China‘s economy has been sizzling hot. Shanghai’s stock market composite index passed 6000 on October 15, which doubled the number early this year and tripled the number from late 2006. The nation’s GDP has been growing at 11.5% in the first half of the year and that momentum is expected to continue. At the recent 17th National People’s Congress Assembly, China President Hu Jintao announced an ambitious goal to quadruple per capital GDP by the year 2020 (as measured against the year 2000).


 


The trickle-down benefits of the growing economy have not only been seen in restaurants, where one can’t find a seat for dinner without booking ahead of time in some parts of Shanghai, but are also seen in the auto market.


 


According to data released by the China Association of Automobile Manufacturers on October 19, passenger vehicle sales in China rose by almost 24% in the first three quarters. January-September sales of domestically made passenger vehicles — sedans, multipurpose vehicles (MPVs), sports utility vehicles (SUVs) and microvans — reached 4.58 million units, up 23.84% from a year ago. It’s widely expected that the total sales volume of automobiles in China will reach nine million by the end of this year.


 


Due to the concerns about environmental pollution and other issues, the Shanghai Municipal Government decided in 2000 to tighten restrictions on new car registrations, auctioning off a limited number of license plates every month. But the measure seems insufficient to curb consumers’ desires. In September, the government issued 8500 plates in Shanghai at an average price of nearly RMB 50,000 ($6667), a record high, which signals strong purchasing power from would-be private car owners.


 


Jim Su, a 27-year-old Shanghai Real Estate Agent, said he bought a Paleo last year for RMB 65,000 ($8,667) before taxes, but is planning to sell the Paleo and buy a new Family model produced by Hai Ma Automobile Corporations, a Chinese car maker based in Hainan province that has a strategic alliance with Japan’s Mazda Corp. The Family car sells for around RMB 100,000 ($13,333) which is considered a B-level (middle level) car in China. Su said the change is because he is now planning to get married, and his future parents-in-law consider a Family car more capacious and comfortable than his Paleo.


 


Jim Su’s cousin, Jin Ruoming, a 26-year-old Shanghainese who used to be a salesman for Toyota, has now opened his own store, J.S Club Auto Studio, to provide service for car owners. Ruoming, a fashionable man who dyes his hair blond, drives a Swift, a popular model among A level cars due to its similarity with the Mini Cooper. “I can’t afford a Mini, so I bought a Swift and changed all the parts to make it a roadster by myself.” The Swift sells for around RMB80,000 ($10,667) and its manufacturer is a joint venture based in Chongqing, middle China, between China’s Chang An Auto and Japan’s Suzuki.


 


Nationwide, according to the report by the China Association of Automobile Manufacturers, in September this year, in the first nine months of this year, the SAIC (Shanghai Automobile Industry Corp.) GM Buick Excelle was the best-selling model, followed by FAW (First Automobile Works) Volkswagen’s Jetta and Guangzhou-Toyota’s Camry mid-sized sedan. Buick Excelle and Jetta are both middle-level models and the Camry is a middle-up class model.


 


A Fiercer Competition than Ever


 


China‘s auto market is now the world’s second biggest. Although car ownership per capita in China is still much lower than in the U.S., the robustly-growing market has caused both international and domestic players to increase their investment In the industry. According to a recent report from Reuters, “Top European automaker Volkswagen AG raised its 2007 China sales target by 12.5% to 900,000 units, reflecting brisk sales in the world’s second-largest auto market. The German automaker said it sold 30.2% more vehicles in mainland China and Hong Kong in the first three quarters of the year than a year earlier.” Volkswagen AG is the first foreign player in China that went into business with Shanghai Automotive in 1985.


 


In 1997, General Motor won the deal for a partnership with Shanghai Automotive that now produces Buicks and other best selling models in China. The Buick has been considered a decent model that represents the identity and taste of China’s business people. It has always been among the biggest sellers, by volume.


 


Ford Motor Co., a relative latecomer to China, posted a 30% increase in its retail sales of vehicles in China to 135,073 units in the first nine months. Chang An Ford Mazda, a joint venture among these three parties based in Chongqing, set up a new R&D center in March and started the production of its second new plant on September 24 in Nanjing, Jiangsu province. Meanwhile, Ford Motor Credit Company is also in full swing in Shanghai.


 


The Japanese auto makers — Toyota, Honda and Nissan — are doing well in China. The big three have been volume leaders for the first eight months in China, ranked respectively number three, five and six, according to J.D. Power & Associates Automotive Resources Asia.


 


“I love Japanese cars. They have good quality and driving performance,” said Belinda Shen, a human resource manager of a local e-commerce company in Shanghai. She just bought a TIIDA last month, a very competitive model from Dongfeng Nissan, which has gained a lot of attention in 2007, especially from office professionals. “I like its shape. It’s big and fashionable. Besides, Japanese companies have a good reputation for product quality.”


 


Chinese local players are not slow movers either, especially in the economical auto market where competition is the most focused. Chery Automobile Co., a state-owned company established in 1997 in Wuhu city of Anhui Province, is now one of the top 10 sellers in China. The company sold around 260,000 units in the first eight months of this year, a 42% increase over the same period last year.


 


The most recent star is BYD Co., a private company based in Shenzhen, south China, which has launched an F3 model to grab the middle-level market. F3 had a good sales performance of around 59,000 units through September of this year. “F3’s outlook design is almost a copy of Toyota’s Corolla, but it sells at around RMB 60000 to RMB100000 ($8000 to $13333). It’s an economical-class vehicle but provides a more spacious shape,” said Jin Ruoming . BYD. is actually the biggest lithium battery manufacturer in China and it entered the car business in 2003 after acquiring an assembly plant.


 


A Declining Margin for Dealers


 


“There is a razor-thin profit for car dealers,” said Ye Chun, marketing manager for Dongfeng Nissan’s Jinjiang store, which is located in one of the most expensive villa districts in west Shanghai. The store sells Nissan’s full series, from Teana and Selphy to TIIDA and Livina. “Generally speaking, we don’t make money from selling cars. Sometimes we even sell a car at a lower-than-cost price for the purpose of achieving a total volume target by year end. What’s making the situation worse is there are heated competitions between different dealers for the same brand. Our profit mainly comes from the after-sales service and auto parts network.”


 


A recent report released by the National Development and Reform Commission on October 18 shows that auto prices this year through September have been down 3.15% over the end of last year, and the decline is bigger than the same period last year. Auto prices are expected to decline further in the fourth quarter.


 


BYD even announced on October 21 that it’s going to launch a mini-car in the first quarter 2008 with a pricing strategy that will make it “the lowest in China,” which means its new model will be priced below RMB20,000 ($2667). The news has surprised the market and raised many questions from critics about quality assurance. But BYD’s public relations officer has stated clearly that “low price is our marketing strategy.”


 


Avoiding a Price War


 


A price war strategy,however, might not benefit all parties involved.


 


Wharton marketing professor John Zhang doesn’t think a price war would be a good strategy for the car makers in China. “Price wars in the auto industry do periodically break out in China. This is because there are many manufacturers, the industry is still a high margin business, and there is insufficient product differentiation. However, the auto manufacturers in China should keep in mind that relying on price promotions to move products will train customers to buy on price. The experience in the U.S. auto industry shows that in a heavy promotion environment, customers will learn to wait for ever larger discounts before they make a purchase, which would force auto manufacturers to offer ever larger discounts to move their products. Once trapped in this vicious cycle, there is no easy way to get out of it, and manufacturers will suffer.”


 


Shaun Rein, managing director of the China Market Research Group (CMR) in Shanghai, shares the same insights. He strongly criticizes General Motors in recent years. “Basically, the auto market is huge in China as China’s emerging 250 million strong middle class aspire to own cars. This has made economical-class cars a good market. Unfortunately, many foreign brands like General Motor’s Buick line have diluted their brand image by lowering the price and standards of their cars to target the middle class. This has left both low and high-end consumers confused as to what the Buick brand stands for. Company CEOs do not want to drive the same brand car as their secretaries. Even if a Lacrosse and Excel are different cars, they have the same label. The price cutting has eroded margins and hit Buick and Volkswagen. Buick is following the same mistakes it made in the U.S. where it is doing badly.”


 


Toyota seems to be doing better, according to observers. “Companies like Toyota have segmented their markets well,” said Rein. “They know who they are as a brand and who they should sell to. For middle-upper middle cars, Toyota sells the Vios or the Camry up to the Crown. For luxury consumers, they sell the Lexus brand, which they differentiate from their Toyota brand.”


 


Another auto expert, Zhong Shi, general manager of Shanghai Smart Strategy Auto Consulting Company, echoed Rein’s comments on Toyota. “What makes a car a hot seller? There are several factors, including the timing of entering the market, the competitor’s actions, the uniqueness of the product and the pricing strategy. For example, Honda’s CR-V increased the price when it was launched. Toyota’s Camry was priced relatively lower at the beginning compared to the classic model Accord from Honda, but when people were crazy about it, there were not enough cars to meet the demand. So the price is up again, and Camry’s price is actually higher than the Accord. This is a very interesting pricing strategy. The CR-V is the same. Some products entered into the market meeting no rivals and won customers immediately by their function, design or some other distinctive traits without lowering the price.”


 


Some managers at multinationals might be well aware of the danger. Including John F. Kwant, director of business intelligence at Ford Motor Company in Dearborn, Mich. As Kwant commented almost two years ago: “There is a certain integrity that the Ford brand has, and we are not going to compromise that integrity by offering some cheaper version. We are not going to compete solely on price ….There are some real price wars happening in China. But I think we are providing the right value proposition for the customer, saying that you could probably always buy cheaper but you are going to get the most for your money with our products.”


 


Ford’s Focus model has been a hot seller this year in China. The 2007 model, which was launched in March at a price range between RMB120,000-160,000 ($16,000-21,333), has sold more than 90,000 units through September, according to its official website. Shaun Rein of CMR said Ford has the opportunity to grow well if it positions itself as a middle-end car and cultivates its core market.


 


Still, you don’t smell the smoke of gunpowder if you are not in the battlefield. When car manufacturers are frequently under sales pressure, it will be hard to curb their temptation to cut prices. However, said Zhang, “they need to realize that to increase their sales or to deal with a rival’s price cuts, their interests might be better served if they think more creatively and look elsewhere for a solution.”


 


Zhang suggests that business managers keep three things in mind. “First, price cutting is the easiest thing to do for you, and so it is for the competition. If you are trigger-happy with price cuts, you will have to deal with the consequences associated with competitive responses. Second, Chinese customers hate to pay a relatively high price so they try hard not to pay more than other customers. This means that a wise pricing policy is to maintain a certain level of pricing rigidity and not to offer arbitrary price cuts. Third, there are other ways to promote your cars more efficiently. For instance, you may offer some option, like an air conditioner or a GPS for free, instead of offering a $2,000 price discount. For price discounts, a dollar to the manufacturer is a dollar to the customer. However, an option that has the perceived value of $2,000 to customers may only cost the manufacturer $800 to produce. Therefore, non-price promotions, when chosen well, can create value for customers as well as for manufacturers.”


 


Some may argue that a price war would make consumers happy. But that’s not necessarily true. “Chinese consumers are multi-faced. They are more quality-concerned than price-concerned [when it comes to] auto products. The real challenge for the car manufacturers is they have to be more innovative. You have to create a really unique model to capture the niche market of your customers,” said Zhong Shi.

“Multinationals need to be proactive in shaping the market rather than reactive,” Rein added. “They need to know what their brand stands for and cultivate the market rather than be too opportunistic because that will destroy their long-term positioning and profits.”