China’s Auto Industry Breaks Into New Territory

I don’t mean to diminish the milestone that China’s auto industry reached last year by surpassing the United States in vehicle sales, but it was a bit like winning a tennis match by default—the American auto industry never showed up.

After chalking up vehicle sales of between 15 million and 17 million annually for much of the past 20 years, the industry in the United States was crippled by the global economic crisis, eeking out sales of just 10.4 million vehicles in 2009, the fewest since 1982. While China’s sales of 13.6 million vehicles in 2009, a 46 percent increase over 2008, were impressive, it took an economic crisis of global proportions to end a century of American dominance of the auto industry that began with Ford’s Model T.

In 2010, however, China’s auto industry is entering brand new territory. Vehicle sales in January surged to a monthly record of 1.7 million, double the number sold in January, 2009. Analysts are now projecting vehicle sales this year to be 15 million or more, and for sales to reach an incredible 25 million in 2015. To put that into perspective, there were only 66 million vehicles sold throughout the world in 2009. China could soon account for 33 percent of the entire world market.

Is there really that much new buying power being created each year in China such that so many more individuals can now afford cars? Not really. While incomes are indeed rising, and wealth creation in China is unprecedented, what we are in fact seeing is the conversion of “unconventional” means of transportation to more conventional cars, trucks and buses. In other words, China’s impressive gains in vehicle sales do not merely reflect new demand for mechanized transportation. They also reflect existing demand that is just being satisfied in a different way. Let me explain.

Every year, approximately 50 million gasoline and diesel engines are made in China for transportation. 13.6 million of those engines in 2009 went into cars, trucks and buses, but the other 36.4 million went into motorcycles, agricultural vehicles and “inkfish,” the contraptions that Chinese innovators create when they combine a chassis with a one-cylinder diesel engine. (They’re called inkfish because they spew off so much black smoke.)

This is the transportation version of what I mean when I talk about China’s two markets, and I use the auto industry as an example all the time when I talk about this phenomenon. The portion of the market that is represented by the 13.6 million cars, trucks and buses sold in 2009 is what I call the “foreign/local” market. This market is characterized by higher price and higher technology and is the battleground where Volkswagen, General Motors and the other global players are fighting for market share with the best of the local players. The vehicles that used the other 36.4 million engines produced in 2009 represent the purely “local” market for transportation, which is characterized by lower price and lower technology. In this purely local, price-driven market, only local companies compete. Despite their different outward appearances, however, vehicles in both market segments serve the same purpose — they move people and goods around the country.

As part of the stimulus package enacted in 2009, China cut the consumption taxes on cars with engines smaller than 1.4 liters, and began granting rebates to residents of China’s rural population who traded in their agricultural vehicles and inkfish for more conventional cars, vans and trucks. That is why compact cars, mini-busses and mini-trucks have been the fastest-growing segments of the market. In 2009, compact cars outperformed in the passenger car market, with “upper small” and “lower middle” cars growing by 73 percent and 56 percent, respectively, and the “upper middle” and “luxury” segments growing by only 25 percent and 21 percent. In commercial vehicles, mini-trucks grew by 43 percent, while mini-busses increased by 83 percent.

There are three conclusions to be drawn from this analysis:

1. The fast growth in China’s auto industry is not necessarily as bad for the environment as one might think. To the extent that heavily polluting inkfish and agricultural vehicles are being replaced by more conventional vehicles, China is actually better off.

2. China’s auto industry will continue to show rapid rates of growth for many years because China’s total demand for transportation is already much bigger than most people think. I would argue that China’s transportation industry is actually 50 million vehicles per year, not the 13.6 million vehicles sold in 2009, or even the 15 million vehicles that might be sold this year. They represent only one part of the market.

3. As smaller vehicles gain market share, so too will local Chinese vehicle makers. Foreign brands now account for 70 percent of the passenger car market today in China, with local brands accounting for the remaining 30 percent. Look for this ratio to be reversed in 10 years.

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