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ICG Risk Blog - [ Supply chain paradigm shifts: read the tea leaves and add minor twists ]

Supply chain paradigm shifts: read the tea leaves and add minor twists

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Chrysler's consideration of a Chinese JV to make Chrysler vehicles in China and export them to North America and SeaCode's intent to anchor a used cruise ship converted into a 24/7 floating programming factory off the US coast are seen by some as a shock, a new departure, but are in reality a tweaked progression of trends already in motion.

DaimlerChrysler's 'export Chryslers' made in China

DaimlerChrysler's effort is an attractive proposal to a Chinese firm in that it:

  • Builds a new substitute supply chain in China for "a totally new [DCX] segment"
  • Provides technological assess to the technology and design of that new segment
  • Offers an early export exit path against other Chinese competitors
  • Reduces buyer reticence as the Chinese vehicle is sold as a 'Chrysler' and not as an unknown Chinese badge
  • Provides an opportunity to intimately study Chrysler marketing and brand awareness process (much like two of China's largest state-run tobacco companies will do as part of permitting Altria/Philip Morris to manufacture and sell Marlboros in China)

While it has been suggested that DCX "may just be sending a warning shot across the bows of the United Auto Workers union in the United States [because the] costs of making a car in China today [despite low labor costs] are still not competitive when factoring in logistics, the supply network and import tariffs," I think that it is far more than that - although that will have an undeniable effect on the UAW. DaimlerChrysler is accelerating trends already in motion.

Morgan Stanley has long held that "exports are likely" from the principal global manufacturers now in China, e.g., Honda, General Motors (GM), Volkswagen (VW), Toyota, Ford, Daimler-Chrysler (DCX), Nissan/Renault, and Hyundai. Morgan Stanley believes that all these manufacturers:

have at least a "Plan B" to export cars from China if domestic demand does not absorb domestic capacity. We would point out that most OEMs have located manufacturing facilities near the coast and, thus, have easy access to shipping. To be an efficient exporter, manufacturing costs need to come down [for Chinese made vehicles] and quality needs to improve. With domestic volume ramping up rapidly, and more supplier investment coming into China (reducing the need for imported components), we would expect costs to fall sharply [for Chinese made vehicles] in the near term.

Current currency evaluations "would clearly favor exports" as Western direct labor, benefits included, of $1,500-$2,300 per car is significantly offset by Chinese direct labor at "one-tenth of Western levels" plus some $400-$500 in shipping costs:

While current domestic demand is too strong to allow for any significant exports, we believe that as production costs come down, exports will be an option if domestic demand slows... Currently, auto parts comprise the bulk of automotive-related exports from China to the US...

Morgan Stanley says that the "three biggest questions investors currently have about China" are:

  • Are there likely to be significant vehicle exports from China?
  • Will margins in the region fall to more normal levels in the near future?
  • Is there a bubble in the vehicle market?

Morgan Stanley's opinions on answers are, respectively, Yes, Yes, and Maybe.

China's long-term potential as "a significant export base for vehicles" is not limited to Western OEMs (manufacturers). Despite demand growth that should continue as Chinese automotive consumers proliferate and move up-market, the possibility of significant excess capacity remains high for domestic and foreign manufacturers. Conservative estimates point to a 25-30% annual growth in demand to absorb announced additions in capacity without taking into account the rapid pace of announcements by "major OEMs [racing] to stake out future market-share positions."

Chinese OEMs are competing among themselves, with foreign OEMs, and with Joint venture partnerships made with other Chinese and foreign OEMs. Profits in an excess capacity condition have favored firms "that are low cost and deliver product that consumers are willing to pay for." It defies imagination that China will not follow the export path of Japan in the 1960s and Korea in the 1980s, increasingly delivering better car content at low cost, but domestic shocks could accelerate Chinese OEM export:

If China fails to become the world's second-biggest car market by 2010 [McKinsey prediction], the country could suddenly find itself saddled with millions of unsold cars... "If you have all this capacity, you'll have to consider going abroad. This is the route all Chinese companies are going to take, and car makers are no exception. Eventually the market will become saturated." A market downturn is fueling fears. After nearly doubling in 2003, car sales growth braked to just 15 percent in 2004 and should grow at an even slower pace in 2005.

If DCX proceeds, I would expect to see accelerated actions by other foreign OEMs, all of which will accelerate Chinese vehicle export and impact US vehicle manufacture.

Part 2 SeaCode's floating Maquiladora

Daimler ponders exporting Chryslers from China to North America
Reuters / April 21, 2005
Automotive News

China's Car Makers Ready to Go Global?
By Ben Blanchard
Reuters
Sat Apr 16, 2005 08:11 AM ET

Chinese Auto Market: Reading the Tea Leaves
Team Leader: Stephen J. Girsky, Analyst
Morgan Stanley
Global Autos & Auto Parts, Manufacturers Group
February 17, 2004

Gordon Housworth


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