LATEST: This is how Cost Leadership Enjoyed by BIG 3 Chinese Car Manufacturers

At the Beijing Auto Show (in November 2006) Chinese car manufacturers felt confident enough to show off not just their newest low-cost runabouts, but also luxury and sports models, ‘concept cars’ showing future possible designs and even a few hybrid and electric vehicles. Local car makers in the world’s third largest and fastest-growing car market would appear to have come of age.

Until recently many Chinese car manufacturers built thinly-disguised copies of vehicles made by Volkswagen, GM and Toyota. In the past few years things have changed. In preparation for a push overseas local firms such as Chery, Great Wall and Geely have proved they can develop their own vehicles too. Buying designs from international specialists and installing fancy robotic production lines means more than 100 new models will be introduced in China this year.

Chinese car manufacturers have captured 27% of the market in China and will export 75,000 vehicles to over 100 countries this year. Foreign car makers are worried by the Chinese firms’ ultra low prices. The latest Shanghai Maple, for example, with leather seats, anti-lock brakes, air conditioning and a 2 year warranty costs a mere $6,500. Foreign firms grumble that they cannot even buy the steel needed to make the car for that price.

How much of this miracle is the result of good business sense – rather than special treatment granted to
local firms – is not entirely clear. A lot of early technology was borrowed. The government also offered
support to fledgling firms via direct investments and guaranteed loans. Universities provided technical help, especially in the development of expensive engines. The authorities even considered a law that would mandate a 50% share for local firms by 2010. Future legislation is likely to force foreign firms to do more research and development in conjunction with Chinese partners to ensure continued access to cutting-edge engineering skills.

Chinese car brands
Chinese Car Manufacturers

In a market where buyers are unashamedly experimental, brands have little value so far, except in the
luxury segment. For most buyers cost is more important. With average retail process falling by $1,250 a
year producers are racing to cut costs, not improve quality. The number of faults per 100 cars made rose
from 246 in 2005 to 338 in 2006. Reliability is likely to deteriorate further.

Chinese cars exported today mostly go to Africa, south-east Asia and the Middle East where expectations
are lower and price matters more. The various ways the Chinese car manufacturers enjoy competitive advantages made their industry unique and the most competitive. We recommend a strategy for Chinese car manufacturers based on our analysis.

How Cost Leadership advantages enjoyed by the Chinese car manufacturers :

The scenario suggests the following sources of the Cost Leadership advantages enjoyed by the Chinese
car industry:

Demand conditions: China is a very large market (third largest) and fast growing. This enables firms to gain significant economies of scale and also to justify investment in the new models (100 next year) and production equipment. With the exception of the luxury segment the demand is for low price cars and this has forced car manufacturers to concentrate on reducing costs.

Related industries: The only cited example is the assistance from universities in R&D. This provides significant cost advantages compared with in-house development. The low price of the Shanghai Maple suggests that steel and other components are being sourced cheaply too.

Factor conditions: China clearly has a good technical education system. It is also known for having abundant cheap labor and land available for building car plants. It has good sea links and freight handling for the purposes of exporting.

Firm strategy, structure and rivalry: The scenario mentions only three firms which, between them, share 27% of the Chinese car market. The Chinese government wishes this to increase to 50%. This will give each significant economies of scale and an incentive to invest in product and process improvement. That foreign-made cars are allowed into China gives a stimulus to product development and the search for competitive advantage. It is noticeable that the predominant mode of competition is price/cost and not quality. The industry seeks to build a me-too version of a foreign car but at a lower price.

The attempt by Chinese car manufacturers to go ‘up-market’ and develop unique designs and distinctive brands for export is a mistake. It suggests a vanity that could sacrifice the industry’s competitive advantage.

The appropriate strategy for the car industry is to remain a low cost player. It has huge internal markets available to it that value its present offerings. Its low cost position may enable it to focus on export markets such as other developing economies where low cost is also important. However its advantages are location specific and it should access these markets by exporting rather than, say, setting up factories outside China.

The poor quality of its products should be addressed. The number of faults is rising and by giving a two-year warranty the firms are bearing the substantial costs of rectifying these. It may be cheaper to stop the faults happening than it is to fix them and it would improve customer perception at home and abroad.

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