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Competing in the China Truck Market

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We are pleased to share with you a report titled: Competing in the China Truck Market.

While global brands have enjoyed success in China's passenger vehicle market, the same cannot be said for the commercial vehicle market. This segment has been dominated by local Chinese manufacturers who have relied on sales to local buyers seeking low-priced equipment. However, we anticipate that several factors will be reshaping the market and competitive landscape in the commercial truck sector, creating a “window of opportunity” in China for participation in what has historically been a predominantly local market.

We believe that market conditions and regulatory challenges will create a need within China’s truck industry to form alliances with foreign partners to secure capabilities which are lacking in the commercial vehicle sector in China. China’s truck manufacturers will need to upgrade their technology to meet demanding new regulations, and will need to improve their service and distribution business practices as the market matures. The changing mix of products towards a higher concentration of line-haul HT, along with anticipated policy changes brought about from China’s intention to reform its State-Owned Enterprises, are driving forces which will alter the landscape of competition in the commercial truck sector.

In this paper, we offer our “deeply rooted in China” perspective to the analysis of the impact of each of these developments.

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Competing in the China Truck Market

  1. 1. Competing in the China Truck Market Bill Russo Edward Tse
  2. 2. Gao Feng Advisory Company Competing in the China Truck Market Driven by strong economic growth and infrastructure investment, the China auto industry has enjoyed explosive expansion in the past decade, at a compound annual growth rate of nearly 25% over the period through 2011. However, the year-over-year growth rate slowed down to 2.5% in 2011 and 4.3% in 2012 due to a combination of policy and economic factors, such as the termination of the tax incentive policy, the credit crunch, purchase restrictions in China’s largest cities, supply-chain disruptions and the global debt crisis. 2 Exhibit 1 Overall China Auto Industry by Segment This market slow-down was followed by 14% growth in 2013, with overall sales approaching 22 million units. Despite this recovery, the slowdown is evident once again in 2014 sales, especially in the commercial sector. Few analysts doubt that China’s automotive sector has arrived at an inflection point where future sales will expand at a more stable and moderate growth rate.
  3. 3. Gao Feng Advisory Company 3 Commercial vehicles in China consist of trucks and buses, which have been negatively impacted by the economic slow-down. Over the past decade, the truck sector has grown to meet the demands from China’s expanding economy. Historically, the sales of MDT and HDT1) accounts for 30% to 35% of the truck sector, which tripled in size from 409,000 units in 2001 to 1,287,000 units in 2010. As is apparent from Exhibit 2, this growth momentum has not been linear. Instead, several waves of fluctuations have occurred caused by macroeconomics and policy changes which directly impact the amount of capital available to businesses that Exhibit 2 Historical Sales of Commercial Trucks in China Competing in the China Truck Market 1) According to China national standard, truck is classified into four segments in terms of gross vehicle weight (GVW). Heavy Duty Truck (HDT) is >14 metric tons, Medium Duty Truck (MDT) is above 6 tons and less than 14 tons (incl. 14T); Light Duty Truck (LDT) is above 1.8 tons and less than 6 tons (incl. 6T), while Mini Truck is less than 1.8 tons. typically invest in commercial trucks. Government policies, which directly determine the levels of investment in infrastructure, along with measures to introduce stricter emission standards, have resulted in big fluctuations in the market. In particular, the large stimulus package launched in 2009 sharply accelerated demand. “Cash-for-clunkers” schemes introduced in 2010 helped drive replacement demand as well as improve the quality of the overall vehicle parc. When nearly all government stimulus measures expired in 2011, the truck segment entered a downward cycle and went down to 929,000 units sold in 2012.
  4. 4. Gao Feng Advisory Company 4 Competing in the China Truck Market Contrary to the US and Europe, where most sales are replacement sales, in China MDT & HDT are predominately new sales which increase the size of the fleet. Though the parc of HDT and MDT reached 3.9 million units by 2010, there is still a large gap relative to the developed markets in terms of per capita vehicle ownership. Moreover, several fundamental drivers will prevail in next few years to push forward the demand for MDT & HDT. First, industrialization and urbanization in China drives higher fixed-asset investment. Fixed asset investment of China (adjusted by Purchase Power Parity) is 1.3-1.6 times higher than that of Western Europe and the U.S. Such huge investment is mostly spent on the railway, highway and other infrastructure projects, which in turn drives demand for more commercial (mainly heavy duty) trucks. Meanwhile, China’s current urbanization rate is about 50%, ant this will increase to over 60% by 2020. Clearly, these trends will continue to fuel higher demand for commercial vehicles for the foreseeable future. Second, cargo transportation demand of China is larger than that of the U.S with a higher growth rate. High cargo transportation demand is a result of inefficient logistics, urbanization and the size of country. All of these factors will push higher demand for Long-Haul HDT. Third, the replacement cycle of HDT/MDT in China is much shorter than that of the developed markets. This will create significantly more replacement buying in China than international makets. In China, line-haul HDT can typically only be used for 0.9 to 1.1 million Km while in the US, the number is as high as 1.5 to 1.7 million Km. As a result of such differences, the average age of MDT/HDT in China is only 6 years, much lower than 11.3 years in US. Taking a broader look at the global context, several macroeconomic and sociopolitical developments are altering balance of power in the automotive industry. These include the recent financial crises, which have effectively resulted in a redistribution of global economic power, altered the global trade balance, and renewed concerns over energy security and environmental issues. The growing size and influence of the Asian economies – especially China – are triggering a transformation of the automotive business model, with automotive enterprises seeking to leverage the momentum of the region. The recent shift underscores the importance of the Asian economies to the future growth and profitability of the global auto industry. Most of the recent growth in the world’s auto industry has been in the Asia-Pacific region, and more than half of that growth over the next decade is forecasted to come from China. Similar regional demand migration also applies to the MDT/HDT sector. Driven by continuous industrialization, urbanization and cargo transportation demand, China’s MDT/HDT market is anticipated to come through the current down-cycle and experience a strong rebound thru 2015.
  5. 5. Gao Feng Advisory Company 5 Competing in the China Truck Market Going forward, several overarching market trends will shape the MDT & HDT demand structure: 1. Line-haul HDT demand will be even larger than vocational trucks in China resulting from the comparably lower professional level and lower operational efficiency of the logistics infrastructure. This creates opportunities for international entrants who have a strong on-road tractor line-up. 2. A push to meet stricter fuel economy and emissions standards will drive a need for advanced technology and accelerate the truck manufacturers’ emphasis on technology upgrades and alternative fuel application. 3. The source of OEM’s profitability will increasingly shift from new truck sales to after-sales services, including vehicle logistics, value- added services, parts sales, and auto finance, etc. All of the trends noted here will raise the level of interest among China’s local truck manufacturers to form alliances with international truck manufacturers. The growing influence that China wields is not simply derived from the size and scale of its domestic market, which is an increasingly important focus in a growth- challenged industry. Increasingly, financially weakened automotive companies and their suppliers must strive to deepen their participation in the China market if they hope to remain viable. It only stands to reason that companies that have weakened positions in their domestic market would benefit by redistributing some of their focus to the growth markets and in particular China. In summary, China’s HDT/MDT market is expected to come through the short macroeconomic cycle into a sustainable growth track from now through 2020, and global truck makers should position themselves to participate in the market by forming alliances to leverage their unique capabilities in the areas of product, technology and after-sales services.
  6. 6. Gao Feng Advisory Company 6 Corp (CNHTC) in the top 3 positions for HDT. Together they have a combined market share of 55% of the MDT/HDT market, as indicated in Exhibit 3. However, each OEM has distinctive positioning and advantages in the HDT segment.  FAW and DFM enjoy the best brand image and have a deep commercial vehicle experience, along with a well- developed dealer and service network. However, both suffer from weak corporate governance and a lack of employee performance incentives. Both companies have developed their HDT product line-up through upgrades from their MDT platforms, and they positioned themselves as volume leaders in the medium- to low-priced HDT segment Exhibit 3 Market Share and Sales of Chinese Commercial Truck Makers Competing in the China Truck Market Competitive landscape Unlike the passenger vehicles market, domestic brand manufacturers dominate the commercial truck sector in China. Historically, the top China truck manufacturers started their MDT & HDT development from older generation platforms, which originated from the former Soviet Union and Austria (Steyr). The availability of low cost platforms, and very low freight rates (which have remained firm for the past two decades), has created a hidden cost barrier for major international players. Full-year sales in 2013 indicates that a 75% market share of MDT/HDT was taken by 5 Chinese OEMs, with First Auto Works (FAW), Dongfeng Motors (DFM) and China National Heavy Duty Truck
  7. 7. Gao Feng Advisory Company 7 Shaanqi benefited from previous cooperation with MAN and their technology assistance. However, such advantages are eroded by the MAN alliance with CNHTC. Shaanqi is also fighting with their parent company (Weichai) for operational control.  Among the smaller truck makers, JAC and Beiben are most likely to close the gap with Shaanqi, since they can leverage the advanced technology supply from their international partners respectively. JAC has been discussing potential partnerships with Navistar and Caterpillar, while Beiben is cooperating with Hyundai.  The rest and other new entrants, such as SAIC, CAMC and Nanjun, have a much narrower range and face several technical and financial constraints to expand their market share. Competing in the China Truck Market  CNHTC is considered the best competitor in the construction sector. They develop their own parts and will benefit from the JV with MAN in the area of product and component development, procurement and sales. CNHTC is weak in their portfolio of long-haul vehicles. Their company operation is considered very bureaucratic and they have a poorly- developed dealer and service network.  BAIC Foton is behind the top 3 in sales, and should considerably benefit from the JV with Daimler to develop engines. Despite their smaller scale, Foton has more efficient product development, stronger marketing and a better dealer network.  Shaanqi has comparable sales to BAIC Foton, and is well recognized in the vocational HDT sector. Historically, Exhibit 4 Market Share and Sales of Chinese Commercial Truck Makers
  8. 8. Gao Feng Advisory Company 8 China MDT/HDT manufacturers benefit from low labor and raw material costs, which enable them to sell their Vehicles at 25 – 33% of the price of international products. As shown in Exhibit 4, prices for trucks produced by multinationals can range as high as USD $350,000 (MAN), whereas the highest priced product in China sells for 72% less at USD $100,000 (FAW). However, Chinese truck makers are increasingly confronted with a different set of challenges: On the demand side, the government and commercial fleet demand is slowing down, and buyers are increasingly concerned with fuel economy and durability. Further complicating the landscape is the fact that more stringent regulations regarding safety and environmental standards are being implemented – driving cost structure higher. Exhibit 5 Potential Ventures Between Foreign and Chinese Truck Makers On the supply side, the technology and feature gap among local manufacturers is narrowing. It is becoming increasingly difficult to charge any price premium on new vehicles as the market has become hyper-competitive and less differentiated. Those challenges are pushing local brands to alter their thinking regarding the need for development and technology support from international partners. With the gates to China’s commercial truck market potentially beginning to open, leading HDT manufacturers have begun to explore joint ventures and alliances in China with top-tier manufacturers. Various joint venture and equity shareholding relationships were established since the SAIC Iveco successfully formed its JV with Chongqing Hongyan in 2006 (see Exhibit 5). Competing in the China Truck Market
  9. 9. Gao Feng Advisory Company The cooperation between MAN/CNHTC offers perhaps the most promising cooperation, as the interests of both parties are apparently well aligned. The strategy includes formation of an R&D center and involves a global strategy including direct exports to the EU. The Daimler/BAIC-Foton JV entails a strong technology component and a solid market component. The Iveco/SAIC cooperation has been in place for several years and provides a limited rage of products for the domestic market. Navistar/JAC have more recently discussed a potential cooperation for the China domestic market, and Volvo Truck is partnering with Dongfeng Motor to form a HDT joint venture after ending their cooperation with CNHTC. This JV is to be majority (55%) controlled by 9 Exhibit 6 Price Comparison of Foreign vs. Domestic OEMs Dongfeng, and may involve building a locally-branded HDT based off a European standard cab and chassis supplied by Volvo. Expanded cooperation between domestic manufacturers and international players will reshape the landscape of China’s HDT market. As depicted in Exhibit 6, the market can be broken down into three price segments: Low-end (less than 200,000 RMB, e.g. 32,000 USD), Mid- market (200,000-350,000 RMB, e.g. 32,000-55,000 USD) and High- end/imported segment (above 350,000 RMB). Among which, the mid-market segment is more than 70%, and being continually enlarged by virtue of the continuous upgrading of locally built trucks. Competing in the China Truck Market
  10. 10. Gao Feng Advisory Company 10 Competing in the China Truck Market The mid-market HDT segment is different from the low-end product segment, not only by pricing, but also by vehicle capacity and sophistication of technologies. Mid-market HDT is characterized as higher gross weight (18 tons and above), higher power output (range from 230HP-420HP), and more advanced safety and fuel economy technologies. Two paths are followed by Chinese truck manufacturers for obtaining such technologies. Independent development on the inherited vehicle platform is one approach. The Jiefang brand J6 developed by FAW is one good example. However, J6 was a cost- and time- intensive project for FAW, which spent a total of seven years and invested more than USD $100 million. As an alternative, China local manufacturers are choosing to collaborate with international partners to locally adapt their existing global platforms to the Chinese market requirements. Starting with the initial cooperation between MAN and Shannaqi on the F2000 platform in 2004, other collaborative partnerships have followed. Dongfeng worked with Nissan Diesel on development of the Tianlong series, CNHTC developed its Howo A7 based off the F10 cab from Volvo, and BAIC Foton is planning to use a Mercedes-Benz diesel engine to power their Auman trucks. These locally adapted international technologies are widely welcomed by Chinese customers as “best value” products since they outperform low-end trucks while retaining a huge price advantage over the high-end/imported trucks. Obviously strong demand for mid- market products is motivating Chinese truck manufacturers to turn to international partners for technology and shared investment. With the market slow-down since 2011, many truck manufacturers are becoming concerned that they may have been overly aggressive regarding their growth prospects. Overcapacity in China will be an issue for the years to come. The forecasted demand for HDT in 2015 stands at 1.5 million units, whereas capacity will likely exceed 2 million units. Existing OEMs have ambitious expansion plans, and new entrants are also considering expanding their business into the HD truck market. To overcome the overcapacity problem, leading Chinese truck manufacturers are considering aggressive export strategies, particularly to Africa, South America and South East Asia and other countries with low emission standards, low tariffs and weak domestic truck competition. What gives Chinese OEMs the confidence to expand the truck export business is their low-price, “good enough” quality Chinese supply base. Competitive parts sourcing cost in China has the potential to change the global competitive landscape for commercial vehicles 2). Already today, China accounts for 50% of the global MDT/HDT market, with localized suppliers. 2) China with its unique business environment (enormous size, fiercely competitive companies, low labor costs, and explosive growth in infrastructure and public service), gives this new global mid-market players an enormous platform to grow and to improve their quality and reliability, largely protected from foreign competitors, who find it hard to penetrate this segment and focus on the high-end market. In addition the new innovators will be fully attuned to the Chinese needs, particularly in the B2B area, which will make them very competitive in other emerging markets.
  11. 11. Gao Feng Advisory Company In summary, the China MDT/HDT market is almost fully dominated by domestic truck manufacturers led by FAW, DFM and CNHTC. The competitive landscape will be altered when Chinese OEMs pursue partnerships designed to upgrade their capabilities to address growing market needs for better value HDT products. 11 Exhibit 7 Top Vehicles Manufacturers in China Competing in the China Truck Market promulgated in the early of 2009, “capable Chinese players are encouraged to grow stronger by M&A and restructure”. The plan outlines an intention to consolidate the industry into 2 distinct “tiers”: the Tier 1 group consisting of companies with an annual capacity of 2 million units that are encouraged to acquire smaller automotive companies throughout China, whereas Tier 2 consists of companies with an annual capacity of 1 million units are encouraged to drive regional consolidation. The plan even names 4 tier 1 companies as well a 4 tier 2 companies: Policy & regulatory outlook Government policy plays leading role in driving the development and eventual consolidation of China’s auto industry. According to the Plan on Adjusting and Revitalizing the Auto Industry
  12. 12. Gao Feng Advisory Company  TIER 1: – Shanghai Automotive Industrial Corp (SAIC) – First Auto Works (FAW) Group – Dongfeng Motors (DFM) – Chang’An Automotive  TIER 2 – Beijing Automotive Industrial Corp (BAIC) – Guangzhou Automotive Industrial Group (GAIG) – Chery Automobile – China National Heavy Duty Truck Corp (CNHTC) As shown in Exhibit 7, the top 3 HDT manufacturers including FAW, DFM and CNHTC are among the Tier 1 and 2 OEM 12 Exhibit 8 Acquirers and Acquirees among Top 10 HDT/MDT players groups named within this consolidation plan, and are therefore likely to receive extra funding and policy support from the central government when acquiring smaller companies. Responding to the government policy indication, leading auto groups are actively establishing their growth strategies and seeking to build scale advantage. Among them FAW, DFM, BAIC, SAIC, and CNHTC are more likely to be acquirers in industry consolidation among the HDT/MDT players (See Exhibit 8). The early stages of industry consolidation have already begun. Starting from its acquisition of Nanjing Auto Group in 2007, SAIC has expanded their production bases from Shanghai to Yizheng and Nanjing in Jiangsu province. FAW is had approached Brilliance regarding business restructuring and acquisition. Competing in the China Truck Market
  13. 13. Gao Feng Advisory Company If the deal is done, FAW could grow larger than SAIC in terms of scale. To defend themselves and avoid being acquired, smaller commercial vehicle companies like JAC, Beiben and others are actively expanding their business coverage, developing special sectors, and establishing product technology cooperation. For global truck manufacturers, the consolidation of the China auto industry implies that a more structured and disciplined market will eventually emerge which will increase the efficiency, scale and R&D capabilities of the remaining competitors. Leading Chinese OEMs will seek to expand their ownership of assets and capabilities needed to compete in an increasingly global business. 13 Exhibit 9 Implementation of Truck-related regulations in China Competing in the China Truck Market Chinese OEMs must therefore move up the value chain to deliver products with competitive technology to address a growing demand generated for world- class quality trucks. To achieve this, they will undoubtedly allocate larger investments into product development, enabling better responsiveness to the market. Further, the industry will require better IP protection and enforcement to facilitate technology sharing with international players. Exhibit 9 provides a summary of the truck-based regulations implemented in recent years in China.
  14. 14. Gao Feng Advisory Company 14 Competing in the China Truck Market Though industry consolidation will likely be a central theme in the next decade, there are several other policy and regulatory trends that pose challenges to the global truck manufacturers in China. First, the China government is closing the gate for international newcomers by raising the entry barrier for new project approval. Automotive industry policy makers have strong concerns with overcapacity risks in the China auto industry. These concerns are having an impact on their willingness to consider new vehicle manufacturing projects including HDT. Therefore, Ministry of Industry and Information Technology (MIIT) released the Admission Management Rule for Commercial Vehicle Enterprises and Products, which took effect from January 1st, 2011, requiring all truck manufacturers to strictly follow current investment and capacity utilization requirements. Despite this, other very challenging policy objectives must also be met, including the upgrading of the technology used in the local brands, new energy vehicle development and export promotion. Global manufacturers who are willing to share critical technology and capabilities with their Chinese partner may be able to successfully receive approval for their new manufacturing project in China. Second, although Chinese policy makers stress their serious attention to the subject, Intellectual Property (IP) protection is an area of great uncertainty for global manufacturers. Global vehicle manufacturers are pushed to transfer their leading technologies in a market where the legislation and law enforcement for IP rights violations is far from sufficient. Many IP related lawsuits claimed by international manufacturers in China have not been met with satisfactory results, such as BMW’s compliant for Hubei Shuanghuan’s styling imitation of X5, Fiat’s claim for Great Wall’s copy of Panda, as well as GM’s claim for Chery’s copy of the Chevrolet Spark. Such issues also extend into areas of technology and other transfer of capabilities. Learning from past experiences, many international manufacturers have taken both technical and commercial measures to protect their IP when cooperating with Chinese partners. For instance, a modular sourcing strategy from Tier 1 suppliers can be employed (instead of sourcing individual component through the Joint Venture) has become a common practice to protect IPR of the multinational partner. Third, global truck manufacturers will increasingly face China unique standards, which are influenced by the local players. Global truck manufacturers who have made significant commitments to the market often feel like a “guest in their own house” when doing business in China. For instance, the delay of Euro 4 gives local MDT/HDT manufacturers more time to develop their technology, as they retain their enormous cost-advantage compared to foreign high- end OEMs. Similar advantage for Local MDT/HDT manufacturers is the current End-of-life regulation, which requires scrapping after 600,000 km. Such developments might be influenced by politics. To mitigate risk of such unfavorable standard, global truck manufacturers have to make proactive
  15. 15. Gao Feng Advisory Company 15 Competing in the China Truck Market efforts in involving and lobbying the organizations that develop regulations. The resources and experience of the Chinese partner in dealing with the policy- makers are also essential to be leveraged to address this challenge. Finally, global truck manufacturers will be exposed to legal compliance risks when working with their Chinese joint venture or affiliated company. In spite of measures taken to address the problem, bribery and other corrupt business practices are common in China. Several years ago, individuals within the Daimler Truck division were implicated in an anti-bribery case in China. Daimler was required to pay as much as USD $185Mn for reconciliation, and the company has been compelled to reinforce corporate compliance in every process of the business operation. Corrective actions such as establishment of a regional compliance office, compliance-related business processes, mandatory compliance training, and a hotline to report violations of compliance behavior have turned out to be highly effective in mitigating the compliance risk for Daimler in China. Implications for multi- national corporations (MNCs) China’s market size has been hyped to the point of clichésince the country first opened its doors to foreign investment. By 2020, as noted in Exhibit 10, the China HD/MD truck market is expected to reach 1.7 million units sold per year. As noted previously, products positioned in the in the price range between 200K – 350K RMB account for 70% of total sales. The companies positioned to sell to this rapidly expanding “mid-market” segment aim to address the needs of domestic customers looking for goods and services that offer “good enough” quality and value for the money. Sandwiched between the premium market and the bottom of the pyramid, lies the rapidly expanding global middle market (see Exhibit 11) -- a segment of business and retail customers that is rapidly gaining buying power, especially in emerging markets. The middle market offers more than incremental customers and profits – it is a key competitive battleground. The winners here will likely be the leading companies of tomorrow. Beneath the veneer of many middle market strategies ostensibly focused on incremental growth, the emerging markets are incubators for a wave of local companies that are trying to climb up the product-price pyramid to eventually emerge as global competitors.
  16. 16. Gao Feng Advisory Company 16 Exhibit 11 China Truck Market Pyramid Competing in the China Truck Market Exhibit 10 Global Truck Sales by Region in 2020
  17. 17. Gao Feng Advisory Company 17 Competing in the China Truck Market Whatever the motivation for pursuing mid-market strategies with an increasingly global scope, the elements of offense and defense have become equal in importance. In the spirit of the Innovator’s Dilemma, written and popularized by Harvard’s Clayton M. Christenson 3), companies are adopting the mantra, ‘if I don’t do it to myself, someone else will do it to me.’ The dilemma of introducing fit-for-purpose, but lower priced products in the home markets of multi-national corporations has challenged the conventional business logic of pursuing projects with ever-higher return on investment. However, succeeding in the rapidly expanding mid- market will certainly trump having an emerging-market competitor do it before you. 3) Clayton M. Christenson, The Innovator’s Dilemma (Harper Business: 1997) Mid-market form The underlying reason for the emergence of mid-market players in China is the nature of the country’s economic growth. For many industries, China’s product market segmentation has become very diverse, typically far more than MNCs’ home countries. In many countries, the market pyramid has a small top wedge, a modest middle slice and large base. But in some others, the lower tier is smaller, the top is growing but still relatively small, and much of the expansion is coming in a bulging middle. Whatever its size, this middle tier is the natural home base for many of the best Chinese companies. Here is where they find the opportunities best aligned with their strengths. However, of most importance is that while winning in the mid-market will determine the fate of many companies within China, China’s mid-market impact will be felt far beyond the country’s borders, as some of the more prescient multinational companies have started to realize. The Chinese companies emerging in this space will gain access to enormous scale advantages. Any profits they make will be reinvested, allowing them to move both up the value chain, and eventually out of the country to the international markets.
  18. 18. Gao Feng Advisory Company 18 Competing in the China Truck Market Breeding ground The importance of China’s mid-market stems from the fact that this is where Chinese companies are establishing themselves. China’s domestic HD/MD manufacturers already command more than 90% share of the market for commercial trucks, and virtually all of the low-end market. Having locked in this business, market leaders including CNHTC, FAW, DFM, BAIC and SAIC are in the process of acquiring capabilities that allow them to address the expanding mid-market. Developing a highly adaptive and good-enough mid-market product offering is the pathway for such companies to win in China as well as expand beyond China. They know they cannot enter at the top end of the market for most goods – in almost every industry; their products are not good enough to take on multinationals head-to-head. They also know that while the bottom tier is perhaps their most natural home, such is the rate of China’s economic growth that this segment – however big it may be today – can only shrink, and at a rapid rate, over the next few years. Companies that want to grow must therefore address the middle tiers. This is where their range of advantages can be brought to bear. Domestic businesses have – and will continue to have – privileged access to this tier. Not only will they be better positioned to offer strong value propositions, but they will also be better prepared to overcome the structural impediments that will prevent the rapid adoption of global business models in sectors such as construction and agriculture. The size and diversity of China has created very complex market segmentation. Regions are developing at different rates, with differing amounts of access to other markets both within the country and overseas. While this diversity will not last for ever, the transition stage the country has already entered will persist for many years to come – far longer than in other emerging markets, such as those of Japan, South Korea and Taiwan. Here they will be able to temper themselves and build scale. The major new companies that emerge from this breeding ground – some private, others state-owned – will be some of the most disruptive forces in Chinese business. Subject to intense competition from other mid-market firms, and selling to customers who themselves are constrained by competition, these businesses are both frugal and focused. From their mid-market bases, the best of them can build scale, add capabilities, and start to encroach on turf that multinationals have long regarded as their own. For local players in the emerging markets, a mid-market strategy can be quite challenging, since local brands frequently incur greater pricing risk when delivering higher contented products into the market. This is for a couple of reasons. First, when the local product’s brand image does not naturally carry the price points required to support feature- rich products, these products are at risk of having to be discounted. Second, local
  19. 19. Gao Feng Advisory Company 19 Competing in the China Truck Market companies are typically less accustomed to managing the complexity entailed in feature rich products, introducing the risks of cost-creep. Overcoming such challenges is key to the development of the next generation of global competitors. Many Multinationals assume that they just have to hold on until the Chinese market is mature enough to afford their products. But by that time these mid- market innovators will have built long- lasting relationships with their Chinese clients, and will have narrowed the gap between themselves and their global competitors. Sany, who became the world-largest concrete pump manufacturer and who has recently acquired the second largest producer (Germany’s Putzmeister), is an example of this new breed of global players (see Exhibit12). Exhibit 12 Chinese Mid-Market Case Example: Sany Competing in China’s Mid- Market Therefore, most multi-national companies that aspire to be global leaders have no choice but to find a way to win in the Chinese mid-market. Most common strategies by MNCs are either to: 1. Ignore the risk and avoid competing in China’s mid-market altogether. 2. Offer global products and wait until China catches up to more upscale demand, which works only for a limited number of sectors.
  20. 20. Gao Feng Advisory Company 20 Competing in the China Truck Market 3. Pursue a two-tier strategy with a core brand sold along with a lower-priced “good enough” brand considered. MAN is following this approach since early 2011 and Daimler trucks are considering it with their partner Foton. Multinationals simply cannot afford to cede this mid-market to local competitors. Instead, they must set about organizing themselves to face the Chinese competitors emerging there on their own terms – with products that meet Chinese needs, developed at Chinese cost, and which can then be taken out of China to other markets around the world. They must stop thinking about what it is they can bring to China, and instead start focusing on what China’s mid-market can offer them – what culture and structures they must adopt that will allow them to innovate at a lower cost and so produce the goods and services that will drive the next round of global growth. A good example can be found in the construction equipment industry. Caterpillar, which in the 1990s focused on government relationships and selling traditional, high end products to China, shifted focus after the entry of Japanese and Korean competitors in the mid- market segments, and being squeezed by lower-end local players. In the late 2000’s, Caterpillar acquired Shandong Engineering Machinery and formed local R&D centers to expand into lower end market, while optimizing its cost base to compete. Clearly, Caterpillar reasoned, there was a market segment that was here to stay and CAT’s traditional product and business model positioning wasn’t going to be adequate. In the medical equipment sector, another good example of a mid-market innovation was General Electric’s development of ultrasound machines. From 1990 to 2000, GE served the Chinese ultrasound market with machines developed in the US and Japan, priced at $100K and upwards. While these products were successful with a narrow set of hospitals, the price point was above the affordability threshold of many. In 2002, GE’s local team in China leveraged GE global resources to develop a cheaper, portable machine, priced at $30-40K. And then in 2007, GE’s local, China organization launched a dramatically cheaper model, priced at only $15K. The result of these step-wise innovations in somewhat functionality but at dramatically lower price points, were products that saw rapidly increasing sales in China from $4M in 2002 to $278M in 2008, and at the same time, these mid-market products found new markets abroad. As it turned out, there had been latent demand for lower-priced ultrasound machines even in the world’s most developed markets , but neither GE nor its competitors had realized this or pursued this demand with relevant products. Mid-market products are not simply lower-cost variants to global, high end products that can be delivered at lower price points . Foreign and Chinese companies will bring very different mindsets into the battle for the middle market, as illustrated in Exhibit 13.
  21. 21. Gao Feng Advisory Company 21 Competing in the China Truck Market Although the competitive strategy to address the middle markets may be different, the path for both Chinese and foreign companies is the same: access the middle market growth opportunity to both extend brands and product reach with the magnitude of impact that can change the global competitive landscape. Ultimately, mid-market capabilities rooted in China can be leveraged to tap global markets with similar demand patterns, as illustrated in Exhibit 14. Exhibit 13 Chinese Mid-Market Case Example: Sany  Quality -- building in quality and reliability precisely in the areas that are most important to customers  Branding -- systematically moving up-market without overpromising and under-delivering  Functionality -- resisting the temptation to layer in unnecessary content in products beyond what middle market customers will pay for  Product ‘plus’ -- recognizing the role that services and solutions play in augmenting the core value of physical products themselves, and building these into business systems  Mind-set and training -- shifting from “just good enough” philosophy to “world class in all that we do”  Functionality – Take out bells and whistles, while ensuring differentiating features, quality remain – Adding additional functionality that makes difference for consumers, but can be delivered at low cost due to lower China factor costs (engineering/design, manufacturing)  Business system costs -- reducing unnecessary non-product costs, unrelated to mid-market offering, that have been built into business system over time (complexity driven, corporate overhead, etc.)  Leveraging low cost factor potential in emerging markets, avoiding cost creep driven by mindset from developed markets  Organization -- mid-market products and business models at odds with established corporate practices and bases of power Typical Challenges  Brand positioning -- move up-market to boost image  Offense -- challenge MNCs at the lower end of MNC product range, and eventually migrate upwards on product/price pyramid  Pursuit of global middle market customers in emerging AND developed markets  Growth -- Tap into larger volume of customers than high end positioning allows  Defense -- innovate in mid-market before MNC/Chinese competitors do  Selectively, leverage China mid-market to sell to other emerging and developed markets Motivation for Middle Market Push Typical starting point  Mid to lower end products  Emerging brands, concentrated in China, often with some sales in other emerging markets Chinese Companies in China  High end products  Established brands and strong market positions in developed markets world-wide Foreign Companies In China  Quality -- building in quality and reliability precisely in the areas that are most important to customers  Branding -- systematically moving up-market without overpromising and under-delivering  Functionality -- resisting the temptation to layer in unnecessary content in products beyond what middle market customers will pay for  Product ‘plus’ -- recognizing the role that services and solutions play in augmenting the core value of physical products themselves, and building these into business systems  Mind-set and training -- shifting from “just good enough” philosophy to “world class in all that we do”  Functionality – Take out bells and whistles, while ensuring differentiating features, quality remain – Adding additional functionality that makes difference for consumers, but can be delivered at low cost due to lower China factor costs (engineering/design, manufacturing)  Business system costs -- reducing unnecessary non-product costs, unrelated to mid-market offering, that have been built into business system over time (complexity driven, corporate overhead, etc.)  Leveraging low cost factor potential in emerging markets, avoiding cost creep driven by mindset from developed markets  Organization -- mid-market products and business models at odds with established corporate practices and bases of power Typical Challenges  Brand positioning -- move up-market to boost image  Offense -- challenge MNCs at the lower end of MNC product range, and eventually migrate upwards on product/price pyramid  Pursuit of global middle market customers in emerging AND developed markets  Growth -- Tap into larger volume of customers than high end positioning allows  Defense -- innovate in mid-market before MNC/Chinese competitors do  Selectively, leverage China mid-market to sell to other emerging and developed markets Motivation for Middle Market Push Typical starting point  Mid to lower end products  Emerging brands, concentrated in China, often with some sales in other emerging markets Chinese Companies in China  High end products  Established brands and strong market positions in developed markets world-wide Foreign Companies In China Pursuit of the Middle Market
  22. 22. Gao Feng Advisory Company 22 Competing in the China Truck Market While the size and importance of the Chinese mid-market opportunity may be understood, it is often unclear how Multinationals can participate in the market. The Chinese market is already highly fragmented, and the pathway to entry for foreign players is not obvious. However, we believe that several market entry options exist, as noted in Exhibit 15. In all cases, it is important to understand that competing in Chinas rapidly expanding and highly competitive mid- market will require an integrated set of capabilities. Exhibit 14 Increasing Business Evolution in China and Beyond
  23. 23. Gao Feng Advisory Company 23 Competing in the China Truck Market For example, MAN SE (Maschinenfabrik Augsburg-Nürnberg), in a joint venture with China’s Sinotruk, has maintained a two-tiered strategy since early 2011. Vehicles for the Chinese market are sold under the Shandeka brand name, and those for other emerging markets across Asia, Africa, and the Middle East are sold as Sitrak. This strategy allows MAN to sell two different vehicles at two different price points to two different markets, with separate business models. In China’s passenger vehicle market, similar two-tiered strategies are increasingly adopted by international OEMs in the form of Joint Venture local brand development. Starting with the Everus brand launch by Guangzhou Exhibit 15 China Truck Market Entry Model Options Honda in 2010, Shanghai GM Wuling, Dongfeng Nissan, and Dongfeng Honda have each launched their respective JV local brands. The vehicles carrying those brands are often originally branded vehicles at the end of their life cycle, which are rebranded after certain local adaptations are made to meet the taste of the Chinese consumer. Such an approach is intended to generate higher volume through upgraded old generation vehicles without diluting the brand image of international players. The two-tiered strategy, with separate but parallel business models, can be effective: it enables companies to compete in mid-markets where they otherwise could not. However, it is not a
  24. 24. Gao Feng Advisory Company 24 Competing in the China Truck Market trivial task for many global producers of industrial equipment to build the capabilities needed to sell effectively to mid-market customers in China. They must invest in Chinese (or equivalent) R&D and product development, simultaneously integrating their new operations with their old and managing intellectual property challenges. They also lack the home advantages that Chinese mid-market innovators possess: the knowledge of their market niche, access to low-cost production resources, and a deep understanding of the regulatory and operational environment. Joint ventures such as MAN’s can help, but they also add complexity. A small number of global companies are focusing on developing an integrated capabilities system that approaches Chinese mid-market customers and Western higher-end customers in an integrated way. This requires a relentless focus on improving operations and product development together with regional integration. For example, a company might migrate more parts of its value chain and innovation practices to China and other lower-cost countries — with the intent not of saving labor costs, but of gaining distinctive production and sourcing capabilities that can be put in place around the world. These new efforts can specifically target the country’s mid-market and use local engineers and research staff accustomed to more frugal ways of thinking. It may not be obvious at first how particular product lines will be affected, but the new efforts can act as springboards for the kinds of ventures that lead to capabilities that can be leveraged around the world4). 4) Edward Tse, John Jullens and Bill Russo, “China’s Mid Market Innovators”, Strategy & Business, Summer 2012, Issue 67. Conclusions We are in the midst of an economic revolution: a shift of the global center of gravity of economic strength towards the east, which is fundamentally reshaping the competitive landscape of numerous industries. As an economic bellwether, the automotive industry is of great importance to this rebalancing of economic power. The changes that result from the restructuring underway in the automotive sector are fundamental and irreversible. After an unprecedented period of economic expansion, the Chinese government began taking measures to shift the economy to a more stable and sustainable pattern going forward. China is likely to manage the risks associated with this transition with little disruption to the world, the environment, and the fabric of its own society. By 2020, we anticipate that the commercial HD/MD trucks install base will increase by almost 7 million units to 10.7 million and annual sales will rise to 1.7 million – representing 43% of the global truck market. With anticipated growth in export sales of Chinese- assembled trucks, it is easy to see how the Chinese market will be the most important market in the world. It is becoming increasingly urgent for global truck manufacturers to get in the game in China. The local players will increasingly influence regulatory policies and standards, making it more difficult to enter and compete in the market in the
  25. 25. Gao Feng Advisory Company 25 Competing in the China Truck Market future. The delay of Euro 4 gives local MDV/HDV manufactures more time to develop their technology, as they retain their enormous cost-advantage compared to European and Japanese high-end OEMs. While it is legitimate to question whether Chinese companies can assume a leadership role in the transformation of the global commercial truck industry, one simply cannot deny the influence that China has had on industry developments. The sheer size and growth of the China market will require multinationals to consider reprioritization of their capital plans and resource allocation. The reallocation of production and supply resources to China has fundamentally changed the cost structure of many industries – which changes the entire competitive pricing game. China’s government policies and centrally planned economy have supported the creation of the infrastructure needed to stimulate both the supply and demand side of the auto business. Already, low-cost “good-enough” quality Chinese companies are about to change the global competitive landscape with products that are relevant to the high- growth global emerging markets. As China automotive players begin to consolidate, they will increase their efficiency, scale and R&D capabilities – making them even more competitive in the future. Global manufacturers will increasingly be pushed into the luxury “niche”, unless they adjust their business model and develop low-price, as opposed to low-cost products, which are not just “good enough”, but have the right features, durability, more rapid innovation, and lower price to be sold globally. The Chinese market is already highly fragmented, and the pathway to entry for foreign players is not obvious. However, we believe that several market entry options exist as previously noted. MAN’s JV with Sinotruk may be able to crack open the mid-range market in which local OEMs are dominant. A catalyst is defined as “a person or thing that precipitates an event”. This is an appropriate characterization of China’s role in the transformation of the global auto industry. In a globalized world, we will likely find that the transformation of the automotive business model may not be linked to any one company or country. Instead, leading 21st century companies will be the ones that can quickly adapt to the reality of globalization. The emergence of China as the largest automobile market in the world is a significant event only in the sense that it causes the entire world to take notice of just how fast this economy is developing – and to also understand precisely how China is transforming the global auto industry. Rather than trying in vain to turn the clock back to the way things used to be, it would be wise to learn how to use these transformational forces to define a business model to leverage the capabilities which globalization makes possible.
  26. 26. Gao Feng Advisory Company 26 Competing in the China Truck Market Appendix China’s truck classification is different from what is employed in other markets. Exhibit16 compares China’s classification scheme with that of the US market. Exhibit 16 China vs. US Truck Truck Classification
  27. 27. About the Authors Edward Tse is founder and CEO of Gao Feng Advisory Company. He built and ran the Greater China operations of two leading international management consulting firms for a period of 20 years. He has consulted to hundreds of companies – both headquartered in and outside of China – on all critical aspects of business in China and China for the world. He also consulted to the Chinese government on regional strategies, state-owned enterprise reform and Chinese companies going overseas. He is the author of over 100 articles and three books including the award-winning The China Strategy. He is working on his fourth book. Bill Russo is the Managing Director and Automotive Practice leader at Gao Feng Advisory Company. His 30 years of experience includes 15 years as an automotive executive, including 10 years of experience in China and Asia. Mr. Russo has worked with numerous multi-national and local Chinese firms in the formulation and implementation of their global market and product strategies. While the Vice President of Chrysler North East Asia, Mr. Russo successfully negotiated agreements with partners and obtained required approvals from the China government to bring 6 new vehicle programs to the market in a 3-year period, while concurrently establishing an infrastructure for local sourcing and sales distribution. Mr. Russo is a highly sought after opinion leader on the development of the China automotive industry. Gao Feng Advisory Company ( is a pre-eminent strategy and management consulting firm with roots in China coupled with global vision, capabilities, and a broad resources network. We help our clients address and solve their toughest business and management issues -- issues that arise in the current fast-changing, complicated and ambiguous operating environment. We commit to putting our clients’ interest first and foremost. We are objective and we view our client engagements as long- term relationships rather than one-off projects. We not only help our clients “formulate” the solutions but also assist in implementation, often hand-in-hand. We believe in teaming and working together to add value and contribute to problem solving for our clients, from the most junior to the most senior. Our senior team is made up of seasoned consultants previously at leading management consulting firms and/or ex-top executives at large corporations. We believe this combination of management theory and operational experience would deliver the most benefit to our clients. Our name Gao Feng is taken from the Song Dynasty Chinese proverb Gao Feng Liang Jie. Gao Feng denotes noble character while Liang Jie refers to a sharp sense of integrity. We believe that this principle lies at the core of management consulting – a truly trustworthy partner who will help clients tackle their toughest issues.