China's Fast-Moving Vehicles

By Daren Fonda

Mel Rapton doesn't know how to pronounce the name of the Chinese company whose automobiles he would like to import and perhaps sell at his Honda dealership in Sacramento, Calif. He doesn't know what styles he'll promote, what he'll charge or how exactly he'll persuade Americans to buy a car made in China--one that isn't a Hot Wheels toy, that is.

Rapton does know that when he took a tour of the Hebei Zhongxing Automobile factory south of Beijing last November, he watched workers weld vehicle components together by hand--an assembly scene out of the '50s. But after his son test-drove a few models, Rapton started to think he could sell China's cars in the U.S. Setting aside doubts about Hebei's quality control, he signed a "memo of understanding" to negotiate an import deal. "It might take them a year or two to get started," he says, "but I'm willing to take my chances."

Slide over Hyundai--the next automotive upstart that takes the wheel in the U.S. will probably be Chinese. In Detroit this week, a small company called Geely (pronounced Jee-lee) will be the first Chinese automaker to display a car at the North American International Auto Show. Unveiling the compact sedan, whose name translates as Free Cruiser, is a bit of a stunt since Geely may be a couple of years away from shipping products to the U.S. Yet the company has big plans, aiming to export 1.3 million vehicles worldwide, including small sedans for less than $10,000 and a sports car, the Beauty Leopard, which sells for $15,125 in China. Other Chinese manufacturers, with varying levels of sophistication, are developing export models too, notably Chery, which is being promoted by Malcolm Bricklin, a New York City entrepreneur who made his fortune importing Subarus and his name importing the ill-fated Yugo. "What you're seeing is the first stage," says Mike Hanley, global director of Ernst & Young's automotive practice. "Everybody recognizes that Chinese cars will end up in North America. It's a matter of time."

And what a lousy time for U.S. automakers, struggling under competitive pressures that the Chinese are only starting to experience. Chery is developing a full line of vehicles, from compacts to SUVs, shooting for a 2007 launch. And those aren't Chinese Yugos. At the 2005 Shanghai Auto Show, Chery unveiled a convertible with a retractable hardtop, designed by Italy's Pininfarina studio, that won the award for best new car. Yale Zhang, an industry analyst in Shanghai with CSM Worldwide, an automotive consulting firm, says he expects Chery to begin exporting a minivan and a four-door sedan next year. Chery recently cleared two hurdles: settling a law-suit with GM over charges that it ripped off a design from GM's Daewoo subsidiary, and agreeing to find a new name for North American models--since Chery sounds like Chevy, GM had threatened to press the matter in court. Bricklin, meanwhile, claims to have signed up more than two dozen dealers. Chery plans to sell cars up to 40% below current market prices. That will help buyers get past the jokes that their Chinese cars may not make it off the lot, the same jokes once aimed at Japanese brands.

With production workers earning $2 an hour, China is pressing its labor advantage, luring foreign automakers to both supply its domestic market and develop export programs. Almost all the big names--GM, Ford, Honda, Volkswagen--have joint ventures that assemble vehicles for the local market, with sales booming at a 22% average annual clip. Strong sales in China have cooled the impetus to export. So has the majors' ample capacity at plants overseas. And low wages don't make China a low-cost producer. The country has an inefficient supply chain, high component costs (many parts are slapped with import tariffs) and nonwage expenses like housing for factory workers. CSM's Zhang estimates that materials account for 80% to 85% of a vehicle's cost (vs. 65% in Detroit), eroding much of the labor savings. "It's not particularly cheap to produce a car in China," notes Steven Blackman, head of Ernst & Young's automotive practice in Europe.

Yet while China may not be the cheapest place to build cars, it's growing more attractive. Tariffs on parts have declined lately, and logistics costs should decrease as China's transport infrastructure improves. Last year Honda became the first foreign automaker to set up a major export operation, shipping a compact to Europe from a plant in Guangdong's special, duty-free zone. Chrysler plans to build its 300-model sedan in Beijing for domestic sale and possible export (although not to North America, where autoworkers would probably object). GM and Volkswagen export small quantities too, such as Chevy Venture minivans to the Philippines and Polo compact cars to Australia. A Chinese supplier, Wanxiang Group, is reportedly even negotiating to buy some assets of the bankrupt U.S. partsmaker Delphi.

For upstarts like Geely and Chery, it's a formidable task to pierce the cutthroat U.S. market, in which only a handful of sophisticated players (Honda, Toyota, BMW) consistently post profits. Geely was founded as a maker of refrigerators in 1986 and shifted to cars in 1998; Chery launched its first model in 2000. And although Chinese vehicle quality is improving, it lags Western standards by wide margins. Chery's QQ model, for instance, had an average 391 problems per 100 vehicles, according to J.D. Power's latest initial-quality survey. For U.S. models, the average is 118. Chinese manufacturers must also redesign cars to meet tougher U.S. emissions and safety standards, a cumbersome, costly process. And they must build distribution and sales networks, which will take time and money.

The manufacturer that gets to market first carries China's automotive reputation on its shoulders. If the first Chinese car in the U.S. flops, later entries will struggle to gain a foothold. John Harmer, vice president of marketing at Geely-USA, vows that Geely isn't rushing into production at the expense of solid engineering. "We'll make sure Geely doesn't become a member of the group of manufacturers that came to the U.S. prematurely and failed," he says.

The bright side for Geely and Chery is that Americans are growing accustomed to higher-end Chinese products, such as flat-screen TVs and laptop PCs. Art Spinella, president of CNW Marketing Research, surveyed consumers to see if they would consider buying a Chinese car. About 36% said they would. "That level of consideration is twice what it was for Korean brands 10 years ago," he says. Mel Rapton, the California car dealer, figures that a combo of 100,000-mile warranties and cut-rate pricing will get Chinese cars moving. "It's a pretty big gamble," the 77-year-old admits. "But if I were 50, I wouldn't consider it a gamble."

With reporting by With Reporting By Bill Powell/Shanghal, Joseph R. Szczesny/Detroit