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SOTI 2015

China: Exposed and Explained

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When Jim Smith, editor of Tire Review, asked me to write this piece, he said, “Americans don’t really understand how China works.” So he asked me to try and explain it in 1,800 words, more or less.

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In some ways, China is similar to the U.S. The consumer tire market is completely different from the commercial vehicle tire market. Different customers; different value propositions; different sales stories.

Everything in China is fiercely competitive – probably more competitive than the U.S. As you might guess, this means price competition is intense.

Road conditions are pretty similar: Good quality tarmac or concrete roads, long distances, low speeds and few rotaries. There is minimal consumer information or comparative data about tires for either consumers or for commercial fleets.

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In these and other ways, the Chinese tire market is not so different from the U.S. But in other ways, it is completely different.

Quite obviously the names are different. How are Americans supposed to know whether a Chaoyang tire is better than one from Shengtai or Sailun or one of those seemingly made-up names like Effiplus or Roadstone?

Probably the biggest difference is the sheer size and scale of China’s tire industry. No one really knows how many tiremakers there are in China. Mary Xu, secretary general of the quasi-governmental China Rubber Industry Association (CRIA) admitted that even the China government has no idea.

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The best educated guesses put a number of at least 500; to put that in perspective, the rest of the world put together probably only has 400 tiremakers. Keep in mind that many Chinese tiremakers produce tires for bicycles, scooters and motorcycles, and the same core manufacturers may have several tire plants that operate under separate corporate names.

Still, that is a lot of capacity for a still-maturing market.

In the Global Market

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Click to view larger graph.

Some of those Chinese factories are at least partially controlled by the government. In some cases that’s the national government; in others it is a regional government or a large city. The vast majority, however, are small and privately-held.

One locality in Shandong Province – Dongying City and its neighboring municipality of Guangrao – can claim to be home to 200-300 tire factories alone. That makes Shandong Province the home of tire making in China. Bigger and more concentrated than Akron ever was.

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Another difference is the speed of growth. Three decades ago, there were only a handful of tiremakers in China. Now China completely dominates global tire production.

Total capacity for truck tires in China is around 160 million units per year. Actual output in 2014 was around 100 million units. Again, some perspective: total global demand for truck tires is 160 million units per year.

In passenger car radials no one really knows what China’s total capacity is. We can guess at one billion units. Actual production in 2014 was something like 500 million units. Global demand in 2014 was something like 1.6 billion units.

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The numbers are staggering, but look at capacity utilization: 60% in truck tires and 50% in passenger car radials. Latest reports from a meeting of industry leaders in China at the end of June suggest that capacity utilization has fallen further in the first half of 2015, following new duties from the U.S. government.

According to customs statistics, from January to May, China’s passenger car tire exports fell 6.1%, export delivery value dropped 17.5% and exports of the product concerned to the U.S. dropped 40.6%.

Plant Economics

I was always taught that a tire factory is both labor- and capital-intensive. In the West, few tire factories can remain open if they operate at less than 90% capacity. Most plant managers aim for around 105%. So the economics of Chinese tire production seem to be a bit different, as well.

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This difference is one aspect of the current trade dispute between the U.S. Department of Commerce and the China tire industry. Whatever the origins of the U.S. anti-dumping and countervailing duties, they have catalyzed a crisis in the China tire manufacturing sector.

Catalyzed, but not caused.

There were already strong negative factors in the Chinese industry. A slowing economy, falling land prices, plummeting share prices and tougher legislation have all taken their toll.

U.S. duties aside, probably the biggest factor in the Chinese tire industry crisis is the slew of new legislation being issued by the Chinese government and managed through the CRIA. China is set to become the most-heavily regulated country in the world for tire manufacturing.

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From 2016, China will introduce a tire performance labeling scheme similar to the European scheme. 2016 will be a transition year and the scheme will be voluntary, but within a few years it will become compulsory.

Other laws cover specific energy consumption (energy per ton of tires produced); specific water consumption, maximum rubber content, prescribed materials, recommended materials and permitted materials, minimum factory size, specified equipment, emissions limits and so on.

Da-Wu Chen, director of global sales and marketing of Taiwan’s Federal Tire Corp. told me, “We expect to see many fewer factories in China. So that hopefully the tire industry will return to a more healthy situation.”

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He added that, even for Taiwan it is hard to predict what will really happen.

Zhao Hongli, vice general manager of Chaoyang Long March Tire, said, “The situation in China is very difficult to know.”

Richard Li, marketing director of Zhongce Rubber Group, speaking last year, said, “One thing is clear – there will be fewer tiremakers in China in the future.”

Producer Implosion

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Click to view larger graph.

Why these dire predictions? Be-cause China’s tire industry is imploding under multiple pressures.

I attended a meeting of the CRIA in Dalian in June 2015. Senior CRIA executives presented data showing that tire factory output from January-April fell by 7.33%, exports fell by 10% and overall sales revenues fell by 14.32%, but with a 32.5% decline in profits.

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In the January-May period, Chinese exports of passenger radial tires fell by 25.7% in terms of unit volume, but prices fell even more, with export values down by 34.6%. Despite an overall decline in production of 8.27% and declining selling prices, inventory value rose by 11.4% as more tiremakers were unable to sell their tires either domestically or abroad, even with deep discounts.

This is putting huge pressure on small, independent tiremakers in China, and especially around Dongying City. As one Chinese tiremaker told me, “We are competing by committing suicide. We just hope our neighbor bleeds to death before we do.”

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In the West, there have been confirmed reports of only two or three closures in China: Deruibao Tire of Dongying City in February and Beijing Capital Tire in March. At the end of July, a third company, Shandong Fu Taier – which only opened in 2015 – was also reported to have shut down.

Although we know about these few bankruptcies – and in the case of Deruibao, another tiremaker, Double Star, has taken a rental contract on the molds and production lines – the common rumor in China is that 100 or more factories around Dongying City are closed and unlikely ever to reopen.

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Click to view larger graph.

In particular, this volatile situation adds risk to American companies that import tires from China. Which suppliers will remain in business and which will not? As Federal’s Da-Wu Chen indicated, even the insiders do not know who will survive. What we can say is that the top 43 tiremakers in China are tracked by the CRIA and tend to have stronger financial positions.

For the other, smaller companies, it may be wise for purchasers to take whatever steps are necessary to ensure payments are not made to a company that may be on the point of bankruptcy.

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Some companies close to bankruptcy are slashing prices just to win sales and revenues. That means a deal that appears too good to be true may be exactly that.

The biggest tiremaker in China is the Zhongce Rubber Group, based in the tourist city of Hangzhou. It is owned mainly by the city and region of Hangzhou, so the financial risk is tiny, but it is small compared to say, Bridgestone or Goodyear. If you add the top 25 tiremakers in China together, the total sales are about the same as Bridgestone’s.

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So each company has minimal resources to spend on marketing, R&D or benchmarking, let alone market research. They just build capacity and hope they can sell the outputs.

A lot of that over-capacity is for out-dated, low-profit tires. In medium truck, the demand is changing from tubed 20-inch tires to tubeless 22.5-inch tires. Increasingly we’ll see super-wides, too.

A lot of the machines installed in the early 2000s cannot make those products, so they need to be scrapped.

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In passenger car radials, there was a boom in tire capacity after the government in 2007 subsidized private car purchase. Hundreds of Chinese entrepreneurs worked out that more car sales will lead to more tire sales. So now hundreds of new PCR tiremakers from China are chasing every type of market niche in every part of the world, and this is changing the structure of the industry. For better or worse, these are mostly in 13- to 16-inch wheel sizes. Once again, there is over-capacity for low-profit products, but under-capacity for the more modern, high-profit products.

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Even the premium tiremakers such as Goodyear and Michelin are being forced to respond to this change.

Saturation selling by Chinese tiremakers who are used to competing only on price has slashed profitability of whole segments of the industry. In every market around the world, there is a clear correlation between the number of Chinese participants in any given product and dimension and the average price. More Chinese suppliers means lower average prices. It’s a universal rule.

That’s the bad news.

On the up side, Chinese are used to change. In the U.S., even though the business cycle rises and falls, we don’t see many changes to the structure of the industry, or the key players.

Click to view larger graph.

Click to view larger graph.

The forthcoming consolidation in China is just another period of change for them. But the fact that China is now exporting its ability to change markets means that we in the West will have to learn to adapt more quickly to a changing business environment.

Already tire shops across America are seeing that even the most loyal customers are looking at Chinese-made products and the price advantages they offer. A successful response to that threat may well require a change in the way Westerners do business.

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But the changes are not limited to small businesses. Online sales are playing a big part in the Chinese tire revolution. Within China, the wholesaler/retailer infrastructure is complicated and relatively unsophisticated. To get around this and to better serve their customers, Goodyear, Michelin and the other premium brands are developing O2O (online-to-offline) business models in China.

With O2O, consumers go to a portal controlled by the respective companies and then go to a bricks-and-mortar outlet to get the tires fitted. The portal owners offer the opportunity for the buyer to select a local outlet and arrange an appointment. The portal owners then work with logistics teams to get the tires to the local outlet.

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This model is being developed aggressively in China. Already we have seen Goodyear try to adopt a similar model in the U.S. This model was developed by Delticom in Europe and copied by Blackcircles in the U.K. and Allopneus in France.

Michelin has bought Blackcircles and has a 40% stake in Allopneus. Michelin is also seeking to deliver online tire information to the majority of consumers who research online before making a purchase.

That alleged Chinese curse, “May you live in interesting times,” turns out to be a British invention from the 1930s, but it might as well not be.

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