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Why China is getting tougher for Ford, GM and other automakers

Key Points
  • Auto sales in China are the slowest they have been in China in two decades, say industry watchers.
  • Part of it is a slowing economy. However, a crackdown on unconventional lending practices, the conservative Chinese consumer mindset and a trade war with the U.S. also have weighed on sales.
  • Some foreign automakers have performed better than others in the region.
A customer speaks with a sales agent while standing between a Ford Motor Co. Everest sport utility vehicle (SUV), right, and a Mustang sports car on display at a Ford dealership in Shanghai, China, on Thursday, July 19, 2018. 
Oilai Shen | Bloomberg | Getty Images

It is not a great time to sell cars in China.

The world's largest car market is experiencing what some industry watchers say is its biggest slowdown in two decades. Foreign automakers, such as General Motors have so far been able to weather the storm, but others, such as Ford, have watched their business in the region deteriorate.

China is the world's largest car market, with about 28 million vehicles expected to sell in 2018, according to IHS Markit. That is compared with about 17 million expected in the U.S., the world's second largest car market.

Auto sales in China fell 14 percent in November over the same month in 2017, said the Chinese Association of Automobile Manufacturers. This has continued a general downward trend in the country that began in July, but the November declines are the worst so far this year.

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The Chinese government has reportedly considered taking action to reverse course, and automakers are unrolling plans to revamp lineups and devote more attention to one of the last great growth opportunities in the world.

"This is the first sustained downturn in memory," said Michael Dunne, CEO of ZoZoGo, a firm that advises automakers on doing business in China. "We would have to go back to the Asian financial crisis in 1998-1999 to see the last time China had flat or down sales for four months or more in a row."

There are a few factors that have contributed to the slowdown in the region.

One is a crackdown this year by the Chinese government in certain unconventional forms of lending, Dunne said. For several years China permitted a form of peer-to-peer lending that allowed wealthier Chinese to lend money directly to the less wealthy, without going through a traditional banking system. This form of peer-to-peer lending has made a lot of credit available to newly minted members of China's growing middle class, particularly in second- and third-tier cities, which are so named for their smaller size and smaller economies when compared with first-tier cities such as Beijing and Shanghai. This has made this demographic one of the fastest growing markets in China's automotive industry.

But since the beginning of 2018, as many as 25 percent of the businesses facilitating this type of lending have been closed or shut down, Dunne said.

That has put the remaining three quarters on notice, and stoked fears they may be the next to come under scrutiny. Everyone in that business has grown a lot more careful and the cash flows that were formerly so available to this important segment of buyers have dried up.

There is some disagreement over just how influential peer-to-peer lending is in China as the auto market has matured.

"In the new-car market, P2P is a relatively small financing method," to Jacob George, who is vice president and general manager of J.D. Power Asia Pacific. "It is only about 2.7 percent of the retail credit market. The captive auto financing companies are the biggest source of loans if the customer doesn't pay cash — which occurs about 40 percent of the time. Hence, we don't believe that this will have a major effect on the new-car market."

They were a more significant and growing source of funds in the used car market, until 2018, George said, but tighter regulations have likely shrunk the market.

The reason for the discrepancy could be that when consumers secure loans through informal or unlicensed channels, they either take the money to a dealership and pay cash for a vehicle, or take the money to a bank and secure a loan, Dunne said. Thus when surveyed, consumers might be saying they are using loans from banks rather than unlicensed channels.

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"Maybe the respondent does not report or want to disclose p2p as the original source of his/ her funds because there is an awareness that these channels compete with state banks and do not have official blessing," he said.

An even more significant factor influencing the downturn has to do with the mindset of Chinese consumers, Dunne said. China's economy is showing signs of slowing, and the trade war with the United States is something virtually no one in that country has experienced before.

This has produced a lot of uncertainty, which leads to a kind of bearishness among Chinese buyers that tends to be much stronger than what one might see in other cultures.

"When times are good, the Chinese are really bullish and bold. But when times are uncertain, they are exceptionally conservative," he said. "They overcompensate when things are uncertain, meaning they hold off on purchases. And it is contagious. Word goes out now is not the good time to buy a car, and it starts circling around. That sounds a lot like the American concept of 'consumer confidence' but there is a special spice to the Chinese mentality that makes it distinct."

Some brands have fared better than others of course.

General Motors reported record equity income of $500 million in China in the third quarter of 2018, despite the challenging environment. The company is expecting to make $2 billion in the region for the whole of 2018. GM reports its income as "equity income" due to its arrangement with its joint venture partner Shanghai Automotive Industry Corporation. In China, all foreign automakers have to partner with local manufacturers.

On the one hand, GM has seen sales of some profitable vehicles rise. Sales at Cadillac, GM's luxury brand, rose 20 percent in the third quarter, with a strong mix of products.

But retail sales were down 15 percent in the same quarter. GM CFO Dhivya Suryadevara said the automaker saw the biggest volume declines in China's tier three to tier five cities, which are generally less populated areas with smaller economies.

The largest U.S. automaker is expected to rank second in sales behind Volkswagen in 2020, said IHS Markit automotive analyst Stephanie Brinley.

Part of the credit for GM's success is due to its partnership with SAIC, which has been regarded as the strongest partner GM could have hoped for in the region. That has given it a leg up over competitors.

"GM just has a stronger alliance," Brinley said. "Their JV partner has really worked out really well for them. Both Ford and [Fiat Chrysler Automotive] have struggled to get partners. "

Ford has also struggled because it has not introduced new products at a fast enough pace to keep up with changing demand and competition from the bevy of manufacturers operating in the country. But Ford has recently taken steps to address its less-than-stellar performance. The automaker has appointed a president and CEO just for China alone and separated Ford China from the rest of Ford's Asia-Pacific group. It is also introducing 50 new vehicles by 2025, some of which are directed right at that burgeoning middle class in China's second-tier cities.

Ford's sales in China are down more than 30 percent year-to-date compared with the same January-November period in 2017. In November, sales fell more than 50 percent over the same month last year. However, it is also important to note that Lincoln sales have fared better, taking advantage of the growing luxury market in the country. Lincoln sales were up 3 percent year-to-date in the country in November, with sales of flagship models such as the Navigator up 129 percent over the same month in 2017.

"China is absolutely essential to Ford globally," said Anning Chen, president and CEO, Ford Greater China, when the company released November sales numbers in mid-December. "The management team of Ford China is focusing on our China Turnaround Plan. We are building a robust management team and efficient organizational structure to drive the business forward. To win against the competition in China, we must better understand the Chinese customer, respond to market changes quickly, introduce more products that customers like and want, streamline the organization, improve the capability of our team, speed up decision-making, and strengthen our relationships with dealers."

"Ford has some catching up to do, but it is not a lost cause," Brinley said.

Despite the recent slowdown, there is still plenty of room left for growth in the country. By 2024, IHS expects China auto sales to hit around 33 million units, she said.

"Even if it gets to a normal growth pace, it is a huge market," Brinley said. "If you can grab it, there is opportunity there."