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Bigger, better, broader: A perspective on China's auto market in 2020 - Automotive & Assembly Practice - US-China ...
Automotive & Assembly Practice

Bigger, better, broader:
A perspective on China’s
auto market in 2020

   Arthur Wang
   Wenkan Liao
   Arnt-Philipp Hein
Bigger, better, broader: A perspective on China's auto market in 2020 - Automotive & Assembly Practice - US-China ...
Bigger, better, broader: A perspective on China's auto market in 2020 - Automotive & Assembly Practice - US-China ...
Automotive & Assembly Practice

Bigger, better, broader:
A perspective on China’s
auto market in 2020

   Arthur Wang
   Wenkan Liao
   Arnt-Philipp Hein
Bigger, better, broader: A perspective on China's auto market in 2020 - Automotive & Assembly Practice - US-China ...
Automotive & Assembly Practice
Bigger, better, broader: A perspective on China’s auto market in 2020                                               1

               Bigger, better, broader:
               A perspective on China’s auto market in 2020

               China’s automotive sector grew at a compound average rate of 24 percent a year between
               2005 and 2011 and, in 2010, overtook the United States as the largest single-country, new-
               car market. We forecast that the growth of China’s auto market will slow to an average of
               8 percent a year between 2011 and 2020 – still very fast by developed-world standards.
               Sales are forecast to reach 22 million in 2020, bigger than either the European or North
               American markets.

               As the years pass and the market matures, Chinese consumers are growing more
               sophisticated about cars and their tastes are evolving. Many have already purchased a
               first, entry-level car and will be ready to upgrade to newer and better models. To succeed
               in this more demanding environment, automakers must better understand what their
               customers want, and how their expectations differ from region to region and from auto-
               body-type segment to segment. In this way, the Chinese car market is becoming more
               like that of North American, Europe, and Japan and perhaps even more complex, given
               the many regional and segment differences. To address the need for deeper insights,
               McKinsey has developed detailed demand forecasts through 2020 of Chinese auto
               customers by region and segment. In the analysis, we identified fundamental drivers
               for demand growth such as increasing urbanization, rising household income, low car
               penetration rates, and infrastructure improvements.

               The following trends will shape the Chinese auto market in the next 10 years, according to
               our analysis:

               ƒƒ   Going bigger: Sales of sport utility vehicles (SUVs) will triple, although sedans will remain
                    the largest segment
               ƒƒ   Trading up: There will be more second-time buyers, and they will buy more high-priced
                    cars
               ƒƒ   High volatility: The volatile growth rates for new cars observed over the last two decades
                    are likely to continue
               ƒƒ   Regional differences: Consumer behavior by region and car-model preference will vary
                    greatly
               Our findings, detailed below, have significant implications for automakers. For example,
               they will have to place their bets on specific market segments and decide in which city
               clusters they should focus their efforts to take advantage of the “going bigger” and
               “trading up” trends. They will also have to be agile and flexible to react to the market
               volatility.

               Where the market is headed
               New car sales in China are forecast to contribute 35 percent of the world’s car-market
               growth between 2011 and 2020 (Exhibit 1). Still, car penetration will reach only about 15
               percent by 2020.
2

    Exhibit 1

           China became the largest single-country market           China will contribute ~35% of
           in 2010, and is expected to maintain strong              worldwide growth from 2011 to 2020
           growth momentum                                          Million units, percentage
           Million units
                                                                    Worldwide growth from 2011 to 2020
                                                                    100% = ~33 mn units
           25
                                               ~8% p.a.
           20

           15                                                                                            China
                         ~24% p.a.

           10                                                                                         34%
                                                                     ROW
                                                                           42%
            5

            0
                 2005      2010         2011    2015       2020
                                                                                                14%
           China surpassed the U.S        China will even exceed                      10%
           (9.7 mn) to become the No.     North America (16.8 mn)                                  North America
           1 single-country               and Europe (19.9 mn) to                 Europe
           passenger car market in        become the No. 1 area
           2010                           market in 2020

    We  observe three factors that will drive the growth of China’s auto market:
     SOURCE: McKinsey GOG analysis; McKinsey Insights China; team analysis

    ƒƒ   The country’s economy is expected to continue to grow 7 to 8 percent a year in the next
         10 years while the percentage of the population residing in urban areas is expected to
         rise to 60 percent in 2020, from 51 percent in 2011. Increased urbanization will have a
         profound impact on mobility demands
    ƒƒ   The number of high-income urban households – those earning more than 80,000 RMB a
         year -- will expand greatly, to 58 percent in 2020, from 17 percent in 2011. Higher incomes
         plus low auto penetration suggest that the passenger car market has not reached the
         saturation level
    ƒƒ   The quality of roads has improved significantly in recent years while expansion of road
         systems has continued apace; more progress is likely in both areas
    But automakers must also factor in the uncertainties that may slow or disrupt market
    growth. The potential developments mentioned below could further contribute to the
    volatility that the Chinese car market has experienced in the past two decades, when new
    car sales growth ranged from 0 to 70 percent annually (Exhibit 2). The volatility, combined
    with chronic overcapacity, adds greatly to the challenges of doing business in the Chinese
    market.
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Bigger, better, broader: A perspective on China’s auto                                                                                                 3

               Exhibit 2

                       Annual car sales growth rate (and GDP growth rates)                                                          Historical sales
                                                                                                                                    development
                       Percent
                                                                                                                                    Historical GDP
                                                                                                                                    development
                                                                                                                          Today
                                                                                                                                    Dips

                       70

                       60

                       50

                       40

                       30

                       20

                       10

                         0
                         1995 96      97   98    99 2000 01       02    03   04   05     06      07   08   09   10   11   12 2013
                                                              5 years                  4 years             3 years

                 SOURCE: IHS Global Insight (for 1995-2009)

               ƒƒ   The current global economic uncertainties will likely have a negative impact on China’s
                    prospects, and may also lead to a slowdown in the pace of urbanization, as fewer jobs
                    would be created in the cities.
               ƒƒ   Governments could introduce policies that might restrict car use in big cities because of
                    worsening traffic conditions and environmental concerns such as air pollution. Beijing,
                    Guangzhou, and Shanghai, where car density has reached a burdensome 250 vehicles
                    per kilometer of roads, have already introduced restrictions. We estimate that by 2020,
                    another 20 Chinese cities will exceed this car-density threshold, perhaps prompting
                    officials to implement similar restrictions.
               ƒƒ   Emerging urban alternatives to new car ownership such as improved public
                    transportation and increased availability of car rentals and sharing could alter consumer
                    behavior, as already seen in Western cities such as Berlin.
               ƒƒ   The used-car market in China is growing, a development that could cannibalize new car
                    sales, especially in the lower price segment.
               ƒƒ   Consumers put increasing weight on quality and safety. Sales of domestically developed
                    cars could suffer if automakers fail to address these concerns, although there are signs of
                    improvement.
               ƒƒ   The Chinese automotive landscape faces major disruption if, as expected, the industry
                    consolidates as a result of increasing competition.
4

    Where the growth will come from
    Two trends will drive growth of the Chinese auto market, our analysis found: consumers
    will increasingly choose to buy bigger and more expensive cars.

    Going bigger

    Sales of SUVs are forecast to rise 13 percent, compounded annually, from 2011 to 2020,
    exceeding the growth rate of all other segments. Overall, we expect annual SUV sales to
    triple in the next 10 years, as the number of wealthy consumers increases. Our research
    found that wealthy consumers are more likely to consider buying SUVs than the rest of
    the market. Purchasing an SUV would allow them not only to satisfy their driving needs,
    but also to show off their personal taste and lifestyles, the research suggests. Also,
    Chinese consumers consider buying SUV an upgrade from a sedan (Exhibit 3). Despite the
    expected high growth, the forecasted market share of SUVs in 2020 -- about 20 percent
    -- will be significantly lower than the 35-percent market share found in the United States in
    2011.

    Exhibit 3

           Body type mix comparison                                                                                      Sedan         MPV
           Million units, percentage

                                                                                                                                 SUV
                                China car demand forecast
                                             2005                                2011                      SUV size
                                       100% = 3.0 mn                       100% = 11.1 mn
                                            5% 6%                                   5%                      1.6 mn
                                                                                     15%

                                                                               80%
                                          88%
                                                                                                               ~3x
                                             2015                                2020

                                      100% = 16.4 mn                      100% = 22.2 mn
                                                                                     5%
                                                5%
                                                                                          22%               4.9 mn
                                                  19%

                                         76%
                                                                          73%

     SOURCE: McKinsey GOG analysis; McKinsey Insights China; McKinsey 2011 auto survey ; Global insight; team analysis

    Sedans will still command 70 percent of the total car market by 2020. Within the sedan
    segment, the “C” model will remain the main choice for many Chinese consumers looking
Automotive & Assembly Practice
Bigger, better, broader: A perspective on China’s auto                                                                                              5

               to buy a car for the first time and will account for 55 percent of the market by 20201 (Exhibit
               4).

                Exhibit 4

                                                                                                                             E&F            A
                      Sedan body type mix comparison
                      Million units, percentage
                                                                                                                             D                  B

                                                                                                                                       C
                      China sedan demand forecast

                       2005                                 2011                               2015                   2020

                          100% = 2.7 mn                      100% = 8.9 mn                      100% = 12.4 mn        100% = 16.2 mn

                                                                        5 6                                                  8     5
                                   4 12                                                                    6 6                             14
                           20                                                                       14           16   16
                                                                   18         17
                                           21

                                 44                                     54
                                                                                                           58
                                                                                                                                 56

                   SOURCE: McKinsey GOG analysis; McKinsey Insights China; Global Insight; team analysis

               Preference for bigger cars will increase the market share of E and F models while
               squeezing A and B’s share. The A and B models, as a share of the total sedan market, will
               shrink to 19 percent, from 23 percent, while the E and F models will increase to 8 percent,
               from 5 percent. The Chinese consumer will choose a bigger car, as long as he or she can
               afford it. Even in the budget segment, we expect consumers increasingly to choose larger
               cars, especially as Chinese-multinational joint ventures aggressively enter the market with
               C models. Local automakers currently dominate the budget car segment, especially the A
               model.

               Although “going bigger” is clearly a trend, there are still strong sales opportunities in the
               small car segment, especially as a new urban lifestyle emerges. The premium small-car
               price segment, such as Smart, represented only 2 percent of the A model market in 2011.
               Our study suggests, however, that this niche will reach 8 percent of the total segment in

               1    A,B,C,D,E, and F are model-size segmentations for a sedan. We apply the segmentation definition from
                    Global Insight. A is the utility/city class, which is an inexpensive, entry-level small passenger city car, mostly
                    three-door hatchbacks but five-door models increasingly common. B is the supermini class, typically a
                    small three- or five- door hatchback. C is medium-sized five-door hatchback, while D is an upper medium-
                    sized or executive passenger car. E and F are further defined by price, which are large and luxury or super
                    luxury class.
6

    2020, when more urban residents buy a second car for commuting (Exhibit 5). The
    trend is consistent with the market development of Germany and the United States,
    where a large share of the small-car segment have high price tags. Meantime, electric
    vehicles (EVs) are expected to grow in the A model segment, with higher public
    environmental awareness and more government policy incentives expected.

     Exhibit 5

             ‘A’ model sales evolution in China
             Thousand units, percentage

                            100% = 535                668          804          100% = 1,143             186      25
                      >80k RMB     2%                 4%           8%       Premium     12
                                                                            model
                                                                                                         38
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Bigger, better, broader: A perspective on China’s auto                                                                               7

                   Exhibit 6

                            Price segment1 share (Sedan and SUV combined) in China
                            Million units, RMB, percentage

                                                                                                  06-11 CAGR 11-15 CAGR 15-20 CAGR
                                       100% =      4       11     16          21    Segment       Percent    Percent    Percent
                                                                              25
                                                                                       600K         42%        12%        10%
                                                         1 3 2   3            3
                                                   1
                                                2006      2011   2015        2020

                    1 Excludes the impact of inflation

                    SOURCE: McKinsey GOG analysis; McKinsey Insights China; team analysis

               There’s another important factor for automakers to consider besides the “going bigger”
               and “trading up” trends. China’s passenger car market has experienced significant price
               erosion, ranging from 4 to 6 percent, compounded annually, over the past decade, and
               prices are expected to continue to fall over the next five to 10 years.

               The geographical imperative
               Similar to the trend of urbanization, China’s car market has strong regional characteristics.
               Take city tiers2 : China’s smaller cities are accounting for more and more automotive sales.
               From 2002 to 2011, for example, tier three and four cities contributed about 40 percent of
               total new car sales in China. We project that the contribution to growth of new car sales of
               these smaller cities will reach almost 60 percent between now and 2020. New car sales
               in tier three and four cities are forecast to grow at about 10 percent a year, compounded
               annually, from 2011 to 2020, compared with four percent for tier one cities and 6 percent
               for tier two cities.

               2    City tiers are defined by 2010 nominal urban GDP: Tier 1> 932 billion RMB, Tier 2 >120 billion RMB, Tier 3
                    >22 billion RMB and Tier 4
8

    However, city tiers alone are not sufficient to describe geographical differences in car
    sales. Drilling down into the country’s geographic growth patterns, we identified 25
    distinct clusters comprising 815 cities (Exhibit 7). Each cluster displays unique consumer
    attributes.
        Exhibit 7

         China Auto Market Cluster Map

                                                                                                                                              1 Jingjinji (34)           2 Shandong byland (46)
                            Hub           x    Cluster name (# of cities1)
                                                                                                                                                     947 | 4.1% | 7.8%          797 | 7.8% | 6.6%
                            Big shot           2011 size | 2011-2020 growth | 2011 share
                                                                                                                                              3 Shanghai (16)            4 Hangzhou (32)
                            Rising star
                                                                                                                                                     760 |8.2% | 6.3%           756 | 8.4% | 6.2%
                                                                                                                                          5
                                                                                                                                              5 Changchun-Haerbin (56)   6 Liao central south (27)
                                                                                                                                    Haerbin          332 | 8.3% | 2.7%          352 | 8.9% | 2.9%

                                                                                                                              Changchun       7 Guanzhong (16)           8 Central (40)
                      Wulumuqi                                                                                                                       227 | 5.4% | 1.9%          371 | 6.8% | 3.3%
                                   17
                                                                                                                                              9 Hefei (21)               10 Nanjing (24)
                                                                                                            1                Shenyang
                                                                                                                                                     208 | 6.6% | 1.7%          402 | 8.9% | 3.3%
                                                                                  Baotou Huhehaote                                    6
                                                                                                      Beijing
                                                                                                                                              11 Yangzi mid-lower (34)   12 Chengdu (25)
                                                                      19 Wuhai                   18        Tianjin
                                                                                                                          Dalian                    252 | 11.5% | 2.1%          326 | 8.0% | 2.7%
                                                                                    Dongsheng
                                                                              Taiyuan                                         2               11 Yangzi mid-lower (34)   12 Chengdu (25)
                                              20
                                                                                                                          Qingdao                   252 | 11.5% | 2.1%          326 | 8.0% | 2.7%
                                          Lanzhou                            7 Yanan YulinSX
                                                                                                            Jinan            Nanjing 10
                                                                                                                                              13 Changzhutan (27)        14 Xiamen-Fuzhou (30)
                                                                                                       8                          Shanghai
                                                                                                                9                                    208 | 6.0% | 1.7%          293 | 9.1% | 2.4%
                                                                                  Xian                                                    3
                                                                                               Zhengzhou
                                                                                                                                              15 Guangzhou (33)          16 Shenzhen (2)
                                                                             21                                                    Hangzhou          530 | 6.5% | 4.4%          341 | 2.6% | 2.8%
                                                                                         Wuhan               Hefei
                                                   12 Chengdu                            11                                           4       17 Wulumuqi (18)           18 Taiyuan (15)
           ▪   Total cluster market                                           Chongqing                Nanchang
                                                                                                                                                    118 | 10.4% | 1.0%          184 | 7.8% | 1.5%
               size in 2011 = 8.4                                                  22     13
               million                                                         Guiyang
                                                                                                                              14              19 Huhehaote (14)          20 Lan-Xi (25)
           ▪   Top 4 clusters                                 24                     Changsha
                                                                                                       23
                                                                                                                            Fuzhou                   180 | 8.8% | 1.5%         133 | 10.2% | 1.1%
               accounted for 35% of                 Kunming
                                                                                         Guangzhou                    Xiamen                  21 Chongqing (6)           22 Qianzhong (12)
               the total China market
                                                                                                                                                     157 | 9.3% | 1.3%          89 | 5.1% | 0.7%
               in 2011
                                                                        25                       15
                                                                                                      Shenzhen                                23 Nanchang (21)           24 Kunming (18)
                                                                                                                     16
                                                                     Nanning                                                                         119 | 7.3% | 1.0%          177 | 6.8% | 1.5%

                                                                                                                                              25 Nanning (22)
                                                                                                                                                     152 | 7.4% | 1.3%

         1 Dark blue - top 4 clusters with >= 6% share of the total national market; Blue - 12 clusters with a 2-6%
           share of the total national market; Light blue - remaining 9 clusters with < 2% share of total national market

         SOURCE: Polk data; McKinsey GOG analysis; McKinsey Insights china; team analysis

    For example, Fuzhou, Hangzhou, Shandong, and Shanghai are all located along China’s
    east coast, but consumers in Hangzhou and Shandong say they care about attractive
    external styling while their counterparts in Shanghai and Fujian are less concerned with
    exterior appearance and more sensitive to price, according to McKinsey research3.

    In another example, consumers in the adjacent clusters of Guangzhou and Shenzhen
    illustrate different behaviors with respect to media. Our research finds that outdoor
    billboards are the most influential media in Shenzhen, but have much less impact on
    consumers in Guangzhou, who are more receptive to information in newspaper ads. Also,
    as a cluster with many young people, Shenzhen is much more open to up-and-coming
    brands than Guangzhou, where a significant proportion of consumers say they buy only
    well-known brands.

    Three forces shape these clusters: local economic linkages, such as the state of
    infrastructure development; local consumer preferences; and the extent to which

    3    McKinsey Insights China, 2010 Annual Consumer Survey
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Bigger, better, broader: A perspective on China’s auto                                                       9

               automakers are physically present in a particular region through manufacturing plants or
               big offices. The 25 clusters, with clear hub-and-spoke cities inside them, comprised 75
               percent of China’s automotive market in 2011, or 8.4 million cars. Our research shows that
               the top four clusters accounted for 36 percent of sedan sales and 31 percent of SUV sales
               in 2011. Consumer attitudes in hub cities have strong influence over the spoke cities. Our
               analysis of cluster dynamics found two main groups of cities within them, which we call
               “big shots” and “rising stars.”

               Big shots

               Thirty cities accounted for 36 percent of car sales in 2011, or 3.8 million vehicles; these
               cities will still represent 25 percent of the market in 2020, our analysis shows, despite
               expected faster growth in smaller cities and more government car-use restrictions. They
               are also extremely influential in new model launches, with the cumulative sales ramp-up
               speed for a new model in these “big shots” cities as much as four times as high as the
               national average. Our consumer survey and interviews also show the influence of hubs on
               their spoke cities, whose residents are more likely to follow the consumption habits and
               lifestyle preferences of their hub neighbors because of the powerful reach of local media
               and word of mouth.

               Rising stars

               Twenty cities are expected to lead market growth in the years to come. We forecast that
               sales in “rising stars” will increase 10 percent, compounded annually, from 2011 to 2020,
               faster than growth nationally and for that of the “big shots.” Total new car sales of the
               “rising stars” will represent 8 percent of China’s market in 2020.

               Automakers can use hub cities as springboards to penetrate an entire cluster. Our
               experience suggests that leading auto brands invest disproportionately in and
               achieve much higher success rates in selected top cities compared with their average
               performance. This point illustrates that even the most successful companies exhibit
               variable performance across regions.

               A basic guide for automakers
               Our findings suggest a few lessons for automakers seeking to win in the emerging Chinese
               automotive market:

               Offer products for the growing segments of the markets: Automakers should
               systematically review their product-cycle plans and identify the most favorable segments
               in which they might play. Are you prepared for the strongly growing segments such as
               SUVs or higher-priced vehicles (250,000 RMB and above)? Are you prepared for the
               environmentally conscious consumers, such as those in the premium A or EV segments?
               And how do you tailor your products and brand communications to appeal to a bipolar
               consumer market comprising new and experienced consumers living in urban and rural
               markets?
10

     Balance the product portfolio: Chinese consumers want more spacious cars, but
     China is imposing increasingly stringent fleet fuel-economy requirements. In response,
     automakers’ product portfolios must strike a balance between the bigger cars consumers
     desire and the more fuel-efficient cars and EVs that will enable OEMs to meet fuel
     economy standards.

     Prepare for customer upgrading – and retain existing customers: Automakers have
     prioritized first-time buyers, but it’s time to re-think that strategy. More and more
     consumers are ready to upgrade and trade up. Do you have the right product mix for the
     upgrade? Do you have the appropriate CRM program to monitor their upgrade demand?
     Do you have a used-car program to help them trade in and an attractive financing program
     for the upgrade?

     Look at the market through a regional and granular lens: Automakers typically think
     of China as one market or a maximum of three to four markets (tier 1 to tier 4 cities). As
     we have shown, Chinese consumers now exhibit much more differentiated behavior
     than before, and automakers must prepare to serve those diverse needs. For example,
     they should step up their games in consumer research if they are to take advantage of
     the opportunities. That means gaining a better, more granular understanding of market
     segments and geographical differences.

     Improve agility in operations to prepare for volatility: Increasing volatility in car sales
     in a slower-growing overall market could be problematic. For example, a drop in plant
     utilization could also affect cash flow. How agile and flexible is your operation system to
     react to the volatility? Do you have a strong dealer network and well performing suppliers
     under critical market situations?

                                                * * *

     Chinese consumers are becoming increasingly sophisticated about cars, and are
     developing strong preferences, following in the footsteps of consumers in Japan and the
     West. Millions are preparing to upgrade to bigger, higher-priced models. At the same time,
     they are displaying increasingly diverse behavior and needs. Automakers should invest in
     better understanding these evolving consumer attitudes, and prepare accordingly for the
     Chinese market of the future.
About the authors

              Arthur Wang is a Partner in Hong Kong.

              Wenkan Liao is an Associate Partner in Shanghai.

              Arnt-Philipp Hein is an Associate Partner in Munich.

  About the research
  Our model comprises two subsystems. The first provides Chinese national-level
  projections of total car demand and demand by size and price segment. The
  second is a city car model. In the latter, outputs from the national model serve as
  benchmarks for city-level projections to ensure consistency. Weighted adjustment
  was necessary to align the sum of car segment demand with total demand. All
  results should be statistically significant.

  We cross-checked our results with available data sources and international
  benchmarks to make sure the estimates were reasonable, and interviewed experts
  to round out our understanding of specific factors such as city car-use restrictions
  that might affect market development.

  Acknowledgements
  We would like to acknowledge the contributions to this article of Paul Gao, Sha Sha,
  Joseph He ,Xiujun Lillian Li, Chaoqiong Wu, William Cheng and Yangmei Hu.
November 2012
Copyright © McKinsey & Company
www.mckinseychina.com
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