Moving Too Fast?

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Easy credit has made it simpler for Chinese firms to pile into the car industry. A few years ago, as Chinese consumers began amassing enough disposable income to buy TVs, appliances and consumer electronics, companies crowded into those fields, driving down prices and profit margins until only a few of the largest now compete. Today one of the new hot zones is autos; sales are accelerating, and margins can be fat. "It's too hard to make money from washing machines now," complains Zhao Yong, a director of Guangdong-based Midea, an appliance maker that plans to buy a bus factory near the China-Burma border. "So we'll start making buses and move into sedans." Others, often with no previous experience in auto manufacturing, have devised similar strategies. Sanxing Aux, producer of China's cheapest air conditioners, last fall announced it had purchased a carmaker in the country's far northeast and would soon unveil a line of sport-utility vehicles. At least three other electronic-goods makers have announced intentions to buy auto plants. Even the maker of one of China's best-known liquors, Wu Liang Ye, has revealed plans to expand into cars.

These homegrown carmakers will have to compete with multinationals like General Motors, Ford, Toyota, Volkswagen and Citroen, all of which have invested heavily in Chinese joint ventures and are muscling for market share. GM, which has made Buicks in China since 1999, will soon launch top-of-the-line Cadillacs and plans to increase total production 50% in the next two years. In a first for the country, Beijing recently announced it will allow GM to import cars made overseas without going through a Chinese partner. Ford plans to increase production sevenfold, to 150,000 cars a year. Volkswagen, maker of the best-selling cars in China, plans to invest $6.5 billion with its joint-venture partner to double annual capacity at its Shanghai plant to a million cars by 2007.

With Japanese and U.S. technology battling it out at the top, the only hope for domestic carmakers without joint-venture partners is to capture the bottom end of the market, then begin the slow ascent up the price-and-sophistication ladder. That's the path chosen by BYD, the former bombmaker. The Flyer retails for about $4,700, making it affordable to the 50 million Chinese earning at least $7,000 a year, whom the government considers middle class. "Look around my office," says Liu, the BYD general manager. He has one dusty filing cabinet, bare whitewashed walls and a view overlooking the decrepit former bomb factory. "We can get by on the slimmest profits."

The Flyer was designed by Chinese engineers, but at least two other companies are suspected of trying to cut costs through a time-tested Asian shortcut: copying Western designs. Analysts once considered cars too sophisticated to knock off. They were underestimating Chinese ingenuity. In 2002 a Volkswagen-like subcompact made by a small company in Anhui province now called SAIC-Chery Automobile began appearing: it was made with components provided by suppliers that were believed to have signed exclusive deals with Volkswagen's joint venture. More recently, Chery has run afoul of GM by releasing a car, called the QQ, that looks almost exactly like a GM model — the Spark — that didn't hit the Chinese market until December. PSA Peugeot Citroen, the French maker of the successful Citroen sedan in central China, faces a similar problem. A local producer called Shanghai Maple introduced a model that looks startlingly like the Citroen: same body, same interior, even the same way of tooting the horn from the turn-signal toggle. "It's exactly the same as the Citroen except half the price," boasts Liu Xiaojun, a Shanghai Maple dealer in Beijing. Citroen suspects that Shanghai Maple poached its suppliers and says it is considering legal action.

The effects of hypercompetition in autos are working their way through the system. The cost of a sedan dropped 9% last year in China. And although the country's soaring demand for metals has caused a sharp increase in raw-materials prices this year, overinvestment could eventually cause prices to collapse there too. A metals trader in the U.S., for example, hangs on his wall a world map with black dots indicating the location of aluminum plants. Most producing countries have five or six dots; China has 130. "China is building smelters like McDonald's opens restaurants," says the trader, who asked not to be identified. He's worried, because China used to be a net importer of aluminum before starting to export and driving down world prices. China exported 621,000 tons in the first nine months of 2003, and far more could hit the market in coming years.