Competing in the China Truck Market

Competing in the China Truck Market

Bill Russo Edward Tse

Gao Feng Advisory Company


Driven by strong economic growth and

infrastructure investment, the China auto

industry has enjoyed explosive expansion

in the past decade, at a compound

annual growth rate of nearly 25% over

the period through 2011. However, the

year-over-year growth rate slowed down

to 2.5% in 2011 and 4.3% in 2012 due to

a combination of policy and economic

factors, such as the termination of the tax

incentive policy, the credit crunch,

purchase restrictions in China’s largest

cities, supply-chain disruptions and the

global debt crisis.

2

Exhibit 1

Overall China Auto Industry by Segment

This market slow-down was followed by

14% growth in 2013, with overall sales

approaching 22 million units. Despite this

recovery, the slowdown is evident once

again in 2014 sales, especially in the

commercial sector. Few analysts doubt

that China’s automotive sector has

arrived at an inflection point where future

sales will expand at a more stable and

moderate growth rate.


3

Commercial vehicles in China consist of

trucks and buses, which have been

negatively impacted by the economic

slow-down. Over the past decade, the

truck sector has grown to meet the

demands from China’s expanding

economy. Historically, the sales of MDT

and HDT1) accounts for 30% to 35% of

the truck sector, which tripled in size from

409,000 units in 2001 to 1,287,000 units

in 2010. As is apparent from Exhibit 2,

this growth momentum has not been

linear. Instead, several waves of

fluctuations have occurred caused by

macroeconomics and policy changes

which directly impact the amount of

capital available to businesses that

Exhibit 2

Historical Sales of Commercial Trucks in China


1) According to China national standard, truck is classified into four segments in terms of gross vehicle weight (GVW). Heavy Duty Truck (HDT) is >14 metric tons, Medium Duty Truck (MDT) is above 6 tons and less than 14 tons (incl. 14T); Light Duty Truck (LDT) is above 1.8 tons and less than 6 tons (incl. 6T), while Mini Truck is less than 1.8 tons.

typically invest in commercial trucks.

Government policies, which directly

determine the levels of investment in

infrastructure, along with measures to

introduce stricter emission standards,

have resulted in big fluctuations in the

market.

In particular, the large stimulus package

launched in 2009 sharply accelerated

demand. “Cash-for-clunkers” schemes

introduced in 2010 helped drive

replacement demand as well as improve

the quality of the overall vehicle parc.

When nearly all government stimulus

measures expired in 2011, the truck

segment entered a downward cycle and

went down to 929,000 units sold in 2012.


4 Competing in the China Truck Market

Contrary to the US and Europe, where

most sales are replacement sales, in

China MDT & HDT are predominately

new sales which increase the size of the

fleet. Though the parc of HDT and MDT

reached 3.9 million units by 2010, there is

still a large gap relative to the developed

markets in terms of per capita vehicle

ownership. Moreover, several

fundamental drivers will prevail in next

few years to push forward the demand for

MDT & HDT.

First, industrialization and urbanization

in China drives higher fixed-asset

investment. Fixed asset investment of

China (adjusted by Purchase Power

Parity) is 1.3-1.6 times higher than that of

Western Europe and the U.S. Such huge

investment is mostly spent on the railway,

highway and other infrastructure projects,

which in turn drives demand for more

commercial (mainly heavy duty) trucks.

Meanwhile, China’s current urbanization

rate is about 50%, ant this will increase to

over 60% by 2020. Clearly, these trends

will continue to fuel higher demand for

commercial vehicles for the foreseeable

future.

Second, cargo transportation demand

of China is larger than that of the U.S

with a higher growth rate. High cargo

transportation demand is a result of

inefficient logistics, urbanization and the

size of country. All of these factors will

push higher demand for Long-Haul HDT.

Third, the replacement cycle of

HDT/MDT in China is much shorter

than that of the developed markets.

This will create significantly more

replacement buying in China than

international makets.

In China, line-haul HDT can typically only

be used for 0.9 to 1.1 million Km while in

the US, the number is as high as 1.5 to

1.7 million Km. As a result of such

differences, the average age of MDT/HDT

in China is only 6 years, much lower than

11.3 years in US.

Taking a broader look at the global

context, several macroeconomic and

sociopolitical developments are altering

balance of power in the automotive

industry. These include the recent

financial crises, which have effectively

resulted in a redistribution of global

economic power, altered the global trade

balance, and renewed concerns over

energy security and environmental

issues. The growing size and influence

of the Asian economies – especially

China – are triggering a transformation of

the automotive business model, with

automotive enterprises seeking to

leverage the momentum of the region.

The recent shift underscores the

importance of the Asian economies to the

future growth and profitability of the

global auto industry.

Most of the recent growth in the world’s

auto industry has been in the Asia-Pacific

region, and more than half of that growth

over the next decade is forecasted to

come from China. Similar regional

demand migration also applies to the

MDT/HDT sector.

Driven by continuous industrialization,

urbanization and cargo transportation

demand, China’s MDT/HDT market is

anticipated to come through the current

down-cycle and experience a strong

rebound thru 2015.



Going forward, several overarching

market trends will shape the MDT & HDT

demand structure:

1. Line-haul HDT demand will be even

larger than vocational trucks in

China resulting from the comparably

lower professional level and lower

operational efficiency of the logistics

infrastructure. This creates

opportunities for international entrants

who have a strong on-road tractor

line-up.

2. A push to meet stricter fuel

economy and emissions standards

will drive a need for advanced

technology and accelerate the truck

manufacturers’ emphasis on

technology upgrades and alternative

fuel application.

3. The source of OEM’s profitability

will increasingly shift from new

truck sales to after-sales services,

including vehicle logistics, value-

added services, parts sales, and auto

finance, etc.

All of the trends noted here will raise the

level of interest among China’s local truck

manufacturers to form alliances with

international truck manufacturers.

The growing influence that China wields

is not simply derived from the size and

scale of its domestic market, which is an

increasingly important focus in a growth-

challenged industry. Increasingly,

financially weakened automotive

companies and their suppliers must strive

to deepen their participation in the China

market if they hope to remain viable.

It only stands to reason that companies

that have weakened positions in their

domestic market would benefit by

redistributing some of their focus to the

growth markets and in particular China.

In summary, China’s HDT/MDT market is

expected to come through the short

macroeconomic cycle into a sustainable

growth track from now through

2020, and global truck makers should

position themselves to participate in the

market by forming alliances to leverage

their unique capabilities in the areas of

product, technology and after-sales

services.


6

Corp (CNHTC) in the top 3 positions for

HDT. Together they have a combined

market share of 55% of the MDT/HDT

market, as indicated in Exhibit 3.

However, each OEM has distinctive

positioning and advantages in the HDT

segment.

FAW and DFM enjoy the best brand

image and have a deep commercial

vehicle experience, along with a well-

developed dealer and service network.

However, both suffer from weak

corporate governance and a lack of

employee performance incentives.

Both companies have developed their

HDT product line-up through upgrades

from their MDT platforms, and they

positioned themselves as volume

leaders in the medium- to low-priced

HDT segment

Exhibit 3

Market Share and Sales of Chinese Commercial Truck Makers


Competitive landscape

Unlike the passenger vehicles market,

domestic brand manufacturers dominate

the commercial truck sector in China.

Historically, the top China truck

manufacturers started their MDT & HDT

development from older generation

platforms, which originated from the

former Soviet Union and Austria (Steyr).

The availability of low cost platforms, and

very low freight rates (which have

remained firm for the past two decades),

has created a hidden cost barrier for

major international players.

Full-year sales in 2013 indicates that a

75% market share of MDT/HDT was

taken by 5 Chinese OEMs, with First Auto

Works (FAW), Dongfeng Motors (DFM)

and China National Heavy Duty Truck


7

Shaanqi benefited from previous

cooperation with MAN and their

technology assistance. However, such

advantages are eroded by the MAN

alliance with CNHTC. Shaanqi is also

fighting with their parent company

(Weichai) for operational control.

Among the smaller truck makers, JAC

and Beiben are most likely to close the

gap with Shaanqi, since they can

leverage the advanced technology

supply from their international partners

respectively. JAC has been discussing

potential partnerships with Navistar

and Caterpillar, while Beiben is

cooperating with Hyundai.

The rest and other new entrants, such

as SAIC, CAMC and Nanjun, have a

much narrower range and face several

technical and financial constraints to

expand their market share.


CNHTC is considered the best

competitor in the construction sector.

They develop their own parts and will

benefit from the JV with MAN in the

area of product and component

development, procurement and sales.

CNHTC is weak in their portfolio of

long-haul vehicles. Their company

operation is considered very

bureaucratic and they have a poorly-

developed dealer and service network.

BAIC Foton is behind the top 3 in

sales, and should considerably benefit

from the JV with Daimler to develop

engines. Despite their smaller scale,

Foton has more efficient product

development, stronger marketing and a

better dealer network.

Shaanqi has comparable sales to

BAIC Foton, and is well recognized in

the vocational HDT sector. Historically,

Exhibit 4

Market Share and Sales of Chinese Commercial Truck Makers


8

China MDT/HDT manufacturers benefit

from low labor and raw material costs,

which enable them to sell their Vehicles

at 25 – 33% of the price of international

products. As shown in Exhibit 4, prices

for trucks produced by multinationals can

range as high as USD $350,000 (MAN),

whereas the highest priced product in

China sells for 72% less at USD

$100,000 (FAW).

However, Chinese truck makers are

increasingly confronted with a different

set of challenges:

On the demand side, the government

and commercial fleet demand is slowing

down, and buyers are increasingly

concerned with fuel economy and

durability. Further complicating the

landscape is the fact that more stringent

regulations regarding safety and

environmental standards are being

implemented – driving cost structure

higher.

Exhibit 5

Potential Ventures Between Foreign and Chinese Truck Makers

On the supply side, the technology and

feature gap among local manufacturers is

narrowing. It is becoming increasingly

difficult to charge any price premium on

new vehicles as the market has become

hyper-competitive and less differentiated.

Those challenges are pushing local

brands to alter their thinking regarding the

need for development and technology

support from international partners.

With the gates to China’s commercial

truck market potentially beginning to

open, leading HDT manufacturers have

begun to explore joint ventures and

alliances in China with top-tier

manufacturers. Various joint venture and

equity shareholding relationships were

established since the SAIC Iveco

successfully formed its JV with

Chongqing Hongyan in 2006 (see Exhibit

5).



The cooperation between MAN/CNHTC

offers perhaps the most promising

cooperation, as the interests of both

parties are apparently well aligned. The

strategy includes formation of an R&D

center and involves a global strategy

including direct exports to the EU.

The Daimler/BAIC-Foton JV entails a

strong technology component and a solid

market component. The Iveco/SAIC

cooperation has been in place for several

years and provides a limited rage of

products for the domestic market.

Navistar/JAC have more recently

discussed a potential cooperation for the

China domestic market, and Volvo Truck

is partnering with Dongfeng Motor to form

a HDT joint venture after ending their

cooperation with CNHTC. This JV is to

be majority (55%) controlled by

9

Exhibit 6

Price Comparison of Foreign vs. Domestic OEMs

Dongfeng, and may involve building a

locally-branded HDT based off a

European standard cab and chassis

supplied by Volvo.

Expanded cooperation between domestic

manufacturers and international players

will reshape the landscape of China’s

HDT market. As depicted in Exhibit 6,

the market can be broken down into three

price segments: Low-end (less than

200,000 RMB, e.g. 32,000 USD), Mid-

market (200,000-350,000 RMB, e.g.

32,000-55,000 USD) and High-

end/imported segment (above 350,000

RMB). Among which, the mid-market

segment is more than 70%, and being

continually enlarged by virtue of the

continuous upgrading of locally built

trucks.




The mid-market HDT segment is different

from the low-end product segment, not

only by pricing, but also by vehicle

capacity and sophistication of

technologies. Mid-market HDT is

characterized as higher gross weight (18

tons and above), higher power output

(range from 230HP-420HP), and more

advanced safety and fuel economy

technologies.

Two paths are followed by Chinese truck

manufacturers for obtaining such

technologies. Independent development

on the inherited vehicle platform is one

approach. The Jiefang brand J6

developed by FAW is one good example.

However, J6 was a cost- and time-

intensive project for FAW, which spent a

total of seven years and invested more

than USD $100 million. As an alternative,

China local manufacturers are choosing

to collaborate with international partners

to locally adapt their existing global

platforms to the Chinese market

requirements. Starting with the initial

cooperation between MAN and Shannaqi

on the F2000 platform in 2004, other

collaborative partnerships have followed.

Dongfeng worked with Nissan Diesel on

development of the Tianlong series,

CNHTC developed its Howo A7 based off

the F10 cab from Volvo, and BAIC Foton

is planning to use a Mercedes-Benz

diesel engine to power their Auman

trucks.

These locally adapted international

technologies are widely welcomed by

Chinese customers as “best value”

products since they outperform low-end

trucks while retaining a huge price

advantage over the high-end/imported

trucks. Obviously strong demand for mid-

market products is motivating Chinese

truck manufacturers to turn to

international partners for technology and

shared investment.

With the market slow-down since 2011,

many truck manufacturers are becoming

concerned that they may have been

overly aggressive regarding their growth

prospects. Overcapacity in China will be

an issue for the years to come. The

forecasted demand for HDT in 2015

stands at 1.5 million units, whereas

capacity will likely exceed 2 million units.

Existing OEMs have ambitious expansion

plans, and new entrants are also

considering expanding their business into

the HD truck market. To overcome the

overcapacity problem, leading Chinese

truck manufacturers are considering

aggressive export strategies, particularly

to Africa, South America and South East

Asia and other countries with low

emission standards, low tariffs and weak

domestic truck competition.

What gives Chinese OEMs the

confidence to expand the truck export

business is their low-price, “good enough”

quality Chinese supply base. Competitive

parts sourcing cost in China has the

potential to change the global competitive

landscape for commercial vehicles 2).

Already today, China accounts for 50% of

the global MDT/HDT market, with

localized suppliers.

2) China with its unique business environment (enormous size, fiercely competitive companies, low labor costs, and explosive growth in infrastructure and public service), gives this new global mid-market players an enormous platform to grow and to improve their quality and reliability, largely protected from foreign competitors, who find it hard to penetrate this segment and focus on the high-end market. In addition the new innovators will be fully attuned to the Chinese needs, particularly in the B2B area, which will make them very competitive in other emerging markets.


In summary, the China MDT/HDT market

is almost fully dominated by domestic

truck manufacturers led by FAW, DFM

and CNHTC. The competitive landscape

will be altered when Chinese OEMs

pursue partnerships designed to upgrade

their capabilities to address growing

market needs for better value HDT

products.

11

Exhibit 7

Top Vehicles Manufacturers in China


promulgated in the early of 2009,

“capable Chinese players are encouraged

to grow stronger by M&A and

restructure”.

The plan outlines an intention to

consolidate the industry into 2 distinct

“tiers”: the Tier 1 group consisting of

companies with an annual capacity of 2

million units that are encouraged to

acquire smaller automotive companies

throughout China, whereas Tier 2

consists of companies with an annual

capacity of 1 million units are encouraged

to drive regional consolidation.

The plan even names 4 tier 1 companies

as well a 4 tier 2 companies:

Policy & regulatory outlook

Government policy plays leading role in

driving the development and eventual

consolidation of China’s auto industry.

According to the Plan on Adjusting and

Revitalizing the Auto Industry


TIER 1:

– Shanghai Automotive Industrial Corp

(SAIC)

– First Auto Works (FAW) Group

– Dongfeng Motors (DFM)

– Chang’An Automotive

TIER 2

– Beijing Automotive Industrial Corp

(BAIC)

– Guangzhou Automotive Industrial

Group (GAIG)

– Chery Automobile

– China National Heavy Duty Truck

Corp (CNHTC)

As shown in Exhibit 7, the top 3 HDT

manufacturers including FAW, DFM and

CNHTC are among the Tier 1 and 2 OEM

12

Exhibit 8

Acquirers and Acquirees among Top 10 HDT/MDT players

groups named within this consolidation

plan, and are therefore likely to receive

extra funding and policy support from the

central government when acquiring

smaller companies.

Responding to the government policy

indication, leading auto groups are

actively establishing their growth

strategies and seeking to build scale

advantage. Among them FAW, DFM,

BAIC, SAIC, and CNHTC are more likely

to be acquirers in industry consolidation

among the HDT/MDT players (See

Exhibit 8).

The early stages of industry consolidation

have already begun. Starting from its

acquisition of Nanjing Auto Group in

2007, SAIC has expanded their

production bases from Shanghai to

Yizheng and Nanjing in Jiangsu province.

FAW is had approached Brilliance

regarding business restructuring and

acquisition.



If the deal is done, FAW could grow

larger than SAIC in terms of scale. To

defend themselves and avoid being

acquired, smaller commercial vehicle

companies like JAC, Beiben and others

are actively expanding their business

coverage, developing special sectors,

and establishing product technology

cooperation.

For global truck manufacturers, the

consolidation of the China auto industry

implies that a more structured and

disciplined market will eventually emerge

which will increase the efficiency, scale

and R&D capabilities of the remaining

competitors. Leading Chinese OEMs will

seek to expand their ownership of assets

and capabilities needed to compete in an

increasingly global business.

13

Exhibit 9

Implementation of Truck-related regulations in China


Chinese OEMs must therefore move up

the value chain to deliver products with

competitive technology to address a

growing demand generated for world-

class quality trucks. To achieve this, they

will undoubtedly allocate larger

investments into product development,

enabling better responsiveness to the

market. Further, the industry will require

better IP protection and enforcement to

facilitate technology sharing with

international players.

Exhibit 9 provides a summary of the

truck-based regulations implemented in

recent years in China.



Though industry consolidation will likely

be a central theme in the next decade,

there are several other policy and

regulatory trends that pose challenges to

the global truck manufacturers in China.

First, the China government is closing the

gate for international newcomers by

raising the entry barrier for new

project approval. Automotive industry

policy makers have strong concerns with

overcapacity risks in the China auto

industry. These concerns are having an

impact on their willingness to consider

new vehicle manufacturing projects

including HDT. Therefore, Ministry of

Industry and Information Technology

(MIIT) released the Admission

Management Rule for Commercial

Vehicle Enterprises and Products, which

took effect from January 1st, 2011,

requiring all truck manufacturers to strictly

follow current investment and capacity

utilization requirements. Despite this,

other very challenging policy objectives

must also be met, including the upgrading

of the technology used in the local

brands, new energy vehicle development

and export promotion. Global

manufacturers who are willing to share

critical technology and capabilities with

their Chinese partner may be able to

successfully receive approval for their

new manufacturing project in China.

Second, although Chinese policy makers

stress their serious attention to the

subject, Intellectual Property (IP)

protection is an area of great uncertainty

for global manufacturers. Global vehicle

manufacturers are pushed to transfer

their leading technologies in a market

where the legislation and law

enforcement for IP rights violations is far

from sufficient. Many IP related lawsuits

claimed by international manufacturers in

China have not been met with

satisfactory results, such as BMW’s

compliant for Hubei Shuanghuan’s styling

imitation of X5, Fiat’s claim for Great

Wall’s copy of Panda, as well as GM’s

claim for Chery’s copy of the Chevrolet

Spark. Such issues also extend into

areas of technology and other transfer of

capabilities. Learning from past

experiences, many international

manufacturers have taken both technical

and commercial measures to protect their

IP when cooperating with Chinese

partners. For instance, a modular

sourcing strategy from Tier 1 suppliers

can be employed (instead of sourcing

individual component through the Joint

Venture) has become a common practice

to protect IPR of the multinational partner.

Third, global truck manufacturers will

increasingly face China unique

standards, which are influenced by the

local players. Global truck

manufacturers who have made significant

commitments to the market often feel like

a “guest in their own house” when doing

business in China. For instance, the

delay of Euro 4 gives local MDT/HDT

manufacturers more time to develop their

technology, as they retain their enormous

cost-advantage compared to foreign high-

end OEMs. Similar advantage for Local

MDT/HDT manufacturers is the current

End-of-life regulation, which requires

scrapping after 600,000 km. Such

developments might be influenced by

politics. To mitigate risk of such

unfavorable standard, global truck

manufacturers have to make proactive



efforts in involving and lobbying the

organizations that develop regulations.

The resources and experience of the

Chinese partner in dealing with the policy-

makers are also essential to be leveraged

to address this challenge.

Finally, global truck manufacturers will be

exposed to legal compliance risks when

working with their Chinese joint venture or

affiliated company. In spite of measures

taken to address the problem, bribery and

other corrupt business practices are

common in China. Several years ago,

individuals within the Daimler Truck

division were implicated in an anti-bribery

case in China. Daimler was required to

pay as much as USD $185Mn for

reconciliation, and the company has been

compelled to reinforce corporate

compliance in every process of the

business operation. Corrective actions

such as establishment of a regional

compliance office, compliance-related

business processes, mandatory

compliance training, and a hotline to

report violations of compliance behavior

have turned out to be highly effective in

mitigating the compliance risk for Daimler

in China.

Implications for multi-

national corporations

(MNCs)

China’s market size has been hyped to

the point of cliché since the country first

opened its doors to foreign investment.

By 2020, as noted in Exhibit 10, the

China HD/MD truck market is expected to

reach 1.7 million units sold per year. As

noted previously, products positioned in

the in the price range between 200K –

350K RMB account for 70% of total sales.

The companies positioned to sell to this

rapidly expanding “mid-market” segment

aim to address the needs of domestic

customers looking for goods and services

that offer “good enough” quality and value

for the money.

Sandwiched between the premium

market and the bottom of the pyramid,

lies the rapidly expanding global middle

market (see Exhibit 11) -- a segment of

business and retail customers that is

rapidly gaining buying power, especially

in emerging markets. The middle market

offers more than incremental customers

and profits – it is a key competitive

battleground. The winners here will likely

be the leading companies of tomorrow.

Beneath the veneer of many middle

market strategies ostensibly focused on

incremental growth, the emerging

markets are incubators for a wave of local

companies that are trying to climb up the

product-price pyramid to eventually

emerge as global competitors.


16

Exhibit 11

China Truck Market Pyramid


Exhibit 10

Global Truck Sales by Region in 2020



Whatever the motivation for pursuing

mid-market strategies with an

increasingly global scope, the elements of

offense and defense have become equal

in importance. In the spirit of the

Innovator’s Dilemma, written and

popularized by Harvard’s Clayton M.

Christenson 3), companies are adopting

the mantra, ‘if I don’t do it to myself,

someone else will do it to me.’ The

dilemma of introducing fit-for-purpose, but

lower priced products in the home

markets of multi-national corporations

has challenged the conventional business

logic of pursuing projects with ever-higher

return on investment. However,

succeeding in the rapidly expanding mid-

market will certainly trump having an

emerging-market competitor do it before

you.

3) Clayton M. Christenson, The Innovator’s Dilemma (Harper Business: 1997)

Mid-market form

The underlying reason for the emergence

of mid-market players in China is the

nature of the country’s economic growth.

For many industries, China’s product

market segmentation has become very

diverse, typically far more than MNCs’

home countries. In many countries, the

market pyramid has a small top wedge, a

modest middle slice and large base. But

in some others, the lower tier is smaller,

the top is growing but still relatively small,

and much of the expansion is coming in a

bulging middle. Whatever its size, this

middle tier is the natural home base for

many of the best Chinese companies.

Here is where they find the opportunities

best aligned with their strengths.

However, of most importance is that while

winning in the mid-market will determine

the fate of many companies within China,

China’s mid-market impact will be felt far

beyond the country’s borders, as some of

the more prescient multinational

companies have started to realize. The

Chinese companies emerging in this

space will gain access to enormous scale

advantages. Any profits they make will be

reinvested, allowing them to move both

up the value chain, and eventually out of

the country to the international markets.



Breeding ground

The importance of China’s mid-market

stems from the fact that this is where

Chinese companies are establishing

themselves. China’s domestic HD/MD

manufacturers already command more

than 90% share of the market for

commercial trucks, and virtually all of the

low-end market. Having locked in this

business, market leaders including

CNHTC, FAW, DFM, BAIC and SAIC are

in the process of acquiring capabilities

that allow them to address the expanding

mid-market. Developing a highly

adaptive and good-enough mid-market

product offering is the pathway for such

companies to win in China as well as

expand beyond China.

They know they cannot enter at the top

end of the market for most goods – in

almost every industry; their products are

not good enough to take on multinationals

head-to-head. They also know that while

the bottom tier is perhaps their most

natural home, such is the rate of China’s

economic growth that this segment –

however big it may be today – can only

shrink, and at a rapid rate, over the next

few years. Companies that want to grow

must therefore address the middle tiers.

This is where their range of advantages

can be brought to bear. Domestic

businesses have – and will continue to

have – privileged access to this tier. Not

only will they be better positioned to offer

strong value propositions, but they will

also be better prepared to overcome the

structural impediments that will prevent

the rapid adoption of global business

models in sectors such as construction

and agriculture.

The size and diversity of China has

created very complex market

segmentation. Regions are developing at

different rates, with differing amounts of

access to other markets both within the

country and overseas. While this diversity

will not last for ever, the transition stage

the country has already entered will

persist for many years to come – far

longer than in other emerging markets,

such as those of Japan, South Korea and

Taiwan. Here they will be able to temper

themselves and build scale.

The major new companies that emerge

from this breeding ground – some private,

others state-owned – will be some of the

most disruptive forces in Chinese

business. Subject to intense competition

from other mid-market firms, and selling

to customers who themselves are

constrained by competition, these

businesses are both frugal and focused.

From their mid-market bases, the best of

them can build scale, add capabilities,

and start to encroach on turf that

multinationals have long regarded as their

own.

For local players in the emerging

markets, a mid-market strategy can be

quite challenging, since local brands

frequently incur greater pricing risk when

delivering higher contented products into

the market. This is for a couple of

reasons. First, when the local product’s

brand image does not naturally carry the

price points required to support feature-

rich products, these products are at risk

of having to be discounted. Second, local



companies are typically less accustomed

to managing the complexity entailed in

feature rich products, introducing the

risks of cost-creep. Overcoming such

challenges is key to the development of

the next generation of global competitors.

Many Multinationals assume that they

just have to hold on until the Chinese

market is mature enough to afford their

products. But by that time these mid-

market innovators will have built long-

lasting relationships with their Chinese

clients, and will have narrowed the gap

between themselves and their global

competitors. Sany, who became the

world-largest concrete pump

manufacturer and who has recently

acquired the second largest producer

(Germany’s Putzmeister), is an example

of this new breed of global players (see

Exhibit12).

Exhibit 12

Chinese Mid-Market Case Example: Sany

Competing in China’s Mid-

Market

Therefore, most multi-national companies

that aspire to be global leaders have no

choice but to find a way to win in the

Chinese mid-market.

Most common strategies by MNCs are

either to:

1. Ignore the risk and avoid competing in

China’s mid-market altogether.

2. Offer global products and wait until

China catches up to more upscale

demand, which works only for a

limited number of sectors.



3. Pursue a two-tier strategy with a core

brand sold along with a lower-priced

“good enough” brand considered.

MAN is following this approach since

early 2011 and Daimler trucks are

considering it with their partner Foton.

Multinationals simply cannot afford to

cede this mid-market to local competitors.

Instead, they must set about organizing

themselves to face the Chinese

competitors emerging there on their own

terms – with products that

meet Chinese needs, developed at

Chinese cost, and which can then be

taken out of China to other markets

around the world. They must stop

thinking about what it is they can bring to

China, and instead start focusing on what

China’s mid-market can offer them – what

culture and structures they must adopt

that will allow them to innovate at a lower

cost and so produce the goods and

services that will drive the next round of

global growth.

A good example can be found in the

construction equipment industry.

Caterpillar, which in the 1990s focused on

government relationships and selling

traditional, high end products to China,

shifted focus after the entry of Japanese

and Korean competitors in the mid-

market segments, and being squeezed

by lower-end local players. In the late

2000’s, Caterpillar acquired Shandong

Engineering Machinery and formed local

R&D centers to expand into lower end

market, while optimizing its cost base to

compete. Clearly, Caterpillar reasoned,

there was a market segment that was

here to stay and CAT’s traditional product

and business model positioning wasn’t

going to be adequate.

In the medical equipment sector, another

good example of a mid-market innovation

was General Electric’s development of

ultrasound machines. From 1990 to 2000,

GE served the Chinese ultrasound

market with machines developed in the

US and Japan, priced at $100K and

upwards. While these products were

successful with a narrow set of hospitals,

the price point was above the affordability

threshold of many. In 2002, GE’s local

team in China leveraged GE global

resources to develop a cheaper, portable

machine, priced at $30-40K. And then in

2007, GE’s local, China organization

launched a dramatically cheaper model,

priced at only $15K. The result of these

step-wise innovations in somewhat

functionality but at dramatically lower

price points, were products that saw

rapidly increasing sales in China from

$4M in 2002 to $278M in 2008, and at the

same time, these mid-market products

found new markets abroad. As it turned

out, there had been latent demand for

lower-priced ultrasound machines even in

the world’s most developed markets , but

neither GE nor its competitors had

realized this or pursued this demand with

relevant products.

Mid-market products are not simply

lower-cost variants to global, high end

products that can be delivered at lower

price points . Foreign and Chinese

companies will bring very different

mindsets into the battle for the middle

market, as illustrated in Exhibit 13.



Although the competitive strategy to

address the middle markets may be

different, the path for both Chinese and

foreign companies is the same: access

the middle market growth opportunity to

both extend brands and product reach

with the magnitude of impact that can

change the global competitive landscape.

Ultimately, mid-market capabilities rooted

in China can be leveraged to tap global

markets with similar demand patterns, as

illustrated in Exhibit 14.

Exhibit 13

Chinese Mid-Market Case Example: Sany

Quality -- building in quality and reliability precisely in the areas that are most important to customers

Branding -- systematically moving up-market without overpromising and under-delivering

Functionality -- resisting the temptation to layer in unnecessary content in products beyond what middle market customers will pay for

Product ‘plus’ -- recognizing the role that services and solutions play in augmenting the core value of physical products themselves, and building these into business systems

Mind-set and training -- shifting from “just good enough”philosophy to “world class in all that we do”

Functionality

– Take out bells and whistles, while ensuring differentiating features, quality remain

– Adding additional functionality that makes difference for consumers, but can be delivered at low cost due to lower China factor costs (engineering/design, manufacturing)

Business system costs -- reducing unnecessary non-product costs, unrelated to mid-market offering, that have been built into business system over time (complexity driven, corporate overhead, etc.)

Leveraging low cost factor potential in emerging markets, avoiding cost creep driven by mindset from developed markets

Organization -- mid-market products and business models at odds with established corporate practices and bases of power

Typical Challenges

Brand positioning -- move up-market to boost image

Offense -- challenge MNCs at the lower end of MNC product range, and eventually migrate upwards on product/price pyramid

Pursuit of global middle market customers in emerging AND developed markets

Growth -- Tap into larger volume of customers than high end positioning allows

Defense -- innovate in mid-market before MNC/Chinese competitors do

Selectively, leverage China mid-market to sell to other emerging and developed markets

Motivation for Middle

Market Push

Typical starting point

Mid to lower end products

Emerging brands, concentrated in China, often with some sales in other emerging markets

Chinese Companies in China

High end products

Established brands and strong market positions in developed markets world-wide

Foreign Companies In China

Quality -- building in quality and reliability precisely in the areas that are most important to customers

Branding -- systematically moving up-market without overpromising and under-delivering

Functionality -- resisting the temptation to layer in unnecessary content in products beyond what middle market customers will pay for

Product ‘plus’ -- recognizing the role that services and solutions play in augmenting the core value of physical products themselves, and building these into business systems

Mind-set and training -- shifting from “just good enough”philosophy to “world class in all that we do”

Functionality

– Take out bells and whistles, while ensuring differentiating features, quality remain

– Adding additional functionality that makes difference for consumers, but can be delivered at low cost due to lower China factor costs (engineering/design, manufacturing)

Business system costs -- reducing unnecessary non-product costs, unrelated to mid-market offering, that have been built into business system over time (complexity driven, corporate overhead, etc.)

Leveraging low cost factor potential in emerging markets, avoiding cost creep driven by mindset from developed markets

Organization -- mid-market products and business models at odds with established corporate practices and bases of power

Typical Challenges

Brand positioning -- move up-market to boost image

Offense -- challenge MNCs at the lower end of MNC product range, and eventually migrate upwards on product/price pyramid

Pursuit of global middle market customers in emerging AND developed markets

Growth -- Tap into larger volume of customers than high end positioning allows

Defense -- innovate in mid-market before MNC/Chinese competitors do

Selectively, leverage China mid-market to sell to other emerging and developed markets

Motivation for Middle

Market Push

Typical starting point

Mid to lower end products

Emerging brands, concentrated in China, often with some sales in other emerging markets

Chinese Companies in China

High end products

Established brands and strong market positions in developed markets world-wide

Foreign Companies In China

Pursuit of the Middle Market



While the size and importance of the

Chinese mid-market opportunity may be

understood, it is often unclear how

Multinationals can participate in the

market. The Chinese market is already

highly fragmented, and the pathway to

entry for foreign players is not obvious.

However, we believe that several market

entry options exist, as noted in Exhibit 15.

In all cases, it is important to understand

that competing in Chinas rapidly

expanding and highly competitive mid-

market will require an integrated set of

capabilities.

Exhibit 14

Increasing Business Evolution in China and Beyond



For example, MAN SE (Maschinenfabrik

Augsburg-Nürnberg), in a joint venture

with China’s Sinotruk, has maintained a

two-tiered strategy since early 2011.

Vehicles for the Chinese market are sold

under the Shandeka brand name, and

those for other emerging markets across

Asia, Africa, and the Middle East are sold

as Sitrak. This strategy allows MAN to

sell two different vehicles at two different

price points to two different markets, with

separate business models.

In China’s passenger vehicle market,

similar two-tiered strategies are

increasingly adopted by international

OEMs in the form of Joint Venture local

brand development. Starting with the

Everus brand launch by Guangzhou

Exhibit 15

China Truck Market Entry Model Options

Honda in 2010, Shanghai GM Wuling,

Dongfeng Nissan, and Dongfeng Honda

have each launched their respective JV

local brands. The vehicles carrying those

brands are often originally branded

vehicles at the end of their life cycle,

which are rebranded after certain local

adaptations are made to meet the taste of

the Chinese consumer. Such an

approach is intended to generate higher

volume through upgraded old generation

vehicles without diluting the brand image

of international players.

The two-tiered strategy, with separate but

parallel business models, can be

effective: it enables companies to

compete in mid-markets where they

otherwise could not. However, it is not a



trivial task for many global producers of

industrial equipment to build the

capabilities needed to sell effectively to

mid-market customers in China. They

must invest in Chinese (or equivalent)

R&D and product development,

simultaneously integrating their new

operations with their old and managing

intellectual property challenges. They

also lack the home advantages that

Chinese mid-market innovators possess:

the knowledge of their market niche,

access to low-cost production resources,

and a deep understanding of the

regulatory and operational environment.

Joint ventures such as MAN’s can help,

but they also add complexity.

A small number of global companies are

focusing on developing an integrated

capabilities system that approaches

Chinese mid-market customers and

Western higher-end customers in an

integrated way. This requires a relentless

focus on improving operations and

product development together with

regional integration. For example, a

company might migrate more parts of its

value chain and innovation practices to

China and other lower-cost countries —

with the intent not of saving labor costs,

but of gaining distinctive production and

sourcing capabilities that can be put in

place around the world. These new

efforts can specifically target the

country’s mid-market and use local

engineers and research staff accustomed

to more frugal ways of thinking. It may

not be obvious at first how particular

product lines will be affected, but the new

efforts can act as springboards for the

kinds of ventures that lead to capabilities

that can be leveraged around the world4).

4) Edward Tse, John Jullens and Bill Russo, “China’s Mid Market Innovators”, Strategy & Business, Summer 2012, Issue 67.

Conclusions

We are in the midst of an economic

revolution: a shift of the global center of

gravity of economic strength towards the

east, which is fundamentally reshaping

the competitive landscape of numerous

industries. As an economic bellwether,

the automotive industry is of great

importance to this rebalancing of

economic power. The changes that

result from the restructuring underway in

the automotive sector are fundamental

and irreversible.

After an unprecedented period of

economic expansion, the Chinese

government began taking measures to

shift the economy to a more stable and

sustainable pattern going forward. China

is likely to manage the risks associated

with this transition with little disruption to

the world, the environment, and the fabric

of its own society.

By 2020, we anticipate that the

commercial HD/MD trucks install base

will increase by almost 7 million units to

10.7 million and annual sales will rise to

1.7 million – representing 43% of the

global truck market. With anticipated

growth in export sales of Chinese-

assembled trucks, it is easy to see how

the Chinese market will be the most

important market in the world.

It is becoming increasingly urgent for

global truck manufacturers to get in the

game in China. The local players will

increasingly influence regulatory policies

and standards, making it more difficult to

enter and compete in the market in the



future. The delay of Euro 4 gives local

MDV/HDV manufactures more time to

develop their technology, as they retain

their enormous cost-advantage compared

to European and Japanese high-end

OEMs.

While it is legitimate to question whether

Chinese companies can assume a

leadership role in the transformation of

the global commercial truck industry, one

simply cannot deny the influence that

China has had on industry developments.

The sheer size and growth of the China

market will require multinationals to

consider reprioritization of their capital

plans and resource allocation. The

reallocation of production and supply

resources to China has fundamentally

changed the cost structure of many

industries – which changes the entire

competitive pricing game. China’s

government policies and centrally

planned economy have supported the

creation of the infrastructure needed to

stimulate both the supply and demand

side of the auto business.

Already, low-cost “good-enough” quality

Chinese companies are about to change

the global competitive landscape with

products that are relevant to the high-

growth global emerging markets. As

China automotive players begin to

consolidate, they will increase their

efficiency, scale and R&D capabilities –

making them even more competitive in

the future.

Global manufacturers will increasingly be

pushed into the luxury “niche”, unless

they adjust their business model and

develop low-price, as opposed to low-cost

products, which are not just “good

enough”, but have the right features,

durability, more rapid innovation, and

lower price to be sold globally. The

Chinese market is already highly

fragmented, and the pathway to entry for

foreign players is not obvious. However,

we believe that several market entry

options exist as previously noted. MAN’s

JV with Sinotruk may be able to crack

open the mid-range market in which local

OEMs are dominant.

A catalyst is defined as “a person or thing

that precipitates an event”. This is an

appropriate characterization of China’s

role in the transformation of the global

auto industry. In a globalized world, we

will likely find that the transformation of

the automotive business model may not

be linked to any one company or country.

Instead, leading 21st century companies

will be the ones that can quickly adapt to

the reality of globalization.

The emergence of China as the largest

automobile market in the world is a

significant event only in the sense that it

causes the entire world to take notice of

just how fast this economy is developing

– and to also understand precisely how

China is transforming the global auto

industry. Rather than trying in vain to

turn the clock back to the way things

used to be, it would be wise to learn how

to use these transformational forces to

define a business model to leverage the

capabilities which globalization makes

possible.



Appendix

China’s truck classification is different

from what is employed in other markets.

Exhibit16 compares China’s classification

scheme with that of the US market.

Exhibit 16

China vs. US Truck Truck Classification

About the Authors

Edward Tse is founder and CEO of Gao Feng

Advisory Company. He built and ran the Greater

China operations of two leading international

management consulting firms for a period of 20

years. He has consulted to hundreds of

companies – both headquartered in and outside

of China – on all critical aspects of business in

China and China for the world. He also

consulted to the Chinese government on

regional strategies, state-owned enterprise

reform and Chinese companies going overseas.

He is the author of over 100 articles and three

books including the award-winning The China

Strategy. He is working on his fourth book.

Bill Russo is the Managing Director and

Automotive Practice leader at Gao Feng

Advisory Company. His 30 years of experience

includes 15 years as an automotive executive,

including 10 years of experience in China and

Asia. Mr. Russo has worked with numerous

multi-national and local Chinese firms in the

formulation and implementation of their global

market and product strategies. While the Vice

President of Chrysler North East Asia, Mr.

Russo successfully negotiated agreements with

partners and obtained required approvals from

the China government to bring 6 new vehicle

programs to the market in a 3-year period, while

concurrently establishing an infrastructure for

local sourcing and sales distribution. Mr. Russo

is a highly sought after opinion leader on the

development of the China automotive industry.

Gao Feng Advisory Company (www.gaofengadv.com) is a pre-eminent strategy and management consulting firm with roots in China coupled with global vision, capabilities, and a broad resources network. We help our clients address and solve their toughest business and management issues -- issues that arise in the current fast-changing, complicated and ambiguous operating environment. We commit to putting our clients’ interest first and foremost. We are objective and we view our client engagements as long-term relationships rather than one-off projects. We not only help our clients “formulate” the solutions but also assist in implementation, often hand-in-hand. We believe in teaming and working together to add value and contribute to problem solving for our clients, from the most junior to the most senior. Our senior team is made up of seasoned consultants previously at leading management consulting firms and/or ex-top executives at large corporations. We believe this combination of management theory and operational experience would deliver the most benefit to our clients. Our name Gao Feng is taken from the Song Dynasty Chinese proverb Gao Feng Liang Jie. Gao Feng denotes noble character while Liang Jie refers to a sharp sense of integrity. We believe that this principle lies at the core of management consulting – a truly trustworthy partner who will help clients tackle their toughest issues.

Competing in the China Truck Market

Automotive

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