Wednesday, May 11, 2005

Sky is falling on GM and VW: First-mover: advantage or disadvantage in the Chinese market

2005 has not been a good year for General Motors and Volkswagen. They are witnessing their first-mover advantages in China’s vast automobile market rapidly eroding. VW lost half of its market share since 2000 to 20% and GM managed to cling on to the second spot for now with 10%. Sales at VW decreased by two-thirds in the first quarter 2005 and GM’s sales decreased 35% in the first quarter and its overall profits in China declined by 80% to $33 million. New market entrants Hyundai, Honda as well as domestic automaker Chery are boasting increasing market shares and soaring car sales. They are offering smaller and cheaper cars to a population that wants good quality at an affordable price. Hyundai’s unit sales increased by 156% in the first quarter 2005 over the same period last year largely due to the success of its Elantra compact priced starting at $13,600. Honda sold 76% more cars as consumers bought its $10,360 Fit. Meanwhile, domestic automaker Chery’s sales rose 42% driven by the sales of its $3,600 QQ.

There are competing views on these events. Business Week believes that these companies went to China too early. There are no first-mover advantages, or at least they did not build it up correctly. GM formed its Shanghai joint venture in 1997 while Volkswagen arrived in 1984. As first movers, the two companies benefited from high tariffs that kept out imports and allowed them to extract immense profits. In addition, most of the auto sales were made to state-owned companies that were not very concerned about price. However, with these benefits came the iron hand of the Chinese Government, which restricted GM to focus production solely on the expensive Buick Regal, and insisted that Volkswagen develop separate distribution networks for each of its two manufacturing operations. Newer market entrants Honda and Hyundai had far less bureaucracy to manage. Now GM and Volkswagen are moving to improve operations by cutting down costs, introducing smaller cars, and urging more suppliers to start producing in China. Others claim fierce competition is the culprit. Competition is intensifying as capacity in China is expected to increase by 30% this year. Hyundai, Ford, and Nissan are investing billions to increase annual production capacity, add new dealerships, continue market research to offer cars that consumers want, and expand their range of car models.

We believe there are merits in the argument that GM and VW missed opportunities to develop sustainable competitive advantages often afforded to first movers in the market. They did not recognize the need to plan for future capacity growth in the automobile market as well as perform market research to answer the demands of the inevitable birth of the Chinese consumer. Granted there were heavy restrictions imposed by China’s government, however there sees to be no excuse for GM and Volkswagen to have maintained inefficient manufacturing operations, not create more flexible assembly operations. They are responding to these challenges now, investing billions of dollars in capacity and introducing new models with a reactive frenzy.

What does the future hold for these two pioneers in China? This is an extremely important question for these two companies since they depend so much on the Chinese market. To answer this question, we first look at the auto industry in China. The consumers, have a lot of power these days, especially since early 2004 when new government regulations weakened demand to less than supply. There are real risks that the industry will have over-capacity in 2007. Rivalry is fierce. All main automakers in the world, maybe with the exception of the ailing Fiat of Italy, are competing in the market. Excess capacity triggered price wars, which delayed buying decisions as consumers anticipate lower prices. This could be a downward spiral as the prices of raw materials such as steel are rising, forcing automakers to face tightly squeezed margins. Barrier-to-entry is high, but not prohibitive for any major auto company, or indeed some smaller local players. The only upside for the players in the industry is the still heady forecast of the Chinese market. According to one estimate, the market is set to grow by more than three-fold from now to 2014.

Which of these companies will win out in the end? We give our nod to VW over GM for sure. VW, through its 20-year presence in China, is a household brand name, has the highest localization of spare parts, and the most intensive commercial network. They still have a 25% market share, which is not bad in a country of 1.5 billion people. If they can tough out the early competition and maintain a strong brand name for quality they will be able to target the new upper class as it emerges with the Audi models as well as the price conscience consumer in China with it VW brand. For now analysts say the majority of the growth will come from the low-end of the market, where VW has a strong history of serving with such classics as the Golf. Consumers will increasingly demand value for money. The quality image VW has developed and maintained will help it win the battle eventually. GM is much harder to predict. As of right now, it has a big share in the luxury segments with Regal. It has also introduced the Cadillac line. The established relationship with the government will continue to help in the mid-term. The problem is that GM has not been able to defend even its home turf. Without something short of miracle, GM is likely to continue to slide in China.

By: Alexis Collins, Xiaolin Jeff Li, and Victoria Soriano


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