Analysis
15 Jan 20

A brutal 2020 for China’s OEMs

China’s economy is slowing down; Western media outlets like to remind their readers and viewers that the seemingly unstoppable success of the world’s second biggest economy has come to an end and the country is in crisis.

The reality however is a bit more nuanced. Yes, the trade war with the US has a direct impact on growth, which is translating into decreased export figures, high import costs and a manufacturing drain to countries such as Vietnam, but there is also another cause for the slowing down of China’s economy.

The country is transforming the core identity of its industries, moving away from its “low-cost, low-quality” reputation to a high-tech one. This – planned – transformation is taking time and requires change and investment. China counts on continuous growth to achieve its objectives; when growth slows down, innovation slows down.

Automotive sector

Even if the market is gigantic, automotive manufacturers are facing other challenges in addition to the overall economy’s slowdown. First, subventions for low-performance EVs have been cancelled by the Government. China produces many EVs, but many of those are pretty basic, have a limited range and are not produced according the Government’s standards in terms of sustainability, efficiency and use of materials. These vehicles are sub-par compared to a Tesla or a Leaf, but they were affordable for a car-eager middle class, who is now forced to look at combustion alternatives, that are much more difficult to register (registering an ICE in China is either very costly or is regulated via a lottery system).

Difficult customer

A second challenge for Chinese OEMs is its customer. The Chinese consumer liked sedans until they liked SUVs, they liked European-styled vehicles until they liked a more local design… In order to please the local car buyer, the manufacturers need to be able to anticipate to each change of taste of a very difficult consumer. Strategic mistakes can terminate an OEM; for instance, those who have missed the SUV trend are paying a high price today.

Failing distribution network

As the appetite for cars grew, the size and number of car dealerships increased dramatically. Chinese car dealerships are huge and expensive palaces with an enormous stock of vehicles to satisfy the unwillingness of the consumer to wait for their cars to be delivered. This situation has generated 2 additional problems for the OEMs. Firstly, as car sales are slowing down, many of the dealers are no longer able to reimburse the loans taken to build the concessions, which has led to first wave of bankruptcies and the need for OEMs to pump money into the distribution network, just to ensure its survival.

The second problem is again linked to the unpredictable behavior of the consumer. The Chinese car buyer is no longer happy with the experience of a regular dealership. They don’t need salespeople to obtain information and compare prices – why would they, as information is widely available online? The Chinese consumer is looking for a digital experience in city-center flagship stores and wants the actual dealerships to be located in the easily accessible outskirts of the mega-cities. This is a completely different distribution strategy and OEMs are not prepared.

Failing pricing strategy

Most Chinese pay their vehicles either in cash or via a bank loan. Previously, when the economy was still in its massive growth phase, cash was widely available, and banks didn’t mind lending some cash to buy expensive cars – salaries increased by 10% or more year on year. People today however are less certain about salary increases and prefer to invest their cash in items that keep their value.

The Chinese OEMs have reacted to this by increasing discounts on the vehicles, resulting in discount wars between manufacturers and dealerships. Obviously, the residual values of these heavily discounted vehicles dropped even further, and sales dropped even more.

Mobility as a Competitor

Finally, the Chinese market is transiting from “purchase” to “mobility” without passing by the “leasing” option, as it is the case in North America and Europe. The leasing industry in the West has, to a large extend, saved the automotive industry as it led directly to volume increases, better renewal cycles and a professionalization of the secondhand market.

China is skipping the leasing phase and is moving directly to mobility solutions, aided by the difficulties to register a private car. The car industry is therefore missing out on corporate volumes and remarketing expertise.

Knockout match

BAIC, China’s number 4 OEM and a local EV manufacturing leader, is anticipating another brutal year. This is how their GM, Zhang Xiyong puts it: “It is a knockout match that some auto industry insiders have not yet understood to the full extent.”

Local OEMs need the joint ventures with EU and US brands to work well in order to survive. Another risk here, as the Chinese Government is allowing for foreign manufacturers (under certain conditions, such as innovation, high-tech implementation…) to operate in China without JVs in place.

Eventually, Chinese manufacturers will need to start focusing on export, which has never been very high on the agendas. This requires again an expensive change in strategy… All in all, not a good time to make cars in China. We’ll probably see a “survival of the fittest” 2020, surely with a few bankruptcies, mergers and – it’s China after all – a volatile regulatory landscape.

Authored by: Yves Helven
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