Go West! (and North) China s New Automotive Manufacturing Clusters Image can go here
Contents 01 Introduction 01 Go West! (and North) 04 Parts Manufacturers 04 Three keys to controlling the downside 05 Final words 05 About Pinsent Masons Automotive Team 4427
Pinsent Masons Go West! (and North) Introduction The days of 40% annual passenger vehicle sales growth in China may have passed, but Original Equipment Manufactures (OEMs) are nonetheless adding capacity at a remarkable rate. In recent months, joint ventures of Nissan, Honda, Toyota, Volkswagen, Hyundai, GM and Ford have all announced or completed significant capacity expansions. However, this production boost isn t limited to China s traditional automotive manufacturing clusters. Government policy and the market are increasingly guiding OEM plants away from the eastern and southern coasts. It is our view that parts manufacturers must and will follow OEMs away from the prosperous coasts, and that planning done before breaking ground on any new facility is crucial to mitigating the downside risk of expansion for parts makers. Go West! (and North) The last year has seen a wave of OEM capacity increases announced or completed. The projects made public include: The addition of the third phase of FAW Volkswagen s Chengdu plant, as well as its fourth plant in Foshan, in 2013 will increase its total manufacturing capacity to 1.65 million vehicles. FAW s plant in Tianjin will double its manufacturing capacity of 0.75 million vehicles in the municipality to 1.5 million vehicles by 2015. SAIC-GM-Wuling will open the $1 billion first phase of a manufacturing base in Chongqing in 2015 with a capacity of 400,000 vehicles. Shanghai General Motors broke ground on a $1.1 billion Wuhan facility that will have a capacity of 300,000 vehicles when opened in 2014. The second plant of Chang an Ford Mazda, with a capital injection of $490 million, opened in Chongqing increasing Ford s passenger car capacity in China by one-third to 600,000 units. Recent announcements show that while there s still some expansion in coastal regions, the most significant growth is inland. We see three main reasons for this inland push. 1
Chasing Tomorrow s Customers Car ownership rates in coastal Tier I cities are approaching those of Japan. This current level of 250 to 500 cars per person is creating unmanageable congestion on the streets of coastal China. Megalopolises such as Beijing and Shanghai can not sustain current levels of vehicle growth of between 6 and 12 percent let alone previous rises of over 30 percent. Those cities are already limiting access to new vehicle plate registrations through the implementation of a lottery, in the case of Beijing, or through exorbitant pricing, as in the case of Shanghai. By contrast, the road grids of Central and Western China, just off a round of stimulus backed construction, still have the ability to absorb new traffic. However, it s not as simple as it seems for OEMs to reorient their coastal production bases towards inland markets. Car makers are focusing on smaller, less expensive vehicles in Tier II, III and IV markets in order to attract first time buyers. GM-SAIC-Wuling has created a new brand, Baojun, specifically for the lower tier market. The new brand has seen explosive growth and now enjoys an 8 percent share of its market segment. The Nissan/Dongfeng joint venture joined GM-SAIC-Wuling with the launch of its own budget brand, Venucia, to compete in the under $10,000 price range. This diversification in product line necessitates a parallel diversification in production lines. Logistics Bottlenecks China s expensive domestic logistics rates also harm the commercial viability of shipping cars inland from the coast. Operational and regulatory inefficiencies cause logistics expenses to constitute nearly 18% of China s GDP, or more than double that in the European Union and United States. This level has remained consistent since 2001 despite massive hard infrastructure investment. The result is that it often costs more to ship from Guangzhou to Beijing than from Guangzhou to the American west coast. Wage hikes and worker shortages are also driving manufacturers of all sorts to move production inland. Technology manufacturing giant Foxconn has nearly doubled factory wages in the last two years in Shenzhen as a response to worker demands. Migration patterns are also changing, as the inland workers that used to fill coastal factories increasingly choose to stay close to home. OEMs and parts manufacturers see opportunities to take advantage of labor supply and insulate themselves from high coastal production costs by moving inland. 2 4427
Pinsent Masons Go West! (and North) Government Policy Government policies and encouragement, both local and central, have played a significant role in the development of new inland manufacturing clusters. Hyper-competitive provinces and cities have long used incentives as a means of luring high visibility industries and companies. Doing so helps boost local GDP and jurisdictions ability to hit ambitious targets. Perhaps most importantly, OEMs contribute significant income tax to local government coffers. While many cities around China, including Qingdao and Changchun, are pursuing OEMs, we see the Central and Southwestern metropolises of Wuhan, Chongqing and Chengdu as being particularly aggressive in their development of sustainable automotive manufacturing clusters. Chengdu has designated its Chengdu Economic and Technological Development Zone to be a production base for vehicles. The city set a target capacity of 1 million vehicles per year by 2015 in its 12th Five Year Plan. Wuhan expects production capacity, chiefly in its Jinkou and Zhuankou districts, to reach 3 million vehicles per year by 2015 if all planned projects are built. Chongqing has announced that the development of an auto industry cluster, dominated by Chang an Auto, with more the RMB 600 billion invested in its Liangjian New Area as the backbone of its Twelfth Five Year Plan. The municipality has stated a target capacity of 4 million vehicles by the completion of the plan in 2015. The central government s Go West policy also seems to be influencing OEM investment priorities. Volkswagen s investment in a $225 million Urumqi factory stands out among other new production facilities as Xinjiang s population is too small to constitute a major market and logistics issues make shipping to the Chinese heartland sub optimal. While Volkswagen hasn t commented on the issue, their investment makes most sense when viewed in the context of government relations. We feel that this governmental encouragement extends to other OEMs and increases their motivation to develop facilities away from the eastern and southern coasts. 3
Parts Manufacturers: The Next Wave of Factory Construction Production location and proximity to OEM customers is of paramount importance to parts manufacturers and will force them to follow their clients inland. Luckily, they will find local governments waiting with open arms. The same cities that have chased OEM s in the past few years recognize the importance of parts makers in a sustainable automotive manufacturing cluster. Chongqing, Chengdu and Wuhan have all formally acknowledged this by including ambitious targets in their five year plans. Bureaucrats in other areas also surely recognize the importance of auto parts factories to the medium and long term success of their headline grabbing OEM anchors. Three Keys to Controlling Risk The construction of additional manufacturing facilities increases organisational complexity and risk for parts manufacturers. We recommend our clients take the following three steps to ensure that new company structures don t get in the way of their commercial aims. Operate under a Wholly Owned Foreign Enterprise (WFOE) rather than a Joint Venture (JV) We generally advise our clients to operate under a WFOE rather than a JV for any project in China. The inclusion of a Chinese partner creates the risk of competing business goals, processes and relationships undermining commercial success. However, these risks are magnified if foreign enterprises operate multiple JV s in China. A foreign auto parts manufacturer s Shanghai JV partner would more naturally see a new JV partner for the same foreign enterprise in Wuhan as a competitor rather than a partner. Such competition has a huge downside risk for foreign investors, especially if a JV partners asks its local government to weigh in on its side. Utilise a Virtual Holding Structure rather than invest in the creation of a formal entity Creating a holding company for your Chinese entities can be expensive and, we find, unnecessary. We recommend that auto parts manufacturers group their entities under a Virtual Holding Structure. This gives companies the organisational structure needed to effectively manage their China operations while saving the cost and time of setting up a formal entity. Nurture strong relationships with business and government partners Business and governmental partners in the Chinese inland tend to have less experience dealing with foreign enterprises, which creates challenges. Extra scrutiny should be given when choosing suppliers and service providers in order to ensure consistent quality and delivery. We also advise that more emphasis be given to government relations in order to help resolve any misunderstandings that may arise. Final Words The long term geography of OEM factories in China is becoming clear. The looming threat of overcapacity has closed China to new OEM s after the addition of Jaguar Land Rover, and will limit future OEM factory construction after the current round is completed. However, auto parts manufacturers must now respond to the new landscape by following their customers inland. Doing so will take significant investment in time and money. We believe that planning done before work on any facility starts is crucial to the long term success of foreign parts manufactures in China. 4 4427
Pinsent Masons Go West! (and North) About Pinsent Masons Automotive Team The Automotive Industry continues to grapple with opportunities and challenges presented by the ever increasing global marketplace. Companies in this sector are often at the leading edge of international investment in new frontiers in order to find the consumers of tomorrow. Automotive companies that embrace change against a backdrop of geopolitical and economic shifts have access to unprecedented opportunities in the 21st century. In a Sector which is sensitive to a litany of trade and regulatory frameworks, it can be difficult to navigate the changing business environment. Our focus is on providing pragmatic advice that makes a real difference- by providing solutions, not just identifying problems. We help our clients to steer a clear path through the multijurisdictional regulatory and legal minefields that stand between them and success. Our M&A, TMT, Corporate, Private Equity, Construction, Dispute Resolution and Real Estate teams all have a wealth of experience within the sector and regularly draw upon the complementary and specialist skills each other offer within the field. Our Automotive Team, operating out of hubs in Munich, Paris, Shanghai and the British Midlands have advised clients on the legal solutions required for original equipment and parts manufacturers operating in an increasingly global market. The team has extensive expertise advising clients on the construction of production facilities, developing strategic alliances, international acquisitions, structuring and restructuring Chinese corporate entities as well as giving operational support regarding risk management, compliance and intellectual property. To find out more about how we can help you, visit www.pinsentmasons.com or contact enquiries@pinsentmasons.com. 5
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