Today’s Financial Times features a rather timely article, Glut warning for China’s auto industry, (free sign-up account may be required) which notes that there is currently fierce debate occurring whether China’s auto industry is marching to a serious problem of overcapacity.  A top Chinese government official has warned recently that current industry investment targeted to collectively reach 31 million vehicles by 2015 may not only lead to significant overcapacity, but also a glut in the global markets which may lead to negative market competitiveness.  This challenge is not a new one when it comes to China’s industrial policy, and again uncovers a fundamental flaw in China’s overall global supply chain strategy.

The issue of build-up of overcapacity is not new to China.  In 2006, and again in 2007, as a global supply chain industry analyst for IDC, I warned of impending overcapacity that was being set in motion across China’s iron and steel and high tech industry sectors. This ultimately led to products being dumped in other global markets including the U.S..

China’s manufacturers aggressively compete with one another for industry and capacity presence with a notion that capacity is king, and it is better to have capacity than potentially losing an order because of lack of readily available capacity. This strategy raises considerable fears in the broader global supply chain community as to whether Chinese industry is really planning for increased dominance in world markets.  As the FT article also notes, the Chinese government is influencing the formation of ‘four large state-owned national champions’ producing 2 million vehicles per year, and four more companies producing 1 million each, for a total capacity of 12 million vehicles.  Consider, too, that at its height, the North America auto market peaked at 16 million, and of late is struggling to achieve a momentum of 11 million in vehicle sales.  North America auto sales are also heavily facilitated by consumer credit arrangements, whereas buying an anything with credit is often an anathema for many Chinese consumers.

I believe that this continuing trend uncovers a significant flaw in China’s overall supply chain philosophy, always having a China centric capacity strategy.  While other global providers try to balance a combination of low-cost sourcing and near-shoring production strategies, China insists on a ‘made only in China’ type of strategy across many of China’s growth markets which worked fine for Japan many years ago when energy and transportation costs were more stable.

Will China’s emerging middle class become affluent enough in the next five years to buy 31 million vehicles annually, many of which are high-end brands?  Would it not make sense to balance domestic and potential export market needs by practicing a smarter strategy of balancing domestic and outsourcing capacity considerations?

The Chinese government is right to be concerned with Chinese owned auto makers marching to this over optimistic scenario of domestic and  global manufacturing capacity.

What’s your view?  Are Chinese auto manufacturers properly positioning to support China’s future auto buyers, or are there grander visions?

Bob Ferrari