Time for a Shakeout in China's Auto Industry?

Yesterday China Bureau Chief of Automotive News, Yang Jian posted an interesting article (free registration reqd.) speculating as to possible consequences of a recent slowdown in auto sales in China.  In the first two months of 2012, auto sales decreased four percent, year-on-year – and this comes on the heels of (for China) a rather anemic 2011 in which sales only grew about 2.5% and Chinese-branded passenger vehicles gave up nearly two percentage points in market share to the foreign brands.

In short, Yang Jian's point is that, should this drop in sales become a trend that lasts through 2012, some of the weaker players in China's auto industry could be forced into bankruptcy or possibly out of business altogether.

From the perspective of China's central government, which has been begging and pleading for this heavily fragmented industry to consolidate itself for nearly three decades, this wouldn't be such a bad thing.  (Of course it would be a bad thing for the employees of those companies that went out of business.)  There are still well over 100 vehicle manufacturers operating in China (compared to only 24 in the United States), and this fragmentation prevents the industry as a whole from becoming more competitive vis-à-vis the foreign automakers.

So what is the likelihood that a decline in sales could lead to a shakeout of the weaker players?  Well, let's take a look at what happened the last time China's auto industry experienced a slowdown in sales growth.  After enjoying annual sales growth of anywhere between 14% and 37% since 2001, the onset of the Great Recession in 2008 caused China's growth rate to drop to a horrifyingly low 7%.  (Yes, the word “horrifyingly” should be interpreted sarcastically.)

I remember talking to a lot of auto industry insiders in China in the spring of 2009 when some of them lamented the fact that the much hoped-for shakeout didn't happen back then.  (And it seems like Yang Jian himself may have been among those who expressed such sentiment to me then.)

Why didn't the shakeout happen?  

The central government rode to the rescue with a far-reaching stimulus program that not only prevented another year of miserably low sales growth, but that, for the first time ever, launched China into position as the world's single largest market for automobiles in 2009.  Hence the lamentations from some of my interviewees at the time.  As Yang Jian hopes today, many of them also hoped soft sales growth would kill off some of the weaker players in 2009.

So will the central government ride to the rescue again this year? 

I think it is less likely.  With large cities in China already limiting the number of cars that can be sold and driven on their streets, and with the central government clamping down on overcapacity in the industry, AND now that China is already the number one auto market in the world (they can't go any higher), a rescue is probably not in the cards.

Does that mean a shakeout will occur? 

I wouldn't bet on that either.  Among the top-10 automakers, Chang'an, Chery and BYD each experienced sales declines in 2011, which doesn't look good for them.  Except that Chang'an is among China's “Big 4” and Chery is among China's “Small 4.”  What this means is that the central government has designated these automakers to be among those remaining after the industry consolidates.  And BYD is privately-owned (its shares are traded in Hong Kong), and, though it hasn't sold as many EVs and hybrids as it had hoped to by now, it is probably China's best chance of having an automaker who can compete in this space.

Will a shakeout then occur among the dozens of tiny, inefficient and unprofitable automakers scattered around the country? 

I think this is the best hope, but whether the downturn will be deep enough and long enough to outlast local governments' ability to prop up these firms remains to be seen.  Local governments tend to be rather fond of their automakers -- even the ones that lose money.

Book Talk at USC

Several weeks ago I gave a talk related to my forthcoming book at the University of Southern California.  Watch as I attempt to summarize four years of research and a 300-page book in less than an hour.  :)

Volvo is Geely, and Geely is Volvo

It was only a matter of time.

The privately-held Chinese automaker Geely has announced that it will be forming a joint venture with its subsidiary Volvo.  As you may remember, Geely’s owner, Li Shufu conducted a high-profile purchase of the Swedish automaker Volvo from Ford in 2010.

The concern at the time had been that Geely simply wanted to strip away Volvo’s intellectual property for itself, but Li Shufu assured observers that the two entities would remain separate: “Volvo is Volvo, and Geely is Geely.”  And indeed, the purchase was structured so that both the Hong Kong-listed Geely Motors and Volvo are both subsidiaries of a holding company controlled by Li Shufu.  (In other words, Geely doesn’t own Volvo, technically, Li Shufu does.)

So why is Geely now forming a JV with Volvo?  Because it has to in order to build cars in China.  China’s rules require that any “foreign” automaker that wants to assemble cars in China may only do so through a joint venture with a Chinese automaker, and the foreign entity may hold no more than 50 percent of the JV.  Since Volvo is still headquartered in Sweden, it is considered foreign.

The icing on the cake for China here is that, like all other foreign automakers who have sought permission from Beijing for expansion or establishment of a new venture anytime during the past two years, Volvo is also being required to “assist” Geely in building a Chinese-branded car.

Until now, this has only applied to state-owned enterprises because only state-owned enterprises had joint ventures with foreign automakers (with the exception of a small JV between BYD and Daimler to develop electric vehicles).  The assumption had been that the SOEs, which had been dragging their feet in terms of developing their own brands, would be “given” slightly out-of-date technology by their foreign partners.  They would then produce cars under a Chinese brand name using the foreign technology and designs.  (I have previously written about this phenomenon, which I refer to as "sub-brands" or “JV Brands.”)

What is interesting here is that Geely, unlike the SOEs cannot be accused of “dragging its feet” in developing Chinese brands.  Indeed, Chinese brands are all Geely has ever made!

So what does this mean for Volvo?  What it means is that Volvo will simply be handing over technology onto which will be slapped a Geely-owned Chinese brand name.

Perhaps Li Shufu would now like to change his quote to, “Volvo is Geely, and Geely is Volvo.”

GM's Kevin Wale on Innovation in China

The consulting firm McKinsey published on its website an interview with Kevin Wale, president and managing director of General Motors China.  The whole interview is worth a read if you are interested in the state of innovation in China, but here are a few of the more revealing excerpts with a little of my own commentary.

Kevin Wale: When the Chinese get an idea, they test it in the marketplace. They’re happy to do three to four rounds of commercialization to get an idea right, whereas in the West companies spend the same amount of time on research, testing, and validation before trying to take products to market.

This is both scary and admirable.  Scary, because the Chinese are, at least according to Mr Wale, willing to put products into the market before they are fully tested as a means of development.  When you think about it, this is pretty much what Apple does with its products.  The first iPhone wasn't fully ready, but it was ready enough.  Feedback from customers helped them to improve on subsequent iterations.

What's scary about this is that driving a car that has been put into the market on an experimental basis doesn't sound like something I would want to do.  If my iPhone blows up, I would probably survive.  I'm not sure I could survive my car blowing up.  While I would hope that GM is able to prevent its partner, Shanghai Auto, from putting dangerous vehicles on the market, I wonder whether other Chinese auto companies are quite as careful.

The Buick LaCrosse, partially designed in Shanghai

The Chinese system supports the idea that it’s OK to fail if you fail in a government-sponsored direction. It’s OK to make mistakes as long as you’re moving forward. They’re quite OK to get out there, do something, find out it’s not perfect, but quickly adapt it and move forward. There’s no recrimination internally for doing that if that’s the direction the country wants to move in.

It's a great thing that people feel comfortable to experiment within the boundaries set by the state, but the opposite of Mr. Wale's statement is that they do not feel comfortable experimenting outside the boundaries set by the state.  But what if a worker has an idea that's not in “the direction the country wants to move in.”?  Too bad.

This, in my view, is precisely why China will always be a step behind.  Governments have historically been quite bad at charting an unknown course in terms of picking winners and losers.  In China, true technical innovation will always have to come from outside until people feel free to make mistakes in all areas of business, not just those approved by the geniuses in Beijing.

McKinsey Quarterly: Do you source innovation from outside GM China?  Kevin Wale: The answer depends on whether you’re talking about joint ventures or GM. In our joint ventures, we’re happy to take innovation from suppliers any day of the week.

This is more interesting for what Mr Wale doesn't say.  When asked whether GM gets innovation from outside, Mr. Wale assumes the question is about whether GM sources innovation from its joint ventures in China.  From his answer, it seems pretty clear that they don't.

Let's be honest here, the technology is still only flowing in one direction, and that's from GM to its Chinese partners.  At what point will GM's partner have enough technology that it doesn't need GM anymore?

Chinese-branded cars lost market share in 2011

In early 2009 China's government released a fairly comprehensive policy for the auto industry called the "Automobile Industry Adjustment and Stimulus Plan (汽车产业调整和振兴规划)." 

Among the major targets included in this plan was for an increase in market share of China's home-grown auto brands (also known as 自主品牌). One of the targets was for Chinese-branded  passenger cars (轿车, aka, sedans) to increase domestic market share to 30 percent in three years' time (by the end of 2011).  (Up from about 26 percent at the end of 2008.)

China's auto industry enjoyed robust sales growth of 48 percent in that very year, giving the Chinese brands a 29.7 percent market share by the end of 2009.  And just in case the leaders weren't satisfied with rounding up to 30, Chinese brands achieved a 30.9 percent market share by the end of 2010.

Unfortunately, the tide turned against manufacturers of Chinese-branded cars in 2011, causing them to lose market share for the first time. Though the absolute number of Chinese-branded cars sold increased, foreign-branded car sales grew at a faster rate, dropping the domestic brands to a 29.1 percent market share -- just in time to miss the target that had been set out for them three years earlier.

And this came in a year during which luxury automakers enjoyed enviable sales growth in China: Audi-37%, BMW-37%, JaguarLandRover 61%, Cadillac-73%.

Why did Chinese cars suddenly lose market share to the foreign brands?

Did quality decline? Not at all!  In fact, Chinese brands have been closing the quality perception gap with the foreign automakers.

What happened was that another provision in the "Adjustment and Stimulus Plan" of 2009 distorted sales growth in 2009 and 2010.  The plan included a 50 percent cut in auto sales taxes for vehicles with engine sizes of 1.6 liters or less -- in other words, small cars.

The stimulus really worked! In 2009 sales of cars in the 1.6 liter and below segment grew 71 percent while sales in all other passenger car segments grew by "only" 23 percent. And the beauty of this stimulus plan was that, at the time of its introduction, fully 85 percent of the market for 1.6 liter and under cars was occupied by Chinese brands.  This was none other than a plan to stimulate sales of Chinese brands.

The stimulus also worked in 2010, but it was later halved to only a 25 percent sales tax cut, and then, by the end of 2010, the stimulus was lifted completely -- resulting in disappointing performance in 2011.

Of course, we can't blame it all on lifting of the stimulus because, once the stimulus was enacted in 2009, foreign automakers scrambled to enter the 1.6 liter and below segment as quickly as possible.

Still, this does illustrate well the distorting effects of government schemes on markets. And it is somewhat ironic that the same plan that brought such growth in 2009, took it away once the stimulus provision was allowed to expire.

GM Wants its 1% back. Good luck.

GM announced yesterday (again) that it wants to repurchase a one percent stake in its joint venture with Shanghai Auto (SAIC) that it sold for a handful of magic beans a few years ago.

Back in December of 2009, GM and SAIC announced a major change to their partnership which involved GM selling one percent of the SAIC-GM joint venture (JV) to SAIC for $85 million.  This announcement also included details on a new Hong Kong-registered joint venture through which GM and SAIC would partner to conduct business in other countries, primarily India.

The net result was that GM and SAIC were no longer 50:50 owners in the main China JV.  With the one percent transfer, SAIC became the majority owner with a 51 percent stake.  On paper at least, GM had been reduced to the role of junior partner.

At the time, GM management explained that the purpose of the one percent transfer was in consideration of some future help from SAIC.  And though it wasn't explicitly stated, GM statements sort of hinted that SAIC's help may come in the form of help with future funding.

Early speculation was that GM needed the money.  And since GM had emerged from bankruptcy only a few months earlier, that seemed to make sense, except that, in the whole scheme of things, $85 million didn't really seem like a lot of money.  At year-end 2009, the company had over $14 billion in cash on its balance sheet, so it wasn't cash poor.  And with a current ratio (current assets/current liabilities) of 1.13, it wasn't facing an impending liquidity crisis.

Since I happened to be in Shanghai only a few weeks after this announcement was made, and since I was fortunate enough to land an interview with a senior SAIC executive who was integral to the negotiations with GM, I asked the SAIC executive to explain why GM would give up any leverage it had over the JV for a measly $85 million.  His explanation made a little more sense.

In short, SAIC wanted to be able to consolidate the top-line revenues of the JV into its parent company income statement, and under accounting rules, it could only do this if it owned more than 50 percent of the company.  Chinese companies were (and are) under a great deal of pressure from Beijing to move up in the rankings of the Global Fortune 500, and since the Fortune list looks at sales, not profits, SAIC needed to make its sales number bigger.

Does this sound ridiculous?  It did to me too.  But it's also the truth, as this particular executive, on two different occasions, emphasized to me the importance of moving up the list of the Fortune 500.

So what did GM get for handing over control?  According to the SAIC executive, GM wanted desperately to continue expanding its global footprint, but was facing two hurdles.  First, as GM had recently exited bankruptcy, the terms it could receive on bank lending were highly unfavorable.  Second, still being majority owned by the taxpayers of the US, GM was restricted in its ability to fund any activity that didn't somehow create American jobs or shore up the US-side of its business.

And this is where SAIC came in.  Through this partnership, SAIC, with its stellar credit rating, not to mention being a major state-owned corporation with access to favorable loan terms from both state-owned mainland banks as well as Hong Kong banks, would be able to help GM out with its funding needs overseas.

The SAIC executive did suggest that GM and SAIC could have entered into an agreement whereby the two companies would create an entirely separate sales JV to which all vehicles manufactured would be sold.  Then SAIC would own 51 percent of the sales JV, also allowing it to consolidate revenue into the parent company's income statement.  (SAIC and its other major partner, Volkswagen have a similar arrangement.)

However, this particular arrangement didn't work for GM either as, once again, GM's government minders in Washington were not interested in entering into any arrangements that didn't serve the interests of the US.

Fast-forward a couple of years, and now GM wants its one percent back.  The only way I can see this happening is if GM were to agree to set up the sales organization that SAIC had first proposed, which may be possible now that the US government is no longer a majority owner in GM (though still technically the controlling owner).

Of course, since the time of that transaction, GM has been very vocal about the importance of the China market to the company's future.  In fact, GM now sells more vehicles in China than in the US (2.6 million vehicles in China vs 2.5 million in US in 2011.)

One wonders how eager SAIC will be to give up the majority control it has enjoyed for more than two years.  Furthermore, given the importance of its China JV, GM can probably expect to pay considerably more than $85 million for the return of its one percent.

End of the Road for Foreign Automakers in China?

Last week a story emerged that China's industrial planner, the National Development and Reform Commission (NDRC), has announced that it will stop supporting foreign investment in its auto industry. (News stories may be found here, here and here.)


This bit from a China Daily article explains a little about why these restrictions were being put in place:

China...has removed industries from the list of those it encourages foreign companies to invest in. No longer part of that group are automakers, large coal-to-chemical operations and manufacturers of polycrystalline silicon.

"The restrictions generally apply to industries that have excessively large capacities and that pollute the environment," said Zhang Xiaoji, senior researcher at State Council's development research center. (emphasis added)

My take on this story is that the NDRC actually has no real intention of restricting foreign investment in its auto industry. To understand why this is so, one needs only a limited understanding of the history of foreign involvement in China's auto sector, which I lay out in an op-ed in today's Asian Wall Street Journal.

In short, I make the claim that:

... the NDRC's announcement is more about improving Chinese leverage in negotiations with foreign automakers so Chinese automakers can more quickly overcome their innovation deficit.

For the rest of the op-ed at the WSJ site, click here.

And for all of the stories behind the main story of business-government relations in China's auto sector, my book, Designated Drivers: How China Plans to Dominate the Global Auto Industry, will be published by Wiley and Sons this year.

Coming to a bookstore, mailbox or e-reader near you in Spring 2012. Stay tuned!

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EDIT:
I was just notified that my article was also picked up by WSJ's US op-ed page. It will run in Thursday's edition. (January 5)

Hold on to your lugnuts! It's time for a Trade War!

The Wall Street Journal is reporting today that China is preparing to levy duties on certain autos imported from the US. This would be on top of the 25 percent duties that China is still allowed to levy under its WTO commitments.

China's Ministry of Commerce said in a statement late Wednesday that it will levy antidumping and antisubsidy duties on imports from the U.S. of some vehicles with engine capacities above 2.5 liters beginning on Thursday and lasting through the next two years. ...

The ministry said several U.S. companies, including General Motors Co., Chrysler Group LLC and the U.S. arm of Honda Motor Co., engage in dumping and subsidizing. The statement said the move would also affect cars made by the U.S. arms of Mercedes-Benz and BMW AG, though it said their level of dumping was smaller.

Note that China's Commerce Ministry singled out not only the traditional US automakers GM and Chrysler, but also the US arms of Honda, Mercedes and BMW.

While China could have plausibly argued that GM and Chrysler benefit from government subsidies due to the bailouts these two companies received, they instead chose to make this about all cars with engines larger than 2.5 liters made in the US (but not in Japan or Germany!).

Does anyone think the US Congress will choose to view this as any less than an attack on the livelihoods of American workers -- and in an election year no less? Of course, Congress cannot portray themselves as innocents in all of this as Congress has already singled out China's solar panel industry for US-imposed tariffs. Then again, Congress can point to China's currency...

And on and on it goes. One thing I learned in grad school about wars (the kind in which people shoot at each other) is that it is nearly impossible to identify who started it. No matter which incident one side points to, the other side can go further back in history to identify another.

If we look at this incident only with regard to China's auto industry, it is also easy to see a kind of pattern here. Back in 2009, when China launched the stimulus heard round the world, they chose to subsidize consumer purchases of vehicles with engines smaller than 1.6 liters.

Why 1.6 liters? Because the foreign automakers that were dominating China's auto market had very little to offer in the small car segment. That subsidy was intended to boost sales of Chinese-branded cars.

Of course, the foreign automakers didn't stand still. Many of them already had small cars in the pipeline, so they got them to market faster -- just in time for China to cancel the subsidy toward the end of 2010.

Why are the import duties now focused on 2.5 liters? Because this is an area in which the foreign automakers pretty much own the market. This effort to make these imports more expensive may ideally (from China's point-of-view) accomplish two things: 1) make Chinese consumers more likely to consider a less expensive Chinese-branded car, and 2) make foreign automakers consider moving more assembly of their larger models to China.

In reality China's new tariff may not accomplish either purpose. For one, the Chinese consumers who are more interested in these larger cars (as the WSJ article points out) are less price sensitive anyway. They are already interested in these large foreign brands because they perceive them to have higher quality. In addition, because the volume of these larger cars in China is still comparatively small, it is highly doubtful that much, if any, of their production would be moved to China. (Perhaps that second one is a straw man argument.)

So what does China really stand to gain? Not much, really. In the end, China will get the trade war that it has been warning us about for years, and its home-grown automakers will still face a quality gap with their foreign partners/competitors.

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In case you're wondering where the picture at the top came from:

A legitimate beef with China

A leader in this week's Economist, concerning the US Senate's passage of a bill intended to punish China for currency manipulation, warns that, however right the Senate may be about currency manipulation, passage of the bill would risk an unnecessary trade war.

The Economist goes on to say that America does have "legitimate beefs with China, but this bill is the wrong way to address them. It is legally flawed, economically dangerous and unnecessary." If passed, China would surely have a legitimate claim against the US through the WTO, and would almost certainly retaliate with its own trade-limiting measures.

While I understand the value of this measure as a political tactic for Senators who are part of the most hated US Congress in history, the fact is that there are better ways for America to get what it wants (not that Congress even cares).

While the WTO mechanisms designed to facilitate open trade are slow to work, China recognizes them as legitimate and has generally adhered to their judgments in the past. Although, as The Economist admits, currency manipulation is not addressed in WTO rules, America indeed has "legitimate beefs" with China that could be addressed under the WTO. Yet, for some reason, the US Congress chooses to focus on currency, and the Obama administration apparently chooses to look the other way when it comes to some of China's real WTO violations.

While I haven't cataloged all of China's violations, I know that there are several going on in the auto industry that no one seems to think are worth calling China on. For example, a couple of key measures in China's WTO accession agreement forbid China from conditioning investment in China on technology transfer and local content requirement. (This agreement dates back to 2001, by the way, so it's nothing new.)

As for the tech transfer part of the rules, China's ability to apply pressure to foreign automakers to transfer technology in exchange for permission to expand in the country has been well-documented. (A couple of example articles are here and here.)

The latest attempt by the Chinese to adhere to the letter of the law while blatantly violating its spirit includes holding off on investment approval until the foreign company "voluntarily" offers to contribute technology toward establishing a Chinese brand with its (state-owned) Chinese partner. Peugeot's CEO was quoted by the Financial Times as saying that, cooperating on building a Chinese brand is now "part of the deal."

And the automakers involved in this attempted extortion have no incentive to complain about it for fear of losing their access, all the while knowing that their competitors are all doing the same thing.

Okay, you may say, perhaps China's violations in this case would be too difficult to prove under the WTO's mechanisms. After all, the foreign automakers all appear to be "voluntarily" contributing technology in these cases, and anyway, none of them is complaining. Perhaps.

Then how about a more obvious violation of the rules? In this case, it involves the imposition of illegal local content requirements.

This actually surfaced a few weeks ago, and I commented about it on twitter, but only my friend @alexwoods5 seemed to think it was an issue worth being concerned about. The issue in question arose from a recent Wikileaks cable in which an employee of Ford in China revealed to US diplomatic personnel that Ford's operation in China is subject to a 40 percent local content requirement. This is the relevant section:

¶9. (SBU) All of Ford's parts suppliers must meet the Chinese Government's rules of minimum 40 percent local content by value, Chuang explained.

Does that not sound like a local content requirement? Could this have been a condition for Ford's recent investment in new factories in China?

I even emailed an acquaintance of mine at Ford, twice, seeking some sort of explanation or confirmation. The fact that he has yet even to respond with a "no comment" tells me that this may be worth investigating.

But is the Obama administration investigating it? If not, why not?

I know that the administration, or at least certain individuals in it, understand that the currency bill passed by the Senate would do great harm to both global trade and to America's relationship with China. But if they want to avoid such unpleasantness, why not at least make an effort to make China follow the agreements it has signed?

Who cares about IPR, what about innovation in China?

The Wall Street Journal reports on a brief debate that took place yesterday between US Ambassador to China, Gary Locke and an advisor to the People's Bank of China, Li Daokui. The exchange took place during a panel discussion at the World Economic Forum meeting currently taking place in Dalian, China.



The apparently civil discussion surrounded a disagreement as to the repercussions of China's difficulties in enforcing intellectual property rights (IPR) protections. In short, Locke expressed his view that lack of IPR enforcement would stifle Chinese innovation. Li, on the other hand, merely expressed his disagreement and noted that China's policy focus instead needed to be on supporting entrepreneurs and removing barriers to their success. (Notice how Li cleverly took Locke's cue and changed the topic from IPR to innovation?)

So who is right about innovation? Where should China focus its policy in order to better support innovation? Should it beef up IPR enforcement, or should it focus on removing barriers to the private sector? Which would give it the biggest bang for its policy buck? (Not that this is necessarily an either/or proposition -- China is big and rich enough now to do both -- but humor me on this.)

Some of my readers may be surprised to learn that I think Li Daokui was right. While Locke was certainly carrying out his duty as Ambassador by saying that China needs to improve IPR protection, the truth is that IPR protection has very little to do with innovation in a developing country like China. In fact, history tells us that, since the dawn of the Industrial Revolution, every subsequent country to jump on the development bandwagon has copied those who came before.

...every country that became economically great began by copying: the Germans copied the British; the Americans copied the British and the Germans, and the Japanese copied everybody.*

This is not to excuse the Chinese companies that blatantly copy foreign products and the government that often chooses to look the other way, but since Locke chose to introduce innovation into the discussion, the issue deserves a closer look.

My research on China's auto industry reveals that the most innovative among China's automakers are the private and independent automakers, not the massive state-owned enterprises (SOEs) with their foreign joint venture partners. While private players have yet to introduce any real breakthrough innovation, their progress in developing new energy vehicles and unique Chinese brands is ahead of the SOEs. The reason for this (and you'll have to take my word for it until my book comes out) is twofold.

First, leadership positions in SOEs are essentially political positions. The men who run these companies have their eyes on their next job, which will be a political appointment to run an association or a local government, or even to become a Vice Minister or Minister in the central government. In order to better assure themselves of a good position, they tend to be risk-averse in their decision making.

Second, because these guys have short-term investment horizons, "wasting" money on R&D is not high on their agendas. R&D spending only helps the next guy. It is much easier to rake in profits building and selling foreign branded cars. They simply lack the career incentives to take the kind of risks that result in significant innovation.

(Here is another story today about how "JV brands" have not resulted in the innovation that the central government had been hoping for. Why? Again, forcing foreign partners to hand over technology does not translate into innovation, especially when leadership incentives are not changed. I previously wrote about this "JV brands" or "sub brands" issue several months back.)

So while Li Daokui seemed to be changing the subject above, he was actually addressing Locke's point about innovation. And if China's auto industry is any kind of indication for China as a whole, the central government would do well to follow Li's advice and remove the barriers that continue to marginalize private business in China.

Of course, as an American, I would like to see the home team do well, so if China continues to insist on a preponderance of state control over all of its major industries, I believe that will ultimately be to the advantage of China's competitors. And they need every advantage they can get.

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* William Kingston, “An Agenda for Radical Intellectual Property Reform,” in International Public Goods and Transfer of Technology Under a Globalized Intellectual Property Regime, ed. Keith E. Maskus and Jerome H. Reichman (New York: Cambridge University Press, 2005), 658.

American Wheels, Chinese Roads: a review

For several months I have been eagerly awaiting the arrival of Michael J. Dunne's new book, American Wheels, Chinese Roads: The Story of General Motors in China (Singapore: John Wiley & Sons Asia, 2011).


If you have read any news stories covering China's auto industry over the past decade, you have almost certainly read quotes from Mike Dunne. Until recently he was in charge of J.D. Power's China unit, and now he runs his own consulting company.

There are few people more qualified than Mike Dunne to write about China's auto industry. He grew up in Detroit, worked at GM, and earned his MBA from the University of Michigan. He has also spent over two decades of his life living and working in China.

American Wheels, Chinese Roads is a more-or-less chronological telling of the experience of General Motors in China, but at appropriate points, Dunne interjects relevant stories about other auto companies and their experiences in China. And it is a pretty quick read because the story is so entertainingly told.

The stories are all fascinating because many reveal lessons that GM learned along the way and often contain fly-on-the-wall details about negotiations between Chinese and foreign automakers. Dunne makes these stories even more interesting (and demonstrates his China credentials) by weaving in little Chinese language lessons and references to Chinese philosophers and historical figures. He doesn't just lay the lessons on us; he often delves deeper into why things are the way they are in China.

At a few points, GM is portrayed almost as a naive victim, caught off guard by the machinations of the government or GM's competitors. For example, when GM inked its deal with Shanghai Auto (SAIC), it was promised a monopoly in the luxury vehicle segment only to be surprised a few months later that Shanghai Auto's other partner, Volkswagen was being allowed to introduce a competing vehicle.

Dunne also retells the story about how Chery Auto managed to beat GM to market with the QQ, a copy of the Chevrolet Spark, adding new details that I had not seen elsewhere.

GM's curious sale of one percent of its joint venture to Shanghai Auto in 2009 is also covered here, though little is said about the possible motivation of SAIC. (But you will be able to find SAIC's side of the story in my forthcoming book on China's auto industry.)

In the penultimate chapter, Dunne sums up the experiences, not only of GM, but most foreign companies attempting to succeed in China:

While placing their bets, companies must never forget that to be dealt a hand in the game of electric cars -- or almost any business in China -- you will need to get approval for a license.

And get a partner.

Once those are secured, you will begin to compete with both the house and the player. The ones making the rules are also playing the game -- and they're determined to triumph.

This nicely sums up much of my own research on China's auto industry. Getting into China is hard, and once there, you will only be there as long as the Chinese find you useful.

In terms of the details, I was very pleased to find that Dunne's take on China's auto industry largely agrees with my own -- not that it has to, but having spent several years researching this industry in which Dunne is an expert, I am happy to note that my own research was not off-base. This is not always the case when two writers tackle the same topic in relation to China: it often depends on which part of the elephant one is touching.

As enjoyable as this book was to read (it is truly a page-turner!), as a researcher, I often wished to see footnotes to support certain quotes, figures or other claims. For some reason, the non-academic world has an aversion to footnotes. From the point-of-view of a researcher, footnotes make a particular work more attractive as a documentary source, and ensures that the book is cited more frequently. More citations will very likely translate into more sales. (And if you're the kind of reader who hates footnotes, you may also be happy that the book comes in a Kindle edition.)

My sense in this case is that many of the quotes come from Dunne's first-hand experience, although I would not have minded his saying so in the text. There seems to be a trend toward increasing acceptable use of the first person in non-fiction nowadays, a trend that I fully support: if you did the work, conducted the interview, etc., I think you should feel free to say so.

But this minimal criticism only reflects my personal preference, and in no way does it detract from this book as both an entertaining work of non-fiction and a source of wise advice on the pleasures and pitfalls of doing business in China.

In the conclusion, Dunne leaves no doubt as to where he stands in his own assessment of the business environment for foreigners in China. His parting shot takes the form of a fictitious memo from a foreign auto executive in China to the US Auto Task Force. His final recommendations aren't delivered in anger; they are a matter-of-fact assessment of a playing field on which foreign businesses have been forced to face down the entire Chinese government all on their own for far too long.

Finally, some good news for BYD

Last October I wrote about a situation in which BYD, the private automaker from Shenzhen, was punished for attempting to build a factory on farmland near Xi'an.

In short, BYD was fined about $435K and had seven buildings, on which it had already begun construction, confiscated and ordered destroyed. In addition 14 local officials in Shaanxi province were also punished for violating rules forbidding the use of arable land for non-farming purposes. Ouch. And this came in a tough year for BYD whose sales only grew 16 percent in 2010 (compared to China's auto industry as a whole which enjoyed 32 percent growth).

The story surfaced a few days ago that BYD was preparing to restart construction in Xi'an. According to an earlier story in the Economic Observer, the land has been "legalized" (合法化) and rezoned as industrial land. BYD was allowed to bid for the land in a public auction, and -- surprise! -- BYD won the auction. (There was no word on whether anyone else bid for the land.)

Even though BYD didn't get all of the land it had secured before, it still got most of the land, and, most conveniently, it got the part of the land on which its unfinished construction already stood. Back in October, the announcement from the Ministry of Land and Resources said BYD's buildings would have to be destroyed, but, fortunately for BYD, no one had got around to destroying them yet.

This strikes me as quite a miraculous turnabout for BYD. The problem that led to BYD's punishment was (and is) that China, despite being a huge country, has precious little of the arable land it needs to feed 1.3 billion people. The central government has recently become quite serious about preserving arable land.

But not that serious apparently.

In the months following BYD's punishment last October, Local officials in Xi'an had begun to complain that they had been deprived of a major source of local income -- sales of land use rights. The Economic Observer quoted a local official as saying that Shaanxi's annual demand for industrial land is running at about 400,000 mu (67,000 acres) per year, but they are only able to supply about 150,000 mu.

I was initially happy to see the central government finally taking a stand last fall by supporting their own laws forbidding illegal use of arable land. For once, it wasn't just about the money. At the time, I took this as a positive sign that rule-of-law was actually starting to mean something in China.

It's amazing to me how a scarce resource such as arable land could have been so quickly and easily "rezoned" as industrial. Apparently it really was about the money.

Creating 'Chinese' brands now 'part of the deal' for foreign automakers

Last December I wrote about a trend among Chinese-foreign automotive joint ventures in which the foreign partner gives technology to the JV to sell under a Chinese brand. Some of the English language China auto blogs refer to these as "sub-brands."

For example, Honda contributed the design of an outdated City vehicle it no longer makes to its JV with Guangzhou Auto. The JV now sells it under the Chinese brand Linian.

At the time I noticed this trend among several automakers (Guangzhou Honda, Dongfeng Nissan, Shanghai-GM), my assumption was that this was an attempt on the part of the Chinese automakers to wean Chinese consumers away from foreign brands. Chinese consumers still overwhelmingly prefer foreign brands (if they can afford them), because they perceive them to have higher quality.

Now several other foreign automakers including Volkswagen and PSA Peugeot-Citroen are discussing similar arrangements with their Chinese partners. PSA Peugeot-Citroen's CEO told the Financial Times that helping their partner to develop a local brand is now "part of the deal".

Last December I speculated that this may have been under central government coordination, but I had no evidence of that. Today, evidence seems to have surfaced in this report from the Financial Times.

The story quotes Mike Dunne, formerly of JD Power in China, who now has his own consulting company:

Nothing is written down, but when automakers go to apply for capacity expansion, in their application it’s clear that they should have a plan for an indigenous brand with jointly owned product rights and some provision for new energy vehicles. Foreigners want more capacity; China is saying: ‘We want more own brands’.

Back in 2001, when China joined the WTO, they gave up the right to demand technology transfer as a condition for approval of foreign investment. Of course, this new rule did nothing to change China's appetite for foreign technology.

The new demand, rather than for "technology transfer", appears to be: if you want to expand capacity, then X% needs to be devoted to Chinese-branded cars.

The foreign automakers now have a choice. They can pour precious R&D money into joint development of cars that compete directly with their own, or they can just hand over technology they already have.

The technology the foreigners are now handing over may be slightly outdated, so the foreigners aren't being forced to hand over their latest and greatest innovations. But again, it seems to me that these foreign-designed, Chinese-branded cars that the central government is now forcing the JVs to sell will fill the perceived quality gap between Chinese- and foreign-branded cars.

China's central government fully intends that its largest state-owned automakers will be global contenders, and they are patiently finding ways to make that happen. The WTO will not stand in the way. Wherever there's a rule, there's a way around it.

How fragmented is China's auto industry?

For anyone wondering where I've been for the past several months, I've been right here at my desk. But instead of posting to this blog, I've been in a push to complete a full first draft of my dissertation by the end of March -- which is beginning to look like a real possibility.

For now, here's a quick post of some numbers I've been looking at for the past few days on market shares in China's auto industry.

Probably the most consistent component of China's auto policy since the mid-80s has been the insistence of the central government on consolidation in the industry. Just looking at the raw numbers, I think most people would agree that this demand has been completely justified.

In 1978, the year that Deng Xiaoping launched the first experimental market reforms in China, there were 55 auto assemblers. The number peaked at 124 in the mid-90s, and by 2008 (the latest numbers available) there were still 117 -- clearly, way too many.

But just how fragmented is China's auto industry? Here is a quick comparison with the US.

This chart compares cumulative 2010 market shares for the top five auto companies in the US and China.








If China were to take the US as its example, then it would seem to have already achieved a fair amount of consolidation. China’s largest auto group has a slightly larger share of its market than does the largest automaker in the U.S., and the top five in both markets are practically even.

Of course, we already know that the US market is somewhat less concentrated than it used to be. In 1980, for example, the Detroit Three held 76 percent of the US market. But I think few people would argue that less concentration in the US market has not been good for consumers.

So while it would appear that China is starting to see some solid growth out of the players at the top of its auto industry, the problem lies with all of those tiny companies at the bottom that, for some reason, refuse to go away.

Who are these small players? Quite a few are small, locally-owned automakers that lack any kind of scale to be profitable. In any given year, they probably break even on a cash flow basis, which means that the local government is absorbing their cost of capital. If exposed to true market competition, these small firms would quickly disappear.

So why haven't they? Local governments don't want them to. They employ anywhere from a few dozen to maybe even a few hundred local people, and local governments are not inclined to create any more of an unemployment problem than they have to.

Of course, the central government, through the NDRC or MIIT, could force these local enterprises to close, but why would they? The central government is no more interested in putting people out of work than are the local governments.

So if we simply accept that some of these small players are part of a welfare system that keeps people gainfully employed, then China's leaders should at least be satisfied that, at the top of its auto industry, it appears to have the makings of an increasingly strong and competitive industry. Right?

I don't think so, and this next chart reveals why.

Here we have the top five companies in both the US and China along with their respective market shares.









What I notice about this chart is that each of the companies on the US side also corresponds with a brand, but each of the companies on the Chinese side is just a big old state-owned enterprise that assembles cars for foreign companies.

SAIC makes most of its money selling VW and GM cars. Dongfeng sells Nissan and Citroen. FAW sells Toyota and VW. Chang'an sells Ford, Mazda and Suzuki. BAIC sells Hyundai and Mercedes.

Yes, each of these companies also sells some cars under its own brand, but the numbers are comparatively small. Overall, only 30.9 percent of sedans sold in China in 2010 were of local brands -- up only slightly from 30 percent in 2009.

And therein lies the problem. China's central government wants its biggest SOEs to get bigger so that they can compete with the foreign multinationals. For now, they would just like to dominate in their own market, but eventually, they want to compete in overseas markets as well.

The problem is that, while these SOEs are indeed developing their own brands, it's just so easy to sit back and rake in profits while the foreigners contribute all of the intellectual property.

Designing your own stuff is hard.

*UPDATED* - Who is Li Shufu's "Associate"?

UPDATE below...
_______________________

From the corporate governance files...

Geely is probably best known as the Chinese auto company that bought Volvo from Ford last year. It is also known as China's largest "private" automaker. I put the term "private" in quotation marks because, in China, the meaning of the word is not quite the same as in most developed countries.

As is generally well-known among China watchers, the government -- particularly local governments -- have influence on private businesses that goes beyond mere regulation. And the larger the "private" business, the greater the government's influence.

At a minimum, the local state is everyone's landlord. At the extreme, a local government can force private businesses to sell out to state owned businesses, as has been done with alarming frequency in the coal industry, or local officials can demand an ownership share.

On the positive side, not all governments necessarily seek to own or control private businesses, and many even provide help to private businesses in startup mode such as tax breaks, free or cheap land and utilities, access to bank loans, etc.

But the question that this kind of help often raises is, what does the government expect in return? Is it enough to be a successful business that employs people and pays its taxes on time, or do local officials expect more?

Because we always hear that Geely is a "private" business, I decided to try to find out exactly how "private" Geely is -- at least in terms of legal ownership. Geely is listed on the Hong Kong Stock Exchange, so its audited financial statements and accompanying notes are made available on the HKSE website. Geely's latest annual report (2009) is available here (pdf).

In an effort to determine who exactly owns Geely, I constructed the following partial org chart from information available in the annual report. The listed company is in the purple box. About 48 percent of the Geely Auto Holdings is held by public shareholders, and the remaining majority of shares are owned by a company named Proper Glory Holdings which is incorporated in the British Virgin Islands.

According to the annual report, Proper Glory is ultimately controlled by Geely's Chairman "Mr. Li Shufu and his associate," but for some reason it does not say who this "associate" is. (Here I am referring to the yellow box at the top of the diagram.)

Looking back over the years, this "associate" did not begin to be mentioned as an owner until 2008, but he, she or it seems to be pretty important. If you do the math, this anonymous "associate" could potentially control up to 35 percent of the listed company. And if "associate" owns as little as 75 percent of Zhejiang Geely Holding Group Ltd, he, she or it would be the listed company's largest single shareholder with a 26 percent interest.

Furthermore, as you can see at the bottom of the org chart, Li Shufu and this mysterious "associate" also own 9% of the auto plants.



I contacted several friends who are even more knowledgeable than I about China's auto industry, and their assumption, like mine, is that Li Shufu controls the company. One suggested, however, that the "associate" may be Li's son or brother. Another speculated that it could even be a Communist Party member to whom Li is beholden for something.

I am not suggesting that there is anything illegal going on here, but it seems to me that Geely's auditor, the Hong Kong office of Grant Thornton (which has recently lost most of its employees to BDO) is not doing a thorough enough job of reporting by allowing a shareholder with the potential to control the company to remain completely anonymous.

If there is nothing to hide, why not reveal the name of the "associate"? At a minimum, why not reveal the respective ownership shares that Li Shufu and "associate" have in Zhejiang Geely Holding Group Ltd?

______________
UPDATE, January 28, 2011:

Thanks to one of my readers for bringing this to my attention.

Above I said that Li Shufu's unnamed "associate" could control the listed Geely company with 75% ownership of Zhejiang Geely Holding Group Ltd. (ZGHGL). That's not entirely accurate. I was thinking more like an accountant than a lawyer. (And I am neither, though my work previously involved a lot of accounting).

I should have more accurately said that the "associate" could control Geely with only a majority ownership of ZGHGL. If the associate held 50% plus one share of ZGHGL, then he would effectively control Proper Glory, which, because it owns 51.3%, also controls the listed Geely Company.

Again, while my assumption is that Li Shufu is the controlling owner of Geely, until someone reveals how much of ZGHGL the associate owns, we cannot be entirely sure of that.

Subsequent to the above post, I have also received information from someone who knows the identity of the associate. This "associate" is apparently an influential Party member who helped Geely to get central government approval for the Volvo purchase. Unfortunately, I cannot reveal the source, but it is someone whom I trust, and who is in a position to know.

If that is indeed true, then, if I were a Geely shareholder, I would be even more interested to know how much influence and/or control the "associate" actually has.

First Auto became "Third Auto" in 2010

Ever since the Chinese Association of Automobile Manufacturers (CAAM) realized people who really need data would be willing to pay for it (graduate students excepted), getting one's hands on sales data has become a bit of a challenge. Whereas in years past one could wait until a few days after the close of the year to get a complete list of China's vehicle sales by manufacturer, now we have to troll Chinese language news releases that dribble out during January.

An interesting phenomenon I have begun to notice is that, the longer it takes an automaker to release publicly its sales numbers, the greater the likelihood that those numbers aren't very good. A case in point is First Auto Works (FAW), a central state-owned enterprise with a long and storied history as the PRC's first automobile factory, and maker of the iconic Red Flag Limousine used to ferry Party Leaders shouting "同志们好!" (hello, comrades!) in parades.

Even though two of China's largest automakers, Shanghai Auto (SAIC) and Dongfeng, released their 2010 numbers in the first week of January, FAW's numbers did not come out until today, January 18. And while FAW's numbers, by themselves would be the envy of any automaker, they weren't as good as Dongfeng's.

For the longest time, FAW could hold its head high as, not only the first automaker, but also the largest. In the chart below, FAW still held the number one position as recently as 2005, but dropped to second behind Shanghai Auto in 2006. In 2010, FAW dropped to third behind Dongfeng, which, until about 20 years ago, was appropriately named Second Auto Works (SAW).

Vehicle Sales 2005-2010 (thousands of vehicles)

I look forward to conducting more analysis on these numbers as the laggards finally begin to report in. (I'm looking at you, Guangzhou Auto and Brilliance.)

The missing link in China's auto development?

An interesting article in today’s WSJ by ace China auto reporter Nori Shirouzu summarizes an interesting trend in China’s auto development. China’s state-owned automakers, along with their foreign joint-venture partners, are beginning to develop China-only brands.

Battleground in the small car segment

At least part of the impetus behind this trend, I believe, is the popularity of small economy cars in China. Beginning in early 2009, when China halved the sales tax on cars with engines 1.6 liters or smaller, sales of these small cars have really blossomed. (The number of cars sold in the less than 1.6 liter category rose by 71 percent over 2008 while sales of larger cars rose by only 23 percent.) The tax on smaller cars was increased slightly at the beginning of 2010, but small cars have nevertheless remained hot sellers in China.

The good news for makers of Chinese-branded autos was that the foreigners had almost nothing to offer in the less than 1.6 liter space, so Chinese brands dominated. The bad news for Beijing, however, was that the SOEs also had very little to offer in this space. It was the private automakers (along with independent SOEs such as Chery) that benefited most.

New Strategy: Joint development

Enter this new strategy of jointly-developed, Chinese-branded cars that, nearly as I can tell, is a win-win for the big SOEs and their foreign partners – at least in the short-run.

This strategy appears to have two variations. One is for the Chinese and foreign partner to develop a car together, combining the intellectual property of both sides. SAIC-GM-Wuling have taken this route with the Baojun (pictured below). According to the authoritative China Car Times, “The platform was designed in Korea, whilst the body design was done in China with GM’s help, the brand was developed in China and also the engine was developed by [Shanghai Auto] in the UK technical center.”

The SAIC-GM-Wuling Baojun

Shirouzu’s article today reveals that Volkswagen and PSA Peugeot Citroen are considering a similar strategy.

The other variation is simply to re-badge an older model from the foreign partner. Honda and Nissan are doing this with their respective partners in China, Guangzhou Auto and Dongfeng Auto. Guangzhou-Honda is a new Linian model which is a re-badged Honda City from a few years back, and Dongfeng Nissan are building the Qichen from old Nissan technology.

What's driving this trend?

There are a couple of factors at work behind this trend. First, although China’s central government has been pushing hard for development of Chinese brands since China joined the WTO, only China’s independent automakers (both private and local SOEs without JV partners) have made significant headway in introducing Chinese brands. Yes, the big SOEs have also introduced their own brands, but they have been “developed” mostly through purchased technology. That is, the big SOEs have yet to demonstrate any real engineering prowess.

Second, there is a big gap between the foreign-branded, mid-sized cars sold in China and the small, Chinese-branded cars. It’s a gap in terms of both price and quality, and Chinese consumers understand this very well. This is why, despite the growth of Chinese brands (they now make up over 30 percent of passenger cars sold in China), Chinese consumers would still prefer a foreign brand if they can afford it.

The Missing Link

These new, jointly-developed, Chinese-branded cars are, I believe, the missing link between foreign- and Chinese-branded cars. And the fact that this kind of development is happening in almost all of China’s big SOEs at the same time tells me there is some kind of central coordination going on – either that, or it’s just a big coincidence. Regardless, I think the strategy here is to provide Chinese consumers with a new product intended to wean them away from foreign cars and make them more accepting of Chinese brands.

And, if I am right, this should call into question the future role of foreign automakers in China’s market.

Another interesting wrinkle to this story is of whether Chinese automakers are learning any better how to design their own cars.

What some of these SOEs are doing is simply buying (or being given) old designs by their foreign partners, and then slapping on a Chinese badge. On the other hand, China’s private automakers have essentially been doing that for years ... only, they don’t have foreign partners ... and, um, they don’t pay for the stuff they copy. But in the process, the private automakers have probably gotten better at auto design. Even the process of copying must have imparted to the private firms some useful engineering skills that the SOEs have yet really to develop.

Perhaps this new method of (legally) copying what their foreign partners have already done will impart to SOE engineers some of those same skills.

Let's have more competition!...Just kidding!

An interesting bit of news came across the teletype today. The annual China-Europe Auto Manufacturers' Forum took place toward the end of last month (October 2010). Sometime during the discussion, the Assistant Director of the State Council's think tank, the Development Research Council, made a provocative statement that apparently freaked out a lot of people.

Let the foreigners have more than 50 percent?

The Assistant Director, Professor Liu Shijin, someone whose views on the auto industry are highly respected and influential, suggested that it was about time for China to end its 50 percent ownership restriction on foreign auto companies that invest in China. Currently, China's policy limits foreign auto assembly joint-venture (JV) partners to an ownership stake of 50 percent or less. (This only applies to whole vehicle assembly operations; parts companies may be wholly foreign-owned.)

(A Chinese source for Liu's statement and the controversy that followed may be found here.)

According to a writer for China's "First Finance" website, "the audience members with blonde hair and blue eyes applauded and nodded in agreement, while those with dark hair and dark eyes shook their heads [in disagreement]." I think what the writer intended to convey was that the foreigners in the audience agreed with Liu and the Chinese did not.

No! We're still not ready!

The Chinese arguments against Liu echoed those made prior to China’s joining the WTO: the Chinese auto industry is not yet mature enough to take on the foreigners head-on. If restrictions were lifted, foreigners would completely occupy China’s market to the exclusion of the Chinese manufacturers.

However, there was at least one Chinese auto executive who fully agreed with Liu: Li Shufu, Chairman of Geely. Li was later quoted:

Only complete lifting of the restrictions [on foreign investment] will help the development of the Chinese auto industry. The current policy of the 50 percent limit on foreign investment is disadvantageous; it does not protect the Chinese auto industry at all. On the contrary, it restricts foreign car companies from entering China.

Reflecting a refrain that Li has been preaching for years, he continues to be so confident in his company’s ability to compete with foreign producers (especially now that Geely owns Volvo) that he welcomes increased competition. (Here's a post on this blog from March of 2009 where Li lays out his argument that the private firms will eventually triumph over the SOEs.)

What Li most likely expects is that increased foreign competition within China would more quickly drive out the weaker competitors. That, of course, is anathema to the central government.

Since an overwhelming majority of China’s automakers are state-owned, it logically follows that an overwhelming majority of the weaker players are state-owned. And because the auto industry has been designated as a "pillar" industry since the mid-80s, it just wouldn't do to have an auto industry dominated by foreign and/or private enterprises.

Well, ... nevermind

The interesting news that came across the wires today is that Liu Shijin has now completely backed away from his earlier suggestion: "I never said I support opening up the restrictions on foreign investment."

Setting aside the fact that he clearly said exactly that at the conference, we have to ask why he's now backing down. Either he said something he shouldn't have, and was threatened with punishment if he didn't go to the media and retract what he said, or he was deliberately floating a trial balloon to gauge the reaction.

Knowing that Chinese planners at the NDRC and MIIT are hard at work on the next version of China's auto policy right now, I am leaning toward the latter explanation. And since he's backing away, it seems reasonable to assume that the 50 percent ownership restriction will remain in the next iteration of the auto policy.

Let the flowers bloom!

From an objective point of view (i.e. from someone who has no vested interest in which auto companies succeed) I think this is a mistake, and here's why.

Joint-ventures are notoriously inefficient -- particularly those that attempt to meld vastly different business cultures. Having worked for a 50/50 US-Japanese JV, I have experienced this first hand. When no single owner dominates, everything -- and I mean everything -- has to be negotiated, from corporate strategy to the temperature of the office.

I am not saying that all JVs are, by definition, contentious -- there are exceptions that prove the rule -- but the exceptions are extremely rare.

The original intent of forcing all foreign auto companies into joint-ventures was technology transfer, but over time, it became clear that the foreigners were withholding their best stuff from their Chinese partners. So why didn't the Chinese decide to dispense with the foreigners altogether and just import their cars to reverse-engineer?

Because Chinese consumers love foreign brands. And they love them so much that Chinese-foreign JVs have become cash-cows. National pride runs pretty deep in China, but if there's anything that runs deeper, it's a love of money, and the huge SOEs have become drunk off of cash generated by their partners' foreign-branded cars.

And here's why I think Liu's suggestion was a trial balloon. If the true goal of having foreign partners is no longer tech transfer (though I recognize the ostensible reason is still tech transfer), then why not be willing to take a smaller share of what could become a much larger pie?

Rather than take 50% of the profits of an inherently inefficient JV, why not take 49% of a much more efficient, foreigner dominated JV? And if there are certain things you don't want the foreigners to do with their increased economic control, then just circumscribe those behaviors by law.

If Li Shufu and the handful of China's planners who believe increased competition would more quickly lead to a shaking out and consolidation of China's auto industry are correct, then the quickest way would be to remove the 50 percent restriction. Entering the WTO did not devastate China's auto industry in the way that everyone feared it would. Indeed, it has become even larger and stronger.

No matter how much the SOEs are urged and ordered to be innovative, they will never do anything more than copy what others have already done. The problem is that SOE incentives are political, not economic. SOE leaders are only interested in their next assignment, but private sector leaders don't have a next assignment. They have no choice but to succeed.

If China truly wants a dominant auto industry, it needs to get over its obsession with state ownership and unleash the creativity of its hungry private sector. One way to do that is to open up competition.

UK platform + US battery = Chinese EV?

A123 Systems announced that its lithium-ion batteries will be used in Shanghai Auto's (SAIC) Roewe branded electric vehicles.

The Roewe brand (荣威 - rong wei -- yes, it sounds like "wrong-way" -- go figure) was created by Shanghai Auto prior to its merger with Nanjing Auto, after which the two combined the intellectual property and auto platforms purchased from the UK's MG-Rover several years ago.

The first electric Roewe will be the 750 (pictured above) which is derived from the British Rover 75. The battery supplier (and IP-owner), A123 Systems, is a purely American company, headquartered in Massachusetts. Though SAIC does own the IP of the Roewe, it was not originally designed in China.

Since the introduction of China's 2004 Auto Industry Development Policy, the constant refrain from Beijing has been a wish for Chinese automakers to develop Chinese-branded "new energy vehicles" using Chinese intellectual property.

While it is a good thing that SAIC is on board with the new energy vehicle trend, I'm not sure this is exactly what Beijing had in mind when it urged Chinese automakers to develop their own hybrid and electric vehicles. The battery, after all, is the heart of the EV -- its most expensive component.

It also calls into question the viability of BYD's battery technology (or that of any other Chinese battery company) when a fellow Chinese automaker would rather pay royalties to an American battery company.

It seems a reasonable assumption that a Chinese-designed battery would be less expensive than an American-designed one. Perhaps the fact that SAIC's partner, GM, which is putting an A123 battery in the Chevy Volt was able to get SAIC a good deal on batteries?

IP issues aside, SAIC's Roewe 550 (below) which was designed in China, will eventually be electrified as well. (And it's a very nice-looking car, in my opinion.)

The sincerest form of flattery?

For reasons I don't fully understand, Chery Auto chose to give itself a name very close to the shortened moniker of Chevrolet (Chevy).

But maybe that was a coincidence.

Then, Chery comes out with a car called the QQ that not only looks like the Chevy Spark but whose doors can be swapped with those of a Spark.

Yet another coincidence?

Now Chery has beat BYD to market with its first pure electric car, the M1-EV.

Well, at least it doesn't look too much like Mitsubishi's iMIEV.