“THIS is one of the most advanced and sustainable car factories in the world.” So declares Karsten Engel, chief executive of BMW China, as he greets visitors to his firm’s newish manufacturing facility in the grim north-eastern city of Shenyang. The plant, run by a joint venture with a local firm called Brilliance, is indeed spotless and efficient, with robots and humans together producing nearly 40 cars each hour. China is the largest market in the world for the firm’s big 5 Series and 7 Series models, and source of perhaps half of its global profits in recent years. Unsurprising, then, that the firm is hoping to double the number of models built locally.
The bosses of many big foreign car firms were in China this week for the Shanghai Auto Show, and they too offered a pretty rosy view of the Middle Kingdom. China has overtaken America as the world’s largest car market, and it has contributed between a third and a half of the global profits of many big automobile manufacturers in recent years. Like BMW, other foreign firms are also betting heavily that the good times will continue by expanding production capacity in the joint ventures that the Chinese government requires them to form with domestic firms. Jochen Siebert of JSC Automotive, a consulting firm, estimates that the joint ventures will open $12 billion-worth of new factories in China this year and next.
And yet the hard truth is that these firms may now be headed for a car crash, shattering their dreams of never-ending profits. The first reason for this is that sales growth is slowing. The days of double-digit annual increases are over. In the first quarter of this year sales of new vehicles slowed to single-digit annual growth. Paul Gao of McKinsey, another Western consulting outfit, forecasts that growth rates will remain in the “mid-to-high single digits” for the next decade.
That is a higher rate of increase than many other countries can look forward to. However, given the new plants being opened, it looks like being insufficient to correct a worrying excess of capacity that is building up. Enough new plants to make another 5.3m light vehicles a year are due to come online in 2015 and 2016, compared with sales last year of 22.8m.
A rough rule of thumb in carmaking is that assembly plants need to be working above about 75% capacity, assuming two eight-hour shifts each normal working day, to be profitable. America’s closures of car factories, followed by a sharp recovery in sales, mean that its plants are now working at above 100% of that capacity. In contrast the average for Chinese assembly plants has now slipped to below 70% (see chart).
So a squeeze is coming. One sign of trouble is a backlash among dealers, who are unhappy about having their bonuses tied to unrealistic sales goals set by the joint ventures during headier times. In January BMW had to offer over $800m in payments to its dealers to quiet their complaints. Toyota is expected to hand $200m to dealers affiliated to FAW, one of its joint-venture partners. Other foreign firms are expected to do the same.
Used cars, once shunned, are now taking off, as motorists realise they can be a better-value alternative to a new set of wheels. In March, Uxin, an online-auction firm specialising in used cars in China, won $170m in funding from Baidu, a local internet-search giant, and KKR, an American private-equity firm.
As new-car buyers have become scarcer, some of the biggest-selling foreign brands in China, such as Ford and VW, have had to start offering rebates and discounts to shift the metal. Second-tier brands and local firms are sure to follow suit. Max Warburton, an industry analyst at Sanford C. Bernstein, a research firm, warns that “price reductions are almost always one-way, so these cuts will lock in lower margins.” Mr Siebert estimates that Western firms will see their profits from China plunge by half this year versus last.
Despite BMW’s expansion plans, in a closed briefing for analysts, its soon-to-retire boss, Norbert Reithofer, recently warned how bad things were looking. Pricing pressures were especially dramatic for the firm’s most luxurious models, such as its British-built Rolls-Royces. “Something has changed in China,” he told them.
As for those Chinese firms not in a joint venture with foreign ones, they have for years had to suffer from their cars being spurned by consumers. A few independent local manufacturers have recently benefited from the rising popularity of small, cheap sport-utility vehicles (SUVs). As it happens, in China such vehicles are mostly built by domestic firms. Great Wall, arguably the best of a bad bunch, has decided to cut its output of saloons to concentrate on its better-known range of SUVs.
However, look beyond this brief respite (Western firms will surely bring their own mini-SUVs to China quickly), and it becomes clear that local firms are in even bigger trouble than foreign ones. Of the dozens of motor manufacturers in China, most are smallish local outfits cranking out lousy cars. Many of these are bleeding red ink. They are able to stay afloat only because of subsidies, and favourable procurement policies, from the authorities in their home cities and provinces.
A handful of the best state-owned carmakers—like Shanghai Automotive, which has joint ventures with both GM and VW—do make handsome profits. However, they are viable only because the government forces foreigners into these joint ventures. The idea was that, by now, the Chinese firms were supposed to have learned from the foreign ones how to design, build and sell great cars. Instead, the cosseted domestic firms have failed to learn, and have been relegated to mere contract manufacturers.
If market forces were allowed to function in the Chinese motor industry—both by ending the subsidies and letting the foreign carmakers either buy up their Chinese partners, or dump them and go it alone—there would surely be a drastic consolidation. Many Chinese firms would cease to exist, though a few, forced to live on their wits, might learn to innovate, and flourish. Even without reform, the increasing squeeze on carmakers in China may prompt a more limited shake-out. In what may be an early sign of this, rumours flew this week that VW was in talks to take a stake in Great Wall.
If China’s dreams of having its own, world-class car brands are not going to be fulfilled by its domestic motor companies, then perhaps it ought to be looking elsewhere—for instance to its innovative and nimble technology firms. Cars are increasingly bundles of software on wheels, and in the future they will increasingly be connected wirelessly to all manner of navigational aids. So if Apple is looking to get into carmaking, why not Xiaomi, a Chinese maker of mobile devices, or Tencent, a social-media and gaming giant?
Or indeed Alibaba. Of all the companies at this week’s Shanghai Auto Show, among those attracting the greatest buzz was the e-commerce company, which unveiled partnerships with GM and BMW to offer Chinese consumers online tools to find, buy, finance and service their cars. What it did not mention publicly this week is that there is also a stealth team working on an AliCar. Watch this space.