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In China's shadow

Thursday, March 31, 2005 - 01:00

Rarely is the U.S. economy discussed these days without mention of China’s dominating influence, and the aftermarket is no exception as topics such as counterfeiting and trade deficits grace media reports and water cooler conversations. The automotive industry is one of China’s booming sectors and a hearty contributor to the country’s ascent as a global economic force.

Amid these discussions of China and its role in the U.S. aftermarket, we don’t quite know what to make of things yet as we become inevitably intertwined with this communist-capitalist country; the terms used will most likely vacillate between “friend” and “foe” depending on who you talk to, with avid arguments supporting each side.

Manufacturing jobs are moving overseas in droves, yet China is also exporting lower-priced goods back into the U.S., enabling American consumers to keep consuming. Additionally, China is voraciously purchasing U.S. debt, rendering itself a benefactor to many stateside lending institutions.

The closest comparison we can make is to Japan’s global rise in the automotive industry decades ago, but even that scenario was wholly different. After all, China is now pursuing capitalism with the same fervor in which it once pursued anti-capitalism, rolling across the world stage with all the might of a reckless freight train.

A look at China’s streets paints the picture of a country still settling in to the automotive age: Bicycles, mule carts and small conveyances with one-cylinder diesel engines still crowd the roads, especially outside of major metropolitan areas.

But China’s vehicle market is the third largest in the world, and its gross domestic product has expanded at a rate of about 10 percent a year, though some economists believe China has purposely understated its growth while depressing the value of its currency, the yuan, to remain more competitive, staying in lockstep with the diminishing value of the U.S. dollar. (Some estimate China’s real GDP to be between 13 and 14 percent.)

To offer a perspective on this growth, Ted C. Fishman, in Inc. magazine, writes that China “is closing in on a 30-year run during which its economy has doubled nearly three times.” China’s growth, he adds, has no equal in our modern history.

Unfortunately, this rise also is taking a serious toll on China’s people and its environment, a dilemma that will later be discussed in detail.

As far as China’s exports, the glut of products has helped trigger a devastating U.S. trade deficit, which lawmakers are trying to resolve by seeking to impose higher tariffs on Chinese goods. A $160 billion trading shortfall last year with China represented an increase of 31 percent from 2003, and the undervaluation of the yuan has cost the U.S. 2.6 million manufacturing jobs since 2001, according to legislators.

A group representing trade associations and unions that calls itself the China Currency Coalition is pushing for across-the-board tariffs on Chinese goods if the yuan is not re-evaluated, but the National Association of Manufacturers asserts the legislation would violate World Trade Organization commitments.

China has definitely taken advantage of opportunities here, but there are also opportunities in China for those in the U.S. aftermarket who haven’t already explored this unique global partnership. And it may not be too long before we see viable Chinese-brand automobiles hitting the streets in the U.S.

A number of stateside distributors we interviewed admitted that Chinese parts move quickly through the supply chain due mainly to their bargain prices. And the quality of goods coming from China has improved and is getting better, they say.

Still, the country is pinned as the top global culprit of intellectual property infringement and counterfeiting, a reputation China must make strides to upright.

Chinese companies have become adept at reverse engineering, which opens the doors for counterfeiting, says Frank Ordoñez, president of Delphi Product & Service Solutions and vice president of Delphi Corporation.

He reports seeing billboards in China featuring the Delphi logo that were neither approved nor purchased by the company.

Ordoñez, who says China’s government has recently put out a branding policy that addresses counterfeiting, believes as the country attains more engineering technology, the theft of intellectual property will decline.

There’s not much more that can be said about counterfeiting that wasn’t already addressed in our comprehensive report last October, and to expound on this topic would only reiterate the reports of other media.

The birth of an aftermarket

While China’s effect on the U.S. aftermarket is considerable — especially as it pertains to manufacturing jobs moving overseas — its own aftermarket may not even exist yet.

A majority of China’s 1.3 billion citizens are still too poor to own a vehicle, but the country’s expanding middle class is producing a drove of automotive consumers just waiting to be served.

Many Chinese citizens now own their very first car, says Lance Ealey, auto analyst for the Freedonia Group, which published a 2003 report on China’s auto industry. Coupled with the fact that these newfound drivers are unfamiliar with automotive maintenance (and basic driving skills, for some), Chinese motorists often lack aftermarket options.

“In just fundamental ways, there is no independent aftermarket, or it’s very small,” says Ealey. “It tends to be dealer-based.”

It will be interesting to see which aftermarket model China eventually adapts, he says. Will it be a robust, independent aftermarket like the U.S., or a European model, where dealers have the foothold? Ealey is putting his money on the European model as this lack of options is prompting Chinese motorists to return to the dealers.

U.S. suppliers with a Chinese presence, like Bosch and ACDelco, are also getting involved in the country’s automotive service, he adds. “These customers are demanding all the bells and whistles found in the U.S., and they’re getting them.”

Scott Mackie, regional general manager for the GM North America Vehicle Sales, Service and Marketing Northeast region, agrees the majority of Chinese drivers are still bound to OE service. The company has more than 100 service centers in China that are independently owned but carry the ACDelco banner.

Because of the sophistication involved with new vehicle engineering, Mackie says Chinese drivers will most likely continue the DIFM trend.

The distribution channels in China are highly fragmented, concedes Mackie, who adds they’re selling through 35 WDs, which, in turn, have thousands of customers, be they technicians or parts dealers. But, he says, consolidation is beginning to take root. “Now the first instances of buying groups are starting to form.”

Xiao Chen, manager of ACDelco Business Development, says the Chinese government is planning to consolidate its service industry, with proposed mandates that require those with less than five chain stores to join a larger chain or close, a move that could essentially drive “mom-and-pop shops” into extinction, though he could not provide a timeline for implementation.

Chen points out a fact that encourages DIFM-heavy Chinese motorists: “Ninety-nine percent of Chinese residents don’t have a garage.”

Delphi’s Ordoñez says China’s distribution system is no comparison to the sophistication of stateside networks.

“The Chinese distribution system runs from a fairly well-organized dealer network, which also acts as an aftermarket outlet, to what I’ll call a parts city,” he says. “A parts city is like a huge flea market; in this flea market are all these little stores full of parts.”

Ordoñez adds that there are no catalogs within these “parts cities”; people are basically left to guess which part to buy. The network of distributors is bound to become more sophisticated, Ordoñez speculates, and it will just be a matter of who will take advantage of this need, presenting an opportunity for U.S. distributors.

Another interesting trend in China is that very few companies have their  own national brands. Instead, Ealey points out, many are relying on existing automotive makes such as GM and Volkswagen. Though these companies have Chinese partners, a requirement to do business in this country, the Chinese aren’t pushing their own brands, he adds.

In time, though, a legitimate aftermarket may emerge, says Ealey. “We’re just starting to see the creation of a used-car market (in China), and with the used-car market will come the creation of a true aftermarket.”

The aftermarket, he adds, is the trailing edge of a phenomenon that has taken place in China over the past 15 years.

The AutoZones and the NAPAs of the world should take note as China migrates to a buyer’s market and emphasizes the retail side of the automotive industry, Ealey advises.

Manufacturing a future

Ever have a customer ask for a “China price” on aftermarket parts or accessories? There’s a reason for that.

As a supply choice, Chinese manufacturers are a viable alternative, says Mackie, and “a little bit of a threat to those who haven’t globalized their cost base.”

He points out that having a manufacturing base in China is beneficial to ACDelco, especially because there are four GM assembly plants in China, forming a “local” network within foreign borders.

Dispelling the country’s checkered past for its notoriously inferior brake rotors, old perceptions are being shaken away as China advances as a global competitor with an immense labor force and access to raw materials, says Mackie.

He considers China an “untapped opportunity” for General Motors as a whole.

Delphi has been in China for more than 15 years, says Ordoñez, who admits the company has simply followed its OE customers. Delphi also wanted to be present in a market that Ordoñez considers “explosive.”

Delphi even sponsors an MIT-level university in China that’s churning out talented future engineers, he adds. “The benefits of operating in China are self-evident.”

Creating ecological casualties

The first and most obvious victim of China’s worldwide growth is its own citizens. Many economists accuse the Chinese government of depressing the value of its currency against the U.S. dollar by as much as 40 percent, as well as underreporting its growth rate in competition for development funds.

Meanwhile, China has invested in U.S. debt securities, when investments in its own economy have the potential to yield 10 times as much return, writes Fishman, who is also author of the book “China, Inc.”

According to Fishman, “The people of China, who earn on average just one-fortieth what Americans do, are indirectly subsidizing the insatiable shopping of Americans, who acquire ever more goods at the same time that Chinese consumers are hampered from buying goods from abroad.”

To emphasize the disparity between U.S. and Chinese currency, Fishman adds: “A dollar spent in China buys almost five times more goods and services than a dollar spent in a typical American city like Indianapolis.”

Despite the country’s global successes, unemployment and poverty remain very real concerns for China.

Another victim is the country’s ecological well-being, and the attendant problem of declining public health, as China relies heavily on unwashed coal to fuel its rapidly growing manufacturing sector. China burns coal for about 70 percent of its domestic energy, according to Brian Bremner, in Business Week Online. The country also wastes a tremendous amount of energy due to “primitive coal-mining techniques, loose building-construction codes and inefficient factories,” adds Bremner. It should also be noted that China suffers massive amounts of accidents and deaths in its coal mines every year. 

Seven of the world’s 10 most polluted cities are in China, according to the United Nations World Health Organization. Water shortages, soil erosion and acid rain are all symptoms of China’s meteoric rise in manufacturing.

This dependence on coal for energy could change with construction of the Three Gorges Dam, expected to be complete between 2007 and 2009. The Three Gorges Dam will be the largest structure of its type in the world, but it will not be without its own share of troubles — like the displacement of more than a million residents, loss of more farmland and local environmental damage. However, the dam will most likely be a necessary evil to keep pace with continued economic change.

In the meantime, China is looking toward nuclear energy to help mend these environmental and energy wounds caused by this zealous climb toward global economic dominance. As the country anticipates stepping up production of nuclear power plants and technology to make its own nuclear reactors, some fear this may lead to increased nuclear weapons proliferation through China’s partnership with Pakistan, writes Thomas Orszag-Land in Oxford, England’s Contemporary Review.

China also has shown interest in coal liquefaction technology and liquid fuels based on coal substitutes, adds Orszag-Land.

But as these plans are bandied about, this most populous country on earth continues to consume more coal than any other nation in the world, and acid rain prompts vast deforestation and desertification, which, in turn, impedes its agricultural base.

The ‘Chery’ on the cake

It may not be long before Chinese-branded automobiles are competing for market share on U.S. streets.

The first cars we may see here are made by China’s Chery Automobile Co., and are expected to be introduced by entrepreneur Malcolm Bricklin. If his name doesn’t immediately ring a bell, Bricklin is responsible for introducing Japan’s Subaru to the U.S., as well as the ill-fated Yugo in the late ’80s.

Bricklin, who plans to bring Chery stateside starting in 2007, will charge about $15 million per dealership, which will fly under the banner Visionary Vehicles LLC.

Only time will tell if Chery can successfully compete in the United States market and improve China’s reputation, says Ealey. “Malcolm Bricklin is a good example of someone who did a great job with Subaru and a not-so-great job with other brands. If he rushes it, it could lead to a negative outcome.”

Japan’s introduction to the U.S. consumer certainly wasn’t a “Harvard Business School” best practice model, reminds Ealey, who adds that consumers can be unforgiving when it comes to brands that get a rough start in the U.S. marketplace. 

Bricklin does and will have staunch competitors. Retro Motors, which is launching a line of remanufactured used vehicles, intends to go head-to-head with Chery both here and in China.

In a press release, Founder Allen Jaffe said he will offer royalty-based plant/factory outlet partnerships for $5 million per facility, undercutting Bricklin’s asking price.

 Creating an additional black mark on China’s reputation for intellectual property infringement, Chery was recently accused of piracy by GM Daewoo Auto & Technology, which asserts that Chery’s QQ is an illegal duplication of its Matiz, licensed as the Chevy Spark. (A look at photographs of the two cars reveals that they are remarkably similar.) GM filed suit last December and the case is still pending.

QQ sales have been much higher than the Spark in China, according to China Daily, which adds the suit arose after China’s State Intellectual Property Office concluded that Chery didn’t infringe upon GM.

China’s government has been criticized more than once for its laxity when it comes to piracy and IP violations.

Honda filed suit against Shuanghuan Automobile for infringement last October, alleging the company lifted designs from its CR-V, and Toyota Motor Corp. filed an infringement lawsuit against privately-owned Geely last year, but lost the case, reports China Daily.

Next month, we’ll continue this discourse by exploring the effects of China on our stateside aftermarket and our growing trade deficit. We’ll also provide advice for those U.S. companies seeking to partner with China.

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