Eric Thun is the Peter Moores lecturer in Chinese business studies at Oxford’s Saïd Business School

The fear outside China is that the Chinese companies which dominate manufacturing at the low-end of the value chain are now moving into higher-end products.

Although foreign acquisitions and the introduction of new models at international auto shows might seem to be an indication of the strength of Chinese auto firms, it is often just the opposite. Weakness at home is forcing Chinese firms to look for solutions abroad. The Chinese government would like nothing more than to support the development of globally competitive auto firms, but has had difficulty figuring out how to do so.

The initial strategy of the Chinese government in the auto sector was to rely on joint ventures (JVs) with foreign firms. Linkages with leading global auto manufacturers would increase the technical knowledge and management skills of joint venture assembly plants, and this knowledge would then disseminate to the hundreds of supply firms that would be created to support the core assembly plant. This was the plan. Investment began in the mid-1980s and, two decades later, virtually all of the world’s auto firms have manufacturing facilities in China.

The Chinese government has done its part—it required 50:50 JVs for auto assembly plants; it created strong incentives for the JVs to localize production of components; and it played foreign firms off one another during the negotiation phase in order to gain access to the latest technology. However, Chinese firms have had difficulty breaking free from their dependence on foreign partners.

Shanghai Auto, for example, is the strongest auto firm in China—it has JVs with both Volkswagen AG and General Motors Corp.—and although it has been tremendously profitable, the design and development for the models it produces take place in Germany and the US. Shanghai Auto has learnt a great deal from its partners about the processes of auto manufacturing, but very little about design. And without design, it cannot hope to independently develop models under the Shanghai Auto brand. In order to develop an independently branded vehicle, Shanghai Auto purchased technology from MG Rover Group Ltd.

A new strategy for the auto sector is to support independent Chinese firms, those that have no foreign partner. Anhui-based Chery Automobile Co., Ltd, the most successful of these firms, began producing cars in 1999 and has grown rapidly. In 2007, it is expected to sell 400,000 vehicles, and half of these will be exported. Zhejiang-based Geely International Corp., the largest private auto manufacturer in China, began auto manufacturing in 1997 and is expected to sell close to 200,000 vehicles in 2007.

As in many sectors, foreign observers have been impressed at the speed with which the local firms have captured domestic market share and moved into export markets. The success of these firms is easily dismissed as the result of intellectual property rights violations, and there have been many well-founded accusations, but this is not the entire story.

First, these firms respond to market shifts far more quickly than the JV projects because they are not selling cars developed for foreign markets. As the private market in China has grown, the independent firms have discovered that first-time auto buyers in China are more concerned with the price and appearance of a car than quality. There is little highway driving in China; as long as the car gets them around town—usually at a crawl due to traffic—the customer is satisfied.

Second, although it will certainly not be easy for these firms to match the development resources of the multinationals, they are attempting to leverage their early success with copies into independent capabilities. They hire engineers that have been trained by foreign firms, and they rely on the supply firms that have been carefully cultivated by the JV projects.

In many respects, these independent firms may be the true (albeit indirect) beneficiaries of foreign investment.

These firms also face many challenges at home, however. The most important is the intensity of domestic competition. China has over 100 automotive manufacturing firms, and many of these are state-owned firms that are protected by local governments. Until recently, the more competitive private firms were officially discriminated against. It is a desire to escape this intense (and often perverse) competition that drives the export push.

In other words, these firms go abroad not from a position of strength, but because they are not sure they can survive the competition at home.

Will they succeed? In the short run, Chinese firms are likely to be hindered by poor technology and quality, and this will hinder their success in developed markets—current exports are almost entirely to the developing world. They will compensate for these weaknesses by leaning more heavily on foreign component firms and forming alliances with foreign firms. In September, Chery announced that it would begin to produce small economy cars on a contract basis for Chrysler. This is exactly the sortof relationship that will enable it to improve its quality standards, and Chrysler may come to regret the role it played in training a future competitor.

It might well be a mistake to focus too heavily on global markets, however, particularly given that China is consistently one of the world’s fastest growing auto markets.

At home, the domestic firms have advantages over their foreign competitors, and the goal should be to maximize these advantages so as to build a solid platform for global expansion.

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Eric Thun is the Peter Moores lecturer in Chinese business studies at Oxford’s Saïd Business School. His book, Changing Lanes in China: Foreign Direct Investment, Local Governments, and Auto Sector Development (Cambridge University Press), was published in 2006.