VW in China 2006-2011
...e industry leader. One strategy that VW has developed recently is in the area of car financing. In the past, Chinese typically would pay cash for their car purchases and this often involved saving money for a long time until they had enough to purchase. With the changing culture and the growing economy, financing is becoming more readily available and a more viable option for the car purchasing population. As a result, and a way to remain in the competitive environment the auto industry is increasingly getting involved in this business. “To become more competitive, VW’s application for a car financing business in China was approved by the China Banking Regulatory Commission…We pin great hopes on car financing to boost our sales in China in the long term…GM’s and Toyota’s application was also approved.” Another way the competitive environment has impacted VW is that new product investments need to be made in order to keep their competitive advantage. Keeping up with the changing buying patterns of the consumer and the development of technology is a requirement to remain competitive in the auto industry. “VW has made a new product plan for the Chinese market within the next 5 to 10 years. 1.2.6 Supply “When SVW first started producing Santana cars, VW insisted on the assembly of CKDs that it shipped to Shanghai from Germany, and it ruled out any possibility of developing a new model locally…the costs were high and the practice was a drain on foreign exchange reserves.” “The supply of reliable, up to standard parts was important to SVW’s success. However, since neither local nor German suppliers had any incentive to lower their prices, SVW production had been based on very high cost structure. This was not a serious problem when the market was closed and little competition existed. SVW enjoyed high profit margins by charging high prices…When more foreign players entered the market to put in more production capacity, competition heated up to drive the prices down.” “The SVW supply network was almost exclusively within Shanghai…only SVW could rely predominantly upon local component firms.” ….the costs were high and the practice was a drain on foreign exchange reserves.” 1.2.7 Cultural Implications A key factor in successfully entering the Chinese market is to understand the different cultural factors and the implications that blending different cultures presents. The Chinese culture is significantly different that what VW is used accustomed. The way of doing business in China presents challenges that need to be met in order to be successful. Along with language differences, many other factors surrounding cultural issues will present challenges to VW in being successful in the Chinese market. “The single most important and fundamental difference between Chinese and Westerners is undoubtedly the role played by the individual in the society. In the West, we place a strong emphasis on personal achievement, creativity, and initiative. We glory in our individual differences, nurture them and value them as the essential features that make us unique…In China…children are given an entirely different set of messages: Don’t question the world around you or try to change it; accept it. Submit willingly and unquestioningly to authority. Your role as an individual is not nearly as great as that of the role you play in a larger group.” “Chinese are socialized not to question the social order or try to change it. They learn that group membership is more important than individuality.” “Decision making is strictly top-down, personal loyalty is highly valued, cryonism is rampant and innovation largely stifled.” “Matters are debated until agreement is reached on a course of action. When this happens, the decision of the leader is the final word. Individual group members are expected to embrace and act on it regardless of their personal views.” This attitude toward decision making may pose challenges at getting things accomplished in a timely fashion, or cause strife while trying to form partnerships. The reason people are buying cars in China is also influenced by their culture. With the growing economy and the increase in the per capita income, purchasing cars is now an option for many new types of buyers. “Previously, the majority of buyers had been state-owned enterprises and governmental organizations, but thanks to favorable government policies and rising wealth, private buyers had become the driving force behind the more recent robust demand.” In china, “the automobile culture was being shaped by young people’s desire for a lifestyle change more than a need for convenient transportation.” “Among Chinese car buyers, 80% were in the market for the first time, and they shopped around to a much greater extent than buyers in more mature car markets…They often developed preferences based on emotional factors and intangible attributes rather than tangible attributes such as fuel efficiency or engine quality. Consumers were also extremely brand conscious and placed great importance on industry leadership.” 1.2.8 Future Strategies Alternative Fuel research (due to oil issues) Better Emissions (due to the pollution problem in Shanghai) Smaller SUVs (due to quantity of vehicles and space issues) 1.3 Regulatory environment/government 1.3.1 Background The attractiveness of China for the automobile industry is the potential future volume (China has the potential to become the 2nd largest auto market in 2015, bypassing Japan that today sells more than 10 Mio new vehicles per year) and also on the expectation that the government will reduce its influence on the industry. The auto industry to date has been dictated by govern¬men¬tal industrial policy. Three agencies regulate the industry : • State Development Planning Committee: responsible for approving new auto sector investments • State Economic and Trade Commission: auto sector planning and strategy • Ministry of Foreign Trade: responsible for managing relations/investments with foreign OEMs These agencies controlled the industry during the 1990s with a strict industrial policy that regulated how many companies could build mainstream market cars, limited any foreign stake in an auto producer to 50% and prevented foreign companies from distributing vehicles. China’s automotive policy was revised in 2000 for a five-year plan (2001-2005) with the following three major objectives ; • Encourage the emergence of a Chinese Big 3. The government wants to focus industrial efforts around First Automotive (VW), Shanghai (VW) and Dongfeng (PSA and now Nissan), and encourage them to consolidate (or force the exit of) the smaller producers. • Authorize foreign investment in the Big 3 and reduce governmental regulation/approval of their activities and investments. • Allow foreign car makers to take a more active role in setting up distribution networks. Despite the focus on the Big 3’s further development, the Chinese government’s policy was not entirely consistent. Other global OEMs are still investing in non-Big 3 local producers. The government has allowed this by continuing to issue new licenses to smaller producers to make passenger cars. Provincial governments are encouraging local producers to seek partners and stay in the auto business. With anumber of foreign OEMs entering into JVs with other local producers during the last 5 years. Before entry into the WTO, tariffs in China were 200% (1980s) and 80%-100% (1990s). Now that China has joined the WTO, tariffs have been coming down and are planned to reach 25% by 2006 . Falling tariffs will make it more realistic to import cars, particularly at the high end. This means domestic producers which already have production costs that are uncompetitive by global standards may lose the profitable top end of the market and have to concentrate on medium and small cars. Post-WTO, foreign OEMs will be able to control sourcing (buying from suppliers overseas), marketing, sales/distribution, servicing and financing. Only manufacturing must remain in JV ownership with a local partner. The key components of taxation are as follows: • Consumption tax of 3%-8% for different cars and minibuses; • Value-added tax of 17%; • Purchase tax of 10%; • Local administration fees of 3%-30% of total purchasing cost, depending on region 1.3.2 Development Policy for Auto Industry, we explain the original intentions and the long term goals of the Policy. On June 1, 2004, the National Development and Reform Commission issued the Development Policy for Auto Industry. The long term objective is to create a fair and uniform market environment; promoting the harmonious development of the auto industry and its correlation industries, the urban transportation infrastructure and the environment protection. The policy is intended to encourage manufacturers to improve their R&D and technical innovation abilities and develop products with independent intellectual property. It is also intended to adjust and restructure the auto industry, organizing several large auto enterprise groups through market competition. Summary of what is encouraged by the Technical policy : • Development of energy efficient and environmental friendly vehicles with small displacement • Research and development of new vehicle fuel, such as alcohol fuels, NG, mixed fuels and hydrogen fuel • Improvement of fuel economy • Research on light materials, recyclable materials and environmental friendly materials • Development of the automotive electronic industry The Structure Adjustment emphasizes that in order to open a new competition situation; the government encourages auto enterprises to form enterprise groups. Complete vehicle manufacturers shall improve their production level during restructuring and adjust their parts supplying units to independent plants specialized in parts manufacturing and open to the society. The Access Administration requires that mandatory technical requirements with respect to safety, environmental protection, energy efficiency and anti theft of motor vehicles shall be formulated. The State Administration of Quality Supervision, Inspection and Quarantine shall designate the certification and testing services of road vehicle products. The Trademark points out that, auto manufacturers shall enhance the trademark consciousness of their own and of their products. As of 2005, all domestic made automobiles and assemblies must be marked with the registered trademark of the manufacturer. The Product Development emphasizes that, the government supports auto manufacturers to establish R&D center to form their own product innovation ability and self-development ability. As of 2005 all the passenger cars shall be subject to brand sales and service. In 2006 cancellation of all current administrative methods for the approval of the power of selling passenger cars, the Minister of Commerce, together with the State Administration for Industry and Commerce formulates the administrative and implementing methods for auto brand selling. Auto dealers shall abide by relevant Chinese laws when operating in China. Auto manufacturers shall also give attention to the overall interests of the manufacturing and sales service industry to improve the comprehensive economic performance. The Investment Administration points out that the government’s approval administrative system for vehicle making investment will be reformed into two forms: filing and approving, in accordance with the principle of benefiting enterprises’ self-development and the government’s macro control. The Consumption of Vehicles emphasizes: cultivating a vehicle market with personal consumption as its mainstay while improving the environment of vehicle use and protecting the rights and interests of consumers by establishing a nationwide unified and open vehicle market and administrative system. It’s also mentioned that the vehicle insurance system shall be improved. 1.3.3 Administrative Regulation for Recalling of Automotive Products with Defects promulgated by 4 Ministries and Commissions; below we describe the “General Rules” of this regulation. It was put into force on October 1, 2004. The regulation is applicable to the activities concerning the production, import, sales, leasing, and maintenance of automotive products in China. The regulation emphasizes that the State Administration of Quality Supervision, Inspection and Quarantine is responsible for the organizing and administrating of the recall of defect motor vehicles in China. The terms of recall of any automotive products starts from it’s delivery to the first user to the end of its life time with safe performance as defined by the manufacturers. Manufacturers shall set up management systems for the gathering and analysis of quality defects and according to the demands of authorities report the potential defects in their products and provide necessary documents to users, dealers and leasers. Written report to authorities shall be completed within 5 working days after the confirmation of defects. Manufacturers shall inform the dealers by effective ways to stop the marketing of these products within 10 working days. 1.3.4 Mandatory National Standard-limits of Fuel Consumption of Passenger Vehicle, this standard stipulates the limits for fuel consumption. China established maximum consumption values for cars in September 2004. Owing to these directives, which take effect in two stages in 2005 and 2008, Volkswagen is also required to adapt its vehicles . It is applicable to the vehicles powered by positive-ignition engine or compression-ignition engine designed speed of 50km/h or more, and vehicles of total mass not exceeding 3500kg. It is not applicable to the vehicles that use gas fuels or alcohol fuels only. The State Administration of Taxation began to impose new rule on the consumption of petrol and diesel on Sept 1, 2005. Under the new rule, any institution and individual who produce, process by contract, or import petrol and diesel in China, are referred to as petrol or diesel consumption tax payer. They need to pay US$ 0.024 for unleaded petrol as per liter, or US$ 0.034 for leaded petrol or US$ 0.012 for diesel. This coincides with the current tax rates. China collects the tax since 1994. Statistics show that 2004 saw a total of US$ 3.161 billion tax collected, a year on year up of 27.2 percent. The consumption tax is different from the long awaited fuel tax, yet the two are designed to achieve the same effect. Some analysts propose to raise the consumption tax rate to avoid the inconveniences in ending the road maintenance fees. Big cities like Beijing and Shanghai have banned diesel-powered passenger cars since 1998 , but experts say new technologies have properly settled the emission problem. Shanghai government encouraging using small displacement vehicles. On Aug 30, 2005 JIAO Yang, spokesman for the Shanghai government, said that the city is formulating incentive policies for the use of vehicles which are high in performance, small in displacement and low in pollution. The city is going to eliminate old vehicles to save energy and the work will start first from the local authorities and the public transportation industries, said a senior official of the city. 1.3.5 Notice to Regulate the Administration of Assessment of Used Vehicles. We explain how it affects the Automobile manufacturers in China. On October 25th 2004, the Ministry of Commerce and relevant authorities under the State Council jointly established Auto Trade Policy. According to the “General Principles” of this policy, the purpose of the establishment of the policy is to form an unified, public, competitive, and orderly auto market. The objective it to uphold the lawful rights and interests of the customers for automobiles; to improve the healthy development of Chinese automotive industry; to boost the consuming and to expand domestic demands; and to form a modern and international comparable auto trading system by 2010. The “Circulation of Second-hand Vehicles” points out; • The Government to encourage the circulation of second hand vehicles • To speed up the forming and setup of markets for second-hand vehicles • To practice voluntary appraising system for second-hand vehicles • To set-up and perfect the certification system for appraisers According to the article of “Foreign Trade Automobiles”, since January 1st, 2005, the government shall adopt automatic administration for the permission of automobile imports. The government bans any import of used vehicles, assemblies and parts. Imported vehicles must get the certificate from the Ministry of Commerce. The government encourages the export of automobiles and relevant products; and to establish ordered and competitive process for the export of automobiles. Before December 11, 2006, the investment share of any foreign investor, who has been engaged in the auto distribution and retailing in China and has had over 30 shops, shall not surpass 49%. 1.3.6 Administrative Method for Loans to Automobiles, we describe the definitions concerning auto loans, loaners and terms of loaning and how this impacts VW. On August 16th, 2004, the People’s Bank of China and China Banking Regulatory Commission promulgated “Administrative Method for Loans to Automobiles. The “General Rules” of the Method describes the definitions concerning auto loans, loaners and terms of loaning . According to the definition, loans to automobiles indicate that the loaners provide loans to the applicants for the applicants for the purchase of automobiles (including second-hand), the loans can be classified as private loans, dealers’ loans, and institutional loans. Loaners indicate the commercial banks and credit unions in cities and towns that are established in China and qualified by China Banking Regulatory Commission and non-bank financing institutes that are authorized by government authorities to deal with the business of auto loans. The term of loan for autos is not more than 15 years, of which, the terms of loan for second hand autos is up to 3 years only. The term for loans for auto dealers is limited to maximum one year. Since 2003, Volkswagen Finance (China) Co., Ltd is present in China as the first European automobile financial provider to be based in China and the first financial services company in the country to be wholly owned by an overseas automobile manufacturer. There is a considerable mid- to long term growth potential for automobile financial services in China, since at present only approximately ten percent of car purchases are loan financed. 2 Volkswagen in the Chinese market 2.1 Initial market entry strategy Instead of using China as its factory floor, VW created domestic production capacity solely for the Chinese market. Exporting Volkswagen from China was not considered for several reasons. Because of the heavily regulated car market in China and the resulting lack of competition, price and quality for parts and for the final product are until today not up to international standards . The Chinese market is itself was regarded to have enough growth opportunity to justify domestic production without the perspective of exports . Among the various options for entering a foreign market, VW chose to form a joint venture with a domestic car manufacturer. Licensing the brand, models or technology to China was impossible. The Chinese industry needed foreign investment and was itself unable to properly implement such a license . Regulations enforced joint ventures for any foreign investment in automotive industry production with a mandatory share of no less than 50% for the domestic partner . We can safely assume that the regulations where created this way to attract new knowledge in car manufacturing together with a part of the required financial resources. The enormous potential of the domestic market made such a venture attractive to Volkswagen anyway. SAIC was chosen as the domestic partner of the joint venture. Even before the deal, SAIC was one of the leading automobile manufacturers in China. It is located in Shanghai and of course entirely state owned. The area of Shanghai was comparably well developed, influential and offered a reliable transport system. The region hat the highest GDP that time . VW entered the Chinese market with just one model: the Santana. At the time of the initial market entry, potential car buyers where either government officials or government taxis. A full sized sedan like the Santana fit the requirements well and matched budget limitations . VW adapted to the immature production environment and inexperienced workforce by manufacturing a previous generation model of the Santana, which required less sophisticated techniques (and reduced the risk of intellectual property theft). When Volkswagen decided to invest in the Chinese market, it had the chance to be the first player in the potentially largest future market in automotive vehicles. But VW had to abide by the very strict regulations imposed by the Chinese government. Investment was practically limited to joint ventures with few domestic manufacturers. The number of models was limited. Sourcing had to be almost purely domestic. There was the risk of intellectual property abuse or even of expropriation. 2.2 Strategy adjustments up to today VW founded a second joint venture with FAV. It was discovered that the intro-Sino market was fragmented. Regions protected their own investments. The market share of VW cars was always the highest in the Shanghai area where the factories stood. FAV is located conveniently close to Bejing, the greatest accumulation of Santana buyers . The second model introduced was the Jetta, a smaller sized sedan ideally suited for taxi companies. It could be offered at a lower price than the Santana. Again, the second latest model was chosen to lower production cost and to mitigate IP theft. The Audi brand was introduced. Like in the rest of the world, Audi is positioned above the Volkswagen brand. It gained access to a more elite clientele of government officials. After further market liberalization, VW introduced more models like the Golf and the Polo. Being smaller than the Santana, those cars aim at the new clientele of private buyers. Sales where disappointing (see 1.1.1). When it comes to cars for the masses, pure Chinese manufacturers or Korean joint ventures got the upper hand. Latest additions to the VW car lineup in China where the Passat and the Turan. The Phaeton will be introduced to China in early 2006. This shows a shift to introducing up-to-date models, there is no more holding back on technology. This completes the transition from a single model strategy to a full lineup of cars, ranging from the small Polo to the upper class Phaeton . VW also offers added services. It’s car finance firm is one of the few to have obtained a license . The first Volkswagen to be exported from China where shipments of Polo’s to the Philippines and to Australia . 3 Strategic alternatives Volkswagen builds and sells passenger cars, this is the core business of the Volkswagen cor¬por¬ation. The strategic question for Volkswagen China is How to meet the growing demand for individual transportation in China? Based on a SWOT analysis we identify the core problems of Volkswagen China. We then pro¬pose two alternate implementation strategies and select the preferred one. 3.1 SWOT analysis We have combined the evidence and facts laid out in the previous chapters in a SWOT analysis. It has become evident that Volkswagens major strength comes from its first mover advantage. Because it is a mature player in the Chinese car market, the position to exploit the opportunities identified is quite strong. Volkswagen’s greatest weaknesses lay in the model line-up. There are no really low-end models available, and the middle class models do not fit the taste of new buyers. Additionally, the lack of a proprietary distribution- and dealer network was identified as a problem. Strengths Weak¬nesses Quality Mature Player Financial Services No Low-End Model Middle Models Not Chinese Taste Distribution Network Opportunities Market Potential + ++ + – – – – – Cheap Labor / + / / / / Demand for Fuel Efficiency / ++ / – – – / Threats Price War + + + – – – – Regulations – ++ / – / / Economic Outlook / – / – – / / Industry Overcapacity / – + / / / The following table shows the rationale behind the ratings assigned to each cell of the SWOT from a company insider perspective. Quality Volkswagen has a world class reputation for quality. This is beneficial when trying to exploit the full potential of the Chinese market. Because customers may be willing to pay a premium for the proverbial Volkswagen quality, It is also an asset when entering a price war. The reputation for quality is endangered when regulations require compromise in sourcing parts. Mature Player Being a mature player with possibly the industries greatest experience of producing and selling cars in China is generally an advantage when exploiting the opportunities present in the Chinese car market. Volkswagen has progressed far on the learning curve of the car business. This may create a strong position when entering a price war and will help to circumvent restricting regulations. Financial Services Volkswagen was quick to obtain a license to offer car finance services to buyers. This can present a minor advantage to gain market share. But today, Chinese car buyers mainly pay upfront. The ability to offer packages of cars and financing may be an advantage to gain customers favor when in a price war. No Low-End Model The cars at the low end of the Volkswagen line-up are still too up-market for an emerging economy like the Chinese. They are too expensive and over engineered for the low-cost segment that has the greatest forecasted growth rate in the next years. The growing demand for fuel efficient cars, which are promoted by government regulations as well, cannot be satisfied without an economic low end model. With the current palette of lower segment models, Volkswagen would have lost a price war before it would have begun. And if the economic development of the region takes a downturn, low price models will have the most robust demand. Middle Models Not Chinese Taste The hatch-back design of many middle class Volkswagen does not suit the Asian (and American) buyers taste. Again, this is problematic when skimming a growing market. The good news is that the upper range models offered by Volkswagen are very competitive. Distribution Network Not being in control of the car distribution and dealer network is a problem because it makes managing the downstream supply chain harder. This may become an obstacle when distribution must keep track of the fast growing market and when in a price war. We now have identified the main course of action that can be implemented in multiple ways. • Create a low-end fuel-efficient model that can be sold globally in huge numbers • Adjust the mid range models to Chinese tastes • Keep the upper range models as they are • Build a proprietary distribution network 4 Strategic analysis and conclusions 4.1 Capture low-end, fuel-efficient transportation market As outlined in previous chapters, the buyer market of cars in China has changed and ordinary people with lower incomes start to buy cars. Additionally, restrictive local policies which bans small car buyers from traveling in certain areas of cities (e.g. in Shanghai, Beijing and Guangzhou, small cars are not allowed on city ring roads during certain times in the day) or forbids small car buyers from obtaining car licenses are about to be lifted. The China National Development and Reform Committee (NDRC), together with five other government entities issued a document on 4 January 2006 urging government entities to remove all restrictions on the use of small cars before the end of March 2006. Another regulatory policy which is about to be introduced in China, is the different pricing of car licenses dependent on the fuel efficiency of the car which makes fuel-efficient car more attractive than more polluting models. These three factors suggest very positive impacts on sales of small cars. However, the current set of models of VW in China does not include a real low-end model. Appendix X shows a table with the major sedan models in China showing its engine power and price. The smallest model in terms of engine-power of VW is the Polo with a 1.4L engine whereas there are ten models with engines of 1.0L or smaller, including models from GM and Suzuki. The cheapest model of VW is the Gol with an average selling price of RMB 78'800. Seven cars sell at an average selling price below RMB 50K including models from Fiat, GM and Suzuki . We see two options for VW concerning this market segment: Option 1: Not to compete in this market segment and have an offering only in the mid- and higher-end of the Chinese market. Option 2: Have an attractive offering in this segment and have a "Volkswagen" also in today's Chinese environment. Due to the sheer size of the Chinese market and the share on the global car market it will have if the forecasted growth rates come true, Option 1 might be no choice for VW. If VW wants to be a major player in ...