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Coming to America

One of the most popular discussion topics in the American auto industry today is “When will the Chinese start exporting in large quantities to the USA?” Almost immediately a second question follows: “Will they be successful in doing this?”


 


The automotive press is full of reports relating to the first question, so this article will focus on the second one. We will draw on our own industry experience but also on material presented at the Elite Dealers Summit conference, put on by Bel-Air Partners in May in New York City, as that conference was dedicated to this very question.


 


The first thing to realize, of course, is that China is already exporting vehicles: 360,000 in 2006, up sharply from prior years, as seen in the first exhibit (see page 12).


 


But as noted on the exhibit, Chinese exports to date are mostly trucks and buses, rather than cars, and mostly sent to developing countries, as opposed to the Triad markets of Japan, North America and the EU. This makes sense, given that the lower specifications required in developing markets makes them easier for still-maturing Chinese OEMs to export to. However, we all know that Chinese OEMs are gearing up for a developed-world assault.


 


A key question arises: why do they do this? Given soaring demand at home, why do they attack developed markets now?


 


There are at least several reasons, from emulation of the Korean and Japanese role models, to matters of national and corporate pride, to a belief that the American market may in fact be less difficult than the Chinese (with its plummeting prices), to simple share price “pumping.”  And finally, as pointed out to me by Wayne Xing, publisher of CBU/CAR, government regulatory and tax discrimination in China against very small vehicles (largely for municipal image concerns) may spur the makers of these cars to seek export outlets.


 


Given all these motives for export, we cannot deny that Chinese cars will be coming to America soon.  However, will they succeed? I see five key barriers to the near- or mid-term success of Chinese OEMs in the USA.


 


Value proposition


 


First, there is the issue of value proposition. Americans are spoiled for choice now: they will need a reason to even consider Chinese vehicles, with their unknown brands and lack of track record.  When the Japanese exploded in America in the 1970s it was due to superior fuel economy – Chinese cars do not have any particular edge in this realm.  When the Koreans soared in the 1990s, they did it with value: a combination of low prices and ultra-long (e.g. 10 years) warrantees.  Can the Chinese undercut the Koreans – and used cars (see below) – on price, and then offer an even longer warranty? The “price window” is not as wide open as it once was.


 


Homologation


 


Second, there is the challenge of homologation: the immense costs of converting a vehicle to American specifications and then going through a year or more of emissions, safety, and other tests: these are costs that are incurred even before the first unit is sold.  Figures vary, but we can assume tens of millions of dollars for a full line of cars.  If a vehicle is pitched at (e.g.) a $5,000 wholesale price and if it earns an above-industry margin of (e.g.) five percent, that is $250/car in profit, and one can see how long it would take to pay off homologation costs (especially if service parts profits are wiped out by an ultra-warranty).


 


Image


 


Third, there is the challenge of image. The Japanese and Koreans had to work hard for years to overcome their down market image, and the task is not yet over for some of the Japanese, and both Koreans. As a recent survey showed, 90 percent of American customers believe that the main reason to even consider a Chinese car is low price (or free options, which is the same thing): once pigeon-holed as a discount car, it may be years or decades before Chinese firms can break out.


 


Used car market


 


Fourth, this is often overlooked as a barrier.With 45,000,000 units annually changing hands in the USA, at an average price (at independent dealers) of only $8,600, this is a formidable rival for new Chinese cars at $5,000 or $7,000. Please note that CNW Market Research tells us that in 2000, when the Koreans were surging ahead, only 10% of their buyers had entered the market intending to buy new cars: they had to be switched by dealers from used units. Chinese OEMs not only have to beat low-priced new Fords: they have to beat 3-year-old used Toyotas.


 


Launch cost


 


Last, there are launch cost. To gear up for and then cut through the clutter of the world’s largest single car market is no small task. National service networks, financing arms, parts distribution systems, and dealer support programs must be in place… and then there is advertising. While it was a different time and a different strategy, please note that in 2006 Lexus spent a quarter of a billion dollars in marketing in its first two years of existence in the USA. Chinese OEMs will get some free advertising in the form of news coverage, but the ongoing marketing burden remains.


 


At the Elite Dealer Summit conference three different importers of Chinese vehicles to the USA showed three very different strategies for dealing with each of these barriers, as shown in the following exhibit.


 


There are interesting features to each of these. Two aim for hybrid or electric vehicles, which certainly eliminates most used-car rivalry and establishes a “green” value proposition. One looks to diversify risk (Company X) by serving as importer of cars from an initial 3-4 Chinese OEMs.  Another, Visionary Vehicles, hopes to eliminate the usual factory/dealer friction by having dealers buy into and thus heavily control the venture.


 


Other firms with other approaches are on the way, as the news reports tell us. In my own personal view, the likelihood of any one of these firms succeeding is fairly low, with the likelihood of at least one of them succeeding as very high. That is, it is too early to predict winners, but hard to say there will not be at least one. This leads to an issue for all the Chinese as a group of course: if one of their members fails spectacularly (e.g. engine fires hit the headlines), the group as a whole will be painted with the same negative PR. So it is in their best interests to see everyone do pretty well.


 


As a closing remark, in our industry “winning” is usually counted in units, not in dollars or reminbi. The Chinese OEM that “wins” in America by establishing a strong market share may regret its victory, as it sees its profits eaten up by the high costs of competing here. That is, I am sure any Chinese OEM envies Ford’s American market share, but not its American losses.  Chinese firms might be advised to tread carefully, lest their unit success in the USA (which will surely come) yields a bitter taste when it is translated to the bottom line. 


 


The first to win in America may also be the first to lose.

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Coming To America:

One of the most popular discussion topics in the American auto industry today is “When will the Chinese start exporting in large quantities to the USA?”  Almost immediately a second question follows: “Will they be successful in doing this?”
 
The automotive press is full of reports relating to the first question, so this article will focus on the second one.  We will draw on our own industry experience but also on material presented at the Elite Dealers Summit conference, put on by Bel-Air Partners in May in New York City, as that conference was dedicated to this very question.
 
The first thing to realize, of course, is that China is already exporting vehicles: 360,000 in 2006, up sharply from prior years, as seen in the first exhibit.
 
But as noted on the exhibit, Chinese exports to date are mostly trucks and buses, rather than cars, and mostly sent to developing countries, as opposed to the Triad markets of Japan, North America and the EU.  This makes sense, given that the lower specifications required in developing markets makes them easier for still-maturing Chinese OEMs to export to.  However, we all know that Chinese OEMs are gearing up for a developed-world assault. 
 
A key question arises: why do they do this?  Given soaring demand at home, why do they attack developed markets now?
 
There are at least several reasons, from emulation of the Korean and Japanese role models, to matters of national and corporate pride, to a belief that the American market may in fact be less difficult than the Chinese (with its plummeting prices), to simple share price “pumping.”  And finally, as pointed out to me by Wayne Xing, publisher of CBU/CAR, government regulatory and tax discrimination in China against very small vehicles (largely for municipal image concerns) may spur the makers of these cars to seek export outlets.
 
Given all these motives for export, we cannot deny that Chinese cars will be coming to America soon.  However, will they succeed? I see five key barriers to the near- or mid-term success of Chinese OEMs in the USA.
 
Value proposition
First, there is the issue of value proposition.  Americans are spoiled for choice now: they will need a reason to even consider Chinese vehicles, with their unknown brands and lack of track record.  When the Japanese exploded in America in the 1970s it was due to superior fuel economy – Chinese cars do not have any particular edge in this realm.  When the Koreans soared in the 1990s, they did it with value: a combination of low prices and ultra-long (e.g. 10 years) warrantees.  Can the Chinese undercut the Koreans – and used cars (see below) — on price, and then offer an even longer warranty?  The “price window” is not as wide open as it once was.
 
Homologation
Second, there is the challenge of homologation: the immense costs of converting a vehicle to American specifications and then going through a year or more of emissions, safety, and other tests: these are costs that are incurred even before the first unit is sold.  Figures vary, but we can assume tens of millions of dollars for a full line of cars.  If a vehicle is pitched at (e.g.) a $5,000 wholesale price and if it earns an above-industry margin of (e.g.) 5 percent, that is $250/car in profit, and one can see how long it would take to pay off homologation costs (especially if service parts profits are wiped out by an ultra-warranty).
 
Image
Third, there is the challenge of image.  The Japanese and Koreans had to work hard for years to overcome their down market image, and the task is not yet over for some of the Japanese, and both Koreans.  As a recent survey showed, 90 percent of American customers believe that the main reason to even consider a Chinese car is low price (or free options, which is the same thing): once pigeon-holed as a discount car, it may be years or decades before Chinese firms can break out.
 
Used car market
Fourth, and this is often overlooked as a barrier, is the immensely strong American used car market.  With 45,000,000 units annually changing hands in the USA, at an average price (at independent dealers) of only $8,600, this is a formidable rival for new Chinese cars at $5,000 or $7,000.  Please note that CNW Market Research tells us that in 2000, when the Koreans were surging ahead, only 10 percent of their buyers had entered the market intending to buy new cars: they had to be switched by dealers from used units.  Chinese OEMs not only have to beat low-priced new Fords: they have to beat 3-year-old used Toyotas.
 
Launch cost
Lastly, there are launch cost. To gear up for and then cut through the clutter of the world’s largest single car market is no small task.  National service networks, financing arms, parts distribution systems, and dealer support programs must be in place… and then there is advertising.  While it was a different time and a different strategy, please note that in 2006 dollars Lexus spent a quarter of a billion dollars in marketing in its first two years of existence in the USA.  Chinese OEMs will get some free advertising in the form of news coverage, but the ongoing marketing burden remains.
 
At the Elite Dealer Summit conference three different importers of Chinese vehicles to the USA showed three very different strategies for dealing with each of these barriers, as shown in the second exhibit. 
 
There are interesting features to each of these.  Two aim for hybrid or electric vehicles, which certainly eliminates most used-car rivalry and establishes a “green” value proposition.  One looks to diversify risk (Company X) by serving as importer of cars from an initial 3-4 Chinese OEMs.  Another, Visionary Vehicles, hopes to eliminate the usual factory/dealer friction by having dealers buy into and thus heavily control the venture.
 
Other firms with other approaches are on the way, as the news reports tell us.  In my own personal view, the likelihood of any one of these firms succeeding is fairly low, with the likelihood of at least one of them succeeding as very high. That is, it is too early to predict winners, but hard to say there will not be at least one.  This leads to an issue for all the Chinese as a group of course: if one of their members fails spectacularly (e.g. engine fires hit the headlines), the group as a whole will be painted with the same negative PR. So it is in their best interests to see everyone do pretty well. 
 
As a closing remark, in our industry “winning” is usually counted in units, not in dollars or reminbi. The Chinese OEM that “wins” in America by establishing a strong market share may regret its victory, as it sees its profits eaten up by the high costs of competing here.  That is, I am sure any Chinese OEM envies Ford its American market share, but not its American losses.  Chinese firms might be advised to tread carefully, lest their unit success in the USA (which will surely come) yields a bitter taste when it is translated to the bottom line. 
 
The first to win in America may also be the first to lose.

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