 percent interest.

Furthermore, as you can see at the bottom of the org chart, Li Shufu and this mysterious "associate" also own 9% of the auto plants.



I contacted several friends who are even more knowledgeable than I about China's auto industry, and their assumption, like mine, is that Li Shufu controls the company. One suggested, however, that the "associate" may be Li's son or brother. Another speculated that it could even be a Communist Party member to whom Li is beholden for something.

I am not suggesting that there is anything illegal going on here, but it seems to me that Geely's auditor, the Hong Kong office of Grant Thornton (which has recently lost most of its employees to BDO) is not doing a thorough enough job of reporting by allowing a shareholder with the potential to control the company to remain completely anonymous.

If there is nothing to hide, why not reveal the name of the "associate"? At a minimum, why not reveal the respective ownership shares that Li Shufu and "associate" have in Zhejiang Geely Holding Group Ltd?

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UPDATE, January 28, 2011:

Thanks to one of my readers for bringing this to my attention.

Above I said that Li Shufu's unnamed "associate" could control the listed Geely company with 75% ownership of Zhejiang Geely Holding Group Ltd. (ZGHGL). That's not entirely accurate. I was thinking more like an accountant than a lawyer. (And I am neither, though my work previously involved a lot of accounting).

I should have more accurately said that the "associate" could control Geely with only a majority ownership of ZGHGL. If the associate held 50% plus one share of ZGHGL, then he would effectively control Proper Glory, which, because it owns 51.3%, also controls the listed Geely Company.

Again, while my assumption is that Li Shufu is the controlling owner of Geely, until someone reveals how much of ZGHGL the associate owns, we cannot be entirely sure of that.

Subsequent to the above post, I have also received information from someone who knows the identity of the associate. This "associate" is apparently an influential Party member who helped Geely to get central government approval for the Volvo purchase. Unfortunately, I cannot reveal the source, but it is someone whom I trust, and who is in a position to know.

If that is indeed true, then, if I were a Geely shareholder, I would be even more interested to know how much influence and/or control the "associate" actually has.

First Auto became "Third Auto" in 2010

Ever since the Chinese Association of Automobile Manufacturers (CAAM) realized people who really need data would be willing to pay for it (graduate students excepted), getting one's hands on sales data has become a bit of a challenge. Whereas in years past one could wait until a few days after the close of the year to get a complete list of China's vehicle sales by manufacturer, now we have to troll Chinese language news releases that dribble out during January.

An interesting phenomenon I have begun to notice is that, the longer it takes an automaker to release publicly its sales numbers, the greater the likelihood that those numbers aren't very good. A case in point is First Auto Works (FAW), a central state-owned enterprise with a long and storied history as the PRC's first automobile factory, and maker of the iconic Red Flag Limousine used to ferry Party Leaders shouting "同志们好!" (hello, comrades!) in parades.

Even though two of China's largest automakers, Shanghai Auto (SAIC) and Dongfeng, released their 2010 numbers in the first week of January, FAW's numbers did not come out until today, January 18. And while FAW's numbers, by themselves would be the envy of any automaker, they weren't as good as Dongfeng's.

For the longest time, FAW could hold its head high as, not only the first automaker, but also the largest. In the chart below, FAW still held the number one position as recently as 2005, but dropped to second behind Shanghai Auto in 2006. In 2010, FAW dropped to third behind Dongfeng, which, until about 20 years ago, was appropriately named Second Auto Works (SAW).

Vehicle Sales 2005-2010 (thousands of vehicles)

I look forward to conducting more analysis on these numbers as the laggards finally begin to report in. (I'm looking at you, Guangzhou Auto and Brilliance.)

The missing link in China's auto development?

An interesting article in today’s WSJ by ace China auto reporter Nori Shirouzu summarizes an interesting trend in China’s auto development. China’s state-owned automakers, along with their foreign joint-venture partners, are beginning to develop China-only brands.

Battleground in the small car segment

At least part of the impetus behind this trend, I believe, is the popularity of small economy cars in China. Beginning in early 2009, when China halved the sales tax on cars with engines 1.6 liters or smaller, sales of these small cars have really blossomed. (The number of cars sold in the less than 1.6 liter category rose by 71 percent over 2008 while sales of larger cars rose by only 23 percent.) The tax on smaller cars was increased slightly at the beginning of 2010, but small cars have nevertheless remained hot sellers in China.

The good news for makers of Chinese-branded autos was that the foreigners had almost nothing to offer in the less than 1.6 liter space, so Chinese brands dominated. The bad news for Beijing, however, was that the SOEs also had very little to offer in this space. It was the private automakers (along with independent SOEs such as Chery) that benefited most.

New Strategy: Joint development

Enter this new strategy of jointly-developed, Chinese-branded cars that, nearly as I can tell, is a win-win for the big SOEs and their foreign partners – at least in the short-run.

This strategy appears to have two variations. One is for the Chinese and foreign partner to develop a car together, combining the intellectual property of both sides. SAIC-GM-Wuling have taken this route with the Baojun (pictured below). According to the authoritative China Car Times, “The platform was designed in Korea, whilst the body design was done in China with GM’s help, the brand was developed in China and also the engine was developed by [Shanghai Auto] in the UK technical center.”

The SAIC-GM-Wuling Baojun

Shirouzu’s article today reveals that Volkswagen and PSA Peugeot Citroen are considering a similar strategy.

The other variation is simply to re-badge an older model from the foreign partner. Honda and Nissan are doing this with their respective partners in China, Guangzhou Auto and Dongfeng Auto. Guangzhou-Honda is a new Linian model which is a re-badged Honda City from a few years back, and Dongfeng Nissan are building the Qichen from old Nissan technology.

What's driving this trend?

There are a couple of factors at work behind this trend. First, although China’s central government has been pushing hard for development of Chinese brands since China joined the WTO, only China’s independent automakers (both private and local SOEs without JV partners) have made significant headway in introducing Chinese brands. Yes, the big SOEs have also introduced their own brands, but they have been “developed” mostly through purchased technology. That is, the big SOEs have yet to demonstrate any real engineering prowess.

Second, there is a big gap between the foreign-branded, mid-sized cars sold in China and the small, Chinese-branded cars. It’s a gap in terms of both price and quality, and Chinese consumers understand this very well. This is why, despite the growth of Chinese brands (they now make up over 30 percent of passenger cars sold in China), Chinese consumers would still prefer a foreign brand if they can afford it.

The Missing Link

These new, jointly-developed, Chinese-branded cars are, I believe, the missing link between foreign- and Chinese-branded cars. And the fact that this kind of development is happening in almost all of China’s big SOEs at the same time tells me there is some kind of central coordination going on – either that, or it’s just a big coincidence. Regardless, I think the strategy here is to provide Chinese consumers with a new product intended to wean them away from foreign cars and make them more accepting of Chinese brands.

And, if I am right, this should call into question the future role of foreign automakers in China’s market.

Another interesting wrinkle to this story is of whether Chinese automakers are learning any better how to design their own cars.

What some of these SOEs are doing is simply buying (or being given) old designs by their foreign partners, and then slapping on a Chinese badge. On the other hand, China’s private automakers have essentially been doing that for years ... only, they don’t have foreign partners ... and, um, they don’t pay for the stuff they copy. But in the process, the private automakers have probably gotten better at auto design. Even the process of copying must have imparted to the private firms some useful engineering skills that the SOEs have yet really to develop.

Perhaps this new method of (legally) copying what their foreign partners have already done will impart to SOE engineers some of those same skills.