Trade tensions hinder needed Sino-foreign co-innovation

Trade tensions hinder needed Sino-foreign co-innovation
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For over three decades, the Chinese government has required foreign carmakers to form joint ventures with local companies in order to produce and sell cars in China.

Foreign carmakers have done so in order to access the growth opportunity potential of the world’s largest car market and avoid the penalty from import duty and transportation costs, which make imported cars less cost competitive.   

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China opened its domestic market to foreign investment in the mid-1980s. The underlying policy guidelines in place since the inception was to use Chinese state-owned enterprises (SOEs) as holding companies for development of the domestic automotive footprint.

 

Foreign-branded carmakers are required to form a joint venture (JV) with a Chinese company that holds at least a 50-percent share of the local manufacturing and sales business, and the foreign carmaker is also required to manufacture at least 40 percent of the value of the car with components manufactured in China.  

Global carmakers that have followed the policy have in large part been able to enjoy strong growth and profitability in what has become the world’s largest car market, which recorded 28.9 million units sold in 2017 (far ahead of U.S. sales of 17.2 million).

Through the use of the JV form of cooperation, the government then hoped a domestic industry would emerge whereby the Chinese domestic companies would learn from their partners and eventually emerge as successful automotive companies.

In theory, the domestic companies would learn from their foreign counterparts the skills needed to manage a complex business, establish manufacturing and supply bases to produce vehicles and ultimately transfer critical technological development capacities in order build their own-branded products.

While China’s automotive market has indeed developed rapidly, it is very clear that the over 30-year journey toward establishing independent automotive capabilities has not fulfilled its purpose to create globally competitive carmakers.

While an infrastructure to manufacture cars has been created around JVs, no global-leading Chinese brands have emerged as a direct result of the policy. The joint-venture SOE partners have largely failed to assimilate technology and know-how from their foreign counterparts.

In fact, leading Chinese domestic car brands such as Geely, Great Wall and BYD are privately-owned enterprises led by entrepreneurs.

China’s “automobility” disruptors

Chinese brands are in fact gaining market share and increasing their capability as traditional car makers. Chinese brands’ share of the passenger car has nearly doubled from 2007 to 2017, accounting for 44 percent of the total sales of passenger vehicles.

Chinese brands are the pacesetters for the fastest growing sport-utility vehicle segment, with seven out of 10 top-selling models. However, the true disruption is not coming from the manufacturing of hardware.

China’s internet giants (including Tencent, Alibaba, and Baidu) are actively investing and transforming hardware into an intelligent platform for wide variety of online and offline services. Ownership is no longer required in order to access personal mobility, and Chinese internet companies are actively investing in future mobility technologies (including connected, electric and autonomous vehicles).  

Competing in this new business model is no longer just about the engineering of physical hardware, but also the capability of building a digital ecosystem relationship with consumers of mobility services. 

Tencent is a co-founder (with Alibaba) of Didi Chuxing (“Didi”), China’s top mobility service provider, and is also the lead investor in Mobike, a leading bike-sharing mobility platform. The internet companies see mobility as a basic human need and integral part of a connected lifestyle.

By leveraging their vast insight and big data relationship with their users, the internet giants aim to provide more tailored services to the market. NIO, a Chinese electric vehicle (EV) startup, has raised more than $1 billion and released its first mass-production EV, ES8 (starting at $68,000).

Tencent, which now owns 5 percent of Tesla, is also investing in NIO and other electric car startups and related technologies. Alibaba and Baidu are also actively investing in the future mobility services and technologies.

In the race to dominate the future of mobility, Chinese mobility startups are quickly emerging and expanding, backed by deep-pocketed investors who are generating profits from China’s booming digital economy.

Chinese companies are creating digitally-enabled mobility solutions that shift the focus from selling product hardware (the “automobile”) to providing access to the utility derived from the hardware (“automobility”). In this new digitally-enabled business model, Chinese companies are leading the mobility revolution. 

The need for Sino-foreign co-innovation

Leading U.S. technology companies like Tesla have been reluctant to play under China’s JV rules, viewing the 50-percent policy requirement as too high a price to pay for market access.

They have chosen to pursue locating a factory in a free-trade zone as a way of avoiding the JV, but this would still carry the cost penalty of an import tax for cars sold in China. While citing the unfairness of China’s policies on U.S. companies, the Trump administration has recently implemented new tariffs, perhaps as a bargaining chip.

However unfair they may be, such tariffs place at risk the business of large American companies, such as Ford and GM, that now sell millions of cars in China each year. Significant growth and profits from China have helped these companies weather the cycles of the global auto industry. 

Pursuing a trade war and/or continuing to attempt to force technology transfer through joint ventures is detrimental to the best interests of both the U.S. and China. In fact, we are entering an era where a sino-foreign collaborative innovation (“co-innovation”) model is needed.

Simply put, China still needs access to technology from the global innovation sources in North America, Europe and Israel. Conversely, global technology firms need access to a market that can bring such innovations to scale. As the world’s most progressive market with a vibrant digital economy, China is the ideal place to deploy and scale new technology.  

China no longer needs foreign capital to grow its economy, and Chinese carmakers are improving and gaining market share without the aid of joint ventures.

China’s digital economy is heavily investing in the future of mobility, and overseas technology companies will benefit from the investment and scale from the China market to accelerate their growth.

The future mobility revolution will largely be led by Chinese digital companies and their ecosystem partners. Participating in a market such as China will be critical for new and emerging global technology companies.

China’s policies will only change when China sees the benefits in doing so for Chinese enterprises. A wise approach would be to study the needs of China and apply policy pressure only in areas that benefit U.S. and Chinese interests. 

Bill Russo is the Founder and CEO of Automobility Limited, a China-based venture capital and private equity firm focused on technology-enabled, on-demand mobility services. He was previously vice president of Chrysler North East Asia, where he managed the business operations for the Greater China and South Korea markets.