A saturated domestic market with mounting overcapacity has brought a rough year for China auto sales. Following exceptional growth between 2001 and 2004, car sales have cooled substantially as local demand has tapered off with sales of passenger vehicles still lagging behind production as recently as September.
The export market would seem a logical outlet for the surplus of China-made autos and components. However, large-scale exports, especially to Western markets, seem unlikely for at least another five years. For the US auto market, in particular, there are a number of factors holding back Chinese imports. These include quality, supply chain problems, just-in-time delivery needs, lack of distribution channels, brand preferences, patent infringement issues and US safety and emissions standards. The biggest catch may simply be that US and European manufacturers, who control some of the best distribution channels, have set up production facilities in China to focus on China sales and are unwilling to cannibalize their positions in their home markets.
To combat slower domestic sales growth and tap into lower-income Chinese consumer markets, both Chinese and foreign auto producers are looking to component and parts suppliers in China to provide cost savings. At the same time, future export prospects will depend heavily on the growth and maturity of Chinese parts suppliers. Accordingly, many observers point to the parts and components industry as a potential driver for another China auto takeoff and a crucial point of interest for investors in China's auto industry.
Auto parts
Prior to China's WTO accession in 2001, domestic automakers had to purchase over 80 percent of parts from local, affiliated suppliers. This gave rise to a highly fragmented industry, with over 5,000 individual manufacturers, which remains today. Most component suppliers are small and medium size companies-only about 2 percent of companies have sales exceeding US$10 million per year, and only 6 percent have sales over US$100 million per year. Research and development (R&D) capabilities among Chinese companies are very weak, with many spending less than 2 percent of their budget on R&D (versus 5-10 percent among foreign companies). Because Chinese suppliers lack the ability to manufacture higher-quality OEM parts with more rigorous specification and tolerances, most parts have been imported for assembly in China. These imports, along with the additional shipping fees and tariffs, contribute to higher production costs that often exceed those in Europe and the US by up to 20 percent. In terms of world auto parts trade, China pales in comparison to the major manufacturing countries. In 2004, China's auto part exports represented less than 0.5 percent of the total world market, with the bulk of exports still coming from North America (30 percent), Europe (25 percent), and Japan (20 percent). Bilaterally, China represented less than 5 percent of the US' total auto component imports in 2004.
Recent Trends
Although China's auto part industry still faces many hurdles before it becomes a world powerhouse, a closer look at recent developments reveals some promising trends for the industry. Auto makers in China are increasingly sourcing locally from a rapidly improving supply base, thereby lowering production costs. The shrinking trade deficit in auto parts is evidence of this: imports of key components and spare parts fell 19 percent and 38 percent, respectively, in the first nine months of 2005. In the export market, Chinese auto part exports have grown steadily (see graph). In the first six months of 2005, Chinese auto part exports to the US grew 45 percent over 2004, while export growth figures from the US' four largest trading partners were all in the single digits.
China's current auto part exports are not limited to the low-quality end of the spectrum anymore. Foreign auto companies are betting on China's future and strategically building Image in china manufacturing bases in-country, which will continue to bring more advanced technology. Shanghai Yanfeng Johnson Controls, a joint venture seating systems producer, ranked in the top five in terms of export volume among all Shanghai-based companies in 2004. By 2009, GM plans to purchase US$4 billion in parts annually for GM assembly factories outside of China and source an extra US$6 billion for China-based operations. Not to be left behind, Ford also has plans to increase parts sourcing from 2003's US$1 billion. Currently, Ford is building an engine plant in Nanjing, which will reportedly have an annual capacity of 350,000 engines and is designed with the flexibility for future expansion.
The deal is a joint venture with Mazda and Changan Automotive Group and will start operation in 2007.
And the winner is
After years of fragmentation and inefficiency among the local auto part suppliers, the time has come for the industry to shape up. Increased local competition, along with cooperation between international companies and local suppliers to improve quality and R&D capabilities are pushing Chinese suppliers to reach competitive price and quality levels. By 2006, tariffs on imported auto parts and components into China will fall to 10 percent, which should put added pressure on local suppliers who stand to lose out to imported parts. With no clear leader in China's auto parts industry, the biggest question is: Who will emerge as the front runner? There is certainly no shortage of candidates. Foreign distributors and foreign manufacturers, such as Delphi, Bosch, and Denso, have foreign expertise and knowledge of distribution channels in the major export markets. On the other hand, Chinese manufacturers (SOE and private) and Chinese trading companies, such as Wanxiang, have home-field advantage when it comes to understanding the local supplier base and are quickly expanding into export markets.
At present, there are still no signs of industry consolidation. The Chinese government has plans to encourage consolidation of local suppliers to form "internationally competitive" groups in the coming years and has set a target that more than 40 percent of domestic companies' sales will be exports by 2010.
Whoever comes out on top will need to provide substantial cost advantages and use economies of scale, as high shipping costs for heavy parts and just-in-time delivery needs are significant drawbacks to sourcing from China. And in a market as young and complex as China's, the importance of a steep learning curve cannot be overstated.
