China's Fast-Moving Vehicles

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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.