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china and autos decentralization and competition in an exploding market

Note that I skipped many slides in my class presentation. Feel free to ask followup questions at:

[email protected]

If you are not using a W&L account, it could get trapped in the new spam filter -- I always acknowledge emails quickly, so if you don\'t hear from me, send it from another account!

China and Autosdecentralization and competition in an exploding market

Spring 2007, Shanghai

Washington & Lee University Study Abroad Trip

two tasks
Two tasks
  • Teach you more about China
  • Prepare you to ask a real expert good questions (Alyssa Webb)

(Maybe teach a little economics, too)

slide5

US

China

Japan

India

Mexico

Korea

Russia

Germany

Brazil

France

UK

Italy

political economy industrial organization
Political economy + Industrial Organization
  • Early auto industry: ford\'s position
    • Monopoly!
  • Then GM, Chrysler
    • Oligopoly
  • Now Toyota, Honda, Nissan
    • And imports, all with multiple models
  • Monopolistic competition
    • Zero (economic) profits, excess capacity, high distribution costs (advertising, inventory)
    • Choice is costly…
so how about china
So how about China?
  • What do you see on the road in Shanghai?
    • When you got into a taxi, what make was it?
  • A VW Santana, right?
  • So how many car producers under Mao?
    • Initial single Soviet plant in Manchuria ca. 1958
  • But then decentralization
    • Entering modern period =
      • 119 firms!
  • Each part of a local monopoly
excess entry
Excess entry
  • Initially one Soviet plant in Manchuria
    • Based on a Fiat plant
    • But also regional military plants from late 1940s
  • But extreme decentralization under Mao
    • "3rd Front" policy put production in remote areas in case Russia invaded
  • Party rewarded output
    • Industry counted (but not quality!)
      • services didn\'t
      • agriculture was grain first
all 30 odd provinces had plants
All 30-odd provinces had plants
  • Trucks of course were primary
    • But also cars
    • Motorcycles, motorbikes
    • Various tractor-like 2-, 3- and 4-wheelers
  • How was that possible
    • Look at Shanghai\'s roads:
      • VW Santana still large share
    • Look at Beijing\'s roads
      • Even though it is the #1 vehicle in China
      • You\'ll see almost no VW Santanas!
political success from output
Political Success from output
  • Not efficiency!
  • Local protectionism
    • Huge employment levels in the aggregate
      • By that measure, China is #1 in world
  • Productivity began improving in the 1990s
    • But still pressure to buy local
      • And military / government demand too
    • Plus not (yet) at international efficiency levels
    • Big jump since 2000
  • Economies of scale -- more later
so how many firms now
So how many firms now?
  • No good count! But … in all likelihood more!
    • So 120+ firms
  • Why no exit?
    • Growth allows all to survive
      • For now…! With help by local governments and banks
    • Compare that to the US market entering WWI, smaller than China\'s market yet dozens of firms
    • Role of suppliers: assemblers, well, assemble!
      • And market
      • And (sometimes!) design
  • Contrary to central government policy!
    • Which has long and unsuccessfully pushed consolidation
however
However…
  • A few success stories developing
    • VW but lots of Buicks in Shanghai
    • Guangdong significantly richer
      • Honda and Nissan and now Toyota
    • 4 domestics stand out
      • Chery, Brilliance, Geely, SAIC
  • Three delta regions (my sense)
    • Pearl River (south), Yangtze (mid), Yellow (north)
    • Sichuan as a potential 4th region
      • But everyone else trying, Anhui doing well!
market structure shifting
Market structure shifting
  • Trucks and luxury vehicles at start
    • Chauffeured vehicles
  • Now mid-sized a big share, plus minivans etc (especially corporate use)
  • New segment: compacts at $7000-$10,000
    • Still a luxury, but lots of rich Chinese
      • Sales are now greater so do China\'s middle/upper class families outnumber Japan\'s population!?
  • regional producers with small, cheap vehicles
      • Also inexpensive
region x segment
Region x segment
  • Fragmented market! - only 2 firms have a double-digit share
  • 20 non-Chinese firms
  • 29 substantial Chinese firms
  • 49 firms total!
    • 14 have sales over 100,000 units
    • 6 have sales over 250,000
      • VW, GM, Honda, Chery, Hyundai, Toyota
    • 1 has sales over 500,000: VW

exit, yes, but still new entry

some adjustment already
Some adjustment already
  • No longer does everything sell
    • Obscene initial monopoly prices gone
    • Profit margins were 30%!!
      • Now prices down 20% for many models
  • VW as representative monopolist
    • No new models
    • Indifferent quality
    • Slow to respond when market changed
  • But in general capacity constraints
      • Which won\'t last forever
sustainable
Sustainable?
  • Some exit over time
      • Some already … Fiat venture up for sale?
      • M&A strategy (maybe) to consolidate regionals?
  • 6.15 million units in 2006 and growing
      • US at 16-17 million still much larger
      • But Germany Japan France all smaller
  • Fragmentation!
      • New models at roughly 1 per week
        • But still less than US with 650 models?
      • Yet industry benefits from economies of scale
  • So a contradiction?
many will survive
Many will survive
  • Fierce competition, will be surprising successes
    • For now hard to fail, will have many producers
      • Compare to Big Six in US, plus Little Six, plus imports
    • Some will end up in bad niches / mismanage JVs
  • Much will hinge on government policy
    • Environment!
    • Auto industry an easy political target everywhere
  • Unique strategies echoing 1910s in US
assembly is not all
Assembly is not all
  • Everwhere…
    • Parts employment at least 2x assembly
  • Assemblers assemble
    • Parts producers make
    • Parts producers engineer
    • Parts producers enjoy economies of scale
  • Outside China, Magna may adopt same
    • Looking to buy Chrysler!
parts production
Parts production
  • Key to the industry
    • All the major players are here
      • 75 of top 100 global firms
      • 1,200 foreign and joint-venture plants total!
        • Can have 100% subsidiaries, unlike assembly
    • Delphi has 500+ engineers
        • More than some car assemblers!
  • Experience & capacity growing rapidly
industrial geography
Industrial geography
  • Asia needs parts producing capacity
    • Duh, Chinese market up 20+% in Q1 of 2007
      • India, ASEAN (Assoc Southeast Asian Nations) growing too
      • You have to add capacity somewhere!
  • Implicit rule of thumb:
      • Assemble where you sell, make parts nearby
      • But a long transition to accomplish that!
  • China not low cost for labor intensive parts!
      • Nor is it always low cost against existing plants
    • But it beats a new plant in Japan or Korea!
        • Not to mention Germany and
other ancillary industries
Other ancillary industries
  • In aggregate 3x manufacturing
    • Repairs and service
      • A big segment
        • old & poor quality vehicles
        • Hard use on rough roads
        • NO info … but maybe you can find some?
        • Yellow Hat of Japan seeking to enter?
    • Dealers
      • Largely ignorant about those in China
        • But will meet Infiniti people
        • Lots of consultants, professional marketing
      • Dealerships can be a real estate play, too
policies
Policies
  • Lots of imports at different points in time (Kia!), but now small share of market (250,000)
  • Strong pressure for joint ventures
    • Constant tensions
      • Some Chinese firms have multiple subsidiaries
        • More than one foreign partner
        • Ambitions to launch vehicles on their own
  • Barriers (perceived & real) encouraged entry

Probably too successful for own good

autos and energy
Autos and Energy
  • Energy demand rising at +2.3% per year
    • Hence doubles in 30 years ["rule of 72"]
    • No growth 1996-2000
  • Why so low?
    • After all, GDP growth is huge!
      • 7%-11% implies economy doubles in
        • ≈ 10 years at 7%
        • < 7 years at 11%
    • Old rule of thumb: elasticity ≥1.0 ["elasticity"=?]
nature of energy demand
Nature of energy demand
  • Less heavy industry
    • New firms use higher quality energy sources
  • Less crude sources by households & others
  • More urban
    • more energy efficient than rural
    • But (duh!) more autos
  • So weight of petroleum up
    • China now a net importer
      • 1979 exports ==> big push development strategy failed
      • Cf. perestroika in USSR … parallels & contrasts
why poor link
Why poor link?
  • Legacy of planned economy
    • Prices are administered
    • Starting efficiency levels abysmal
      • 80% poor quality coal in 1980
        • Still 56%
      • Electricity, petroleum
        • 13% and 24% respectively
now transition over
Now transition over?
  • Initial economic reforms (as in USSR) premised on energy exports
    • Petroleum and coal
      • Former never panned out, now latter nil
  • So net importer
    • Petroleum up 15% to 20% pa
    • Small share of world total at 3.5%
      • But with low growth elsewhere, large share of incremental demand
how will change
How will change?
  • Better quality coal
    • will be source for electricity
  • Motor vehicles petroleum for next 2 decades
    • Electric vehicles in urban, low-distance areas
      • Fits China?!
    • Hydrogen a long ways away?
      • But no existing gasoline infrastructure so sensible?
      • Government policies can push easier than in US / EU
    • Hybrids not viable
      • Silly to put 2 power plants and battery in a small vehicle
autos and pollution
Autos and Pollution
  • 16 of world\'s 20 most polluted cities
    • SO2, NO2 , CO, ozone, PM (particulate matter)
      • In a short breath, smog
    • Est. 590,000 excess deaths a year!
  • Tianjin health impact 3.7% GDP (US$1.1bil)
    • Even though pollution cut by 10+%
  • Source 50-80% from motor vehicles
    • Additional congestion time losses
  • Only recent switch to unleaded fuel
    • Additional hidden costs from brain damage
energy sum
Energy: sum
  • Motor vehicles will account for about
    • 60% of demand in 2020
    • Improving efficiency even 1% has impact!
    • Easy political target
big push for electric cars
Big push for electric cars
  • Good for within-city transport
  • Uses night-time generating capacity
    • Peak load is daytime
    • So electricity providers have huge strategic & management challenge that this helps
  • Technically feasible in short-run
  • But government also favors hybrids
    • Maybe irrationally so
is it good policy
Is it good policy?
  • Maybe … shifts location of emissions away from urban areas
    • Key for smog, as in LA (electric plants downwind in NV)
    • Maybe not be lower overall emissions
      • depending on details
  • Electricity can potentially be cleaner
      • May not save energy or cut CO2
      • Lots of waste across entire electricity chain
      • But electric engines pretty efficient
  • Batteries an issue; government can mandate
political salience
Political salience
  • Consumers "understand" cars
    • Not technical electric power grid issues
  • Few producers so administratively easy
    • Though China stretches the definition of "few" more than anyone!
  • Also licenses etc etc make policy easier to implement
    • Autos are a sexy industry
    • Sex is OK in politics
    • but fouls up decision making (a polite 4-letter "f" word)
lessons 1 of 2
Lessons? 1 of 2
  • Legacy of extreme decentralization
    • Interesting strategy issues
  • Entry game with lots of players
    • long-run reality of monopolistic competition
    • Until then, really profitable

- for some

  • Extreme competition
    • Survivors may have unusual skills and strategies
      • 35% of GM\'s advertising is for internet chat rooms
lessons 2 of 2
Lessons? 2 of 2
  • Political economy
    • Auto industry everywhere politicized
    • At least in post-WWII era
  • Lots of externalities but
  • Direct auto policies not always best
    • Biggest sector (parts!) escapes attention
      • Sheer diversity makes regulation hard
conclusion
Conclusion
  • Transport as a positive externality
    • Without transport, markets can\'t function
    • Motor vehicles offer flexibility trains don\'t
  • Without transport, poverty
    • Poor rural residents vastly outnumber urban poor
  • Transport is ONE element of development
    • A necessary(but not sufficient) component
  • Assignment
    • judge the infrastructure you encounter
      • Vehicles (making selling servicing) isn\'t the issue!
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