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US carmakers must win in China, but it’s going to get more difficult

Published:Thursday | August 23, 2018 | 12:00 AM

The fortunes of Detroit automakers increasingly lie some 7,000 miles to the east in China.

China is already the world's largest car market, selling 29 million light vehicles a year. By 2025, China's new-car sales will be double those of the United States, analysts said.

To put that in perspective, about 17.2 million new light vehicles were sold last year in the US, according to Kelley Blue Book data.

And while new car sales are ballooning in China, they have levelled in the US.

This puts Detroit's car companies at a critical juncture. They must focus on growing their sales in China if they want to sustain total profits enough to succeed elsewhere in the world.

Yet Ford and Fiat Chrysler struggled in China in the second quarter, and it isn't getting any easier in the future for them and General Motors.

"It's going to get more and more difficult to compete in China," said John Bonnell, senior adviser of ZoZo Go, an investment advisory firm specialising in China's electric and autonomous vehicle industries. "With the heavy competition, demand for more electric vehicles, trade wars ... it's not an easy business there."


Detroit's reality check


The Chinese car market is intensely competitive given the rising success of some Chinese car companies in the last few years. Then there is the looming threat of President Donald Trump's proposed 25 percent tariffs on imported cars and parts, which could inflate prices across the board.

But car makers that succeed in China will gain a big advantage in other markets, said Bonnell.

"It will impact their performance here, eventually," said Bonnell. "If you just have the US, you wouldn't have those million-dollar sales to spread to your tooling costs" and to cover other research and development expenses.

In fact, said Bonnell, looking at Volkswagen's success in China, "Its market share in Europe, since they have succeeded in China, has gone straight up."

But the Chinese consumer has distinct needs and requires products tailored to them, said Jeremy Acevedo, manager of data strategy with Edmunds. Therefore, product becomes king if Detroit car makers are to attract new buyers there. "They can't rely on shopper loyalty in the booming Chinese auto market," said Acevedo.

As for Trump's proposed tariff hike and retaliation by the Chinese, Detroit Three exports to China are not a factor because they account for less than five per cent of sales, Michael Dunne, CEO of ZoZo Go, wrote in a newsletter.

"But if tensions escalate, Chinese leaders could steer consumers away from American-brand cars," wrote Dunne.

He noted that Chinese leaders did just that in the past with Korean and Japanese cars to "great effect" when political relations soured.

"So, a reality check is in order," said Dunne. "Intensifying competition from Chinese automakers, plus a dose of acute consumer nationalism, could spell the beginning of the end of Detroit in China."


China sales


Besides fierce competition in China about 110 car brands are sold in China, 60 of which are Chinese the Chinese government is also pushing automakers for more electric vehicle production by 2020, said Bonnell. It has set strict regulations around EVs, he said.

As Ford and FCA try to compete, they are already behind the curve. Through June, Ford had sold 313,000 vehicles, down 38 per cent from the same period a year ago giving it a 2 per cent market share in China, said Bonnell, who references data from LMC Automotive.

In that same period, FCA's Jeep brand was down 34 per cent to 115,000 units. It sells such a small number of vehicles, though, that FCA's market share is negligible, said Bonnell.

For GM, through June, sales of its Buick, Chevrolet, and Cadillac brands were 960,000, up 10 per cent from the same period a year ago. Including GM's minority share in SAIC GM Wuling, GM's sales through June totalled two million, up seven per cent from the same year ago period, said Bonnell.

GM President Dan Ammann told Wall Street analysts recently that GM is successful in China because it has invested in the product and the dealer network there for many years.

But the market in China has been intensely competitive, Ammann said. GM continues to invest in its business there and, "Make sure we're prepared for the next phase of the market there" as it pushes for more electric vehicles and strict emissions.

The strongest non-Chinese automaker is Volkswagen, which has seen consistent growth in China.

"They were the first one to set up in the mid-'80s, and they have strong partners and worked hard to get their brand established and dealer network established," said Bonnell. "Being the first mover offered a big advantage for them."

Volkswagen had sold 2.1 million cars through June in China, up seven per cent from the year-ago period, he said.


Ford's problems


Ford China has struggled with an ageing product portfolio and a thin, unprofitable dealer network. In the second quarter, it lost $483 million, a decline of $506 million from last year, Ford's CFO Bob Shanks said in a call with analysts.

Current products in the showroom are dated. Five new models, arriving this autumn, should help, but there is a lot of lost ground to make up. Ford China sales this year could fall 25 percent below their 2016 peak of 1.2 million. That's a 300,000-vehicle hole to dig out of, Shanks said.

Shanks blamed unfavourable market factors for Ford and Lincoln imports into China, and lower net pricing, some of which is related to tariff changes.

But Ford's Jim Farley said the deterioration of Ford's business in China has been swift.

"I can assure you, we understand the importance of getting our China business back on track," Farley, Ford's executive vice president and president of Global Markets, told analysts.

Ford will launch a new, low-priced, mid size sport utility vehicle called Territory in China early next year, Farley said. The SUV will be built in China and was developed strictly for that market. It will give Ford a better chance to compete against lower priced vehicles than it had in the past there, said Farley.

Ford combats China struggles with low-cost SUV

Ford has serious shortfalls in its go-to-market capabilities, "including inadequate dealer profitability, excess stock including our high-volume (compact) cars", Farley said. "We haven't maintained a fresh enough product line-up for this rapidly changing and dynamic China market".

Those missteps along with an uncompetitive cost structure, hurt Ford China, and Farley said Ford is taking "urgent action".

By the end of next year, 60 percent of Ford China's vehicle line-up will be refreshed or new, said Farley. He said that Ford is improving its competitiveness with aggressive cost cuts and more localised product such as the Explorer.

"We're close to hiring a new CEO for Ford China, and we have already on board a number of local Chinese talent in key management positions such as marketing and sales leads for both Ford and Lincoln to drive not only our strategy, but they're already reinvigorating our sales," said Farley.

But until all of Ford's SUVs are launched in China, he warned, "We'll continue to face this mix deficit."


GM's success


Ford's new products will be competing against several new products from GM China, which already has a strong foothold in the market.

In the second half of the year, GM China will introduce 10 new models, including the Cadillac XT4 small SUV.

"The focus is on high-demand segments, including SUVs and multipurpose vehicles and luxury vehicles," GM CEO Mary Barra said in an analyst call.

GM China reported record results in the second quarter with equity income of $600 million, up $100 million year-over-year. The bulk of those sales are from Baojun, Cadillac and Chevrolet, and GM said it had a "continued focus on cost efficiencies" there.

GM will incur higher costs in the second half because of the cost to launch new vehicles. With competitors launching new vehicles, pricing will come under pressure, too, she said.

"But we remain confident in our 20 years of market strength in China," said Barra. "Due to established local and US brands and our strong Chinese partner, our current outlook does not assume any comprehensive impact in China beyond existing trade flows."

Still, GM's growth is driven by the affordable Baojun (pronounced bow joon) brand and the surging Cadillac brand. Buick and Chevrolet are "crimped at the edges and stalling," wrote Dunne.

Baojun is GM's ultra subcompact that costs less than $15,000. It will account for one in every four GM China sales this year, said Dunne.

But Dunne wrote that the "squeeze on Chevy and Buick reveals a larger, deeper threat to the Detroit Three in China". Consumers there are much less attracted to mass market global brands than they were a few years ago. Instead, they are switching to Chinese brands such as Great Wall, BYD, and Geely, wrote Dunne.

Geely is China's largest private automaker. It will sell almost twice as many cars in China as FCA and Ford combined this year, said Dunne.


FCA's future


In Fiat Chrysler's second-quarter earnings call, CEO Mike Manley acknowledged that "the biggest challenges we face, and frankly we're going to continue to face to some extent for the balance of the year, are all focused in China".

Changes in the tariff drove down sales of Maserati cars and shipments to dealers, Manley said. But he was quick to add, "With all of these duty changes behind us, I'm clearly expecting improved sales performance."

That's provided that FCA manages inventory to meet demand ahead of the transition to China's tougher emission regulations, he said. FCA has lowered its expected year-end results because of those increased regulations.

FCA's joint venture sales volumes were down, partly because of the contraction in the SUV segments and a need for FCA to do a better job to market Jeep in China.

"What frustration FCA leaders must feel when they see their beloved Jeep brand struggle in the world's No. 1 SUV market," said Dunne. "FCA bet on a bottom-up product strategy, starting with the entry-level Compass. Status-conscious Chinese consumers saw cheap and yawned, unimpressed."

Manley, who oversaw FCA's operations in the region that includes China for about six years, is aware of the complex Chinese consumer who is both status-conscious and, "very, very cost conscious or value conscious, probably, in the segment that Maserati plays in", he said.

FCA will launch the new Grand Commander, a seven-passenger SUV designed exclusively for China, soon. FCA started building the SUV in the second quarter at its China JV plant in Changsha. The Grand Commander's interiors are inspired by "business class cabins".

Manley said that all of FCA's new vehicles in China will, "hold pricing power, and then obviously, follow the curve depending on the strength of the brand".

FCA will also strengthen its dealer network in China and update its vehicles there more regularly, he said. But, warned Manley, it will take the balance of the year to achieve sales progress there.

"China is clearly a key priority for me," Manley told analysts. "We do understand the issues that we face, and, more importantly, we know what to do to correct our performance. These actions are already under way."