China: The Rewards May Outweigh the Risks

China: The Rewards May Outweigh the Risks
MiBiz • February 9, 2004
by Jim Gillette, Director of Supplier Analysis, CSM Worldwide

I was in denial about China’s auto industry prospects for years. After all, wasn’t it likely that the Chinese government would once again do something stupid reversing the progress that had been made; something like the 1989 Tiananmen Square fiasco? To date, the foundation of my fears has weakened and I have come to believe that North American suppliers who ignore China’s growing opportunity may be at risk

According to China’s National Bureau of Statistics, the country’s economy grew at an annual rate of 9.9% y-o-y during the fourth quarter beating most analysts’ expectations. GDP growth of all of 2003 was 9.1% compared to a strong 8% pace during 2002. It appears that any damage due to the SARS outbreak earlier in 2003 was transitory at worst. Low inflation, rising household incomes, and improving employment are all underpinning robust growth.

Vehicle sales soar

Passenger car sales surged by more than 75% during 2003. Analysts at CSM Worldwide are predicting that growth could cool to 30% this year, but where in the world can you find a market of this size growing at that clip? Automakers are aggressively cutting prices and launching new models to capture an increasing number of sales. Per capita GDP moved above $1,000 for the first time in 2003 pushing more households at the upper-income levels to the point of affording a private automobile.

There are reports that SARS may have actually helped vehicle sales last year. Individuals fearing exposure to the disease on public transportation opted to buy a car if they could afford it.

By 2006, China will likely surpass Germany as the third largest vehicle-producing country. By 2015, it may pass Japan to move into the number two spot behind the U.S.

The unprecedented size and momentum of opportunity in the Chinese market is nearly enough to blind the most jaded curmudgeon who might have been previously whipped into a frenzy over the promise of an emerging Brazil or a burgeoning capitalist economy in Russia only to be slapped down by systemic financial weakness (or corruption resulting from crony capitalism). Like those two markets that held such promise in the last decade, we keep wondering if some unforeseen event will put an abrupt end to the wild ride in China. After all, no economic system grows at rates like these forever.

China may be less risky that we originally thought

Here my thoughts regarding just a few of the questions often asked:

For one, there is the question of quality. Sure, China manufacturers can make aftermarket parts, but can they produce for the OEMs?

It appears they can. A recent article appearing in Automotive News, quotes General Motors’ purchasing chief Bo Andersson as saying that the Shanghai GM venture receives parts with 23 problems per million on average, compared with 22 per million in the U.S. and 35 per million worldwide.

General Motors has announced that it is upping its target for purchasing Chinese-made auto parts by 2009 to $4 billion for use in vehicles assembled outside of China and $6 billion for vehicles assembled within China. GM bought $200 million in parts for export in 2003 and less than $3 billion for internal use.

Sure they can make parts, but won’t it be a long-time before they can they export complete vehicles of adequate quality to meet world standards?

Volkswagen has begun production of a version of its small Polo car for export to Australia and is forging ahead with plans to export China-made vehicles to 84 countries (outside of North America) within three to five years. Honda is building a new plant from which it hopes to export subcompacts to Europe and Asian destinations within the year. In any case, vehicle exports are not top priority of most automakers as they are more concerned about assembling enough vehicles to meet domestic demand.

Isn’t the Chinese banking system fragile and on the verge of collapse?

While the banking system suffers from the usual emerging market growing pains including problem loans, the government is carefully monitoring the situation and appears to have the resources shore-up any short-term crisis. The recent transfer of $45 billion from the country’s massive foreign currency reserves to two of the country’s largest banks, the Bank of China and the China Construction Bank, was a positive move. Plans are also in the works to take the banks public and to install a Western-type corporate governance system.

With all the new automotive investment in China, is there a danger of overcapacity?

Only in state-controlled economies does overcapacity never become an issue. I can’t imagine a scenario where the increasingly market-driven auto sector in China doesn’t create excess capacity as competing automakers aggressively vie for market position. Yes, it will eventually result in the pullout by some of the weaker players.

The current situation, however, is in stark contrast to South America during the early 1990s where too many automakers made investments without a reasonable hope of profiting. I completed a study back then, for example, that concluded that Hyundai would have needed to make $3,000 net profit per every auto built in order to justify the size of the investment. Given that Hyundai was selling inexpensive subcompacts, this was clearly ridiculous.

Has the government done anything “stupid” recently that puts the auto industry at risk?

Last May, the government came close by issuing a policy draft that would have required that one half of all auto sales in the country be from “domestic” companies with “full ownership of the intellectual property rights” by 2010. Eventually realizing that such a policy, if enforced, would forestall any and all new automotive investment from European and North American automakers and parts suppliers, the Chinese government came to its senses and scratched the requirement from a new policy draft released in January this year.

Suppliers need to view China in the context of a well thought-out international strategy. Delving into questions like those above about global automotive supply issues will be the topic of an Automotive Supplier Symposium on April 20 at Grand Valley State University offered by the Van Andel Global Trade Institute (