JPRI Working Paper No. 95, November 2003
The Japanese Automobile Industry in China
by Walter Arnold

2003 looks like another excellent year in the development of China’s automotive industry.  Reports of record sales, new production, and the announcement of new ventures by global automotive companies abound.   After accession to the World Trade Organization in 2000, the motor vehicle industry advanced by leaps and bounds, as Chinese as well as foreign invested enterprises, private businesses and citizens joined the automotive age in record numbers.  With the highest sales of passenger cars to date along with a large increase in the production of passenger cars, buses and trucks, China’s automotive sector has secured a position as one of the relentless driver in the domestic economy. The automotive sector accounts currently for 40 percent of the machinery industry’s revenues and profits. At the global level, China has moved to the No. 5 position in production behind the USA, Japan, Germany, and France, and is slated to produce 3.8 million to 4 million motor vehicles this year. 
The rapid advances in China’s domestic economy during the 1990s and the fast-growing demand for passenger cars and trucks encouraged domestic and foreign automotive companies to aggressively invest in the expansion of China’s motor vehicle production. Foreign auto giants, Chinese state owned enterprises, and a very large number of privately owned companies invested Billions of US dollars in process and assembly technology for passenger car production.  As a result of the enormous investment activities and numerous Sino-foreign joint ventures, the output of motor vehicles in China increased sharply; the number of passenger cars alone has risen from 42,000 in 1990 to more than 1.1 million in 2002.      
Most remarkable, however, are not China’s staggering production numbers but the leading role of Western motor vehicle assemblers like Volkswagen, PSA Peugeot Citroen, and General Motors, in China’s budding passenger car industry.[1]  Equally astonishing is Japan’s Cinderella existence in China’s auto market through the 1990s. Japanese analysts ascribe Japan’s weak position in China’s automotive sector to diversion by trade frictions with the United States of the 1980s, ease of Japanese motor vehicle exports to China, and disregard of the growth potential of China’s motor vehicle sector.[2]
This paper explores causes of the Western preponderance in China’s motor vehicle sector and the consequences for Japan’s major automotive producers as well as the defensive reactions that followed.  The first section focuses on the historical antecedents of China’s motor vehicle development through the early 1980s and is followed by a brief discussion of the nature of early Japanese presence in China’s motor vehicle market and their refusal to localize assembly. The next section explains the Western foray into China and establishes the causes of Western predominance in passenger car production. Follows a discussion of the uses of strategic auto industry policy to forge strategic alliances with Western auto makers that bring state of the art automotive manufacturing technology and capital to China. Ensues an examination of the causes and consequences of Japan’s latecomer status in China’s automotive market.  Finally, there are some thoughts about the future of Japan’s auto makers in China.
Historical Antecedents
China did not mass produce motor vehicles until 1956.  Although during the 1930s and 1940s a small number of trucks were assembled.  On the coats of Japanese military aggression in China, Nissan and Toyota Motor Company engaged in motor vehicle repair and some small-scale motor vehicle assembly but did not establish a production bases in the occupied territories.  From the 1920s through 1949, American makes dominated China’s automotive stock; American motor vehicles, mostly trucks in the 1940s, included various models of Ford, GMC, Chrysler, and Studebaker. At the time of Communist takeover there were some 85,000 motor vehicles were registered in all of China. 
China’s vision of a national motor vehicle industry originates in Dr. Sun Yat-sen writings of early 1920’s.  However, Sun’s vision became a reality only in 1953, when the First Auto Works, FAW, was formed in a Sino-USSR cooperative effort that led to the production of the first Chinese truck that rolled off the assembly line on July 15, 1956.  Two years later China’s first domestically made passenger car, Hongqi, was launched and the first cross-country motor vehicle went into production.  It appeared that following the Soviet model, China was now on track to produce a larger mix of motor vehicles.  Yet China’s attempts at mass production of motor vehicles in China suffered important setbacks during the Great Leap Forward and the tumultuous Cultural Revolution, as the general political climate severely constrained any normal development of the motor vehicle industry.   During this period, China’s automotive sector was nearly cut off from international interchange. Thus, China was unable to keep up with the development of new automotive technologies and production methods that revolutionized the world motor vehicle industry in the late 1960s and during the 1970s.
More than two decades after its establishment at the end of the Maoist era in 1976-1978, China’s automotive sector was only capable of assembling a mere 135,200 motor vehicles.  This situation became increasingly untenable with the launching of radical economic reforms that dramatically increased demand for motor vehicles of all kind and ushered in a new era of opportunities for China’s motor vehicle industry. The enormous surge in demand for trucks and passenger cars laid lay bare the acute shortage of motor vehicles. And to make up for the shortages, China’s central authorities allowed for the importation of a large amount of new and used foreign built motor vehicles, most of which were of  Japanese origin. 
Supported by the central and local government, China’s motor vehicle factories began to turn to foreign motor vehicle companies for technical assistance.   After gaining official permission from the government, they began to look for foreign partners.  In the early 1980s, China’s central authorities helped dispatch numerous technical delegations to the world’s leading automotive producers who were eager to induce foreign investment and technology transfer to revitalize China’s ailing motor vehicle plants.  For the automotive sector and its advocates in the central government, revitalizing China’s motor vehicle industry became synonymous with China’s ‘Open Door’ to acquire advanced foreign automotive technology and management methods.   However, early in the 1980s all China had to offer was the potential of the world’s largest population.  Yet many foreign automotive companies were fretful and concerned about the possibility of quick and adverse policy changes by the all-embracing government as political and economic uncertainty continued to prevail in China.  Several global automotive companies decided to bypass China.  There was great concern about China’s per capita GDP that was well below the required threshold level of US $ 1,000 needed to sustain automotive production. Noticeable among the detractors were Japan’s Big Three automotive producers, Toyota, Honda, and Nissan that choose to concentrate on the lucrative North American market instead.
Early Japanese Presence in China
In the early 1970s it appeared that geographic proximity and cultural affinity would provide Japanese automotive companies with a natural competitive advantage that neither American nor European companies could ever attain.   Furthermore, Japanese industrial equipment and machinery were generally well received in China, and had acquired important market positions after Sino-Japanese normalization of relations in 1972.  For many foreign observers Japan seemed slated to establish a position of economic preponderance in China.
Japanese automotive companies established an early presence in China, principally as exporters of passenger cars and trucks, licensed production, and as suppliers of CKD kits, spare parts, and automotive components.  Japanese automotive shipments were infrequent during the early 1970s and became more regularized as China began to open up to the outside world in the latter part of the 1970s.   Japanese shipments of new and used motor vehicles helped alleviate the critical motor vehicle shortages during the 1980s and greatly benefited Japanese trading companies and their Chinese counterparts that controlled this important trade.  However, for the Japanese auto companies the scale of these activities were negligible compared with their motor vehicle exports elsewhere.  This economic limitation may partially explain why Japan’s Big Three auto makers discounted China’s market potential in the early 1980s.  
Since both Toyota and Nissan exports to China were relatively small and unpredictable, there seemed little incentive to establish a production base for motor vehicle assembly in China, or even to consider any large-scale direct investment in the Chinese automotive industry.   Japan’s leading automotive producers on no account viewed the China market capable of absorbing large numbers of Japanese motor vehicles, and thus focused their attention on Asia’s emerging economies instead.  Toyota, for example, after researching Taiwan potential for motorization entered into negotiations with relevant local powers to establish a state of the art assembly plant.  Toyota decided to forego a similar investment on the mainland, even after a considerable gambit by the Chinese government to invest there.
Toyota’s decision to not invest on the mainland coincided with a discernable change in Japanese Big Business attitudes toward China in the early 1980s.   At that juncture, Sino-Japanese economic relations had cooled off noticeably as trade and investment disputes surfaced now more frequently and began to afflict commercial and business dealings sufficiently enough to tarnish Japan’s ‘special’ relationship with China.   The spitefulness of some of the disputes and expansiveness of compensation requests in the notorious ‘Baoshan Steel Mill’ contract dispute shocked Japanese business and commercial circles and resulted in sharply diminishing interest for new business ventures in China.  At the same time, Japan’s striking and rapid rise to status of economic superpower and dominant economic power in Asia was noticed in China, as was Japan’subiquitous economic presence in China.  This caused considerable concern by the Chinese Government and was what Chinese student circles then dubbed as ‘Japan’s new invasion of China.’  Not surprisingly, Japan’s Big Three auto makers turned their interest and attention elsewhere.
Chinese authorities, however, were keenly interested in Toyota as an investor and joint venture partner.  Japan surpassed the USA for the first time in 1980 to become the top auto producing country in the world.  In the same year, Toyota had emerged as a world class producer with great organizational and technical capacities, and demonstrated its ability to work with foreign partners even under difficult circumstances.[3] While Japan’s leading motor vehicle producer continued to hold out, only smaller companies like Isuzu and Suzuki showed any interest in expanding technical exchanges and joint ventures and entered in licensing agreements for light trucks and small passenger cars with China manufacturers.
Meanwhile, Toyota continued its export strategy in China and set up sales networks but refused to manufacture locally. Earlier Toyota had contemplated a venture in China but after considerable research reconsidered and preceded to set up a facility in Taiwan that was showing more market potential than all of China.  Toyota’s decision to invest in Taiwan set back its relationship with China for years to come.   First Auto Works (FAW), China’s leading domestic motor vehicle producer, had been involved in numerous technological exchanges with Toyota since the early 1970s and hoped to work with Toyota in the design and manufacturing new motor vehicles and automotive components.  Thus, it seems that Japan’s major auto maker simply forfeited a potential ‘first-comer’ advantage in China’s automotive market.  In addition, Toyota’s strong risk aversion in China and the company’s strong penchant for exports came to haunt Toyota for the next decade and a half as the Chinese now shunned Japan’s Top auto maker but continued to invite other world class producers to engage in joint venture activities in China. 
Western Foray into China – 1980s

Seemingly less perturbed than most Japanese motor vehicle producers, several Western automotive companies started to explore joint ventures and cooperative production arrangements with the Central government and local authorities in several regions of China.  The foray into China by Western motor vehicle companies were remarkable as the Central government insisted on strict 50 per cent or better Chinese ownership and control of all Sino-foreign automotive joint venture and cooperative arrangements.  Clearly, China aimed to develop its automotive sector independently with foreign automotive enterprises relegated to supply capital and provide technological assistance, and ownership on a limited ownership basis. 
Against this backdrop Sino-foreign negotiations for the production of passenger cars began in the late 1970s.  As a result, AMC, Peugeot, and Volkswagen entered into joint venture arrangements with local Chinese partners.  By the mid-1980s the first phase of refurbishing existing factories and training of Chinese engineers and workforce were completed. Soon imported CKD based trial production gave way to scheduled production cycles.           
Business and technical cooperation with some of the Chinese partners proved exceedingly more difficult for some of the Western automotive companies than originally anticipated. Valuation, foreign exchange shortages, transfer pricing for CKD kits, localization of automotive components, and numerous technical and operational issues soon emerged as serious issues of contention.   The production mix for motor vehicles posed another challenge.  Both Peugeot Guangzhou and AMC/Beijing Jeep made wrong bets, as neither the Peugeot 504 passenger car nor the Peugeot 506 station wagon could attract Chinese buyers.  The Jeep Cherokee never appealed much because of its  disdained ‘military look’ and sales remained very sluggish in spite of China’s severe motor vehicle supply crisis. 
For a short while in 1986-87, Japanese risk aversion seemed vindicated when the Chinese authorities had to implement stern policy measures to manage the economic crisis that followed the economic boom generated by China’s opening and economic reforms. China’s retrenchment and ensuing austerity left Japanese businesses even more skeptical of considering China’s growth potential and perceived the country’s stability at great risk. No doubt, from a Japanese business perspective China appeared far less attractive than North America, Europe, and South East Asia where Japan focused its expansion and major overseas activities during the 1980s.     Moreover, given its relative proximity to China, Japanese auto makers were also closely observing the unfolding drama that afflicted both the Sino-US joint venture, AMC/Jeep in Beijing and the Sino-French Guangzhou Peugeot joint venture.  The grand failure of the two ill-conceived projects exerted a powerful demonstration effect on the Japanese business community and further reinforced their risk aversion for business ventures on the Chinese mainland.
After long and difficult negotiations that began in 1978, Germany’s Volkswagen entered a joint venture with Shanghai Automotive Corporation [SAIC], and Shanghai-VW was set up to produce the Santana model in 1984.   After initial equipment set up, Shanghai-Volkswagen began trial production began in 1985.  The VW-Santana went on to distinguished itself as China’s first mass produced modern passenger car. As a result, Volkswagen managed to establish a solid position in China’s automotive sector.  Four years later Volkswagen built on its ‘first comer’ advantage, and secured a second opening in the China market when the central authorities decided to establish two additional passenger car plants.  After competing successfully against GM, Ford, Nissan, Renault, Peugeot, and Citroen, Volkswagen was selected to set up a second joint venture with First Auto Works [FAW] in Changchun in 1988 for CKD-assembly of  the Audi 100 and the construction of a state of the art auto plant to produce the  VW-Jetta  in 1990.  The other project went to Citroen, who succeeded in establishing a joint venture with Dongfeng Motor Corporation for the production of passenger cars after the French government committed to provide preferential loans to the joint venture project.  
Entering the China market, Volkswagen took a pro-active approach in spite of great potential economic risks and committed enormous resources. The German multinational not only committed enormous financial resources but also practiced a rather bold approach in its business dealings in China.   This involved a great deal of high-level political interaction with China’s central and local government authorities for which the German government frequently lent its official support.  Moreover, guided by its dispersed global production strategy, Volkswagen was willing to avail the Chinese partners a broad array of technical and financial resources located in the company’s world-wide organization.  For example, in 1988 Volkswagen allowed FAW a 60 percent share in their joint venture while furnishing most of the manufacturing technology and equipment for its new FAW-Volkswagen Jetta plant in Changchun. Moreover, Volkswagen has been extolled for assisting to raise the quality of local produced automotive components and parts.   Undoubtedly, for the remainder of the 1980s and most of the 1990s Volkswagen reaped its ‘first comer advantage’ in China.  With a market share of more than 50 percent for passenger cars, together with its Chinese partners, Volkswagen benefited considerably from the scarcity of passenger cars and persistence of a sellers’ market that allowed for profitable joint operations with SAIC and FAW well into the 21st century.  
Expansion via Strategic Alliances in the 1994-2000
In 1994, self-confident central authorities set forth China’s new Auto Industry Policy.  The question was no longer how to attract foreign automotive companies to invest but how best to accelerate the development of the Chinese automotive industry and find appropriate strategic partners for the expansion of passenger car production.      
China’s new Auto Industry Policy accorded highest priority to the development of a competitive Chinese motor vehicle industry with foreign participation and stipulated a minimal 50 percent Chinese ownership in any automotive venture.  It also required attainment of 80 percent local content for passenger car production within a three year period.  Furthermore, the auto policy outlined measures to rationalize and consolidate into three major groups. China’s fragmented automotive sector consisted of 124 assemblers and encouraged the formation of three Chinese motor vehicle producers capable of competing at the global level. And finally, the policy made it known that one more large scale joint-venture passenger car plant would be launched during the impending 9th Five Year Plan for 1996-2000.  Nonetheless, the Chinese government indicated that it would not approve any new major automotive assembly venture during the 1996-2000 plan period in order to avoid excessive competition and surplus capacity in China’s automotive market, and to nurture existing producers. 
While the formulation of China's Auto Industry Policy had been in progress, the world automotive business was amidst fundamental structural changes and emerged as a global industry.  For China, the critical issue in the early 1990s was to become part of this global industry.  However, breaking into the evolving global automotive industry required tremendous capital investment and new technology, and China was determined to acquire both through strategic alliances.
Nonetheless, several propitious factors were advancing China’s automotive development in the early 1990s.  At the global level, overcapacity was forcing consolidation in the automotive industry that prompted the world’s leading automotive producers to search for new markets outside of their traditional marketplace, and several European and American automotive enterprises turned attention to China.  Moreover, after more than a decade of their ‘Open Door Policy,’ China’s national and local authorities had become rather sophisticated in leveraging China’s advantages in labor, location, and market potential in negotiations to attract foreign capital and technology and investment for automotive manufacturing facilities.
Not surprisingly then, the months immediately following the announcement of the Auto Industry Policy saw intense competition among foreign companies for entry into China’s automotive sector. Japanese and other foreign automotive companies that had previously shunned China now showed considerable interest in China, and were anxious to secure market share through investment and strategic partnerships with Chinese companies.  In fact, many Chinese and foreigners observers alike came to view China as ‘the last frontier’ for automotive development.  At this point, China’s domestic economy was also rapidly expanding, and the influx of FDI was second only to the United States.  No doubt, these factors considerably strengthened the hand of the Chinese authorities during the 1994-1995 negotiations for the passenger car plant project with top foreign automotive producers that included GM, Ford, Citroen, Fiat, Honda, Nissan, and Toyota. 
On October 31, 1995, after a most arduous process, Shanghai Automotive Industry Corporation [SAIC] and GM signed a basic joint venture agreement for US $1.57 Billion to construct a Greenfield plant on a site in Shanghai’s Jinqiao Export Processing Zone in Pudong.  The new automotive plant was designed to produce 100,000 sedans per year, and it was decided to produce two Buick models modified for China.  GM-Shanghai’s Pudong facility became equipped with the latest automotive machinery and robotics and was furnished with process technology transferred from GM’s world wide operations.  Initially, GM-Shanghai was exposed to a barrage of criticism about the huge size of its investment, and the significant commitments to transfer technology and design capabilities to China.  These criticisms notwithstanding, GM circles reiterated at numerous occasions in China and the United States that China was expected to become the biggest automotive market in the world within two decades and that China represented the single most important emerging market for GM.
Interestingly enough, in spite of their technological and manufacturing prowess, none of the Japanese Big Three auto makers had been among the finalists for the Pudong passenger car plant.  Although there was rumor in Shanghai that Toyota had been under consideration at some point but was rejected because of Toyota’s past aversion to invest in China.  Undoubtedly, the stakes had been extremely high this time and yet the Japanese lost and the outlook in China’s automotive market for Japanese motor vehicle producers was indeed bleak in 1995. And it seemed that the window of opportunity to establish a large Japanese automotive production facility in China had been lost temporarily, since China imposed a moratorium on the launching of any large motor vehicle assembly plant for the duration of the 1996-2000 plan period. 
The Shanghai-GM joint venture confirmed the feasibility of China’s strategy to expand passenger car production through alliances with foreign companies.   While all the major motor Western vehicle producers managed to establish significant positions in China’s automotive sector through strategic alliances or production licensing by the mid-1990s, the Japanese did not.  Volkswagen dominated the Chinese market in passenger cars, Fiat-Iveco had an important bus making venture in Nanjing, while the French held their ground in Wuhan with Citroen and managed to expand activities with Dongfeng Motor Group. Citroen’s relationship with Dongfeng stands in sharp contrast to Peugeot Guangzhou that was plagued by chronic problems that eventually caused its demise.  Paradoxically, American auto companies that saw their home turf invaded by aggressive Japanese competitors and made significant inroads into China with the establishment of Shanghai-GM.  Although Ford was not actively seeking to duplicate the GM-Shanghai joint venture with either FAW or Dongfeng, Ford nevertheless established crucial strategic linkages with several of China’s second-tier motor vehicle makers to produce buses and passenger cars.  Ford’s Visteon[4] concluded licensing and coproduction agreements with a number of Chinese components producers at around that time while Chrysler’s Beijing Jeep venture continued to hemorrhage as before.   
Late Comers without Advantage - Japanese Automakers in China since 1995
Latecomers in development are often assumed to benefit from such advantages as avoiding the same mistakes made by pioneers.  Two decades of development in China’s automotive sector appears to discount this widely held assumption.  By the mid-1990s Japan’s Top Three auto makers had lost the initiative in China’s motor vehicle industry although they were all but newcomers to the Chinese automotive market where most had been operating since 1972.  The basic problem for Japan’s global leaders in automotive technology and marketing was their emphasis on exports of motor vehicles to China, and willful reluctance to commit to large-scale capital intensive investment in production and assembly facilities with China partners.  The unintended consequences of this flawed strategy became manifest with the launching of the Shanghai-GM venture in 1995. Japan’s auto makers saw themselves clearly disadvantaged in what had become the world’s most promising emerging market for motor vehicles.
As a result of several strategic alliances between China’s Big Three - FAW Group, Dongfeng Motor Group, and Shanghai Auto Industry Corporation and the foreign invested joint-ventures from Europe and the United States, China’s automotive market was now dominated by Western passenger cars and motor vehicles.    Although relatively late in committing themselves to the China market, Japanese motor vehicle companies rushed to establish a significant position in China’s automotive sector.  Strategic growth in China became a top priority for Japan’s automotive companies in the early 21st century.
Indeed, the most startling weakness of Japan’s Top Three auto companies in 1994 was that none had any major assembly or production operations in China.  Only Nissan had entered in a small CKD assembly venture for 20,000 units annually with Henan’s Zhengzhou Light Truck Factory in 1993.  However, Nissan was deeply engrossed in making this small truck venture work, and like Toyota and Honda, Nissan was taken off guard. In 1994, China’s Automotive Industry Policy called for the establishment of an additional large-scale passenger car production plant to be jointly developed and operated with one of the world’s top motor vehicle assemblers. 
All through the 1980s and early 1990s Japan’s Top auto makers missed the window of opportunity to form strategic alliances with the then still fledgling Chinese motor vehicle producers.  During this time, European and American competitors forged important partnerships through massive investments and technology transfer agreements that allowed them to establish important positions in China’s still anemic yet slowly emerging passenger car market.  
As late comers to localization of passenger car production in China during the late 1990s, the Japanese automotive companies have been encountering numerous obstacles since then. Particularly finding appropriate strategic partners from among China’s leading motor vehicle producers has caused some trepidation for Toyota, Nissan, and Honda, because China’s Top Three – FAW Group, Dongfeng Motor Group, and SAIC together with their European and American partners control about 70 per cent of China’s total motor vehicle production, and seemed improbable joint venture partners.
After losing out to GM in Shanghai, Toyota began to pursue a multi-faceted approach to establish a basis for passenger car production in China.  First, Toyota had already an extensive sales network and a considerable number of service facilities in China, and in 1995, invested US $ 132 million to set up the Toyota China Technology Center in Tianjin.  This facility has been used to train parts and component suppliers and to support its dealers, service facilities, and Toyota motor vehicle repair centers with factory sponsored technical training.   Their second move was to begin a series of targeted investments in China’s automotive industry.  Between 1995 and 1999, Toyota invested more than US $ 321 million in a joint venture engine plant with Tianjin Automotive Group.  Tianjin Automotive Group was a producer of mini cars, trucks, and buses that also produced the Daihatsu Charade under a licensing agreement. In addition, Toyota established a facility to produce 150,000 Toyota 1.3 liter engines per year, and three major automotive component ventures for the production of universal joints, castings, and steering components in Tianjin. In addition, Toyota set up US $ 67 million joint venture with Sichuan Passenger Vehicle Manufacturing Company for the production of a compact bus.
In the attempt to catch-up in the China market, Toyota managed to establish the nucleus of a basis for passenger car production through investment in technology transfer and production ventures in less than five years.  All these efforts came to fruition in May 2000 when the central authorities granted permission to establish Tianjin Toyota Motor in a joint venture with Tianjin Automotive Xiali Company[5] to produce Toyota’s small car model Vios.  Toyota had been negotiating with Tianjin for several years for a joint venture and also assisted Tianjin Automotive Group to increase production to 150,000 Charade per year to qualify as a key producer in China’s automotive sector.   Since then, the newly formed Tianjin Toyota Motor Company has established several ventures with Chinese automotive suppliers and induced some of its major Japanese suppliers to move operations to the Tianjin area to more effectively support Toyota’s new small car venture.  
In February 2002, in a surprise move at the instigation of the central authorities, the FAW Group acquired a majority stake of 51.9 per cent in the Tianjin Automotive Group.  Toyota then began discussions with the FAW Group over the joint production of mid-size luxury cars in Tianjin, and other vehicle types at several FAW plant sites elsewhere in China.  By mid-2002 Toyota completed a broad tie-up with the FAW Group. About a year later in mid-summer 2003, Toyota and the FAW Group agreed to launch four Toyota models by 2005, including the Corolla, Land Cruiser Prado, and Crown.   Meanwhile, the joint production of the Toyota Vios small car in Tianjin has been unable to keep up to demand due to inadequate production capacity. 
Toyota recognized capacity limitations as its severest constraint in the China market.  It appeared unlikely that Toyota was going to be able to produce any time soon a significant number of passenger cars, the fastest growing segment in China’s motor vehicle market.  Although Toyota was now producing the Vios small passenger car in Tianjin and seemed well positioned through a series of strategic alliances for the production of a broad range of motor vehicles Toyota’s prospects were not encouraging. Above all, Toyota had to establish a production base for mid-size passenger cars, the field dominated by Volkswagen.  Without a doubt, Toyota remains rueful for its inaction of the 1980s and 1990s that allowed Volkswagen to capture half of China’s passenger car market through a number of strategic ventures with SAIC and FAW.  Although, both GM and Honda had managed to make significant inroads on Volkswagen’s turf, Toyota was still not part of China’s rapidly expanding market for mid-size passenger cars. While Toyota’s venture with Tianjin Auto Group and the FAW Group allow for a broader production mix  it did not include its most popular mid-size Camry model, that continued to be supplied through exports from its plants in the USA and Japan. 
As a late comer, Toyota made every effort to locally produce mid-size passenger cars, and created consternation in China’s automotive circles when news broke in mid-summer 2003 that Toyota was in negotiations with Guangzhou Auto Industrial Group for the establishment of a joint venture passenger car plant to produce the Camry model. Industry insiders viewed this development as consistent with Toyota’s new strategic goal of occupying a 20 percent market share in China by 2010 to which end Toyota may have to seek auxiliary joint venture partners in addition to its strategic alliance with the FAW Group.
Perhaps most noteworthy among all Japanese automotive companies operating in China is Honda’s strategic approach.   Honda first made its daring strategic move in 1998, entering a fierce bidding war for the take over of an existing auto plant in Guangzhou of the defunct Guangzhou Peugeot Auto Corporation, a joint venture set up in 1985 between PSA Peugeot and Guangzhou Auto Group.  In the end, Honda – Japan’s No. 2 auto maker, succeeded against stiff competition from GM’s German Opel Division and South Korea’s Hyundai.  The partner selection had followed a familiar pattern; Beijing was pitting several foreign auto makers against each other to get hold of a maximum in capital, design, technology, and manufacturing capabilities, as well as the motor vehicle types deemed appropriate for the Chinese market.  Honda pledged to invest US $ 200 million, and pilot assembly of the American version of the Honda Accord started in 1999 leading to full scale manufacturing in 2000.   Two years later, Guangzhou Honda added assembly of the popular Odyssey MPV to its product mix.  In less than two years, Honda had turned around the loss-making Peugeot facility into one of China’s most successful passenger car joint ventures, an accomplishment that was widely noted by China’s top automotive producers.
It is important to mention that already well before its joint venture with the Guangzhou Auto Group, Honda had captured a significant market share with exports of the popular Honda Accord and a most effective network of dealerships, service and repair facilities to support its motor vehicles all over China. These measures helped Honda not only to attain an excellent reputation and brand recognition, but also strengthened Honda’s bargaining power with the Guangzhou Auto Group.   
Honda also set up a joint venture with the Dongfeng Motor Group for the production of engines at the old Guangzhou Peugeot factory site when it formed the joint venture with the Guangzhou Auto Group. This strategic alliance led to Dongfeng’s production of automotive parts and engines for Honda’s Accord and Odyssey minivan. Perhaps even more important, it paved the way in 2002 when Honda intended to set up a small car plant for exports in Guangzhou.  Honda planned to establish a small production facility with an initial capacity of 50,000 1.0 to 1.5 liter engine vehicles a year targeted for exports to Asian and European markets.  Honda invited both Dongfeng Motor Group and Guangzhou Auto Group to participate with a 25 and 10 percent stake in the US $ 194 million project while Honda retained full operational control with a 65 percent ownership. Honda also committed to source parts and components through Guangzhou Honda’s supply chain of which both Dongfeng and the Guangzhou Auto Group are an integral part.  Although the proposed venture deviated from the minimal 50 per cent Chinese majority ownership Sino-foreign automotive ventures as prescribed by China’s Auto Industry Policy, the central authorities gave the go ahead to the arrangement because of its export-oriented production.
In mid-summer 2003 Honda’s strategic partnering with Dongfeng entered a new stage when a joint venture production agreement was hammered out for the assembly of  30,000 Honda’s CR-V subcompact SUV at the Dongfeng controlled Wuhan Grand Motor plant in Wuhan.  Honda and Dongfeng will invest jointly US $ 44 million to upgrade and retool the plant for SUV production.   Honda’s Wuhan arrangement marks its second joint venture in China and now also includes the production of SUV that emerged as the most rapidly growing segment in China’s automotive market by mid-2003.
Most analysts agree that Honda has been among the most successful and profitable foreign automotive companies currently operating in the competitive China market.  Honda has shown a penchant for a low cost strategic approach that frequently involves the take-over of existing facilities and turning them into profitable operations like the Guangzhou Peugeot plant and more recently the Wuhan Grand Motor facility, while most other foreign producers have set up Greenfield operations.
In sharp contrast to both Toyota and Honda, the Franco-Japanese Nissan-Renault conglomerate started to implement a US $ 2 billion joint venture with Dongfeng in June 2003 to assemble around 500,000 motor vehicles by 2006.  Under the energetic leadership of Carlos Goshen, once dubbed the ‘keiretsu killer,’ Nissan had been attempting to catch up in the China when it signed the agreement with Dongfeng in the fall of 2002.
The Nissan Motor Company had already established a representative office in Beijing in 1985 and similar to Toyota and Honda neglected the China market until 1995.  At that time, the then financially strapped Nissan took a bare minimum stake of 5 per cent in the Zhengzhou Nissan Automobile Company in Hebei for the assembly of  Nissan pick up trucks and small buses. The annual capacity was set 60,000 units per year but production never even reached 10,000 units.  Nissan soon neglected the Zhengzhou venture because financial woes were seriously jeopardized Nissan’s operations as an ongoing concern that eventually caused the Nissan and Renault merger in 1999.  However, still through the long nadir, Nissan maintained its presence in China with annual exports estimated at around 10,000 units. The Zhengzhou and Guangzhou Yunbao ventures in which Nissan held only a small stake managed to muddle through the hard times. Nissan even while under dire financial stress, signed a technical support agreement with Fengshen Auto Company, a Dongfeng subsidiary, and in 1996, Nissan Diesel signed a joint venture agreement with the Dongfeng Motor Group. All these actions indicated that Nissan was determined to last in China.
Managers and engineers at Dongfeng Motor Group understood well what it meant to be strapped for cash, and during Nissan’s ordeal Dongfeng continued to show an active interest in Nissan’s technology and model mix, while Nissan continued to enjoy very high brand recognition in China.  In 2001, after Nissan’s financial situation had stabilized under Ghosn’s management, Dongfeng Motor Group agreed to increase Nissan’s stake from 5 to 30 percent in the Zhengzhou venture, and Nissan committed to produce initially up to 100,000 units of a mix of minibus and three passenger cars and agreed to expand output to 150,000 units by 2004.  
Under severe pressure from its global rivals Nissan-Renault looked for avenues to enter China’s rapidly growing market and was determined to establish a significant presence in China commensurate with its turnaround status as a major player in the world automotive industry.   The expansion of the Nissan Zhengzhou venture was only a first step in the change from a low-key approach to China to an aggressive campaign to leverage Nissan-Renault’s technological resources and product mix.  Nissan successfully leveraged its technological prowess to strengthen its relationship with its strategic partner the Dongfeng Motor Group, one of China’s major automotive groups.
As a result of its efforts, in September 2002 Nissan formally secured a significant manufacturing foothold in China with a new agreement with Dongfeng Motor Group to form one of China’s largest auto groups, Dongfeng Motor Corporation, as a 50-50 venture.   Nissan was reported to put up US $ 1.03 billion, and Dongfeng would provide factories and other assets worth an equal amount. The US $ 2 Billion venture signifies the most extensive partnership ever between a Chinese and foreign auto maker.   Dongfeng Motor Group has more foreign partners than any other Chinese automotive enterprise; by 2003 Dongfeng had formed joint ventures with Cummins Engine of the USA, Citroen, KIA, Honda and Nissan.  Yet the Nissan-Dongfeng landmark joint venture was the single most expansive tie-up ever in Chinese automotive history; the newly formed Dongfeng Motor Corporation will launch six passenger car models by 2006.  According to Chinese industry sources Nissan committed to invest Yen 20 billion to 30 billion to develop vehicles specifically for the Chinese market.  Nissan is targeting local sales of 220,000 passenger cars and 330,000 commercial vehicles by 2006 and a total of 900,000 motor vehicles by 2010 in a market where car sales jumped 56 percent to just break the 1 million mark for passenger cars only in 2002. 
Evidently, Nissan, the once troubled Japanese auto giant has been trying to make up for lost time in China’s booming automotive sector by offering production of a wider range of motor vehicles and models from the very outset than did any other foreign auto maker before.  Nissan’s audacious approach has many considering the enormous risks its China ventures entail but most would concede that as the latest of the world’s top producers to enter China.  Nissan was compelled to pursue a bold strategic approach because of its slow start.  With Nissan’s roaring entry into China, and with most Sino-foreign joint production ventures now established, it seems reasonable to suggest that the wait and see attitude of Japan’s auto makers has irrefutably come to an end.  It appears that the focus and the energies of Japanese and Western auto makers and their Chinese partners are now quickly shifting from issues of capacity to concerns of market share and economies of scale. 
Japanese Auto Makers in China & the Road Ahead
The discussion in this paper has concentrated on the manner in which Japan’s top auto makers have established manufacturing bases in China since 1995 and committed to the China’s automotive market with enormous long-term investments and significant technology infusions. Although Japanese auto makers are now allocating large resources to bolster their position in China’s rapidly expanding automotive sector, long-term remains uncertain.  At this juncture it is open to discussion whether the Japanese auto makers will be able to repeat in China their spectacular accomplishments in North America. 
No doubt, the road to success in China’s automotive sector is fraught with plenty of potholes.   As relative latecomers, Toyota, Honda, and Nissan had fewer options in the hunt for fitting joint venture partners and market positioning than did the ‘first comer’ Volkswagen during the 1980s and General Motors after 1995.   All the way through the early 1990s, foreign auto companies were solicited to enter the Chinese motor vehicle sector and encountered very little domestic competition or challenge.  This situation has changed importantly, and today China’s automotive sector is crowded with the world’s top assemblers that are competing for an opportunity to produce there together with Chinese partners, all vying for advantage and a share of this dynamic market.   Currently, fierce competition pervades among China’s top auto groups that are measurably strengthened by the influx of capital and technology by their foreign partners. Although the outcome of the current competition is still uncertain, it will have far-reaching effects on the structure of China’s motor vehicle industry that will eventually evolve and the Japanese are an important part of.
Chinese analysts leave no doubt that the automotive sector will not allow to be ‘colonized’ similar to Brazil or Mexico where the global giants largely dominate the production arrangements.  Moreover, China long aspired to establish a viable domestic motor vehicle industry, a goal that is attained by forging strategic links to foreign technology and capital that eventually empower some of the Chinese producers to attain world level competitiveness.  In public discussions, the development of a national automotive industry leads to comparison with the experience of South Korea and Japan that are often upheld as models worth emulating.   While these are interesting ideas of a largely hypothetical nature, the problem of looming overcapacity in China’s automotive sector is not.
Many analysts expect surplus capacity to become a critical factor in China’s motor vehicle industry as early as 2005.   Should these predictions come true then overcapacity may coincide with the coming into production of many of the Sino-Japanese projects currently under construction. In addition, expanding output of motor vehicles has created a buyers’ market and started to impact on profit margins and prices since 2001. These trends will unlikely reverse any time soon, and causes concern among public officials and auto industry executives alike.  Finally, there is a possible proliferation of ‘White Elephants,’ i.e. excessive construction of manufacturing facilities and capacity in the automotive sector that has the propensity to undermine the development of the industry that will affect not only Japanese auto ventures but all foreign and domestic producers in China alike.  On this issue, a great deal hinges on the capacity of the state to deal effectively with such potential issues as overcapacity and excessive competition.    
Ostensibly, most of these issues and problems are well beyond the influence and reach of Japan’s Top three Japanese passenger car producers and one is left wondering how Japanese auto makers will cope with these issues in the future.   What remains certain, however, is that the Japanese auto makers are now an integral part of motor vehicle assembly in China.  
WALTER ARNOLD is a professor of political science at Miami University, Oxford Ohio.  This article is excerpted from a book-length study entitled "Industrial Leadership and China's Automotive Industry." He can be reached at

[1] The most recent example of Western preponderance in China’s motor vehicle industry is the September 2003 announcement by Daimler-Chrysler to assemble Mercedes C-Class and E-class sedans, and medium and large trucks in a venture with Chinese partners. New York Times, September 9, 2003, W1 and W7.

[2] See for example, M. Watanabe. 2000 nen no chugoku jidosha sangyo. Tokyo: Machida Sososha. 1996.  

[3] In 1984, Toyota and GM launched successfully the widely noted NUMMI joint venture in Freemont, California, and turned around a GM motor vehicle plant that was declining and destined towards complete closure. 

[4] Visteon, Ford’s  component producing affiliate was spun off in 2000 and now supplies all motor vehicle assemblers.

[5] A leading member of the Tianjin Automotive Group

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