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In 2013, total vehicle demand, including passenger cars and commercial vehicles, in China stood at around 22.2 million units. This is over a quarter of global vehicle demand and makes China’s vehicle market around 40% larger the US market. China overtook the US to become the largest market for automobiles in 2009.
Foreign automakers, although having to operate via joint ventures, control over 70% of passenger car demand and many now rely heavily on China to support their global growth ambitions. Thus, the significance of developments in China on the global auto industry is not difficult to see.
In the last decade, vehicle demand grew at a compound annual growth rate of over 20%. Major cities in the East Coast were the main growth engines initially but in recent years healthy support has also been coming from the spread of motorization in other provincial capitals and medium size cities.
Since the stimulus fueled boom in 2009 and 2010, growth rates have moderated considerably, but have still remained relatively healthy and so far the transition from high growth rates to more moderate growth rates has been relatively smooth.
Looking at the next four to five years, clearly, there are headwinds at macroeconomic level and auto demand is of course vulnerable to these headline risks. On balance, and without going into all these details which are beyond the scope of this article, bearing in mind the government’s track record and the vast resources at its disposal, I would be relatively comfortable and confident in the ability of the government and key policy makers to ensure that structural reforms are undertaken smoothly and that China will also continue to enjoy solid, albeit more moderate rates of economic growth in the coming years.
In the auto market, despite the impressive boom in vehicle sales since 2002, when vehicle demand was just 2 million units, vehicle ownership levels at national level are still very low when compared to most developed countries and hence there is still huge potential for growth, especially outside the mega-cities and in the inner provinces. However, there is little doubt that the market has reached the first stage of maturity.
Congestion and Pollution Creating Some Headwinds
There is now much greater focus on traffic, infrastructure and environmental issues, especially in most of the major cities where congestion and pollution have reached chronic levels. Controls on car registrations are already in place in Beijing, Guangzhou and Tianjin while Shanghai has a Singapore style license plate auction system to control vehicle population. Similar types of controls are now very likely to be adopted in 10-15 other major cities. With very limited growth in car ownership levels in these cities, demand will rely almost exclusively on replacement demand.
Increasingly, national level growth is becoming dependent on an increase in motorization levels in the less developed inner provinces and small/medium size cities in the more developed provinces such as Zhejiang, Guangdong and Jiangsu. Fortunately, this migration of demand from the richer provinces and major cities to the less developed provinces and smaller cities is already well underway and supported by government’s initiative to accelerate economic development through faster urbanization.
Decline in Government Demand
Before 2000, government and state owned companies together with taxi fleets accounted for over 90% of passenger car demand. During the last decade, the main growth engine has been the spectacular boom in demand from individual buyers. The role of government demand has been declining and is set to decline even further in the coming years as the government cracks down on corruption and wasteful spending. This means a sharp decline in demand from government fleets and there is also rising pressure on Chinese officials to use “home grown brands” instead of foreign branded cars. Sales to government fleets will not support the car market and should be regarded as a headwind.
Urban Population of 880 Million by 2025 …40 Cities with Population of Over 5 Million by 2025
Until now, urbanization has been driven by industrialization and investment with the primary objective being economic growth. This has resulted in rising living standards and has been a major factor in supporting booming car demand and the auto industry while the development of auto manufacturing has contributed significantly to economic growth, job creation and urbanization. Thus, the auto industry has accelerated urbanization while urbanization has supported demand for cars.
In 2000, urbanization rate in China stood at 36.2% or around 460 million people. By 2012, this had risen to 52.6% or around 710 million people, meaning that around 250 million people have been added to urban population in just 12 years. Urbanization rate is set to rise to nearly 65% by 2025 and this means over 880 million people living in urban areas. So, in the next 12 years, urban population is expected to increase by 170 million.
Currently, around 25% of China’s total urban resident population of 710 million live in the 25 largest cities with population of over 5 million and over 90% of these urban residents are already living in cities with population of over 1 million people. It will be these cities, which currently have a population over 1 million people, which will be growing bigger and bigger and be the main driving force behind further urbanization. The number of cities with population of over 5 million is set to nearly double to around 40 cities by 2025.
Focus on Green and Low Carbon: Restrictions on Vehicle Ownership in Many Cities
For small and medium sized cities, the traditional model of urbanization will continue and in these cities there is still considerable scope for growth in motorization level and car demand. However, for larger cities, typically with population of over 5 million, the dynamics are now changing rapidly. The main challenge now is traffic/congestion management and limiting the impact on the environment. Government and policy makers have also recognized that the next phase of China’s urbanization should embody the concepts of “green, intensive, intelligent and low-carbon and not just simply construction and industrialization”. Easier said than done and with over 710 million people already in urban areas, it will be massive challenge to adapt most of current mega-cities to adopt such concepts.
· Restrictions on car ownership are already in place in Beijing, Shanghai, Guangzhou, Tianjin and Guiyang. Cities like Shenzhen, Xian, and Shijiazhuang have been assessing options to introduce some measures. A range of measures including alternate day driving, congestion charging similar to London and Singapore are being investigated.
· In the future, other cities which need to address this challenge include cities such as Hangzhou, Dongguan, Foshan, Chengdu, Chongqing, Zhengzhou, Changsha, Kunming, Nanjing, and Wuxi.
· The priority in such cities has to be more efficient public transport and a combination of measures including restrictions on ownership, restrictions on use, congestion charging, improvements in traffic management and parking will be adopted. Electric and hybrid cars will also have bigger role to play once charging infrastructure and incentives are in place; this will have an impact on pollution but not congestion.
What Does All This Mean For Passenger Car Demand Growth Profile?
Fortunately, China’s auto market is no longer overly dependent on government demand or even on what happens in Beijing or Shanghai or even the top 20 cities. Private demand dominates and is fairly well spread across many cities with top 10 cities currently accounting for 25% of car sales, top 40 cities for 50% of car sales and the top 100 cities account for 75% of the demand. This is very different to countries such as Thailand, Indonesia or even Korea where the capital cities dominate national level demand.
· In developed countries, motorization levels tend to be lower in mega cities (especially in central areas) because public transport is better, traffic and congestion makes cars less attractive and parking is often expensive. Car ownership and use is much higher in suburban areas or smaller cities and rural areas simply because public transport is under developed and parking is less of an issue. A similar picture is beginning to develop in China, with suburban areas and smaller/medium size cities taking a greater share of car demand.
· In China’s larger cities, with congestion issues, high ownership levels and now controls on ownership controls, replacement demand will still be considerable and is already beginning to provide the main support for car demand. This is a similar situation to developed countries.
· In the smaller and medium sized cities, further increase in urbanization and purchasing power will continue to provide healthy level of support to growth in motorization and auto demand. Car ownership levels in these cities are rising strongly but from low base.
· Overall, I would expect over 85% of the growth in the next decade to come from outside the top 10 cities (as measured by current size of the car market).
· Even if ownership controls become widespread and are imposed in say 20 major cities, the negative impact on national car demand should not dramatic.
Demand Outlook Still Healthy...Individual Provincial Markets Bigger Than Many Countries
Clearly, the spectacular levels of growth witnessed in the last decade cannot be repeated in the next decade. Growth rates in developed East Coast provinces are now moderating but the base is very large and these provinces will continue to remain as very important for all automakers, with replacement demand providing the main support. Demand in inner and less developed provinces is growing rapidly but from much lower base levels. Even at city level, we have a similar contrasting situation with high growth rates in smaller cities but from low base level and lower or negative growth in some of very large cities.
Overall, passenger car demand is expected to grow at 8-10% rate in the near term and even in the medium term, growth rates of 6-8% will still be achievable. I expect Shandong, Jiangsu, Guangdong, Zhejiang, Hebei, Sichuan and Henan to be the Top 7 most important provinces, as measured by current size of the market and future growth potential.
It is interesting to note that the current level of car demand in many of China’s provinces is much bigger than many country markets. For example, there were at least five provinces in China with higher auto sales than Thailand or Indonesia. Global companies need to recognize this in their planning and resource allocation processes.
Implications on Global Automakers
During the last decade, China has become an important element of global revenues and profits for many global automakers and component suppliers. Even with more moderate growth, China will continue to remain a key market for virtually all automakers and the main growth engine for their global sales, production, revenues and profits. China will also continue to be their main destination for investment. Other BRIC countries have not enjoyed such spectacular growth and there are few signs that they will do so consistently in the future.
Although the era of stellar growth is over, medium term growth outlook is still very healthy. Competition is fierce, foreign automakers are still required to operate via joint ventures with Chinese companies and the government is providing considerable level of protection and financial support to indigenous automakers to become more competitive. However, the progress of Chinese brands remains disappointing and foreign automakers continue to reinforce their market dominance. China is set to remain a highly lucrative market for global automakers.
Automakers Expanding Sales and Production Footprint
Until recently, there has been a tendency for an automaker’s regional sales footprint to mirror its production footprint. For example, Japanese brands have held strong positions in Southern China while VW has been relatively strong in Northern and Eastern provinces but has been relatively weak in the South. Citroen, with its product base in Wuhan, has relied on Hubei province for its sales. This situation is now beginning to change very rapidly. There is less regional protectionism and automakers are now establishing a broader based presence across China to serve the existing core markets and future growth provinces. They are becoming more national, both from a production and sales perspectives. For example, the VW Group, through its “Go South Initiative” has now set up production facilities in Guangdong and has an aggressive strategy to gain market share in Southern provinces.
With the recognition that future growth will come from inner provinces and smaller cities, all foreign brands have been stepping up their dealer expansion plans. Established foreign automakers such as the VW Group and GM have the most extensive dealer network while the Japanese brands and companies like Hyundai and Ford also have an aggressive plan to extend their geographic coverage and are catching up rapidly. The challenge is strike the correct balance between the number of dealer outlets and dealer throughput to ensure good coverage but also viability of operations at a dealer level.
In the more mature cities, with replacement demand forming the bulk of new car demand, the focus is on strong brand, a highly competitive product portfolio and support of new car sales through competitive part exchanges/used car operations, strong after-sales operations and support activities such as finance and insurance.
VW and GM remain the leading players in the passenger market and have been reinforcing their position in recent years. They have the most comprehensive product portfolio, capacity in place with high levels of localization, local R&D and product development capabilities and also the most extensive sales and marketing presence. China will continue to be a very significant profit driver and there are few signs that these two automakers are losing market share or growth momentum.
Ford entered China much later than VW or GM and has been relative laggard until recently. However, in the last two years it has enjoyed very impressive growth, thanks to strong commitment plus investment in new models, additional capacity and more aggressive sales and marketing strategy. From a much lower base compared to VW and GM, growth momentum is set to remain strong in the coming years but Ford’s scale of operations in China cannot approach those of VW and GM.
Japanese automakers (Toyota, Nissan and Honda) have all shown strong commitment to China and enjoyed impressive growth before the Japan-China island dispute and anti-Japanese sentiments hit sales in 2012. Like other automakers, Japanese brands are actively expanding their product portfolios and capacity while extending distribution presence to smaller cities. However, periodic revival of anti-Japanese sentiments will remain the biggest drag on their performance.
German luxury brands (Audi, BMW and Mercedes-Benz) have benefitted hugely from the boom in luxury car demand, especially since 2009. Audi has been the traditional leader but BMW has been rapidly making up ground on Audi in recent years. Mercedes-Benz went through a challenging phase in 2012 but sales have been rebounding strongly in the past year. Although there is a government crack down on conspicuous consumption by officials, private demand remains robust and is being supported by aggressive product launch and local production plans plus expansion of sales footprint into inner provinces and smaller cities. The outlook remains healthy.
How Rapidly Can Chinese Auto Assemblers Close the Competitive Gap? Is There Scope for Cooperation Between Different Players?
The global auto industry is highly competitive. Barriers to entry in areas such as sophistication of technology, capital intensity and production scale, brand development and distribution presence are very high and it is rare to see new players emerge and succeed. So in this global context it has been amazing to see so many domestic brands emerge in China in the last decade.
Progress made by larger automotive SOEs (State Owned Enterprises) in areas such as building their engineering and development capabilities, launching competitive models, building brands and eventually gaining market share has been slow. But, a small number of newer private Chinese companies have made more impressive progress.
Of course, we have to again mention China has a unique industry structure, shaped and tightly controlled by government policy. Without such controls, it is almost certain that China’s industry structure could have become similar to India or Brazil where foreign automakers dominate and only a very few globally competitive domestic automakers emerge and succeed over a longer period.
In China’s unique situation, although there has been a fair bit of consolidation already, there are still too many players and the industry structure is too fragmented. While demand was growing strongly, the fragmented industry structure was not an issue but a prolonged period of slower growth will put pressure on several of smaller automakers to exit, consolidate or seek other ways of operating.
Initially, independent Chinese brands enjoyed success with low price strategies and focus on smaller cities but in recent years, most foreign joint ventures have made very impressive progress in terms of having a broad product portfolio, becoming very price competitive and expanding their distribution to inner provinces and smaller cities. Meanwhile, operating performance of individual Chinese companies has also been erratic.
The most recent development is introduction of joint venture brands such as Baojun, Venucia, Linian, Kaili etc. The product strategy is based on the use of old/outgoing platform from the foreign partner, carrying out some restyling and upgrades and then repositioning the model to appeal to price sensitive buyers, especially in smaller cities. This development will be putting even more pressure on Chinese independent brands.
In an environment of slow growth and intense competition, it becomes even more important to have highly competitive products and strong branding. So, the main challenge is to continue to focus on product quality and technology and continue to improve brand image and customer acceptance.
There are currently no examples of meaningful cooperation between domestic players and the culture of deep cooperation in areas such as engineering, product development, joint purchasing and production, re-badging and sharing distribution channels will take time to evolve.
The government is expected to continue to persist with its support and encouragement to local players to enhance their capabilities and become more competitive. It has been acknowledging that the gap between Chinese companies and major global OEMs is still significant and it will soon have to decide how many companies it is viable to support. How rapidly this gap can close during the coming years will determine the type of progress that Chinese companies can make both in China and globally.
Ashvin Chotai has been covering developments in Chinese and Asian auto industry for over 15 years. He is Managing Director at Intelligence Automotive Asia and was previously the Head of Asian Auto Research at Global Insight, now known as “IHS Automotive”.
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