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What Prosperity Has to Do
With Price of Cars in China

April 17, 2008;

BEIJING -- Two years ago Yue "Ricky" Zong paid 70,000 yuan, or about $10,000, for a minicar made by China's First Auto Works. The car was cramped and didn't have power locks or cruise control, but it got the 31-year-old marketing executive around Beijing, where he works for a U.S. high-tech company.

Now with plans to start a family and a big bonus in the bank, Mr. Zong wants more than just basic transportation and is planning to spend about 200,000 yuan on a bigger, comfier ride. One car Mr. Zong and his wife are considering is the Honda Civic. And side air bags are a must feature this time. "Our current car is just too small and not safe enough," he said.

No longer content with no-frills econo-boxes, Chinese car buyers are increasingly using their new wealth to buy the kind of bigger, more-expensive wheels that predominate in developed markets like the U.S. And the proliferation of swankier models at next week's Beijing auto show is a measure of how these transportation upgrades are changing the booming Chinese auto industry.

The shift has important consequences for auto makers of all sizes in China, now the world's second largest market for passenger vehicles. It bodes well for the global auto makers such as General Motors Corp. and Toyota Motor Corp. and their Chinese partners. Together they produce the kinds of cars consumers like Mr. Zong are moving to -- like the Civic, Toyota's Camry and Volkswagen AG's Jetta.

On the flip side, a slowdown in sales growth of low-cost cars could pressure China's upstart auto makers -- such as Geely Automobile Holdings Ltd. and Chery Automobile Co. -- that have focused on that segment of the market. One of Chery's big-sellers is the QQ model, which is priced as low as about $4,500.

A decade ago, when cars came within range of people entering China's middle class, they were primarily for city use with people driving at low speeds, said Nikolaus Lang, a Boston Consulting researcher in Munich, who recently completed a study on China's auto industry. But now auto makers are encountering "an overall cultural shift among Chinese consumers demanding higher levels of safety, quality and integrity of products," Mr. Lang said. As a result they are buying larger foreign models with proven track records in safety and quality.

"Cheap price tags alone aren't going to do it for them any more," agreed Michael Dunne, an analyst for J.D. Power & Associates in Shanghai.

The change began to hit small home-grown Chinese auto makers last year. Jin Yibo, a Chery spokesman, said the auto maker noticed the trend in September when sales of its small cars began slipping substantially while customers continued to flock to dealers for larger, more upscale cars. The change hit the QQ model particularly hard, even though the company's bigger cars felt little impact. Chery, who sold 392,000 vehicles last year, was able to boost sales by 30% from a year earlier, largely because of strong demand for its car from overseas.

Similarly Geely's 2007 net profit rose 51% on strong export demand despite that the company failed to meet its annual sales target. The manufacturer said Wednesday that net profit for the 12 months ended Dec. 31 rose to 315 million Hong Kong dollars (US$40.4 million). Revenue rose 8%. Geely said it sold 181,517 cars in 2007, up 10% from a year earlier and far short of its original target of 240,000 units. Of the total, 20,000 cars were exported overseas, doubling from 10,000 in 2006.

Trouble for the small and independent auto makers could move the Chinese industry a step closer to a phase of consolidation. Nearly 100 companies make cars in China, but in the long run most will disappear, especially as growth in auto sales moderates. On average, the market has grown about 25% a year for the last several years, and last year more than eight million cars were sold in China. That's about half as many that were sold in the U.S., but more than twice as many as in Germany.

In the next eight years, vehicle-sales growth is expected to average about 8% a year, according to estimates by Boston Consulting Group.

Slower growth is already hitting the low end of the market. Sales of mini and subcompact cars like the Chery QQ grew just 3.9% last year, to 1.27 million vehicles, according to Northville, Mich.-based market researcher CSM Worldwide. In contrast, compact and midsize cars, a grouping that includes the Camry and Jetta, grew 32% to 3.34 million vehicles.

Signs pointing to a consolidation are already cropping up. Last year, Nanjing Auto was acquired by Shanghai Automotive Industry Corp., parent of SAIC Motor Corp., one of GM's two partners in China.

"For sure, we will see more mergers and acquisitions in the next five years," said Yale Zhang, a CSM analyst in Shanghai. "We're going to see a shakeout."

To survive, auto makers have to adjust to the evolving tastes of China's expanding urban middle class, which is getting both richer and more sophisticated.

At the Beijing auto show, Geely plans to show several "concept" cars hinting at the direction of future models, which are going to be larger and sleeker and show the sophistication, some say, of top cars in Europe, Japan and the U.S.

But the taste of buyers like Chenxi "Tony" Xu, a 27-year-old Beijing native, is evolving faster than the auto makers can churn out new models. Educated in Britain, he set up a real-estate business that has taken off, thanks in part to the 2008 Olympic Games that have fueled a housing boom in China's capital. He has been driving a Buick HRV, a GM compact hatchback with a small, four-cylinder engine that he bought in 2005 for 110,000 yuan ($15,730) .

But he is planning to upgrade to a Mercedes-Benz C200, a supercharged sports sedan with leather seats and a system that automatically adjusts the suspension setup depending on the condition of the road. The price tag: 400,000 yuan or about $57,000.

"The thing about the Buick HRV is that it has a sporty look, but the engine is gutless," Mr. Xu said, griping about the car's less-than-desirable acceleration. "The Mercedes can hit 100 [kilometers an hour] from a standstill in about 8 seconds, and the car is loaded with safety features."
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