A bumpy road to profitability
It has been a long, rocky ride for the foreign partners of joint-venture carmakers on the mainland and, as things are going, they are in for an even bumpier drive.
As if cut-throat competition and declining margins were not hard enough, these foreign partners must contend with rising costs as they have to rely on sourcing crucial parts from their mother companies abroad to protect copyright and preserve jobs in their base countries.
'Important parts such as electronic chips and engines involve intellectual property rights issue, therefore joint-venture auto carmakers continue to make these parts in their home countries,' said Heron Chan, managing director of Digi-International Exhibitions, which will launch a car parts exhibition in Hong Kong in May.
'Because of the higher costs [of shipping these parts to China], it is difficult for these auto carmakers to cut the prices of their vehicles. Unless these joint-venture carmakers shift to using parts made in China, they will continue to lose market share.'
In contrast to the pricing problems faced by western carmakers with operations on the mainland, their Japanese and South Korean rivals have been able to keep prices down by sourcing either domestically or from their nearby home countries.
For instance, Volkswagen's market share in China has slid from 25.2 per cent in 2004 to 17.3 per cent last year while Japan's Honda Motor and Korea's Hyundai Motor have been gaining ground.
In the three years to last year, Hyundai's market share in China went up from 2.4 per cent to 5.8 per cent and 7.5 per cent while Honda's expanded from 5.5 per cent to 8.5 per cent but dipped a bit last year to 8 per cent, according to company figures.
On Tuesday, Volkswagen reported the first annual loss - at Euro119 million ($1.1 billion) - for its China joint venture since launching its business there in the 1980s. In 2004, the German firm earned Euro222 million from its Chinese operations.
However, shifting to Chinese-made car parts also poses new problems.
'They need to protect their [mother companies'] workers [in their home countries]. If these companies move their car-parts manufacturing operations to China, they risk angering labour unions back in their home countries,' said Tian Yamei, a representative of the China Association of Automobile Manufacturers.
'As a result, joint-venture carmakers have no choice but to keep making vital parts in their home countries.'
Apart from pricing, analysts said that marketing strategy and a good model range were also critical in keeping or expanding market share in China.
According to an ACNielsen report issued in May last year, buyers all over the world usually considered price as the most crucial factor for new car purchases. In China, however, brand image and prestige were just as important.
'Localising car-parts sourcing in China is one way of sustaining business for joint-venture partners. However, it is more important to put resources on marketing strategy and model range, as the car is categorised as a consumer product,' said Christopher Lee, director of equity research services at Standard & Poor's.
He noted that, compared with other manufacturers, Volkswagen had lagged in marketing and model range over the past two years.
'Volkswagen is a special case as it has two joint ventures in China which means costs are duplicated. In contrast, Honda and Hyundai have had good performance,' Mr Lee added.
Volkswagen, the largest foreign carmaker in China, has joint ventures with Shanghai Auto Industry Corp and First Automotive Works.
Besides the sourcing and marketing hurdles, joint-venture foreign partners have another burden to carry: import taxes.
Under its World Trade Organisation membership commitments, China will cut import tariffs on cars from 35 per cent last year to 25 per cent in the middle of this year.
However, on top of the import tariff, joint-venture carmakers must pay a 17 per cent value-added tariff on their imports which raises their cost of production.
'On the one hand, the [overseas-based parent companies of] the joint-venture foreign partners can profit by exporting their auto parts to China,' said Grace Mak, director of China equity research of Merrill Lynch.
'But, on the other hand, the import tariff is a burden for the foreign partner operating on the mainland. In the end, management must decide how to cut its costs.'
Still, analysts say foreign carmakers are expected to continue flocking to China.
According to the ACNielsen report, only 31 per cent of China's total population own cars, against 92 per cent in the US.
In the end, the ride may be bumpy for foreign partners operating in China, but the bonanza for the winner of the share-market race is just too lucrative to ignore.
In the case of Volkswagen, the German car giant may be finally biting the bullet.
Last month, it warned that it might have to slash 20,000 jobs, mostly in Germany, over the next three years to cap surging manufacturing costs and boost productivity. Many analysts are betting Volkswagen may soon shift some of its car-parts sourcing closer to China, if not on the mainland itself.
