China’s Auto Reform: One Foot on the Gas, One Foot on the Brake

In the Hutong

Good grief, March already?

2111 hrs.


The Associated Press is reporting that we can expect China to undertake a reform of its largely state-owned auto manufacturing sector. The plan apparently calls for China to winnow the number of domestic auto manufacturers from 14 down to 10.

No, Not THAT Big 10…

The AP report refers to a Chinese “Big 10” made up of a top tier of auto makers with the capacity to make 2 million vehicles or more (Shanghai Automotive Industry Corporation (SAIC), First Automobile Works (FAW), Dongfeng Motor, and Changan Motor) and a second tier of six manufacturers with capacity of around 1 million cars per year.

First, some perspective: a million cars a year is not small, but Ford and GM will probably make around 9 million vehicles apiece this year, so “Big 10” is still relative.

Second, in an environment where the auto business is so difficult that even Toyota is starting to sweat, one might ask whether China is being a tad cautious in reforming the auto business. It would seem a tad ambitious to envision a global market with sufficient room for ten Chinese car brands.

In truth, China is being cautious about consolidating the country’s auto business, and for good reasons.

Slow and Steady

The first and most important is the geographic dispersion of China’s car makers, and the political challenges that implies. Unlike the U.S. car industry, which was traditionally concentrated in the state of Michigan, China’s automakers are scattered around China.

Closing one – even if it is just eliminating the brand and keeping the factory – means favoring one region over another, and that is sensitive in an economy so careful with its local companies that domestic protectionism remains a major challenge to the country’s development.

Edmunds Inside Line notes that if local governments want they can derail the process. Even if they do, that derailment won’t be permanent – the central government will get its way, but the question will be the cost: each closure is going to demand negotiation and horse-trading among the governments, meaning more costs and delays.

Second, China does not want to undertake consolidation at the expense of market share. Foreign makes still take up over 60% of local vehicle sales by volume, and closing down too many local companies too fast will mean that foreign marks will gain ground. Given China’s stated intention to create global auto marques of its own (rather than just being the factory for European, Japanese, Korean, and American brands.) Given that the ability of the remaining 10 automakers to increase capacity is limited, best to go slow.

Third, all of the industrial policy in the world does not make up for solid market performance. It is still too early to tell which automakers will be able to make the difficult shift into international markets and then be able to build that into global leadership. Picking candidates, not winners, is the wise approach now.

Upshift

Finally, there are the intertwined issues of technology and the environment. And for us here in the Hutong, this is a big one.

In the coming decade, China’s auto industry is going to have to shift away from petroleum-fired internal combustion engines to something else: The country’s air quality will not be able to take hundreds of millions of cars running on unleaded; simply fueling those cars would put China into a geopolitical face-off with the U.S. and Europe; and the global car manufacturers who remain after the global downturn will be producing their own low-emission or zero-emission vehicles in China.

That shift is going to mean investments so large in technologies so complex that it may force a rethinking of the entire automobile industry. The logic of a single vertically-integrated manufacturer starting with steel, plastic, and rubber and churning out cars may not hold is the industry makes its leap.

As such some companies in China’s auto industry may well elect to specialize either in assembly or components, opening the door for one or more of the current players to ease their way out of making cars and into supplying China’s remaining brands with motors, batteries, fuel cells, bodies, or other major components.

If that happens – and I suspect that at least in the case of second-tier brands it might – it makes more sense to allow that specialization to evolve and chivvying it with the visible hand of government, rather than making those choices now. The coming years, in fact, are likely to involve the government making the case to some manufacturers move to making parts and components.

Taking a “slow-cull” approach to reforming the industry is the wise approach for China’s policy makers. The nation’s auto industry will be reformed in stages rather than with the single stroke of a pen, and the speed of those reforms will depend not only on market growth and global finance, but on the demonstrated ability of China’s automakers to withstand the successive waves of change they will face in the coming years.