The Beginning Of The End Of Foreign Car Joint Ventures In China?

End of last year, we reported that the Chinese government was publicly thinking about new regulations to shift a large chunk of cars bought by the government to home-grown brands. We are talking about a serious amount of money here. The government is the biggest customer of cars in China, with an annual budget of around $15b. Government purchases influence the whole market. To buy Chinese.

The way laws are written in China is a bit byzantine, but sometimes more democratic than one might imagine. An idea is floated in the media. Discussions ensue. The temperature is taken. If people salute when the flag goes up the pole, a law becomes reality. If there is opposition from all corners, the law quietly goes away and isn’t heard of any longer. Which happens with regularity.

The “buy domestic” law was dormant until a few days ago. “Chinese officials will never give up their Audi or Mercedes” was the popular wisdom amongst foreign car executives. Until last Friday, that is. Then, an article appeared in China Daily, which is pretty much the voice of the government. According to this article, the authorities are no longer “mulling new regulations” as the code for testing the waters goes. Now, the government “prepares revisions to regulations on official car procurement.”

Uh, oh. There will be a lot of hectic meetings at foreign joint ventures on Monday.

When the Chinese government is beyond the “mulling” stage, it’s pretty much a done deal. And when China Daily says “the new regulation is slated to be launched in June,” then you can be 90 percent sure that it will happen in June.

The new regulation will mandate that government offices “purchase more than 50 percent domestically branded cars for their fleets in the future.” Sounds benign so far. But there is some fine print, dictating what kind of cars government offices may or may not buy.

Those guidelines, says China Daily, “basically exclude most brands made by joint ventures.”

Ooops.

For instance, current regulations, issued in 2004, require ministerial level cars to have an engine displacement of not more than 3.0 liter and a price lower than 450,000 yuan ($66,000) per unit. A vice-ministerial level car can also have 3 liters of displacement, but should cost less than 350,000 yuan ($51,000).

The new rules would degrade the engine of a ministerial-level official cars to 2.5 liters max. The price must be below 350,000 yuan ($51,000) per unit. A vice-ministerial level official may only be driven around in a 2.5 liter car that costs not more than 300,000 yuan ($44,000).

Lower ranking officials must economize down from currently 250,000 yuan ($37,000) to 160,000 yuan ($23,000) and must make do with an engine no larger than 1.8 liter. We are talking serious volume here. This will hurt.

With those new regulations in place, foreign producers will lose interest in bidding,” said Xue Xu, professor at the school of economics of Peking University.

“The new regulation will provide domestic brands a golden opportunity to expand and compete with foreign rivals in the world’s biggest auto market,” said Dong Yang, secretary-general of the China Association of Automobile Manufacturers.

Discrimination of foreigners? The interesting part of this is that the government hurts itself. Nearly all of the major joint ventures with foreign brands are in the hands of state owned companies. The home-grown brands are to a large degree in private hands.

Take the Audi’s A6. It pretty much turned into the official car of China. As Business Week writes: “Spend any time in Beijing, and you will doubtless see Communist Party bigwigs getting chauffeured around in black Audi A6 sedans. A big government and consumer following for the A6 has turned Volkwagen’s high-end brand into the luxury market leader.”

The Audis are made locally in a joint venture with FAW, a state owned company. Audi said that China would be its biggest market at the end of this year. Next year will be different, if the new law goes into effect.

The proposed law also sheds new light on the Volvo purchase by Geely. When the deal was announced, we commented that “a Volvo owned by Geely may profit big from a possible edict by the Chinese government.” A Volvo owned by a Chinese company is a Chinese company.

After the deal was signed, Li Shufu, chairman of Zhejiang Geely, said that he would use Audi’s business model in China to foster Volvo’s future development here. China Daily interprets this as “a new focus on the world’s biggest government procurement cake.” Statistics from China Machinery Industry Federation show that in 2008, cars accounted for 20 percent of the government’s shopping list.

Government purchases not only account for 8 percent of the Chinese car market. The is a huge knock-on effect. A car driven by high ranking officials gives face to other customers. “Rich Chinese prefer the officials’ car models which indicate car owners’ prestige and provide them with more psychological satisfaction, and demonstrate the difference between them and ordinary people on the street,” said Xiang Hansong, an auto industry watcher cited in China Daily.

Domestic brands like Chery, Geely, Chang’an, Great Wall and BYD are jockeying for slices of the government pie. The edict-in-the-making also explains why government owned auto makers, which so far mostly relied on joint ventures, suddenly display a great interest in developing their own brands. The law also will prod carmakers to go on an acquisition tour in the West, to buy brands that have high prestige and can be made locally without half of the profits going to the joint venture partner.

The law can mean two things: It can move joint ventures to giving the government a better deal, good old Chinese bargaining. Or it could be the first step towards slowly freezing the joint venture partners out of the country.

When I came here 6 years ago, high ranking executives in foreign joint ventures declared after the 5th beer: “In eight years, the Chinese government will want us out.” Well, we have two more years to go on this prediction, inebriated or not.