SA faces Asian invasion

Author: Frik Els, FINWEEK

"The market anticipation is greater as a result of its size and profile. There's almost a sense of fear in the global industry." Martyn Davies is speaking about China's massive and aggressive automotive manufacturing industry.

Davies, CEO of Frontier Advisory and director at the Centre for Chinese Studies at Stellenbosch University, says the Chinese constitute the third wave from Asia - following the Japanese in the Sixties and the Koreans in the Eighties - that threatens to flood the world's vehicle markets.

Though conquering the traditional auto markets of Europe, the United States and Japan may be many years away, 2008 will see Chinese vehicles redoubling their efforts in emerging countries, and in South Africa the market assault is already well under way.

While India's Tata and Mahindra have been in SA for longer, after initial success their profiles have been diminishing (Tata last year lost substantial market share to end up with just 2% of SA's car and bakkie market).

The market is already crowded. Chana SA, owned by the Göbel family, became the first company to sell Chinese vehicles - small 1-litre and 1.3-litre pick-ups and panel vans - in the local market in October 2006. Currently, a dozen or so Chinese brands - Chana, Firmaco/Powerstar, Meiya, Great Wall Motors, Gonow, CAM, AsiaWing, Geely, Soyat, Dongfeng, Africar and Foton - are available in this country. Most have been operating for less than a year.

More brands and models are on their way, and McCarthy, the R20bn/year auto trader in the Bidvest group, has the potential to change the dynamics of the market completely when it starts importing China's leading brand, Chery.

Sales

Only Chana, McCarthy and Gonow report sales to SA's National Association of Automobile Manufacturers so measuring the effect of Chinese vehicles on the market is difficult. McCarthy CEO Brand Pretorius estimates that last year 12 000 Chinese built vehicles - the vast majority being LCVs - were sold in SA. That would give China 2% of the SA market. This year the sales pace is likely to accelerate to around 1 500 per month, though many in the industry put that figure higher.

The China importer's success is in contrast to reported new vehicle sales figures that showed passenger car sales declined almost 10% in 2007, while LCVs were static. Year to date sales are down 14.7% for passenger cars and 6.3% for LCVs. Add the non-reporting Chinese importers and the situation may not appear so dire, although nobody at the banks, the original equipment manufacturers or economists see overall growth returning before 2009, if then.

Reports now surfacing from major SA manufacturers, such as Volkswagen and Nissan, talk of idle plants and others, such as Ford, are not ruling out shutdowns. It's too soon to blame the Chinese for the slowdown at SA's established players: higher interest rates and an economic slowdown are the main culprits.

At dealership level the going is particularly tough, with discounting to move dead stock rife. The used car market has been in a funk for years and the arrival of more Chinese passenger vehicles competing at the low end - Geely and Chery will be joined by a host of others this year - will ensure it stays that way. However, many of the importers Finweek spoke to say their first and foremost competitors are the other Chinese players.

Gavin Maile, KPMG's director: industrial markets automotive, says that if China can corner 10% of the SA market five years out they'd have done well. Consensus is around 5% of the market in the short to medium term. However, established players such as Toyota are saying that during tough times there's a return to the tried and tested. That may hold some water.

Says Maile: "If there are major changes to the Motor Industry Development Programme (MIDP) it could go to 20% - but that's highly unlikely." The MIDP supports manufacturers in SA with incentives based on exports. It's currently being reviewed to bring it in line with World Trade Organisation rules. Changes would likely be centred on incentivising production over export and that it should keep the current manufacturers' business models intact.

Maile says slack sales in SA are being offset by higher export production at local OEMs that will export almost half of their production this year. Sales of imported vehicles overtook SA-produced ones in 2006 and are estimated to reach 62% by the end of the decade. However, a 20% or 30% depreciation in the rand would tilt the balance decidedly back in favour of the OEMs.

Locals plants

Nothing stops the Chinese manufacturers from opening up plants in SA, but lead times for that type of investment are many years.

Importers such as Geely and McCarthy have hinted at the possibility of starting local production once volumes justify it, but mooted changes to the MIDP will favour those who can produce 50 000 units of a particular line. That's a big ask - even for a Toyota Corolla and Volkswagen Golf.

However, a growing African market could change the equation. In fact, next month production will start at a Nissan-Dongfeng plant outside Luanda in Angola that will produce 30 000 vehicles/year. Says Maile: "Africa is opening up. Not many entry-level vehicles are built in SA. The first to produce an entry-level vehicle in SA will make a killing." Some 1,45m vehicles were sold in Africa last year.

But what is certain is that the impact of China on the automotive world is only in its infancy. Asked which brands will increase market share over the next five years, China comes out ahead - with almost 80% of executives surveyed confirming that.

The domestic market in China is 10m vehicles, second only to the US. In 2007, China's vehicle exports grew 79% to reach 612 700 units, after doubling the year before. The majority of its exports are Chinese brands. China's automotive expansion will also be helped by evidence from the annual KPMG survey of automotive executives which shows that 81% believe low-cost and entry-level cars will increase market share (compared with 25% who believe SUV sales will increase) and customers putting affordability high on the list of their buying criteria. China's government has plans to increase the value of its vehicle and parts exports to US$120bn by 2015 - around 10% of the world's total vehicle trading volume. In 2006 it was $15bn.

Those remarkable ambitions may appear surprising given the first crop of Chinese exports to SA. Great Wall Motors' pick-ups and wagons, Gonow's XSpace, CAM's Rhino, Soyat's Junda and McCarthy's Meyia are lookalikes - a hodgepodge of Japanese (Isuzu and Toyota) LCV design, engines and parts from years back.

Competitive

SA's first Chinese bakkies competed on price and on price alone. Destined to be "run into the ground" by plumbers, builders and garden services SMEs those pick-ups sell new for the same price as three-year old Isuzus, Hiluxes and Ford Rangers (see graph). At its launch, Chana's Karl-Heinz Göbel summed up the value proposition of Chinese bakkies this way: "It's not warm and fuzzy. What you see is what you get. It's an honest, rational product."

Some importers are opportunistic operators that take over used-car dealers in second-tier cities and flog cheap and nasty bakkies to unsuspecting buyers and hope never to see them again. However, established market players who write off Chinese importers operating in SA as fly-by-nighters could be underestimating the potential impact of Chinese vehicles in the marketplace. After all, the traditional dominant players were as dismissive of the South Koreans when they entered the SA market in the Nineties. In a few short years Hyundai - bypassing import duties by assembling vehicles in Botswana - were able to sell 80 000 cars. That despite being hamstrung by the same issues as the Chinese importers face today: Hyundai's vehicle technology was old, the products of middling quality and design and the brand virtually unknown.

Richard Rice, client service director for Sub-Sahara Africa at Synovate, a market research company, says: "Hyundai first came to the market with a decidedly average product (the entry level Accent). But they held family fun days for owners at Sun City; when you bought an Accent you got a bottle of champagne; they treated customers totally differently. It was about the whole brand experience."

The Wheels Africa operation - founded by Zimbabwean Billy Rautenbach, who remains a fugitive from the law - folded in 2000. But after being bought by the Imperial Group's Associated Motor Holdings (AMH), Hyundai and Kia are solid brands in the SA market. (AMH doesn't disclose individual sales figures, but the group that also imports Citroën and Daihatsu vehicles account for 10% of the SA market.) The example of Hyundai is an instructive one; in fact, many of the Chinese vehicle importers honed their skills bringing in Korean brands.

Brands

Says Davies: "China doesn't get brands. Ask anyone to name a Taiwanese brand (outside PC company Acer). Branding will take them longer. However, companies such as Chery and Geely have even greater ambition than the south Koreans."

Though price is the key factor in workhorse bakkies, with passenger vehicles - which make up two-thirds of the SA market - it's a different story. The brand counts for a lot. Mike von Höne, solutions executive at TransUnion Auto - compilers of the trade-in value bible, the Auto Dealer's Guide - says: "It will be surprising if the impact of passenger cars is as great as bakkies. Not only has the passenger car market been harder hit than LCVs, South Africans are used to high-specced entry-level cars and extensive service plans."

And it's not cheap establishing a brand. Marcel de Klerk, chief of Absa Vehicle and Asset Finance, puts the amount needed at between R30m and R40m. "Of the dozen or so brands available, only four to six appear to find public acceptance. The bank looks for substantial backing of the product. We're wary of the one-man supplier."

De Klerk says what the Chinese and Indians have been able to do is give first-time buyers the opportunity to acquire a new vehicle. "Four or five years ago you had little choice but to buy a second-hand vehicle."

Synovate's Rice agrees that branding is important but says it also depends on the profile of the buyer. A-to-Bers (versus enthusiasts, trendsetter and family-value buyers) don't care about the brand. "For them it's an issue of rand and cents. A car isn't a long-term investment." Synovate's research shows A-to-Bers make up 10% of the buying public.

Quality is consistently ranked the top consumer buying criterion for private buyers. Squeaks and rattles in a vehicle hauling bricks is one thing but for an individual buying a car - entry level or not - it can be a deal breaker.

JD (Dave) Power, founder of the eponymous vehicle quality-rating agency, was in SA recently and pronounced on the Chinese industry this way: "They have their work cut out." Power says China and India are at least five years behind on quality levels, according to the (limited) data from the company's survey. Whereas European and US manufacturers have managed to limit faults to 120 out of every 100 vehicles throughout the industry, the Chinese and Indians are sitting at 300 to 400 defects.

Power also found a Hyundai analogy in the US when the company began importing the Excel in 1985. "It sold really well initially, but the quality wasn't there and after a couple of years it had to withdraw from the market. Hyundai had to fight its way back in the Nineties and was forced to bring out a 10-year warranty on its cars to rebuild its reputation. Once you lose in the quality stakes, it takes two model cycles (roughly 10 years) to regain it."

Even Toyota got burned in the late Fifties with its Toyapet Crown, which due to quality issues had to be withdrawn.

While it took the Japanese 20 years to establish themselves, and the Koreans 10, Power believes the Chinese can do it in five. "Accelerated globalisation is the key here. Technology is more open today and the Chinese are learning a great deal from joint ventures." Almost all global manufacturers, including Toyota, Volkswagen, Ford and General Motors, have manufacturing joint ventures in China. Chinese brands Chery and Geely are fourth and ninth only in terms of production.

Long way to go

That the Chinese - and the Indians - still have a long way to go to change perceptions among South Africans is evident from a snap poll on Sake24.com. Readers were asked what they'd choose if they had to buy a cheap car: a new Chinese model, a new Indian model or a used car. Some 14% opted for a new Chinese car and 3% said they'd choose one from India. A whopping 83% felt a used car would be the best option.

There are 123 vehicle manufacturers in China and internal competition is fierce. No doubt consolidation to stave off overproduct-ion is coming, and the Chinese government has limited the number of export contracts it issues to automotive companies.

Says Davies: "There are economic problems in China. Inflation is at a 13-year high and wage and employment condition pressures continue to rise. Its competitiveness will be eroded to some extent but not greatly. The Chinese have faced those problems before and have strong central control."

For SA importers, the rand's value adds another competitive headache and on smaller operations the effect of a currency devaluation could be severe - even fatal. Everyone agrees that a shakeout is coming among SA's importers. While you can make money over the short term selling cheap vehicles, longer term the viability of such companies is depends on the quality of service and back-up they provide. The dozen brands currently available could easily be whittled down to three or four. But those that remain would have changed SA auto industry fundamentally.

This article is the cover story of the April 3 edition of Finweek magazine, which is a sister publication of Wheels24. Visit Finweek online at www.fin24.co.za.