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CHINA: Dealers, Tiremakers Are Capitalizing, But Economic Revolution Has Issues

Today’s China-made tires may well carry the names Michelin, Bridgestone, Goodyear or that of other majors and are produced using the same technology, processes and stringent quality standards of those well-known global brands. Only they are being produced for pennies on the dollar.My, how times have changed.

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than $617 a ton in June. Wheel makers there blame it on the demand for steel in China. Tiremakers in Europe are expected to absorb some of this cost when purchasing steel for belts and beads.
Further, the German association of natural rubber processing companies says escalating rubber prices are taking their toll on European companies. They are enduring strong rubber price hikes with a prediction of additional increases to come.
Although the U.S. tire industry hasn’t reported steel or natural rubber supply shortfalls, raw material costs are another thing altogether. Bridgestone/Firestone North American Tire said its raw material costs increased $100 million in 2003. Goodyear, in its annual report, said raw material cost increases had a $335 million impact on the balance sheet.
Even though its impact on supply and demand is indisputable, not all of these cost matters are directly attributable to China. OPEC, after all, is not under China’s control, and natural rubber suppliers in Indonesia, Thailand and Malaysia have been playing games with supply levels and pricing for years.
Still, China is a big dog in terms of volume. But can China’s need for raw materials be quantified in any way that will allow the rest of the world to avoid manufacturing and/or financial worries? No one seems to know.

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Welcome to the Machine
In communist China, nothing – especially an economic boom the likes of which the world has never seen – happens without some government intervention. Anxious for international acceptance and recognition, the Chinese government undertook some major economic reforms designed to draw international investment and hasten growth of its own technology base.
Without going into excessive detail, the Beijing government actively sought partners that would bring investment dollars and were willing to share technology in exchange for low-cost manufacturing. The state targeted key industries, such as personal electronics, appliances, autos, auto parts and tires, and companies like Motorola, General Motors, Ford and hundreds of other global manufacturers invested billions in joint venture plants. On the tire side, nearly all the world’s majors invested heavily in joint-venture tire plants.
This investment created millions of high-paying jobs, at least by China’s standards. As a result, products that were once only available to the country’s political elite – refrigerators, computers, cars and tires – are now well within reach of a new product-hungry middle class. China is fast becoming its own economic perpetual motion machine. As business increases, more workers join China’s burgeoning consumer class. That turns the dial up for increased production, and the cycle continues.
Through the first five months of 2004, Chinese consumers bought some 2.1 million new cars. By contrast, U.S. new car sales topped 7 million units for the same period. While the U.S. is still the new-vehicle sales king, it has reached its peak. Those 2.1 million Chinese car buyers, though, represent just 0.3% of the country’s eligible consumers!
Where tiremakers once looked at China for profit-boosting cheap labor, with consumerism in China growing rapidly, the possibilities within China’s domestic market are even more enticing. In many cases, tiremakers such as Bridgestone, Michelin, Goodyear, Kumho, Hankook, Toyo and Yokohama are retaining their China production for the local market.
Doing business in China, however, comes with certain headaches, as Motorola discovered the hard way. As one of the first companies to commit to China, it dealt with the expected language difficulties — of China’s seven distinct dialects, Mandarin is spoken by more than 70% of the population, is taught in all schools and is the government language of choice – and multiple layers of heavily bureaucratic (and some say corrupt) local, regional, provincial and national governments.
Still, Motorola worked tirelessly to train its partners and suppliers, building a strong network and base in mainland China. These homegrown companies, though, became so proficient at making cellular phones they no longer needed Motorola. And they opted to not spend millions on machinery needed to make handsets and batteries, turning instead to an army of workers. Result: This year, more than 40% of China’s domestic handsets are being supplied by Chinese companies, not foreigners like Motorola or Nokia.
The simple truth is that China does a fair amount of not-so-subtle arm-bending to convince multinational companies to trade access for technology sharing. So much for intellectual property rights – a global legal issue that may never be resolved.
Motorola hasn’t thrown in the towel. Faced with leaving China or competing with the Chinese manufacturing machine it helped create, Motorola has opted to triple its investment in China to more than $10 billion by 2006.

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Quality Goes Global
China’s tire industry consists of far more than just well-recognized global brands. Other names, like Warrior, Long March and Double Coin have been marketed in North America and other parts of the globe for years. For many years, these so-called “third world” brands peacefully co-existed with the accepted and technologically superior major brands of the world.
Thanks to the technology shared via joint ventures with Chinese tiremakers, though, the tires wearing those off-brand names are now as good as any in the world.
Private branders, which long looked to Chinese tire companies to fill out product screens or, more recently, produce branded lines, are even enjoying the technology jump.
Researchers who have spent years in-country report that the quality of a tire made in China is excellent. “We didn’t think this is what we would find,” says one U.S. tire engineer, €but we did. These tires are what we call ‘global quality’ and should not be mistaken for poorly made products.
“They not only meet DOT and ISO standards, they are built with brand-new equipment, in brand-new factories, with the latest technology. We noticed, too, that the Chinese workers who make them do so dutifully and cheerfully.”
One man who has spent more than two decades doing business with Chinese tire companies is Bob Sherkin, president of Dynamic Tire in Brampton, Ontario. He’s not the least bit surprised by the improvement in China’s tire technology. In fact, he likens it to the growth of Japanese tiremakers in the 1970s and 1980s “when the line from the top manufacturers to the bottom manufacturers began to shrink.”
In effect, China has achieved tire radialization almost overnight. Compare that to the 25 or 30 years it took U.S. tiremakers to catch up with European radials or the decades it took Japanese tiremakers to reach – or exceed – the quality levels  of the big boys. Back then, there was a wide disparity between those who could make a good radial and who could not.
The influx of high-quality, low-priced new tires has raised other concerns, as well. There are fewer than 1,000 medium truck tire retreaders in North America, and they have been hit hard by price pressure from new Chinese radials. For some applications, the cost differential is negligible, and truck fleets are going the new-tire route instead of using retreads. This is forcing retreaders, already working with razor-thin margins and their own rising raw material costs, to tighten operating costs even more.
Fortunately, medium truck retread production has stayed fairly level over the last couple of years, but one has to wonder if the price difference could become so close that retreading is no longer a viable option.

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The Downside
Already experienced with buying and selling tires made around the world, North American dealers wouldn’t seem to have too much trouble adjusting to China-made tires. But all is not necessarily rosy.
No one disputes China’s obvious market position. As one U.S. dealer puts it, the Chinese enjoy several distinct advantages – for now. They are producing high-quality, low-cost tires. They have just gone through what the dealer calls “immediate radialization.” And, they are making these tires in brand-new factories with modern technology.
“I can see a time when there is an open plea, from U.S. manufacturers of every type, asking U.S. consumers to buy American,” he says.
Meanwhile, the dealer, who asked that his name not be used, says he can make a 6% to 7% wholesale margin every day on a China-made 225/50R16, and better than 25% on more standard sizes.
“Basically, the price-per-tire breakout looks like this for a 225/40R17 size: If I buy a Chinese tire, it will cost the consumer $60 to $70. If I sell the consumer a non-Chinese-made tire from Goodyear, the price will be $110, and, if I sell them a Michelin or Pirelli non-Chinese-made tire, the cost to the end user will be $170 and up.”
Is he hooked on China? Hardly! “We’re already looking at new sources for overseas tires,” he says. "We’re looking for the next wave – the next supplier of inexpensive, high-quality radials."
China’s growth has brought other, less obvious issues. “At the moment, we’re aware of tires being made in China that are direct copyright rip-offs from major world-brand tiremakers, and that will cause problems,” the dealer says.
“Another big change we’ve seen since China entered the picture is in the supply chain. We used to call and ask for X number of tires, and we received those tires in about a week,” he says. "But a container load of tires traveling more than 7,000 miles to reach California before it is moved inland to me takes many weeks. As a result, we order heavy and store our Chinese-made tires in much larger warehouses. Bigger buildings mean higher overhead and labor costs.
“At the moment, we’re straining to make a profit on these tires,” he says. "We’re looking into some third-tier tires to round out our product offerings. Our hope is that consumers who are looking for these types of tires will help us make money."
In fact, the U.S. consumer really doesn’t care where a product is made as long as the quality is good and the price is right, says one tire industry analyst. “At the end of the day, a tire dealer will still buy tires and sell them. If those tires are from China or a dot of an island in the Pacific, so be it.”

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How Hot is Too Hot?
China has accomplished in a handful of years what it took other economic powerhouses – the U.S., Japan, Germany and the U.K. – decades to reach. But will China get burned by its own red-hot economy?
Providing little solace, the world’s bankers are worried about China’s state-run banks and superheated economy, which they believe is growing too quickly.
“By having changed itself, China is changing the world,” said the New York Times in a recent extensive report on China’s economy. "So, perhaps, we will be as Europe is to us today and China will be our America."
That won’t happen, though, until many reforms take place. By some estimates, nearly half of all Chinese loans are nonperforming, yet lending in China is still rising. Some economists say that, technically, the top four banks in China are insolvent. That’s troubling, given the fact that Chinese demand now drives the economies of Southeast Asia and, increasingly, those of Korea, Taiwan and Japan.
Meanwhile, China is running in overcapacity mode for the home market. According to the New York Times, 90% of everything made in China is in oversupply. Instead of using cheap labor to push their profit margins higher, Chinese companies use cheap labor to drive prices down for the great masses of Chinese workers.
That means a Chinese worker in Shanghai can be part of a new middle class on a yearly household income of just $5,000. Again, the New York Times: “The Chinese, on average, buy nearly five times in goods and services per dollar what an American can with the same dollar in the U.S.”
According to the Times, there are now some 100 million people in China who are comfortably middle class – by Chinese standards. That’s just under a third of the entire U.S. population but only about 8% of China’s total population.
China’s burgeoning urbanization is also startling. According to one account, job growth will fuel a shift of 345 million people from rural to urban China in the next 20 to 25 years.
BusinessWeek said a new upscale housing complex in Shanghai sold all 816 apartments in three days. In another part of greater Shanghai, where apartments go for $325 a square foot, there is a waiting list of 2,200. This in a city of nearly 11 million.
Does that sound like inflation? The concern is that rising commodity prices worldwide, coupled with questionable loans being made by Chinese banks, could boost inflation.
Worse, if China crashes, a global commodity bust could ensue.

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Automakers Run to China Too
On the automotive front, GM is investing more than $3 billion in China over the next three years to build a new engine plant and double its finished vehicle capacity to 1.3 million vehicles. GM even wants to introduce models of its luxury Cadillac line to the Chinese.
Last year, Ford, which has been building cars in China since 1997, announced a $1 billion investment boost that will push the production of its vehicles from 20,000 to 150,000 a year. As part of that investment, just last month Ford’s Changan Ford joint venture announced it would build a new plant near Nanjing, set to open in 2006 with an initial capacity of 200,000 units per year.
Interestingly, when Ford made its $1 billion Chinese investment announcement last year, it also announced the scaling back of European operations that resulted in the loss of 6,700 jobs. In a BBC interview, William Ford, chairman and CEO, said: “The automotive future of China is very bright, and we are participating fully in its growth.”
Ford and GM’s investment plans seem firm, even hopeful. The Chinese government has warned automakers that domestic vehicle sales will only reach 7 million units per year by 2007, even though China’s foreign-supported capacity will exceed 14 million vehicles in 2007. 
It is no secret that, at some point, Chinese-made vehicles will be sold in other countries. But, first, it will be China’s enormous population that will take advantage of low-priced home-grown new vehicles.
If Ford and GM’s gambles are right, they will tie in nicely with the 30% of China’s population that have disposable income and the 48% of those people who want to own their own cars. For those of you counting, that’s 390 million people with disposable income, and 187.2 million looking to own a car. And that’s just today.
It is easy to under-appreciate China’s sheer size. In plain English, that group of car-owner wannabes represents almost 70% of the entire population of the entire United States.
When you’re doing the math, it is important to understand that calculating growth in China is markedly different than calculating business growth anywhere else – if only because most calculators don’t have that many digits.
This past July, GM claimed a 9.5% share of the passenger car market in China, an automotive fact that allowed China to pass Britain and Canada as the company’s second largest market. Further, GM says it plans to use its anchor brand, Chevrolet, to double its market share in China in the next two years.
The automakers aren’t producing Chinese-made pieces and parts for China only. GM, for example, builds the V-6 engine for its new Chevy Equinox SUV in China and then ships it to Ingersoll, Ontario, where the Equinox is assembled – even though GM makes an identical engine at its unionized plant in nearby Tonawanda, N.Y.
Why? Because even after production and shipping costs are considered, GM makes a higher profit on the China-produced engine. The key word in that equation may well be “union.” While no one we talked to addressed the issue, the impact China will have on American and European labor unions cannot be ignored.
Is GM’s engine-shuffle a sign of things to come? Automotive insiders say “yes.” And China-produced vehicles and vehicle components will have a major impact in the U.S. and other developed nations in other ways – and not necessarily good ones.
Motor Vehicle & Equipment Manufacturers Association, which represents OE and aftermarket component makers, cites part counterfeiting in China as one of its top concerns. Counterfeit parts are estimated to cost the auto industry approximately $12 billion in sales annually, along with thousands of jobs.
Most often imitated are low-cost disposable parts, such as oil filters, headlamps, batteries, brake pads, fan belts and spark plugs. Federal-Mogul Corp., which estimates that counterfeiters cost it as much as $50 million a year, says imitators can replicate packaging that appears legitimate. But when the parts fail, there is no place for the consumer or the repair technician to turn to for help.

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What Happens Next?
Is China going to upset the balance of power and trade in the world? The easy answer: Yes. But it is not so completely clear because China remains a land of enormous uncertainties.
In 1998, Jiang Zeming, then president and general secretary of China’s Communist Party, said, “We have to recognize and treat properly the issue of economic globalization. It is an objective trend of world economic development from which none can escape, in an environment in which everyone has to participate.”
Although much of the stiffness and regimentation in China has been dismantled to allow room for its entree into “economic globalization,” how long does the ride last? A free-market economy, after all, is subject to sudden shifts in consumer desires the Chinese have never fathomed. If it becomes too much to handle, China may just pull the plug and return to the days of a closed society – because it can. If that happens, what will that mean for its trade partners around the world?
Considering China’s role in the global tire market raises far more questions than answers. There are many twists and turns for those doing business in China and many political issues we haven’t even raised here.
The promise of higher profits will continue to drive the world’s technology to mainland China, and North American tire dealers will certainly continue to enjoy the fruits of their investment for some time.
Perhaps the most harrowing question is this: How long does China need its current venture partners before it decides to go it alone?

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SIDEBAR:
Tiremakers Make Financial Commitment in China
Virtually every major tiremaker on the planet has, or is making, deep financial commitments to China. There appears to be no other choice.
Goodyear, which says it was the first major tire manufacturer to establish a presence in China, formed a joint venture with the Dalian Rubber General Factory in 1994.
In 2001, Goodyear announced a $120 million expansion at the Dalian plant. “All the tires we make in China are intended for use in China,” said Goodyear. The Akron-based tiremaker said that, by 2007, it will nearly triple its capacity of 1.9 million tires to more than 5.3 million tires to meet the increasing OE and replacement demand in China.
Goodyear Dalian is supplying high performance tires to many leading automakers now building cars in China, including Volkswagen, Audi, GM and Citroen. Says Hugh Pace, Goodyear Asia president, “automakers in China are producing world-class vehicles and need tires that incorporate high levels of technology.”
According to Goodyear, its stake in China is paying off. Dollar sales were up 22% in 2003 vs. 2002, and unit volume was up 8.4% for the same period. The company also expects its retail tire distribution network in China to grow from 1,600 outlets to more than 2,100 by 2005.
Arguably the world’s largest tiremaker, Bridgestone Corp. has built a third tire factory in China. The $99 million radial passenger tire plant will come on-stream in September, with initial production capacity set at 8,000 tires a day for domestic and export sale.
Bridgestone says the new plant in Wuxi, in Jiangsu Province, complements its existing car tire plant in Tianijin and its truck and bus tire plant in Shenyang.
Even all-American Cooper has jumped on board. Looking to increase its overall capacity, Cooper is partnering with Kenda Rubber Industrial Co. to build a passenger and light truck/SUV tire plant near Shanghai. The joint-venture plant will open by late 2005, and initial production is slated for export.
Last October, Cooper announced it was outsourcing all of its North American medium truck tire production to Hangzhou Zhongce Rubber Co. in Hangzhou, China. And, just five months later, Cooper said it would source some one million branded passenger tires from its Hangzhou Zhongce Rubber partner.
Japan’s Yokohama Rubber Co. and Hangzhou Rubber Co. have advanced by two years an expansion of its joint venture Hangzhou Yokohama Tire Co., also in Hangzhou, doubling capacity from 700,000 to 1.4 million passenger tires per year. A third planned expansion will add another 700,000 units to the mix.
South Korea’s Kumho is also a player in China. It plans to double the Nanjing facility’s capacity to five million tires a year by 2007. A second plant in China is not being ruled out by Kumho.
Michelin opened its joint-venture Shanghai Michelin Warrior Tire Co. factory in Shanghai in 2001 and operates another tire plant in Shenyang. The French tire giant also operates a sales and marketing center in Beijing.
Michelin’s efforts there are primarily focused on the Chinese market. “We are seeking a balance of capacity and sales in China,” says Michelin, importing and exporting tires to and from the country as needed.
Sumitomo said in 2003 that it would spend about $150 million to build a passenger tire factory in Jiangsu province. The first of three planned stages will reportedly open this year, with an initial daily production of 2,000 passenger car tires.
Korea’s Hankook has had a tiremaking plant in Jiaxing City since the mid-90s and a joint venture with Jiangsu Qingjiang Rubber Co. involving two plants since 1996.
Taiwan’s Cheng Shin Rubber Industrial Co. is setting up a new truck and bus radial factory with Toyo Tire & Rubber Co. and a state-run rubber maker in Fujian Province. The factory is scheduled to begin mass production this year, with an initial capacity of 600,000 tires.
Cheng Shin recently completed a second-stage expansion at its plant in Kun Shan, Jiangsu Province, boosting annual capacity to an estimated 8 million tires in 2005, making it the largest tire plant in China.
By opening the doors to foreign investment, China was literally handed know-how the moment it inked a deal with the world’s leading tiremakers, therefore avoiding decades of research and development needed to develop top-end radial tire technology. The upshot of moving from zero to 60 in tire technology is China’s wildly escalating importance in the global tire picture.

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