Part 1: Auto Sector
The following is part one of a ten part report evaluating the progress of key Chinese industries as they expand overseas (see the introduction to this series here). CMR interviewed several hundred key executives in each of ten industries to better understand the extent of their globalization thus far, their goals and plans going forward, and the major challenges they are meeting along the way. This section describes the opportunities and challenges facing China's automobile industry.
The auto industry is one of the most advanced Chinese industries in the move to expand overseas. As recently as 2001, many companies were reluctant to begin the move. Today, Chinese brand autos are sold in 188 countries and regions worldwide, for a total of 54.38 billion RMB ($7.23 billion USD) in 2007. While overseas demand for Chinese autos has slowed dramatically in recent months due to effects of the financial crisis on key markets, both auto companies like Chery and the Chinese government will continue to prioritize expansion overseas going forward as it is considered crucial to the continued growth of the Chinese auto sector, for reasons to be described below. 10 out of 10 respondents have started moving overseas, and all consider further development abroad a high priority.
From Ford (NYSE:F) and GM (NYSE:GM) to Bentley and Rolls Royce, auto companies worldwide have been keen to leverage China as a key source of growth where growth rates have hovered at a 20% clip the last several years before sales slowed dramatically in Q4 of 2008. At home, domestic Chinese auto companies are having difficulty competing with international companies in terms of reliability, safety, and emissions control, and are increasingly looking abroad for growth opportunities. Nearly all respondent companies mentioned fierce domestic competition from international and other domestic auto companies as a top factor motivating their expansion overseas.
While demand has dropped steeply in recent months due to the financial crisis, respondents also mentioned high demand as a top factor motivating their overseas expansion; exports reached 557,736 units in the first three quarters of 2008, up 34.9 from the previous year. Because Chinese cars have significant price advantages in foreign markets, companies are finding large demand for their autos overseas, in emerging markets in particular where cheaper and smaller cars are popular. While the financial crisis has slowed demand in many of China's key overseas markets such as Vietnam, Russia, and Ukraine, overseas markets will remain crucial to Chinese auto companies' long term growth plans.
Chinese auto companies are also looking to move abroad as a way to build their brand image, a top priority to nearly all respondents, before refocusing on the domestic China market. By moving abroad, respondents felt, they could evolve from being "simply a Chinese domestic company" to becoming a true an international brand. They feel being able to call themselves "international" will add prestige and cache to the brand, which they can leverage via marketing to compete better both abroad and at home. In the words of one respondent, "selling to so many countries makes us more than a Chinese company. Different countries get to know us and we become an 'international' brand, which is really good for our image."
Current and Future Operations
Emerging markets are currently the top destinations for Chinese auto companies like Chery which just secured a billion + USD loan soley for overseas expansion. 100% of respondents have already established operations in such areas as Russia, the Middle East and Southeast Asia. These emerging markets have less stringent rules and regulations than North America and Western Europe, meaning Chinese companies can more easily enter the market with their existing technologies. Because Chinese cars can be priced considerably lower than others, there is considerable demand for Chinese cars in these areas.
In addition to meeting the rising demand for cheaper but "good enough" vehicles in emerging markets, Chinese auto companies are seizing the opportunity to sell to markets not open to other countries. For example, two industry leaders interviewed are expanding operations in North Korea: one is exporting and one has a complete knockdown (CKD) factory there.
While emerging markets are the primary target for Chinese auto companies now, the vast majority of respondents have as their goal to enter North American and Western European markets in the future, though most lack specific plans at the moment. Chinese companies value these areas not only because of the market size, but because they feel selling in these markets, meeting the array of rules and regulations, and passing the extensive quality and safety tests, signifies their brands have moved up to the next level, achieved truly global status, and they can compete meaningfully in any market.
Thus far, the vast majority of companies interviewed have chosen to develop their presence abroad by finding a partner in the target country. These partnerships can allow Chinese companies access to a wide range of resources and information, such as factories and the partner's own technical knowledge and networks.
Access to factories in the target countries is a crucial step for Chinese auto companies' move abroad. Nearly every respondent company is using access to their partner's factories as their method of bringing their vehicles to market. To avoid the hefty taxes involved with shipping whole vehicles abroad, Chinese companies are exporting via complete knockdown (CKD) or semi knockdown (SKD) – manufacturing auto parts in China and shipping the unassembled or partially assembled parts abroad for final assembly in the target market. Access to these factories in the target market is also crucial in that it allows Chinese companies to provide after-sales services, which cannot easily be supported by export alone. Having a factory abroad also allows Chinese companies to ease rising costs due to RMB appreciation, a key concern for all respondents.
In addition to factory access, Chinese companies are seeking partnerships and setting up R&D centers abroad to help build their own technical and managerial skills. One respondent company has set up an R&D center in Italy, for example, where they have hired professionals to focus on appearance and design, and an R&D center in Japan to focus on design of technological and electrical components.
A minority of companies interviewed are also using M&A as a way of building their presence abroad. With the help of a 2 billion RMB low-interest loan from China Exim Bank—the kind of governmental support described in China's "Going Out" (Zou Chu Qu) policy—Nanjing Auto Group purchased British auto company MG in 2006 as a way to gain access into foreign markets. As the company told us, "the MG brand already has channels in foreign markets, and it is already famous, so we don't need to start from scratch with marketing." While it allows quick access to existing resources, M&A has been a less popular choice for Chinese auto companies due to its capital intensive nature. This past December, Chery received another loan from China Exim, this time totaling 10 billion RMB ($1.5 billion USD), to help support continued international expansion.
Respondent companies reported getting autos past international rules and regulations as the biggest challenge in entering overseas markets, and North America and Western Europe in particular due to their strict quality standards. Nearly all companies also complained of serious challenges in finding the appropriate talent to lead development in both technical and managerial aspects, as well as experts with cross-cultural experience who can help lead the push abroad and develop long-term strategy. As one respondent told us, "We have talented people now but they are young and lack experience. We have problems that need solving now, and we cannot wait until they get more experience to fix them." Thus, some Chinese auto companies like Jianghuai Auto and Nanjing Auto have invested and established R&D abroad and hired foreign talent to do interior designing and development, so that they can produce automotives with world class advanced technology.
While 2009 will be a tough year for Chinese automakers, both in exports and domestic sales, expansion overseas will remain a key long term goal. Chinese auto companies should not be too hasty in their rush to grow abroad. Rather, they should focus energy and resources now on improving their quality and safety, and building the right brand image from the start. While it is possible for brand image to deteriorate quickly from good to bad, it is much harder to build from weaker brand image to good, especially with records of mediocre performance on quality and safety tests.
The next several sections of this report will be published on Seeking Alpha by product category. For more information about this report and accompanying charts and graphs, please contact CMR directly at cmrconsulting.com.cn.
CMR Senior Analyst Ben Cavender, Analysts Natalie Zhu, Meredith Sun, and Charlotte MacAusland, and Summer Intern Christie Sze Contributed to this Report.