The Opening-up of Chinese Automotive Industry and its Impact

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On April 10, 2018, Chinese President Xi Jinping delivered a keynote speech at the Boao Forum, and announced certain major initiatives will be introduced in expanding reform and opening up. The automotive industry was specially mentioned as a strategic manufacturing industry: the restriction on foreign ownership in manufacturing industries, such as the automotive industry, would be lifted as soon as possible. The news was spread in the market rapidly, soon arousing expanded attention and furious discussions. On April 17, the National Development and Reform Commission disclosed the schedule for China's automotive industry to open up for international competitors. Chinese automotive industry will realize full open-up within 5 years to fulfil China’s WTO commitments.

In recent years, voices of oppositions and discussions on the lifting of foreign ownership restriction have been heard continuously. Foreign and inland investors, governments, institutes and canvassing groups have been active in remove the 50% restriction on foreign ownership that is tied to the profits red line of hundreds of billions yuan.

• In 1984, Volkswagen AG and SAIC Motor established the first joint venture in Chinese automotive industry.

• In 1994, the 50% limit on foreign ownership was officially introduced by the Chinese government and applied to all international automobile groups investing in China.

• In early 1990, major international OEMs established joint ventures in China and kept sustained investment.

• Chinese auto market has seen accelerated development since China joined WTO in 2001.

• The market scale grew from only 1 million in 2000 to 15 million in 2010, making Chinese auto market the largest in the world. It was ten years of great development.

• The success of the Chinese market has brought great profits to global OEMs. Therefore, the interest for autonomous investment grows stronger as time move forward.

• President Xi announced the further opening up of Chinese automotive industry in early 2018 and released the official reform schedule in May:• To remove the limit on

foreign ownership in special-purpose vehicles and new energy vehicles in 2018

• To remove the limit on foreign ownership in commercial vehicles in 2020

• To remove the limit on foreign ownership in passenger vehicles, and lift the restriction that no more than two joint ventures are allowed for each foreign investor.

• Chinese automotive industry will fulfil the full opening-up and WTO commitment within 5 years.

1980s, joint venturing started, automotive industry took off

2000s,greatdevelopment

2020-2025,fullyopening up

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Why now? What has changed?

First of all, it’s an inevitable trend facing the automotive industry under the background of China's advocacy of globalization and deepened opening up. China joined WTO in 2001 and promised to fully open up its manufacturing industries as one of the conditions for WTO accession. However, China's auto manufacturing industry was still in its infantry period at the time, with a national market scale of only 1 million unit. The government's decision-making level set the investment ceiling for foreign investors in auto manufacturing enterprises to 50% to support industrial development, hoping to create a balance environment for "market-for-technology". As one of the biggest beneficiaries of globalization, China achieved rapid development by virtue of the “three carriages” (export, infrastructure, investment) and demographic dividends after its accession to WTO. From 2000 to 2010, China’s GDP quadrupled to 41 trillion yuan. During this period, China’s automotive market scale also grew more than 10X from one million to tens of millions. China surpassed US in 2010 to become the world's largest automobile production and sales country. The development of China's automotive market was the result of globalization, especially the burst of economic activities from China's opening-up.

Secondly, China’s Chinese or domestic brands have achieved significant development after years of practices, and have made great progress in aspects like sales volume and brand reputation. The market share of Chinese brands in passenger cars increased from 29% in 2010 to 40% in 2017, and some brands already brought their bargaining power to a new stage. The market share of Chinese brands in the fastest growing SUV subdivision already reached 60%. In JDPower’s 2017 annual evaluation on China Brand Satisfaction Index, two Chinese models were ranked among the best. In 2017, four out of the top ten models of passenger vehicles that reflected the main stream consumption level(RMB100,000-150,000) were Chinese branded models. The high-end brand of Geely Automobile, Lynk, asides from experiencing an early stage of launching, it has soon won the reputation, having some of the best balance between sales volume and prices from customers. Its compact SUV models were sold at prices close to those of joint ventures’ brands of the same subdivision. Furthermore, the long-term pricing trend observed by us showed that the bargaining power of Chinese brands and their market shares by price levels were going up steadily.

On the other hand, China’s new energy market has experienced an explosive growth. It

achieved a compound growth of 40% from 2011 to 2017. 600,000 vehicles were sold in 2017, accounting for half the world total. It can be seen from the data of 2017 that 99% of the new energy vehicles sold in China market were of Chinese brands, which means China’s new energy market is currently dominated by Chinese brands. Considering the policies support from the Chinese government and improved customer acceptance from Chinese consumers, we believe that the new energy vehicle market will continue maintain a rapid growth. PwC Autofactspredicted that the market volume of new energy vehicles would exceed 5 million in 2025, and Chinese brands would fight for market shares in this new field through a neck-and-neck competition with foreign investors.

Under these favourable conditions, Chinese policy makers think now is the right time to officially launch overall opening up due to a combination of both internal causes (self-discipline to abide by international treaties, enhanced survivability of Chinese brands and sufficient competitiveness of new energy sector) and external causes (globalization, demand for opening-up and the driving of outside lobbying groups).

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Market shares of Chinese brands by price levels (2011-2017)

0%

70%

60%

50%

40%

30%

20%

10%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

2%

22%

46%

69%

38%

14%

RMB 100,000-

150,000

RMB 200,000-

250,000

Above 250,000

RMB 150,000-

200,000

Below

RMB100,000

Market Share

Source: IHS，Strategy& Analysis

First and foremost we think international players will expand their investments in China to get more market shares. We believe that the Chinese market will follow a similar development trajectory of US market. Under the premise that the market has sufficient growth space, competitors will concentrate resources to compete in the market with the most growth potential. Foreign capital will still regard China as the most important single market, and they will expand investment in the Chinese market in order to ensure profitability and gain independence in decision making. Our statistics shows, for more than a decade, with the rising status of Chinese market in global automotive market, the share of car sold in Chinese market has accounted for 20-40% of global sales of major international players, and China has become the largest single market for many global brands.

Secondly, further integration will be seen among Chinese enterprises. Chinese market is now characterized by remarkable decentralization. Due to the decoupling of automobile production growth from the number of manufacturers in recent years, we think that the market will enter the phase of elimination, and integration will inevitably occur. This process will be accelerated by lifting foreign ownership restriction. Chinese brands will be tested in a power-led knockout while foreign brands will also re-consider how they will remain on the field.

Thirdly, we believe that Chinese suppliers in the automotive industry chain will have more opportunities. The automotive industry chain has realized global penetration to address the high complexity of auto manufacturing. Chinese suppliers in fields such as batteries, glass, automobile electronics and software, which have their capability enhanced via the process of providing product supporting services for global brands, will have the chances to take part in global cooperation and contribute to further globalization of the automotive industry. Meanwhile, we think foreign-funded enterprises in the supply chain will enhance their R&D and production in China to reduce cost and improve efficiency so as to improve adaptability of products to Chinese market.

Fourthly, privately operated enterprises will see more opportunities, such as M&A of state-owned enterprises. This was procedurally hard to execute before. But with the lifting of foreign ownership restriction, some automobile enterprises will be found losing survivability and in need of rescue. Then, the funding actions of privately operated enterprises will be encouraged.

Global and Chinese sales volume of global major OEMs

0 200 400 600 800 1000

VolkswagenRNM

ToyotaGM

Hyundai-KiaFord

HondaFCAPSA

Suzuki

BMWDaimler

Audi（2017, 10 thousand）

20

30

40

50

60

70

80

0

500

1000

1500

2000

2500

3000

Production VolumeNumber of Assembler

Industrial structure development of China’s automotive industry （2018）

Production Volume（10 thousand） Number of Assembler

Let’s see what the US market experienced in 1970s to 1980s when the market was fully open up to competition. The three auto giants in America were trapped in a dilemma of rising oil prices that in turn cause the American to bear higher consumption cost. Japanese cars, as latecomers to the market, with a strategy of improving fuel efficiency and reduced car size, started to gain more market shares by supplying the market with large amounts of economy cars as substitutes to traditional American muscle cars and whereby earned a place to stand and grow. During that time, Japanese brands made a series of deployments in the US market: export -> investment -> expanded investment.

Case for reference:

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From the industry perspective,what impacts will this bring tothe automotive industry and howwill the situation develop?

Source: PwC Autofacts analysis

How should Chinese brands be prepared forindustry policy shift?

Let’s discuss from 4 levels:

Enhance the business competitiveness of self-owned brand. It’s no doubt that robust brand power will help Chinese players win more right of speech.

Give priority to electric car businesses. Taking lead inelectric car businesses and enhancing platform capabilitieswill put the enterprise in a leading position in the marketplace after 2022.

Develop capability along the industry supply chain.Advantages based on the industry supply chain in aftermarkets, mobility and automobile insurance and financefields will protect the enterprises from product-relatedsingle dimension competitions. The future market willcertainly be a market of multi-dimension competitions,refined capabilities will improve the overall competitivenessand the bargaining position of local firms.

Build world-class brands. The opening up of automotive market willpresent both opportunities and challenges for the Chinese brands.We believe the Chinese market, once completely opened, will havethe opportunity to incubate a series of super competitors that aretruly strong enough to “go global”. At the same time, Chinese carmakers should sufficiently prepare to compete with internationalbrands.

1

2

3

4

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How should international players seize the opportunities?This “battle for profits” that has lasted several years will usher in a favourable situation for foreign investors in the short term, that is, they will be more autonomy in determining the nature of the companies they invest in (i.e., joint venture or sole proprietorship) and whom to partner with, which will help foreign investors gain advantages at the negotiating table, and will also facilitate the management of enterprises towards a more modern corporate governance in the future. Of course, the most direct is the control for profit distribution.

But, will foreign investors choose to immediately withdraw from the existing joint venture entities to seek independence or to achieve absolute control through capital increase? Before we predict their possible courses of action, let’s think about the following questions first:

• It’s a complicated, time-consuming, and resource-intensive process to develop a dealer network without local partners. Have foreign investors been well prepared for this?

• As to the invisible benefits brought by Chinese joint venture partners, such as the in-depth understanding over the local market, the policy inclination of local governments, and the support of talents, how can foreign investors obtain these after gaining independence?

• More importantly, foreign giants should see the “new industry mega trends”(e.g. C.A.S.E) in the global automotive market, which are in full swing. These trends are more obvious in China. The commercial quantification brought by the “C.A.S.E” is even greater in China. Chinese government has been providing all participants in the industrial chain with unparalleled policy support and has given “green light” in many aspects such as urban scene tests, operation licenses and talent landing. So, with the market size in front of us getting bigger and bigger, have foreign investors been well prepared to navigate the competition alone? A more obvious trend we see in the global market is to work together for a win-win situation and each work in areas that we are good at.

I. In 2025, 20% of the vehicles made in China will be new energy vehicles (NEV) as planned by the government. In the NEV field, China’s OEMs are running ahead of the general market in many respects, like battery supply, customer data, operational mode and local government support.

II. By 2030, car sharing will be a super-competitive market with regional/local features involving OEMs, digital technology companies, governments, utilities, transportation companies, logistics and e-commerce fleets.

III. In order to win the next level of competition, OEMs need to develop a new company identity with updated business strategy. All OEMs are required to re-examine their cooperation strategies, business models, alliance partners, production footprints, etc.

Potential development of value chain integration

Build and run

infrastructure

(e.g., charge,

park, V2X)

Build

cars

Design

cars

Retail cars

(where B2C

still relevant)

Finance

cars

Operate

local/

regional

fleets

Create and

operate

digital

services

Retail

mobility

and digital

car

services

Potential

OEM

ways

to play

What

other

players

may do

Today’s OEMs

Fully integrated OEM + mobility provider (comparable to “aircraft + national airlines/carriers +

operations”)

Specialist (“ARM of cars”)

OEM + wholesale operations (comparable to “aircraft OEM + fleet operations”)

Mobility service provider

Retail/logistics/transport

Utilities/energy companies

Cities Ride-hailing firms

Specialized

lease/finance

companies

Local startups

Cities Ride-hailing

Specialist or general-

purpose marketplaces

Partial-own value chain Full-own value chain

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Source: Strategy& analysis

Editor's note:

This is an unprecedented market. Expanded opening up of it will definitely bring pain to the industry. However, we should also see the new opportunities and challenges that will come with the fully opening up of it. We believe that the vision, ability and determination of the participants determine the future of all.

If you wish to continue this dialogue, please contact our industry experts:

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Wilson Liu

PwC HK & China Automotive Leader

Tel: +86 (20) 3819 2278

Email: w.liu@cn.pwc.com

Bill Peng

PwC Strategy& China Automotive Partner

Tel: +852 2289 6394

Email: bill.peng@strategyand.hk.pwc.com

Sophie Shen

PwC China Automotive Sector Senior Manager

Tel: +86 (21) 2323 5329

Email: sophie.x.shen@cn.pwc.com

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