Analysis: Chinese dealerships struggle as growth slows in the automobile market

Gasgoo.com (Shanghai) - The decline in sales growth in the Chinese automobile market is increasingly influencing automobile dealerships across the country. According to a recent study done by J.D. Power and Associates, only 63 percent of automobile dealerships in the country made a profit in 2011, compared with 81 percent the year before. The amount of Chinese dealerships reporting a deficit, meanwhile, jumped from nine percent in 2010 to 20 percent last year. With the state of dealerships continuing to deteriorate, there are fears that the market may witness negative sales growth in the near future.

In order to examine the severity of the problem, Gasgoo.com (Chinese) and the Chutian Metropolis Daily conducted a survey in mid-May, with a total of 2,318 analysts and experts from the automotive industry participating. The four question survey focused the current and future financial status of dealerships in the country.

Participants were first asked how they analyzed the decreasing financial performance of dealerships last year. 44 percent of participants believe that the drop in profits was the inevitable result of excessive expansion on the part of manufacturers and their dealerships. 39 percent answered that it was just another sign of decreasing growth in the market, while 11 percent said that the weak performance of own brand manufacturers held back the overall industry average.

A total of 18.5 million vehicles were sold in China in 2011. Sales growth plummeted from over 30 percent in previous years to just 2.5 percent last year. Despite the drop in sales growth, the fact that it still remained positive means that the financial status of dealerships should remain more or less unchanged from 2010. The question then is why did the amount of dealerships reporting a profit drop nearly 20 percent?

Regardless of whichever aspect one looks at, it is indisputable that the market for automobiles in China is becoming increasingly competitive. On this note, competition among dealerships is also becoming fiercer. This in turn leads to accumulated advantage in the market becoming more apparent, where the most successful dealerships continue to prosper, while their weaker competitors fall further and further back. According to statistics from the China Automobile Dealers Association (CADA), the number of dealerships with total business returns of over 10 billion yuan jumped from 13 outlets in 2010 to 21 last year. Those 21 outlets' sales also accounted for 60 percent of all total dealership sales in 2011. Growth in their business returns, sales and profits were 59 percent, 30 percent and 61 percent, respectively. All of those growth figures were far above the industry average. This signifies that dealers on the lower end of the spectrum performed weaker than average, which would explain the high number of dealerships reporting deficits this year.

In addition to growing competition, several manufacturers have been implementing expansion programs for their sales networks, increasing the total number of dealerships in operation. These programs were established in response to seemingly endless consumer demand for automobiles in 2009 and 2010. The government's Implementing Measures on Management of Automobile Brand Marketing, meanwhile, does not restrict the number of dealerships a manufacturer can possess in a single region. In addition to continuously opening outlets in key cities, the number of dealerships in second- and third-tier cities increased dramatically last year. The government, for its part, poured four trillion yuan to help encourage further economic growth, a significant amount of which ended up in the automobile market. Furthermore, many new dealerships lacked proper sales and management training, and as such offered subpar customer service. As growth in the market began to subside, these dealerships suffered heavily.

One point that remains unresolved is what effect the poor performance of domestic own brand manufacturers had on the overall state of Chinese dealerships. Own brands have indeed lost a significant percentage of market share over the last two years. However, there are no statistics that prove their declining sales significantly affected the overall performance of dealerships in the country.

When asked whether or not the situation would change for the better this year, the majority of participants, 89 percent, were fairly pessimistic. They believe that, due to high number of dealerships currently operating, competition will remain fierce throughout the year, with profit margins for several dealerships becoming smaller and smaller. Only three percent were optimistic that the situation would improve this year, while eight percent were undecided.

According to statistics from the State Administration of Industry and Commerce, there were approximately 65,900 automobile dealerships operating in the country last year. In addition, there are several thousands who are awaiting official certification. New vehicle sales in the world's second largest automobile market, the United States, are two-thirds the amount of China's, but the number of dealerships there are less than one-third of China's.

Not only is the current number of dealerships in China extremely high, it is continuing to grow. Many foreign enterprises and their joint venture partners are highly optimistic about the Chinese market, and as such are continuing to vigorously expand their sales networks in the country. Incomplete statistics reveal that no less than ten different manufacturers are in the process of implementing expansion plans for their sales networks. Among them, General Motors is aiming to add 600 new outlets this year, while Ford and Mercedes-Benz have plans to add 110 and 40 outlets, respectively. FAW Volkswagen is planning to increase its sales network from its current 445 outlets to over 800 by 2015.

By comparison, most own brands have decided to play it safe. Chery and BYD have announced that they will not be adding any new dealerships for the time being, while Geely's network expansion program will focus on improving sales management and other aspects. Great Wall has even stated that it will cut down its sales network by 20 percent by removing outlets that don't meet its standards. However, the number of new enterprises setting up dealerships, including Chery's Qoros, Guangqi Fiat and Changan PSA, will even out any reductions made in own brand networks.

Most growth predictions for the Chinese automobile market this year are between five and eight percent. However, the market actually experienced negative year-on-year growth of 1.3 percent in April, signifying that many dealerships are still under heavy pressure to make sales.

One important reason why dealerships have been struggling recently is that they rely heavily on new car sales to make profits. Their other operations, such as maintenance, insurance and finance work, don't generate nearly as much revenue. According to CADA statistics, automobile sales accounted for 88 percent of cumulative business returns of Chinese dealerships last year. Despite the fact that the gross profit margin for sales is between 30 and 40 percent, the relatively high quantity of sales orders make it the main source of revenue for dealerships. This is in stark contrast to Western markets, where approximately 60 percent of a dealership's gross profits come from maintenance, insurance and other services. Due to their lack of dependence on sales, Western dealerships aren't as easily affected by market fluctuations.

The third question of the survey targeted this issue by asking participants when they believed a change to the traditional profit structure for Chinese dealerships would occur. 45 percent of participants answered that it would take five to ten years for such a reform to take place. 37 percent believe that such a change may happen in the next five years, while the remaining 18 percent said it would take more than a decade.

A trend towards diversifying profit sources has become apparent among Chinese dealerships, though the pace with which it is developing is relatively slow. The percent of returns from aftermarket services for the country's largest dealership network, Pangda Group, has increased from 4.06 percent in 2011 to 6.73 percent in the first half of 2011. The group's gross profit margin from aftermarket services is around 30 percent, as opposed to approximately seven percent from automobile sales. That said, aftermarket and other services still account for less than a quarter of most dealerships' total gross profits. The slow speed profit diversification is taking in the country means that it may take quite a while before domestic dealerships will resemble their counterparts overseas.

The final question on the survey dealt with several dealerships' plans to open themselves to public trading in order to deal with increasingly tough market conditions. Only 14 percent of participants agreed that this method would significantly increase sales growth for dealerships and help them become industry leaders. The majority, 51 percent, maintain that while such a method has certain advantages, the gains to be made are limited. They believe that, since automobile sales remain the primary source of revenue for dealerships in China, offering shares of dealer networks for public trading should not drastically affect their fiscal performance.

29 percent of participants warn that the legal obstacles a company has to deal with when registering for public trading are considerable in China. Even if a dealership managed to successfully register, any profits to be gained would be held down by the large costs they had to incur.