Auto sector growth sustainable

SHANGHAI: China's auto industry is growing up, but the enormous profit margins of yesteryear may be gone forever, said a group of CEOs and industry watchers at the 10th CEO roundtable, with the theme "Auto China," organized by China Daily in Shanghai yesterday.

Instead, the Chinese auto market of the future will take more of its profits from derivatives, like financing and post-sale products, than directly from production.

"Market growth over the years will continue slightly ahead of GDP growth," said Dr. Christoph Stark, Honorary Chairman of the roundtable and President and CEO of the BMW Group in China. However, "the one thing we all agree upon... is that those days of high profits, for the time being, are over."

"I see generally the trends of a maturing market," said Stark. "I think the market will become more similar to... markets in other parts of the world."

"Everybody still sees (China) as the most attractive market and nobody wants to miss out," Stark said. "Everybody is holding on for the China magic to come back."

But the magic, while not altogether gone, is fading and the industry, instead of racing forward with its pedal to the floor is proceeding at a slower, but steadier, speed.

The tide of mergers and acquisitions, price fluctuations, new models and new companies is likely to continue for a while though.

Long term prospects

"Has the Chinese bubble burst? Our view is that the bubble is a long way from bursting in the next five to ten years. We have quite a bullish view in the longer term," said Paul Gao, a partner at consultants McKinsey and Company China.

However, the huge profit margins of 2002 and 2003 have probably gone for good, Gao said.

Three main factors are likely to determine the future growth of the auto industry: Deregulation, infrastructure and consolidation.

These are likely be affected by other factors, such as environmental protection and China's huge employment needs, which may pose a challenge to the immediate growth prospects of both Chinese and foreign manufacturers.

"It's a hot topic in China right now. Perhaps the hottest topic," said Stark. "To my mind one word keeps coming up and that's change."

Growth

If one wanted to describe the Chinese auto market with a single word, then fluidity might best fit the bill.

According to Stark, change is the mainstay of the market, both in growth rates and market share.

"We have an almost dramatic increase in new companies and new models. Anyone who has been to the Shanghai Auto Show can see that," he said. The Shanghai Auto Show ends today and has brought together just about every auto manufacturer in the world. "I think now we have the largest number of manufacturers in China worldwide."

Stephanie Koenig of Internationaler Messeund Ausstellungsd GMBH, organizer of the Auto Shanghai 2005 Show, agrees," For the first time we've seen major global brands coming in as groups. We've seen a lot of new technologies, products and concepts displayed at this A level show."

At the same time, local companies are following the Korean model of developing local and foreign markets simultaneously.

However, one of the challenges for automakers may well be developing new business models that combine both growth and profitability.

"Mass market brands in other markets have done a very good job in destroying shareholder value, by achieving growth without profitability," said Gao.

"The question for many of them is what are they doing differently in China to ensure they are achieving profitable growth. Unfortunately, most of these companies are not doing anything different."

He said a quantum leap is needed in the industry, like the two during the last century that caused shifts in the auto market paradigm.

The first, Gao said, was the development of mass production by Henry Ford. The second was Toyota's innovative production system, which ensured reliability and elevated Japanese auto makers to the world stage.

"Unless (Chinese manufacturers) can figure out the third revolution in the auto industry... they will never be able to catch up," Gao said. "They don't have the required capacity to play the same game."

Foreign automakers also face different challenges in coming years. With many having already established a foothold in the country, the next step will be establishing steady growth.

Ashvin Chotai, director of Asian automotive industry research at Global Insight, warned though, that the double-digit growth of two and three years ago is gone forever.

"The question now is... when will profits converge with the very low margins we have seen in the global industry," Chotai said.

However, others still look at the Chinese market and see dollar signs.

"Everybody is talking about stagnation and about reduction of profits and growth, but nobody is talking about the last month of March when we produced more vehicles in China than ever before," said Dr. Peter Kilgenstein, executive vice-president at Bosch (China) Investment Ltd.

Government

The future of the auto industry in China may very well depend on the central government, its approach to deregulation and how it balances the many issues it faces - such as local employment needs, the economy and market openness.

"You have an industry that is regulated by government policy to a large extent," said Stark.

Both a push for exports and integration into the world market will continue to affect domestic development.

Also, new government regulations on issues like local contents, service networks and used car policy, will have a great impact on market development," Stark said.

At the same time, as the market matures profits may decline while risks increase.

That, said Gao, may be a factor in the government's approach to the auto industry. To date, the government has encouraged the growth of multinationals, but it has also shared in the profits.

"Moving forward, there's going to be less profit to be shared and there's going to be more risk," Gao said.

In the future, said Stark, Chinese auto manufacturing may be focused on one or two top manufacturers.

Freeman Shen, President of BorgWarner China, believes that while industry consolidation is inevitable, some local companies are actually adapting quite different market development strategies, such as targeting the mid size market in Germany and the rest of Europe, instead of following what the Koreans and Japanese did.

"I believe money is not the issue," Stark said. "I believe that the central government will try to weed out all the small companies which operate at a local level.

Regardless of the issues, Kenneth McCall, chief executive officer of TNT China, said prospects for the future are bullish. However, there are major challenges in the automobile industry supply chain; for example, OEMs for the time being are not sharing networks or resources and as such it is extremely difficult to rationalize the supply chain. There are also marked differences in policy and its execution between provincial and municipal governments."

"It will happen. We think it will be the second largest market in the world," said McCall. "We need to concentrate on building infrastructure and building up the aftermarket."

Fragmentation

As the market matures, the fragmentation that characterizes the Chinese auto industry is likely to come to an end.

"You have huge capacity on one hand and on the other, you have a hugely fragmented industry." Stark said.

The future of the industry may well hinge on how this issue is dealt with.

"We have a 50 per cent cap in joint ventures... how long can they keep this restriction in foreign ownership of assets?" asked Chotai . That may get in the way of consolidating the market, which is now full of many different brands.

The question, said Stark, is whether the government will find new employment for people who lose their jobs as the market consolidates.

Rationalizing the market may ensure better profits but it may prove difficult to remove local partners, who have been in the supply chain for decades.

"Here there are one, two or three layers of additional structures that you have to build into the supply chain," said McCall.

Traffic and infrastructure

Infrastructure and traffic development are also likely to affect the growth of the auto industry. The key issue may be how to introduce millions of cars into already overcrowded cities.

"The whole of China will be one big parking lot... this is not a sustainable scenario," said Richard Lee, chairman of Ferrari Maserati Cars International Trading, who is selling 'dream cars' for the select few.

"Are we talking about people commuting to work every day in their car... The whole exercise will be about transportation for the Chinese people.

"I think it's no good for us to think about building 10 million cars a year and jamming them onto the highways of China. I don't think it's economically feasible or ecologically feasible."

Environmental concerns

As more cars are produced, more environmental fears surface.

More cars also create new regulations aimed at cutting down damage to the environment.

One of those regulations, which comes into effect July 1, sets limits on fuel consumption.

"I am concerned," said Ferrari's Lee, whose cars would not pass the new regulations. Neither would some other luxury cars, like some of BMW's bigger models.

"The fuel consumption issue is quite serious," said Zhang Jianwei, of the China Automotive Technology and Research Centre.

There are some big question marks to be answered.

Among them, said Stark, are clean energy regulations, as well as the introduction of diesel fuel into the market.

"The question is not whether, but when diesel will be introduced more widely," said Kilgenstein, of Bosch.

"No one believed 20 years ago that the level of emissions today would be practical," he said. Engineers are working on lower emission levels and "I believe there is change ahead of us."

Eberhard Schrempf, President and CEO of BMW Brilliance, concurs that environmental issues will be a major concern for the industry, particularly as the Beijing 2008 Olympics is approaching. "You don't want to see the same complaints people lodged at the Mexico Olympics in 1968." He said.

Money matters

Ultimately, said Joel Epstein, CEO of AIG Consumer Finance Group, making cars is one thing but mechanisms have to be put in place to allow people to buy them.

Soon, like in the more mature western markets, money may be made through financing car purchases rather than manufacturing cars.

"When will the barriers in the financial and insurance industry come down, so that they can grow and support the growth of output?" he asked.

He said there are three problems.

One is the organization of Chinese financiers, which look at geographical areas rather than products to separate departments.

"It's one big pot of rice for all the different programs offered by the banks and they don't know how much they are making on each different product," Epstein said.

A second issue is the lack of consumer information or credit bureaus, although the Bank of China is moving rapidly in that direction.

"I believe within a few years we will have decent consumer information, which is the glue that holds together consumer financing."

A third issue is the legal environment around registration, portfolios and protecting lender's rights.

"As those barriers come down, it will be much easier for people to finance buying a car," he said. "But I think those things are happening."

Conclusion

Ultimately, said Stark, more questions than answers were raised at the roundtable, which brought together 31 CEOs and senior executives from the entire automobile industry.

"More talks with governments, industry players, consumers and other stakeholders, will be required to sort out those strategic issues, like this CEO roundtable organized by China Daily." Stark concluded.

It was the 10th such event and the first held in China's financial centre. Previous round tables have been held in Beijing and Hong Kong.

Yesterday's event coincided both with the Auto Show, which ends today, and with China Daily's move to improve coverage in Shanghai.

The newspaper recently set up a news centre in the city which, according to Deputy Editor-in-Chief Huang Qing, brings some of the newspapers top reporters to Shanghai to expand coverage.

(04/29/2005)

 
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