A global road map for China’s automakers

Under the hood

Less than a decade ago, the annual production of a typical global automaker dwarfed the output of China’s entire auto industry. Since 2002, however, the country’s automotive sales have grown by 25 percent a year—up from 10 percent a year between 1997 and 2001—and in 2006 China overtook Japan, to become the world’s second-largest market for automobiles. What’s more, from 2001 to 2006, China’s vehicle exports rose by a remarkable 67 percent a year, to more than 340,000 units. Gone are the days when carmakers such as Shanghai Automotive Industry Corporation (SAIC), First Automobile Works (FAW), and Dongfeng Motor relied solely on joint ventures with foreign OEMs to make automobiles.

Today, these carmakers have joined Brilliance Auto, Chery, Geely, and other local players in either launching or announcing plans to produce branded vehicles. In 2007, China exported upward of 500,000 cars and trucks—more than 70 percent of them bearing domestic Chinese brands—to Africa, Eastern Europe, Latin America, Russia, and Southeast Asia.

Significant strategic and structural advantages underpin these successes. Compared with the starting point of the Japanese and South Korean OEMs, in the 1970s and 1980s, respectively, Chinese carmakers enjoy a massive, fast-growing home market that allows them to scale up operations quickly and avoid any reliance on exports for growth. Compared with today’s global carmakers, Chinese OEMs command substantial cost advantages, including lower capital and labor costs, to say nothing of much lower levels of capital investment. (Chinese OEMs typically sub stitute cheaper labor for more expensive plant automation.) Altogether, China’s cost advantages over OEMs based in mature markets have now reached 30 to 40 percent, even after the recent appreciation of China’s currency. Projections foreseeing increased global demand for low-cost cars, as well as growing openness to Chinese brands on the part of Western consumers, suggest that the country’s OEMs do have global opportunities in the long term. Finally, these carmakers, unencumbered by a legacy infrastructure, could leapfrog their global competitors—for example, by developing alternative power-train vehicles to capitalize on growing demand for environmentally friendly products.

Yet the industry’s significant shortcomings must temper such optimism. According to the 2006 J. D. Power and Associates IQS, the Chinese industry average for problems per hundred vehicles, at 231, was nearly twice the US average. Worse still, the average was almost twice as high for domestic Chinese OEMs, at 368, than for locally built international brands. In safety tests conducted by independent agencies in Europe and elsewhere, Chinese carmakers, including Brilliance and Jiangling

Motors, fared terribly. In 2005, Jiangling’s Landwind SUV earned no stars at all from ADAC, an independent German automotive organization.

Our experience working with Chinese OEMs suggests that many of these problems have operational roots. But there are other issues, too. Some OEMs, in their zeal togo global, fail to prioritize target markets sufficiently and therefore divert precious management attention away from product quality. Some embark on ambitious globalization plans before establishing strong market positions at home and so fail to take advantage of the important learning opportunities available there. And some don’t pay enough attention to marketing and distribution—even outsourcing these activities to local partners (see sidebar, "Beyond production"). Such quick-and-dirty approaches risk permanently damaging brands.

Further, organizational shortcomings can short-circuit operational processes and thus raise costs and lower quality. One Chinese carmaker we studied, for instance, had a seemingly robust and well-documented quality-gate system to catch defects during product development. Although the system detected problems adequately, many errors went unfixed, largely because of poor collaboration within the company and intense pressure on engineers to deliver products quickly.

Other OEMs take a scattershot approach to talent. To jumpstart productdevelopment, for example, one of them hurried to recruit dozens of experienced Chinese-born engineers from the Big Three automakers. Although the engineers were skilled in safety, interior design, and other specific technical areas, they lacked the project-management and system-integration skills needed to run an overall vehicle program and had little experience managing interactions with suppliers or colleagues in other departments. The resulting lackluster improvementsdisappointed top executives.

The road ahead

To improve, China’s automakers must adopt a focused strategy, upgrade their operational skills and product quality, and develop rigorous performance evaluation systems that promote a culture of continuous improvement from the C-suite to the shop floor.

A focused strategy

Chinese auto executives should start by asking themselves a tough question: do we have sufficient scale and financial and management resources to go abroad? For the majority, particularly OEMs selling fewer than 300,000 cars a year, the answer is

probably "not yet." Hyundai, for example, entered the US market, in the mid 1980s, with volumes comparable to those of many smaller Chinese OEMs today. Its fast start was hampered by quality and other problems that damaged the company’s reputation with consumers and took several years to repair.

The risks are greatest for China’s smallest OEMs—those selling fewer than 100,000 units a year—which face a difficult trade-off, because the cost of meeting stringent Western safety and emission standards could price vehicles beyond the reach of Chinese consumers. These companies should consider licensing their technology to partners. The fledgling Chinese automaker BYD Auto, for example, which began as a supplier of batteries and electronic components to mobile-phone makers, might be well served by this approach, because the company’s experience with rechargeable batteries gives it advantages in the growing market for vehicles using alternative fuels.

For automakers intent on globalization, the imperative is focus and, in some cases, patience. We’ve seen Chinese OEMs—in their eagerness to expand—overlook or misjudge the size, competitive intensity, or consumer tastes of target markets and consequently find themselves overstretched and playing catch-up against competitors with stronger offerings. Some Chinese OEMs plan to enter 20 or more individual markets simultaneously. The strategic rationale for such plans is weak. In Africa and Southeast Asia, competition isn’t less intense than it is in China, and such markets, even combined, are considerably smaller than China’s domestic market.

Overly ambitious plans can also divert management’s attention and thus compound

operational problems and strategic oversights. In 2006, for example, both Brilliance and Jiangling not only suffered quality and safety problems in their rush to crack the lucrative European market but also unnecessarily limited their potential by misjudging important market characteristics. Neither company offered diesel engines, which power about half of Western Europe’s passenger cars. Brilliance targeted a declining category—Sedan-D, a midsize segment in which European sales are falling by about 6 percent a year—and didn’t offer station wagons, though they constitute about half of Europe’s Sedan-D segment. The results were disappointing: together, the two companies sold only about 150 vehicles in Europe in 2007, far below initial forecasts.

Some OEMs are doing better. Chery and Great Wall Motor, for example, postponed expansion in Europe and North America, instead focusing on Russia, where the market dynamics are more favorable. Russia, for example, has a relatively large fleet of aging, domestically produced vehicles, and the country’s growing economy has spurred strongly growing demand for new cars. Yet because many imports from Western OEMs are out of reach for ordinary Russians, Chinese automakers have opportunities to target consumers seeking new, low-priced cars. Both Chery and Great Wall have capitalized on these advantages: Chery sold about 40,000 vehicles in Russia in 2007, Great Wall more than 8,000. At times, Chery has struggled to ship enough cars to meet Russian demand.

To grow further, Chinese OEMs must develop cars with proprietary design features.

Many of China’s automakers have reached their present size by reverse-engineering the models of competitors. Over the long run, this approach will fall flat in export markets, particularly developed ones. Compact and standard vehicles, representing about 40 percent the EU and US markets, offer good near-term prospects, although they are underrepresented in the offerings of most Chinese OEMs. In the longer term, however, Chinese automakers should aspire to create truly innovative productlines—for example, high-quality electric or hybrid vehicles.