THE AUTOEXTREMIST

May 11, 2011

China’s Endgame spells trouble for the global auto industry.

By Peter M. De Lorenzo.

(Posted 5/9, 5:15 p.m.) Detroit. Whether you’re immersed in this industry up to your eyeballs or you’re just a casual observer, you’ve read countless stories in recent years from me and others delineating the potential for the Chinese automobile market. Suffice to say it’s huge – estimates range from 20,000,000 vehicles per year annually and even higher depending on the growth of the country’s middle class and how the Chinese government controls it – and the potential for its expansion is almost limitless. The operative word here being almost.

The Chinese government is constantly battling classic economic forces such as inflation while trying to manage the country’s growth, and some of the time they’re successful at it and some of the time they’re powerless to control basic human desire for wanting and acquiring new things, at which point they resort to shutting down growth at will with directives that make little sense and have no rhyme or reason attached to them other than the fact that they can.

And when it comes to putting their populace on wheels, the Chinese government has been shrewd in requiring foreign manufacturers to establish joint ventures with existing Chinese companies, so that these companies can develop their own manufacturing expertise while looking over their partners’ shoulders.

These joint ventures can be fraught with peril, but the world’s automobile manufacturers – weary from dealing with mature markets and all of the difficulties that go with them such as the obligatory razor-thin profit margins – have been willing to put up with the Chinese government’s demands of mandatory cribbing of intellectual property and sharing manufacturing secrets because the potential for growth in sales in the Chinese market is so mind-boggling.

I’ll give you just one example: The Chinese market is the reason why you’re seeing the VW Group’s Audi division setting sales record after sales record every month. It’s also why you’re reading about the VW Group’s bullish expansion of Porsche’s product portfolio, because the potential for the growth of the Porsche brand in China knows no bounds at least for the foreseeable future, and the VW Group plans on milking this profit opportunity for all it’s worth.

And you can add every major manufacturer in the world to the list of auto companies salivating at the prospects of hitting home runs in the Chinese market. It’s almost as if they collectively feel that they can move beyond the mistakes they’ve made in the mature markets they’re doing business in and they can apply lessons learned to gain unbridled success in the Chinese market, without reservation or consequences. You only have to look as far as GM’s aggressive plans to get an idea of just how intoxicating the potential of China is.

But along with the potentially huge payoff in the Chinese market comes a huge downside lurking for these automobile manufacturers as well. When all you hear are the phrases “limitless potential” and “monthly double-digit growth” attached to the fertile Chinese automobile market and look at the sheer numbers of consumers who are going to be at the table in the coming decade and beyond, it is intoxicating, and it’s hard to imagine that there is a downside.

But there’s a deeply negative and darkly ominous side to this story as well, and while awash in the euphoria of the global automobile manufacturers’ plans for expansion and upward trajectory in China, I’m going to have to call a huge “time out” and throw an ice cold bucket of reality on the proceedings, because I’m afraid that this is going to be a story that doesn’t end well.

As ably reported by Christine Tierney in the Detroit News, the Chinese government, under its “New Energy Vehicle Development Plan,” is suggesting that in order for electric or plug-in electric vehicles to qualify for incentives, they must be produced in China by a Chinese automaker in a joint venture with a Chinese company, and the manufacturer must have intellectual property rights and "mastery" of one of three key components: the motor, battery or power electronics.

This is akin to putting a gun to the head of these manufacturers and saying, “You’re either gonna hand over your intellectual property and other good stuff and you’re going to like it so that you can get a cut of the profits, or else you’re not going to do business here.”

Let’s just call it for what it is: economic “diplomacy” by gunpoint.

And it could also mean that GM will not be able to sell its Chevrolet Volt in China, which obviously could be a major setback for the automaker because there’s a huge market for the extended-range electric breakthrough vehicle.

Needless to say – and thankfully so, I might add – this isn’t sitting well with some of our politicians in Washington, some of whom are actually paying attention for a change.

Michigan Democrats Senators Debbie Stabenow of Lansing and Carl Levin of Detroit sent a letter to U.S. Trade Representative Ron Kirk urging Kirk to challenge the discriminatory rules proposed under China's “New Energy Vehicle Development Plan.”

"The draft regulations would … continue China's longstanding policies that make the transfer of American intellectual property to Chinese firms a precondition of doing business in China," the senators wrote. "In contrast the United States opens its doors to non-U.S. companies without such restrictions," they said. "We must insist that China play by the same rules."

Uh, no kidding, but then again this is the darkly ominous side I was referring to earlier.

Memo to every single automobile manufacturer jacked-up about doing business in China: The downside to this adventure is plainly staring you in the face. If you choose to do business in China you will eventually be put out of business in China. Let me rephrase that. If you choose to do business in China, you will slowly but surely be forced to give up your intellectual property until it isn’t yours anymore. The Chinese government has made no bones about the fact that they want two or three strong, homegrown auto manufacturers and once those manufacturers are sufficiently capable of competing ­– after being “gifted” the technological expertise and intellectual property from the world’s auto manufacturers – then you watch, the Chinese market will be “closed” to the world’s other manufacturers through a series of tariffs and taxes that will make it plainly impossible to compete there except at ridiculously low volumes.

GM is trying to circumvent the Endgame by launching its Baojun brand in China, something that the Chinese government has strongly suggested to manufacturers would be advantageous to them in the long run. Baojun is aimed at low-end buyers who prefer shopping local Chinese brands, and GM is hopeful ­– even though adding the Baojun brand in China makes seven brands for GM there (ahem, what about that whole “learning from past mistakes” thing? Just askin’.) ­– that by playing ball with the Chinese government it will somehow work out for them in the end. Uh, good luck with that.

The fact of the matter is that the global automobile manufacturers are playing with fire in the Chinese market. The short-term profits and blue-sky sales potential are blinding them to the fact that the Chinese government has made it clear what the Endgame really is. And that is that they will leverage the size of their potential market to siphon off technology in order to accelerate the development of their own homegrown industries.

After that they will say “buh-bye” and “thanks” for visiting.

That’s a giant bowl of Not Good in my estimation.

And that’s the High-Octane truth for this week.

See another live episode of "Autoline After Hours" with hosts John McElroy, from Autoline Detroit, and Peter De Lorenzo, The Autoextremist, and guests this Thursday evening, at 7:00PM EDT at www.autolinedetroit.tv.

By the way, if you'd like to subscribe to the Autoline After Hours podcasts, click on the following links:

Subscribe via iTunes:

http://itunes.apple.com/WebObjects/MZStore.woa/wa/viewPodcast?id=311421319

Subscribe via RSS:

http://www.autolinedetroit.tv/podcasts/feeds/afterhours-audio.xml



If you would like to read previous Autoextremist issues, click on "Next Entry" below.