The Beginning of the End For American Automakers in China

By Michael J. Dunne

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In the early 1980s Chinese leader Deng Xiaoping returned from visits to Japan and the US with a vision of China’s economic future. Seeing a connection between big car industries and economic prosperity, Deng laid out a​ strategy for​ transforming China from ​automotive pauper to ​​​automotive ​powerhouse:

1. Form joint ventures with American, German and Japanese carmakers.

2. ​Lock in Chinese control over the joint ventures.

3. Get the know-how to build our own high quality Chinese cars.

Thirty five years later, that master plan​ has come a long way, but is still incomplete. Yes, China has formed joint ventures with all of the world's ​top foreign automakers. Yes, Chinese has kept tight control over the joint ventures​​. ​And, yes, Chinese brands already control the commercial bus and truck industry, taking more than 90% of sales. ​

Up until now, however, Chinese automakers have struggled​ ​to match the quality of cars made by the global majors. ​Foreign models produced in China still account for the majority of car sales​. Drive the streets ​of Shanghai ​and you'll be ​struck by the number of VWs, Buicks, ​Chevys, ​Hondas, ​Toyotas and Audis.

​​​But change is afoot. Some foreign joint venture plants in China, like the Shanghai-GM factory that builds the Buick Envision, already have internal quality standards that are higher than some GM plants in the US. As Chinese automakers apply lessons learned at these joint venture factories to their domestic brands, the quality gap is closing and Chinese car buyers are shifting​ ​to home-grown brands.

Though China’s automakers still lag their foreign competitors and partners in quality and dependability, they are catching up fast. Vehicles made by one Chinese automaker, Guangzhou Automotive Corporation (GAC), scored higher than Ford and Chevy in the 2016 J.D. Power survey of initial quality. Power’s 2016 study of longer-term dependability also showed that Shanghai Automotive Industry Company’s (SAIC) Roewe and Baojun brands were more reliable than the Buicks it builds in partnership with GM. Of the 26 brands that exceeded the industry average for dependability, no fewer than 10 were Chinese.

Chinese automakers have been slower to catch up with the global majors than Deng probably hoped, but with competitive parity now close at hand his strategy is finally paying off. The Detroit car companies have had a very good run in China ever since the Beijing Jeep started production in 1984, selling millions of cars and earning billions of dollars in what is now the largest global market for cars, but their role in China’s industrial strategy is no longer critical. ​Investors should now ​prepare for the steady demise of GM, Ford and Fiat Chrysler in China. Here’s why:

​China's regulatory ​handcuffs​ - high import tariffs, forced joint ventures and ownership caps​ ​on foreign companies​ - are as suffocating as ever.

An American carmaker entering China suffers 25% import tariffs, an archaic forced joint venture rule and caps on foreign ownership. ​GM, Ford and FCA success ​in China ​​continues to rely largely on cooperation and support of their state-owned partners.

In contrast, a Chinese carmaker entering America can't believe its luck. Duties on imported cars are just 2.5%. And Chinese companies can own 100% of their operations. The playing field could not be more uneven.

​As always in China, the State plays a crucial role in ​shaping winners and losers. ​​How does that work in practice? Let's take a look at SAIC, the Fortune 100 global company owned by the City of Shanghai.

​SAIC runs two​ 50-50​ joint ventures in China. One is with General Motors, the other with Volkswagen. SAIC also produces its own cars under the Roewe brand name.​ ​

​For most of the past two decades, ​the Chinese ​managers at SAIC saw a quicker path to growth and profits selling ​VWs​ and Buicks produced by the joint ventures​ than through the much riskier project ​of ​ developing their own cars. ​

By selling foreign car models, Chinese state enterprise managers - usually Communist Party members - created thousands of new jobs, billions in fresh investment and a rich flow of tax revenues for the city. Those managers would earn hefty bonuses and often get promoted up through Party ranks. Yesterday’s state enterprise CEO in Wuhan becomes today’s Vice Minister in Beijing.

The risk-reward structure was clear: Why invest billions to create an all-new Chinese product when you can make fat profits - right now - selling Buick Envisions? ​

That logic, which has entrenched foreign domination of the Chinese market for decades, is now changing. As Chinese automaker quality improves with every passing year, luring more and more Chinese consumers away from foreign brands, SAIC’s incentives are shifting towards investments in its Roewe products.

In 2016, Roewe sales jumped 143% to 241,000 vehicles. In contrast, Buick sales grew by less than 10 percent and Chevy sales actually declined year-on-year. ​Keep in mind that ​Shanghai-VW and Shanghai GM have always been​ viewed inside China​ merely as subsidiary appendages of the parent company, SAIC.

​Another example: GAC produces the Trumpchi brand and also presides over separate 50-50 joint ventures with Honda, Toyota, and FCA. ​In a nearly flat ​2016 ​market, Trumpchi sales almost doubled to 371,000 units​.​ As Chinese brands overcome their reputation for poor quality, state enterprise managers are beginning to see advantages in selling more Roewe and Trumpchi cars. "​Why ​work hard to sell a Chevy when I can offer a Roewe - and keep 100% of the revenues?" goes the new thinking.

​For ​further evidence of th​is pro-Chinese trend​, look at ​​China's massive SUV market (projected 10 million sales in 2017)​. ​Chinese brands, as a group, overtook foreign brands in the SUV segment for the first time in 2016. China's best-selling SUV is the H6, a ​mid-sized SUV produced by Great Wall Motors​.

And even as Chinese automakers catch up with the global majors in traditional auto industry competencies like design and manufacturing, they are making major investments in the connected, electric and autonomous mobility technologies of the future. As these technologies mature, China hopes to leapfrog from competitive parity in the auto industry today to leadership in the new mobility industry of tomorrow.

Leading this trend are China’s Internet powerhouse companies like Baidu, Alibaba and Tencent (BAT), which are piling into the automotive sector. ​Since 2014, BAT have invested several billion dollars into California companies to access the world's best electric vehicle and autonomous vehicle technologies.

Their strategy: acquire the best technologies in California for deployment behind protectionist walls in the China market. Think California for R&D, China for production and sales.

In March, Baidu led a $600 million round of investment into NextEV, a Chinese premium electric carmaker with operations in Shanghai and San Jose. In April 2016, NextEV announced a $1.5 billion alliance with China’s JAC to conduct joint advanced manufacturing, supply chain and marketing work.

LeEco, the Chinese conglomerate, is investing more than $1 billion to fund Faraday Future, a company with operations in Gardena, California that is developing the FF 91, a Tesla competitor. Last August, LeEco revealed plans for a $1.8 billion dollar investment in a new plant near Hangzhou to build its premium electric vehicles.

Karma Automotive, formerly known as Fisker before it was acquired out of bankruptcy by China’s Wanxiang Group, conducts R&D from its $56 million offices in Costa Mesa, California. In August 2016, Karma unveiled plans to invest $375 million in a new Chinese plant to manufacture 50,000 Karma premium electric cars.

In March 2017 China’s most valuable company, Tencent, spent $1.78 billion for a 5% stake in Tesla. Separately, Tencent is investing in a Chinese electric vehicle startup called Future Mobility, led by several German executives who previously ran BMW’s electric vehicle program. Tencent has the option to partner with Tesla in China or - potentially secure Tesla technology for application at Future Mobility.

Finally, US firms operating in China feel more vulnerable to one-sided Chinese regulations than ever. According to the results from the 2016 survey of American Chamber of Commerce members in China, 4 out of 5 companies feel less welcome in China than before. Two of of their top three concerns are “inconsistent regulatory enforcement" and "increasing [Chinese] protectionism".

China’s regulations for its electric vehicle industry offer a powerful illustration. As with rules governing cars driven by internal combustion engines, all foreign companies that wish to produce EVs in China must form a joint venture with a Chinese company. The foreign company can own no more than 50% of the enterprise.

But with EVs, China takes things a step further by stipulating that all intellectual property introduced into the joint venture is immediately owned by both partners. Put another way, China is demanding full and immediate rights to foreign IP in exchange for market access. Understandably, foreign companies have been very slow to form electric vehicle joint ventures. But for how long can they stay away from the world’s largest EV market?

Does this basket of protectionist policies and pro Chinese brand consumer trends indicate the beginning of the end for Detroit in China? It’s hard to see things working out differently.

Deng Xiaoping, the pragmatic leader who encouraged Chinese people to embrace a market-oriented economy, once said “Observe calmly; secure our position; cope with affairs calmly; hide our capacities and bide our time; be good at maintaining a low profile; and never claim leadership."

This strategy has served China’s auto industry well for the last few decades, but the time may have come for China to move beyond Deng and finally begin to claim leadership.

Michael J. Dunne is president of Dunne Automotive, a Hong Kong-based company that facilitates investments between the US and China. He is also author of American Wheels, Chinese Roads. He has worked in Asia for more than two decades, including as president of General Motors Indonesia, and other operating and advisory roles.

April 2017