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GMtN CHINA'
lo sotelv Wvide itaFna) CadieuttEpaEd thisd* oxler ba sptua.ion ol Ptuteset AavktO@t<]k Da"atna fr/ d* di$ussior, fhe auhots da nol inq.d to illu*ale e:'/horefr*liw d inefleclile hahdlna ot a nanegenat situati@. fha arfio8 my hava disgused enain nan s 2nd akq iltdtnilvingifanalion h t@y Mkagerent Ser,,.fs prchib* any tnn of rcprcduclian, slo/age or b.nsnital withod ns witlen emis,or. Ttis nateial ii not co@d unfu adtwiati@ ton Canoow or ary reproductionrights '@gamatan lo ordot copieso. rcque$ penission la Epdrn ffiteials ctnlad le.v ltublishing l@, Mihgnerr serc.s, .,/a Fi&Ert lvay slhoat at audness, The Unirersilvol wedem ohbno London ta, e#it ees@it v uw.@ ontaia, caiada. N6A3K7:p,pne (519) 661-32A8: (519)661-3aa2: copyndtl @ 2ou,lvey MahagMnt seni.zs vs6ior. (A)2a04-12-41

We have an enviable position in the world's fastest-gto&ing automotive market. Chila- where ilvesfiients in the mid- and late 1990s have paid dividends far larger and sooner tha.'l anyone Fedicted, Our unit sales in thal market increased46 pet cent last year, and we increasedour market sbare.' A leap over the cliff: are the big profirs to be made in China blinding foreign camakers to thc risks ahead? A flood of inveslnent is calsing concem that tbe indusfy will soon be \ulnerable to overcapacity. Thele arc also longer terrrt doubts aboul the rules by Rhich Beijing expectsmanufacturersto play.r

CHALLENGES IN GHINA

Foundedin 1908, GM \r"s the \rorld's largest vehicle manufacturer, with 15 per cert of the global vehicle qlarket and manufactudog operations in 32 countnesBeginning in 1992, GM created glary joint verturs witi Chinese govemmentol^ncd enterprises, and by 2004, GM had attained outstanding profit levels.
'Ihis ca@ has been witton on the basjs orpdblishedsaurces ony Cansquenv lhs iatetpelztion and presahlaOih this case arc nal necassanly persOectives thae of Gerenl Moto6 d any ot s enplayeeg ',Gere.al MotorsCaAaftljon Annual Repq12005 "J. Mackinlash and R Wcregor, A LeapOvet the Clitr," Fin1ncialTines. August 25,2AU, p.13.

lor tne case learnrng ijl::."T*,,.^

l,4amqls ir Eraminaiion Odober ir 2m5nt htemalional Proies:ional Associalioi For rn{r srr.iegl.lssuesGlobalnnon Lrse

However, by the falt of 2004, a senes of issues thtealened GM in China" and several of these issuesraised doubts about GM's strategy. China's entry into the WTO had led rnany io hope tbat the govemmert's inten'eDtionist policies would come to an end. However, in 2004. the governmenl of China promulgated a series of rules in regard to the motor vehiclc scctor, making it clear lhat inte.vention would be ongoing. Of parlicular concem was the continuing reqlirefilenl that foreign ownership of assemblyfactories would be limited to 50 per cefl, requiring a govemment-o$ned rlterprise as an equal paJtner. Meanwhile, itte]lectuaL properry *.as not being protectedin the way that aulomakels had come to expect in other cor-rntries, causing concems about Chinese competito$ copying tle models and designsof foreign corporations. while salesgro&th had been fu\' excptional, therc werc many reasonsto doubL that the rapid pace could continue. Furthermore, huge investrnentsby competing firms would result itr substaotial increascs in production volumes, threatening a rcduction in prices and consequentlyin gross margins aurdprofits. As part of its macroeconomicpolicies, the govnment of China arbitrarily imposed restrictions on automobile financing as a \a,ayof restaining inflation. but this sector-sperific intervcntion inhoducd a \\'ild card inlo demand projcctions- Having kept the foreign exchangelatc at ao overvalucd level for many ycars, it now appearedthar the govemme might allow the exchangcratc to rise substantia.lly,and this could sercrely rcduce the inlemaijonal competitiveness of China's vehiclc manufactuers. The degree10whicb Chincsc production facilities could be used as a low-cost cxpofi baseremainedan imporlant and relaled queslion. AI the same time, th govemment faced a series of questions in regard to the policies it should put in place for thc motor vehicle sector. Through its regulalions. the govemrnent had consistently played a major role in directing the grc\rlh o[ the sector. Io panicular, its rcquiremert for 50 per cenl ChincsJ ounership of each manufacturing investmenl consfained investrnent aad managerial decisions foreignfirms. Ilowever, it wasnot clcar what rulescould by best provide for China's firtuc economic success. Many developing coultries had imposcd foreign o\\.nenihip restricdons, but had later reduced or eliminatcd thcse restrictions in order to stimulate investment and economic grouth. PerhapsChina wolld also follow this palh, By 2004, itflationary plcssules l,.cro building, and the goverruncnl imposed caeditlimitations to restrain purchasesofvehiclcs. .aising the question ofthe appropriaterole for sector-speci{icintervention as a component of China's macmeconomic policies. Meanu'hile, air pollution \ras becoming extretnely severe, and the road system was becoming increasingly inadequale These developoents, as r^'ell, meant thal goventnent intewentions to limi! pollutior and io expand l.hercad systemwould be important determinantsof futlEe motor vehiclesales.

GOINGTO CHll.lA

in By 2004, GM had about 10,000employees Chin4 and it operatedsix joid gnterpdses. had panjcipated$'ith its CM ventues andtwo \4.hollyownedforeigt joint teDtureparhrers investments over $2 billion in China- Wilh a combinec of in vehicles, GM anditsjoint vcntrlresofferedthe capacityof 530,000 rnaaufacturing in widestportfolio of productsamongforeigorDanufactore$ China. GM's major joirt venture partner,SAIC,hadbeenfomded in 1956,and,by 1997,had grorvnto become China's laxgeslhanufaetwing plant. As presentedin GM company joint vntules rporls. these coNistedof the follov/ing:
Shanghal General Moto6 Co, Ltd. (ShanghaiGM)

Shanghai GM \ras a Shanghai-based 50-50 joint venture \a'ith Shanghar Automolivc Industry Corpomtion Group (SAIC). Thc laigest automotive joint venture in Clhina"Shaaghai GM was fonned in Junc 1997 with an initial planDed inveshnent of $1.3 billion and an annual ploduction capacity of 200,000 vehicles while operating on three shifts. ShanghaiGM assembledand distributed a famill ofBuick midsize scdans,the Buick GL8 executive wagon and the $nall-size Buicl Sail. ShanghaiGM began producing engines in 1998. Its powerhain facilily had an annualproductioncapacitl of 180,000V-6 eogines,75,000 L-4 enginesand 100,000 automatic fa{smissions.* ShanghaiGM was supportedby a nenrork of salcs,atersales and parts cenhcs. g) SAlC-GM-Wuling Automobile Ltd. (SAIC-GIl-Wulin Co. SAIC-GM-Wuling u,as a $99.6 million joint l-enture launched in November 2002 and capable ofproducing up to 180.000vehjcles per year. GM held a 34 per cent stakc, $,hile SAIC held 50.1 per cent and WuliDg AutoBlotivc 15.9 pcr cent. This joiltt venture u,as situated il1 Liuzhor! in $'estem Chin4 and it manufactured a rangeof mini-lrucks and minir.ans. Shanghai OongYuefllotorsCo.Ltd. GM Dong Yue N,lotorsCo. Ltd. $,asa 5108 million joinl venture manufacturing faciiity situatcd in Yantai,. Shandong.Shanghai cM held a 50 per cent stake, with GM China aad SAIC each holding 25 per cent stakes. The facility began production of the Buick Sail in April 2003 and had an annual designed production capacity of 100,000rmits*'hi1eoperating tlio shifts. on

"ww.aulatnlell-news com^ews-20024\!ovenbet-2o12Novedbe.-20A2-T,rllovenber-0d02 D10htn. resed o.lober 20 2044.

Co, Powedrain Ltd. GM Shanghai DongYueAutomotive Dong Yue Automotive Powertrain Co, L1d- $'as located in Yantai' Shandong in oortheastem C.hina. The joht venture was the former Shandong Daewoo Automotive Engine Co. Ltd-, which began production in August 1996. Under an agreementsigned in 2004, ShanghaiGM would own 50 per cent ofthe ne1l joial venturc, while GM China and SAIC would each own 25 per cent. The facility would have an annual manufactudng capacity of 300,000 cngines, providing enginesfor vehicles manufbcturcdin Chita by GM and SAIC's joint ventures. Co. !/lotorsAutomotive Ltd. (Jhbei GM) JinbeiGeneral Jinbei GM manufacturedthe Chevrolet Blazer SUV. In 2004, a oew shareholder sfucture was put in place, ud& ShanghaiGM hotding a 50 pei cedt stale, while GM China and SAIC each held 25 per cent stakes. Located in ShenyaDg Liaoning. Jinbei GM's production capacity was 50,000 vehicles. PanAsiaTechnical AulomotivoCenter(PATAC) PATAC' *as a $50 million, 50-50 join venture between General N{otors irnd SAIC. It provided automohvc engineeringsewices including design, dcvelopment, testing and validation of components and vehicles. Among its aclnevemcrts was the reengineering of the Buick Regal. Buick Excelle and other products for ShanghaiGM. GII/I Warehousing Trading(Shanghai) Ltd. Co. and GM Warehousing ald Tradi[g was located in Shanghai's Waigaoqiao Free Trade Zone and representeda Sl.2 miliion investmenl by CM. The wholly owned parts distiibution cente (PDC) officially siafied operalion in .A,ugust 1999. It was establishedto eosure the quick delivery of genuine GM and AC Delco pafls to customels in mainland China. The PDC featured a fully computerized management and inventory coftrol rystem and stocked about 25,000 differcnt pars-

GM(China)lnvestment Corporation GM China w?Ls *holly oimed venturc ba-sed Shanghai.11housed all of GM's a in joint venttrles in China. looal staff and was the invcstor in Glvl's 1,ehic1e Sales, marketing and aftersales serlices \l,ere key imctions of GM China Cadillac. Opel and Saab products qere imported from GIVI facilities worldwide

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and were marketed in China. GM China also supported a network of authorized service centresand pafis distributors acloss China-

Technology Institut. GM-Shanghai Tong University Jiao was a co-operative institution establishedby GM and ShanghaiJiao GM-Sha.nghai Tong University, focusing on joint research and development and on tecbnica! traiBing. GeneBl MotoB Accepianco Corporation (GItlAC) GMAC was onc of the rvorld's largesl automotive fiaancing companies, serving more than eight million customers ir 35 oountries- In 2004, the govemmcnt of China gave it permissioo to operate io China and it was actively seeking to dcvelop local partnerships.

ACDelco ACDelm, the world's leading aftermzLrket brand, oprated a gowing netwo* of more tllan 100 ACDelco service centes il maidaod Chha- The facilities, r'hich stocked genuine ACDelco parts, provided repair and maintenarce seruicesfor a1, makesand models ofvehicles. AllisonTransmbsionDlvlslon{ATD} ATD nas the world's largestproducer 01'automatictransmissioN for medium- and heavy-duqvfucks, buses and specialty i'ehicles. ATD $'as working with Chinese original equipmeot makers aid end-usersto upgrade $e quality ofits medium and heaD. commercial vchicles. Electro-Motive Division(EirO) EMD q.as recognized as a world leader in the design and malufacture of locomuli\e equipmentand tcchoology.EMD operated r_epresentali\c a office in Beijing that eslablished lhls wjrh Chjoa s railr\,a)indurry.'

-M

gnch'na cdn/english/news/backgrounctnnchna.htn, accessadOclobar20, 2004

ShanghaiGM had introduced a selis of new produots in China: . In April 1999, Shanghai GNt begao regular production of three rnodels of midsize luxury sedans:lhe Buick Xi! Shi Ji (NeP Ccttur,), Buick GLX and Buick GL. In May 2000, ShanghaiGM launchedthe driver-ofieded B\ick GS sedanand made in Chin4 the Buick GL8. the hNt exe4utive vr'agon In August 2000, a scdan with a smaller engine, the Buick G, r':s added to the ponlolio. In December2000, ShanghaiGM's f;rst small car, the Buick Sail, came off1he production line. h October 2001, Shalghai GM began exponing the Cl-8-based Chewolet Venture to the Phiiippines. ln November 2001, ShanghaiGM intoduced the Buick S-Rv recreational vehicle. In November 2002, Shanghai GM announced that it had secured a contract wilh GM's CAMI joid lentule in Catradato expolt ergines bcginning in 2003 On December26, 2002, the Buick Regal midsize sedanwas infoduced. On April 19,2003. Shanghai GM unveiledthe Buick Excelle,its first lorermcdium scdan.u

. . . . . . . .

INDUSTRY AND STRUCTURET COMPETITION PROFITASILITY In 2004, sedansrepresented44 per cent of hotor vehicle sales in China, r-ith trucks at 30 per cent alld busesat 26 pr cen1. In was in the sedancomponentthat grorth promised to be most rapid and wherc profits appeared to be mosr substantial. In 2003, Volkswaggn had dominated thc sedanmarket iaith a 36 per cent sltarc. I'lo$'ever, by Junc 2004, GM and its joint venlure partners wcre selling more sedansthan Volks$agen, with ticir joht ventuaesaccounting for 40 pcr cent ofthe total sedanmatket. By 2004.GlvI rvaseamingcxceptionally high profits fiom its Chinaoperalions: China is no longer merely a markel of great potential. It's norl the rcal McCoy, where global compaDies$ith the right piumers and strategiescan and do reap buge profits. The proof is on pagc 37 of Ceneral Motors Cory.'s 2003 report to the federal goverunent callcd a 10-K under the heading "lnvestment in Nonconsolidaled AJfiliates." Right therc. lbr the lirst lime ever, GM publicly revealed how much profit it is raking in from its vehiclc-makin{ventures Chrna. in
6ww.gnchina conlehglish/operalions/sbgn. hln, a@ssed October 20 2OA4

Paoe7 The nurnber was a big one: $437 million last year. Atrd that's otrly half of the profil from GM's foln joint-venture plants ifl Chin4 which sold 386,710vehicles.The o&er half of the prcfits \{ent to the De&oit automaker's Chinese partners. For someperspective,look at ttre numbers this way : Figwe that GM and its Chinese part]els had a combined net prcfit ofnearly $875 million, or about$2,267per vehiclesold in China. ln North Aheriea, GM's net protrt last year was ooly $811 million on salesof 5.6 million cars and mlcks in the Udted Slates.Canada andMexico, or about$145per vehicle. That means CM China was neaxly 15 limcs mora profitable, pcr vehicle sold, th:rn CM Nodh Amcnc.a. "GM is rnaki4g moncy hand over frst in China, selling cars as fast as they can make therb, at very attractive p ces," says Kellieth LieberthaL, a University of Micltigan professor and China expert who wa-ssenior director for Asian affairc on thc National Secwity Council under PresidentBill Clinton. "All of the other car markets ol rl"e\rorld areeilhcr marureor !he\'re Door. ;

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'[tile GM had achieved ou$tandilg results to date, nevert]relessa plethora of competitors \\'erc fighting for market share. ln 2004, China had more thuut200 carmakers. Most werc relativcly small Chinese f-lrms, and these domestic firms, solely o\aned by the go!'ernment, had a 40 per cent market share. Exhibil l iDdicatesmarket sharesas of]une 2004. The goverrment was reluctant to see its motor vehicle rnanufacturerselininated by the new joint venture firrns. Horv to support their existcnce while also attracting foieign technology and managerial skills posed srious challenges at this point in time. As ore analyst sa\\' the sf ategy of domcstic firms: With Japanese U.S. technologybattlhg it out for thc top, the and only hope f,cr domestic carmakeG {ithout joint venture partncrs is to capturefhc bottom end ofthe ma*et then begin the slolv ascent up the price and-sophislicalion ladder. That's the path chosen by BlD, the fonarerbombmaker- Tle Flyer retails for about $4,?00, making it affordable m rhe 50 million Chincse eiming at least $7,000 a year, whom the govemment considersmiddle class. "Look arormd my office," says Liu, the B'l:D gcneml manger. He has one dusty filing cabinet, bare whitewashed r"lls and a view

7t. watsh, 'GM's China bonahza,'Aetmn Free P/e$ hltp / t6fl tcep @n/noney,husinesstura\sh30 20A4033A

ac..rssod March 3A, 2oA4

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overlookingthe decrgpilformer bomb faatory."we car gct by on theslinmestprofits."'

This industr,vstucture createdgireatudcertainqvabout futwe prices. The domestic hrms did not have shareholdersdenanding cartain profit ievels, and so they might strive to maintain thet market share by cutting pdces. Furthermore, an ongoing temptation for them was simply !o copy the desigas and technologies that were being introduced by the new joint ventule fiIms, Meanwhile, foreign competitors were jostling to increasetheir investnents in lhis fast-gro\ring market, a process tlm1 would futher intensify price competition. Already, over the 2001-2004 period, priccs had fallen 25 per cent. Amlysts expectedprices to codinue to fall at a late arcund I 0 per cent a year.' UNCERTAINTIES DETIAND OF ANDSUPPLY PROJECTIONS Some analysts extafnlated thc exceptionally high groMh rates of the 1999-2003 pe od to arive at projections of oolmous salesvolumes. China's auto saleshad climbed from some t$o millioE units in 2000, to more than three million units in 2002, to 4.4 tuillion vehicles in 2003. China's rapid economic gro${h supported the view that an increasing numbcr of Chinese *ould be able to puchase cars in the fttwe, Exhibit 2 presents data in regard to China's economic growth, and Exhibit 3 indicates the very unequal income distritrution as a result of which &e top 20 per cent of China's population would soon be able to afford automobiles. Basedon this optimisrrg someanalystspredicted: China is on track to overtake Japan "ia a couple of years" to become thc \rodd's second biggest vehicle market, according to John Devine, General Motors' chief frnancial officer, in thc U.S. vehiclemaker'slatestbullish asses$nent ofthe maiiland. MJ. Devine said GI4 expected thc market to naintain double-digit growth "for sonle time' on the back of continuing ccononric growth, cheapercats and the approval ofvchicle financing for thtee foreign nanufacturers. GM China sold 386,710 vehiclcs in China last year (2003) though ils various joint ventu.res, 46 per cent on 2002. Saloon car sales up incrcased pcr centyear-on-) 8: ear.r0

'^u fahe./ Moing toal asl1 trre. v 163 t a Febtuary ?3,zou, a6 '--Hee bp Drasoas fts:E!9!p!18! seoerbet 4 2004,p 10 '"Richad Mcc.esat, "cM to focus @ grc||ing Chha nand," EkAlgb]jaet

Febtuary 12, 2OO4p.za

PageI ior the motor vehicle sectoi. the year 2004 witnesscd atr abrupt end to dle 50 per ccnt annual sales gor {h of the previous years. Some of the best-selling models experiencedparticularly sharps decreases, customers shiiicd ro less expensive as automobiles. For some models, Seprcmbcr2004's salesdropped morc than 50 pet cent from the September2003 level. Analysts pointed to a series of ne\! fbrces: a loss of consumer confidence, eKpectationsof further !hicle pice decreases,thc tlreal of oil shortaggsand higher gasoline prices, govemmcnl ratiooing of power supplies, and the goverrunent's abrupt imposition of credit restrictions for automobile finanoing- Long-term constraints included a very poor highway system- in IacL onc analy$ suggcstcdt-hdi-China ha! no national hjghway system.'''' Driving l't"s basically restricted 10 the roads within eaih city. Air pollution had become a major concenl and this could also limit China's rnotor vehicle Srowth. "Aeco-ding to the World Bant, China has 16 of rhe world's 20 most polluted cities,"'' resulting in 300,000 prematwe deaths afiruall.y due to rcspimtory disease. As a result of lhese Bew developments and long-terr, constraints, analystsclaimed that forcign investnetrts thal-had once appearcdto be enotmously succssfulmight rlow be open to question." In the third quarier of 2004.GM sawirs profitsin ChiIa drop 44 per cenrro I iS$8uniilion.'o Over-capaoity will be a major factor rithin two yea$, $ith the passengercar market - already the singlc mosi import rtt sector lrithin the Chiaesevehicle market - likely to be at the foreliont. Paul Brough (managing panoer of I(PMC'S financial advisory services practice in China) contioued: "We are alrcady seeing the first outward sigls of rhe pending ovcr-capacity. Avenge car prices in China have already fallen by scvcn per cert between Januaryand Junethis ycar (2004). A lot of this can be attributed to manufaclufers looking to glab early market shar through aggressiveiy low pricing. In addition. rising iDveltory levels are also rcing price reductions on older models as businessesbok to clearstocklevels-" "L'ulther over-capacily will sce inoreasedprice pressureson sed:rns as well as lower prices and margins. Taking tbe reasoning to its ultirnate exteme also raises the fear of some new pmduction facilities becoming real white elephants as capaciry is inevitably scaledback at someDoint."r)
Gmhah. 'Paddy F'etls Ia Futt Ptoductton tndlg! WeeL [email protected] 2aOO ^Mad "Specat Peoo1 on Cntnas Enwrcrmen!. A G.eat Watt at Wasle. T|'e F@padls. Augrst 2 1. 2AO4 p56 '.t_Petet wonqaan Slowpt Gnwlh.uets An^,.ry ItgWaI SteeLb_zp! Oaobe, ?1,2\aa 813 't2ichard M.Grcga.. 'Camake6 ChanEng Ptans as Chjnese SatesFa| Orf," Financia!Tjnes. adobe. 16. 2 0 u D 2 1j'sgnificant owrcapacit to Hi Chitesa Car Msdct tuithinT@ yea6." M kptug @Nsearchtndex.asp?ctd=753. a&essed August 27, 20U

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As noted above, the intensification of competition was rcsulting is pdce cuts that would inevitably reduce profit mafgins. Fu,-thermore,it \,/as not clear whether cefiain supply constraintsmight limit the expansionplans of China's aulomakels In August 2004, a Financial Times article poinl,ed10 a desease iE car produclion of20 pr cent compared\r'ith th prvious $onth, and noted tha! "Ihis is forcing a rcthink among mullinational and local carnakeis about their multibillion-dollar plansin China."'" expansion

FIRST I,IOVER ADVANTAGE CREATING VALUECHAIN IN A The industD' struchre of parts supplicrs had a similar dual nature. O! the one hand, the joint venture enterprises ioitiated by fo.eign parts suppliers brought modern tehnologiesand managerialplaclices. On the othe. hand, domestic flrms pu$ued traditional practices that re$rlted in poor qualiry components and tbat lacked imovation and ongoing product development. A persistenl temptation for domestic firms was to labei their parts falsely, claimirg them to be the gcnuine products of firms \lith brand-namerecogrftion, A foreign assemblerhad to create an efficient r,'aluechain capablc of creating vehicles thal would be consistently high quality. Just-in-time delivery practicesfaced real challengesin China. The joint veatllre operalions many of the Tiei 1 supp[ers have set up verj little in tcrms of technological sophislication and part qualig bet\r'een what they do h China and the rest of the worl4 says Guy Bouclrct, a vice-prcsidentvr'ith A.T, Keamey. He receotly retumcd to Chicago alter spendingfive years in Chha. The rcst of the local supply basc is a difcrent story. lt's fragmented, and there's a wide spectrum of capabilities, qualifications and qualiry, he says. Solne of these supplien understand the multinationals' rcquiremefis and are ready to play the game. Othels arcn't so willing or able. ''Latc-comers run the risk of no1 being abl to lock in business relationships, in uhatever foro\ with the highest-capabiliry guys," says Bouchet. "You have to tap into a sccond tiet who are not as good, which means lhal your investmerf in terms of faining, in tqlns of revampirg the assets,are higher, which has ar impact_oo your retrm on invesment and your sholt-term competitiveness.""

1.6RchadMcctegot, "chnlese Cat Outpul fals by 2o%,"Financiatfimes August 25,2Oa4 p.13 '' David Dnckhatner,Ealahcng Act," !!!l!sttv WeetaFebruary2004 V ZS3,| 2,49.

WITH NEWOPPORTUNITIES SALESFINANCING lD 2004, China's follr stale-o$Tledbaiks hcld more than 80 per ceff of China's outstanding automobile loar$. while the automobile manufacturers l1ad beer prohibited from enending lorns as part of their salesprcgmms. In August 2004' Ceneral Moto$ became the first overseasautomakel in China to be allowed to issue car loans to its purchascrs. GM had orealed a new joint velture for its financing operations, \rit}t 50 per cenl oEned by Genela] Moton Acceptance Corporalion (GMAC) and 40 per cent owned by SAIC. Analysts expected thal this expansion would grcatly increas GM sales. Other automakers had also applied for permission to offer auto loans, bul GM had a head start Ove6as barks such as Citigroup [oc. and HSBC facd a delay of several years belore they would be allo\^'edto off! loans dnominatedin yuan to chinese purchase.s. GM now eoioyed a brief window of limited c.mpetirion. Houever, GM's finance operations faced cqtain rcslrictions. Inirially, GM could lend as much as 90 per cent of thc car's price tag, but this percentagecould be educed by govemment regulation as a mechanism for restraining dernandin time of inflatiolt- Furihennore, China's cental bar* detennined the interest rates to be rates. chargedon local curency loans; GM would not bc allowed to set its o1'\'n

POST-WTO CHALLENGES: PERSISTENCE GOVERNMENT REGULATIONS. THE OF TRADEAND INVESTMENT RESTRICTIONS, VIOLATONOF INTELLECTUAL AND PROPERry PROTECTION WTOProvisions Prior to joiring the World 'Inde Orgaaization (WTO), China had inposed exceptionaily high tariffs on rnotor vehicles and compoleots, and has also imposed import quotas for cefiain proddcts. China was granted a transition period in 1ariff reduclions. with a deorease from le\.els of 80 per cenl to 100 pcr cent do$.n to 25 per ccnt by 2006. Import quotas \\re to be phased out by 2005. In the past, the goverrmcnt had also imposed local content requirements in order to support domestic supplierc of components, but these also were to be eliminatcd. ln addition, the goverrment had intefl'ered to dictale the types of vehicles thar foreien compaies rnanufactured,with production licences as a requirement. V/ith the WTO, foreign companies received greater independence in production decisions, and by 2004, they were fie to dishibute whatever Fodncts they wished. Wlile Chioa maifltained its 50 per cent domestic o\me$hip requirement for assembly plants, the govemnent did eliminate its joint ventu.e requirements for the production ofengines. Some analysts prcdicted that these WTO reforms would give foteign companies \'aluable new opportr]nilies. ln particular, foreigl! companies raould be able to imp{Jrt certain scgments of their product mix, *hile focusing thcir China

production on a limited product iarye, thereby captuxing geatet economies of scale- This would mean lhat forcigt compades could rationalizc their prcduct mix globa.lly, alrd China's place in global production would depend on its inherent competitivencss. Meanwhile, the dornestic firrns would iace heightened irnport cornpctitioo, as would cotuponentmanufachrers. These market-opedng cornnftments are expecled 10 bring considerable challenges- and opportunities - for both Chines and foieign au(ooakers. For Chinese companies, the challeoges wiil likely outueigh the opporturdties. Reduced ta.iff and nontariff barriers will altow high-quality, inexaensive foreign vchicles to flood the domestic rnarket. China's small and inefficient auto companies \litl probably be unable to compte q'ith wcllcstablishedmultin;tional compctilors-18

Po'sistent Govemment Inie entlon In June 2004, thc govcmment of China ploclaimcd i1s new version of rules concerning foreign investment in Chiaa's vehicle sector. Exhibit 4 plesents KPMG'S surnmarl' of tbese niles and thcir implications. Some rules were unchangedtorn the pas! but ovenll the June 2004 ploclamation reprcsentedan ongoing intervention thal ca$ied uncettaitrry with it. For example, in discussions about formulating these rules, analysts had wamed of the possibility that the govcmmcnt might impose new tules to support techDology development ia domestic companies. ln particular, a policy optiotr bei[g debatedlvas thal 50 per cent ofall salcsin China by 2010 would have to come ftom domesticcompanies that would o&n 100 pcr ceBt of a vchicle's technology. An additional prcposal was that any foreign company that ou'ned 10 per cent or more of a Chinese company would be compelled by law to share its expstise in rcsearch and production a$d sales. lhe 2i104 rules did not include these developmen_t provjsions, but the possibility rcmained thar similar provisions might be imposed ( in lhc firhuero enhance hine\eounerjhjp of rechno)og1 .'" CHALLENGES THEJOINT REOUIREMENT OF VENTURE Chioa's requirement that forcign investors enler joilt ventwes with domestic frrms was a positior held by many developing country govcrTlmenlsin the mid-tolate 20th century. It v,,asgenerally acceptedthroughout the world that foreign direct investrnent (FDI) led to some de$ee of loss of control by host country
'"AIan Zbang,'China's WfO acliessjon:hplications lorttE auta sector,' thw pw x'n/sENJeuptitllFotmat2utl-hftp/'^Dww.pwc.c.n/extwetu'ewclolh nsf/docidF117826, actrssed May 14, 2044. '"Leslie P Nonon, 'A Bunpy Road far Fo.eiqnAuto Make6 in China,"BaM s. June 23,2AA3, V. A3 I 23 MW12

govenunents over their economies. This loss of control was seen :rs a cost to the host cotmtry and to its goverDment. Tratsnational corpomtlons (TNCS)' with intemational Foduction add distribution Detworks, had the flexibiliq' to rspond more quickly to changing conditions in all the countries in **-icb they operated tharr did domsticaliy o\tned frms, If, for example, a host country's real exchange rate rose, a TNC could reallocate production to a cheaper source of suPply in aoother cowfry. A domestically owned firm might not have lhis option, or, if iL did, it miirt exercise it less quickly. A similar situation existed n'ith rnany of the major policy \"riables ulder govemment's commaod. Gove!$nents might lose conuol o\,-erthk ability to nise l-axationrates, wage rates and labol conditions, interesl mles and so on for the fear of tbe reactioa of TNCS in their inlestment and pmduoion decisioru. Many believed that fNCs had very different goals for their opeatrons in host countries than did the host countr,vgolmments ll.trCs could also be subject to presswes liom a number of sourccs, and tiesc sorrces might be outside the ir{luence of host country govemmen8. Consequently, a degree of tension \tas introduced whes lorein investors *'ere permitted to enter ihe pdvate enterprise system. Not only were TNCs seenas lrying to coDtrol the opelalions of their firms in the best interests of their siockholders, but these stocklolders were located oulside the host courtry. Put another way, foreigr invesl$e implied that some form of direct control was exercised lrom outside the coultry- As well, those for whose benefit th control u,as being exercised also resided outside the host coulti.v. Moreover, TNCs were seenas beilg responsiveto the policies and goals of the gove(uncnt in dreir home counfy (and olher countdes in u'hich they operated)and these goals and policies might not be ir the best intercsts of the host country. Based on all these ntionalcs, host muntry govenments xished to be able 10 exercisea degreeofconlrol over foreign invcslors relativc to domestic investors in ordcr to align their operatioirsmore closel), *ith the goals of the cormtiy. Ceneral reslrictions oit foreign investors werc an altempt to lodge some degiee of coD&ol q'i1h domestic ettities, either host country natioials oa, in some cases. the govsrnrnent itself. However, being thc lbreign partner in a joint venture raised manydiff cult challenges. Under the best of circumstancs,joint \Dfires can be difficult to manage.They'vc gone out of fashion among U.S. auto companies becausethd interests of the individual parties frequently divergcd before the ventures had rwr their course. \\llat's wolse is that SAIC owns 50% of each joint lenture by government regulation and gets halfthe votes v"'hcndecisions are made.That's normally a rccipc lor Ilusfatjor and deadlock.

Page14

9805tt007

Asked ho\t disputes get resolved t-hen neithei parq, has a tiebreaking vote, SAIC president Hu says: "wlen we have different ideas, we close doors and argue against each o1her. It is okay to lose your temper as long as rhe door is closed." He addsthat he has leamed a few things abaul conl'lict resolution between differeft nationalities. "Americans have more flexibility thatr the Germans, who are very serious ooce tlEy make up their mind," he says.'" Of centBl concem was the risk that the domestic partner might create an altemative prcduction facility and compete agairst the joint venture. Or the govemmnt of China might arbitarily dissolve the joint venture and encowage SAIC to purchase cM's iaterest in the joint venture. Nationalization of GM's interest secmedan exteme possibililv bur one that could not be completely ruled out. If any of these deveiopmenls were to occur, GM might nov/ be creating i1s orln worst enemy - and not just in China, but perhaps glotrally. Nothing *'ould preved SAIC from exporting to GM's ma*ets throughout thc world. Some China experts believe the joint ventlres will be unwouad once the Chinese are capablc of competing on lheir own. "Foreign automake$ should be airdid of domestic competition-very afraid," trote economist Kroeber. "ln sector after sector, foreign manufacturcrs have piled inro China only to see their technology copied and their prices rurdercut with ala.milg speedby domesdc competiton operating with goverDment supporl Chingse ffms have picked up techrolos/ ouch faster and kicked foreign cornpetitors oul ofthe malkcl far faster tban anyone predicted-'"' And by 2004, SAIC had already shi{led into initial stagesofcompetilion againsl GM: The boldestplans belongto SAIC. In the next tbree years, SAIC aims to make 50.000vehiclesbearingits own brandi in 2003, the companyproduccdfewer than 3.000of its own vehicles.By 2010, SAIC iants 10 be among the world's top 1o__autonlakerc, according Xiao Guopu,a vice-FesidentofSAIC." to ln 1978, China had begun its gradual transition from central pla$ing and srateouned enterprisesto private o\'"netship in a market economy. lt was possible that the joint veoture requiremenl with a govemment-owled partner might be liminated io the fdnrre- If so. Gl\4 lvould facc the stralegic issue of whetber to attempt to purcllase the domesfic partner's intetests in thc joint ventures. The
aAlex Iatlot 111, 'shanghai auto wants lo bo the v/artd'snext great cat Mpany,

t.7,103. ?au,v 150.

Fotlune adotur 4

zPeter Wonoa@l| "Abbat Ains ot Chtnas Car Makers Put Exlstiog fies at Risk W?!! Sbeet Jounal

ts Paqo goveErncnt would face tbe stalcgic issue of how to plil'atize and whether it should rctain a "golden share'' witi veto rights over ceftain managerial decisions. In Gemany, for example, the state of lower Saroay held a "golden share" in Volkwagen tbat gave il powet to override the board should it decide to shift jobs

9805M007

outofCerrnary,
of Property Protection Inlelloctual A major con{lict bctw'eenGM and Chef}. illustrated the thteat that domestjc fttms GM created could copy designs and technologies of tlre foreign invcstor. planned price production farilities for a new small car, the Chewolet Spark, \Mi1h a of $7,50(l and a productiol date of Decembcr 2003. However, before it could begin its sales campaign, one of the local Chinese afiomakers, Chery, begar selling a $6,000 version with many similar features. GM was faced uith an ioportant challengein prolecting its intellectual property. Thc dispule drags GM inro the murky \aatcrs of intellectual propelty-rights protection in China, an arera thal has snagged makers of sneakersald other goods that saw Chinese comp?mies mimic thei \a'ares,'lhe GM complaint is cornplicated by the fact that Cbery is 20% owned by GM's mair joitrt vetrture partner in China, ShanghaiAutomotive lndustrial Coip. GM and SAIC male Buick sedans in Shanghai. as well as cars at two other plants in eisc*'here China. Yet. as GM's dispulcshows,tlese companies could facc a veling battle. GM was not alone in seeing a clonc suddcnly appear &om a domestic manufacturer. Toyota also expedencedthis challeflge: When Geely, China's largesl private carmakcr. launched its Meiri saloon,it madecertainto advertise one of the vehiclc's big sclling points - its Toyota engine, installed under licence fiom the Japanese company. Toyota peftaps could have li\'ed with that, but not with the Geely logo plastered on the Meii's fronr grill, whic\ it considered. looked suspiciously like the stylized 't:shape that brands the Japanese compaay's vehiclesglobally. Similar mislcd but not so much that potential purchasers would he ruled BeUing's Secondhtemediate Couft this \\'cck.

Paqe16

9805MOo7

by throwingout legalactio! mounted To) ota for allegedtrademark infringement."

RISKS IN CHINA OI'IGOING

held by forcign investolsin A KPMG Surveyin 2004 revealedseriousconcms weil as foreign investorsin other Chira. Thescongoingrisks tlreatenedGM as
scclo$: . . . Forty per cent of those surveycd agrce thal govemmmt regulations posed a sigiFcant challengeto their expansionplans. Eiellty pe! cent of compalries sr:weyed said that Intellecnral Properly Rights io infringement posoda significant threat to their businesses China. Nearly 25 per cetrl of those suweyed agree that they overestimated thc potential ofthe Chinese market, and a further 16 per cent evcn adnitied they wrongly believed they would get rich qrick.'''

KPMG listed the most prominent mistakes made lvllen investing in Chha- By working with a joint venture p6r:tncr,GM had been able to avoid nany of these mistakes,and this realjty placed a strong positive value on GM's relationship with SAIC. Faiiure to apprcciate the differences in the Chinese market. Companjes that focus solely on tle largest,high-profile coastalcities may miss out. 2 . Failure to appreciale tbe ferociry of domestic compaitiori. Before 1949, the Chinese were known for entreprercurship. Since 1978, these trading talents have besr levivirg aod local companies qtll go head-to-head !'ith forcign concems. 3 . lnvestrnent information can be difficult to get and may not be reliable. 4 . Failue 1tl apprcciatc and undersland cultuml diffcrences. In Cbina many cornrnonWestem cultural and economic paradigtns do not apply . . . Contacts are certainly not wo.rthlcssin Clhina,bu1 their signilicance is not as great as they are in the Wesi."
l.

./IACROECONOMrc POLICIES As Exhibit 2 indicates, China had experienced fir,e years of very rapid grol\'th, radging from sevea per cent to over nine per cellt afirualb, u'ithout experiencing any significant inflalion. In fact, in the years 1999 and 2002, China's general price level appears to have fallen. However, with thc year 2004, analysts
4.Rtchad Mcet'sor, 'Chhese t-aw Coutts Makelheir Maryue," Ellplcialllnes. '-'ww kpng cd/en/news/pt20@O6A8 hh|, acrpssdJuty 2, 20U ""Consuner a'kels in China- the reat deal?' KPMG intenati&al 20U wwwkpna ca!..cn/pub.hln? id=669. I,lovenber 2A, 2003, 20.

thJoughoutthc $oild becameincreasingly concemed about the possibility of rapid inflation in Chiru" and the govemment of China shared this concem Essentially, there was a substantial increase io aggregate derBand due to higher consumcr incomcs, increased levels of exports ard substantiai ioeign investment. At the sams time, there appearedto b new constaints on global capaciry b ptoduce natural resoulces necessary for t}!e burgeoning Clnnese manufactunng sector. Wodd prices for natural resources, aod panicularly oil, were skyrocketing' and this threalened1odrive up cost lcvels and, therefore, prices in China Inflation in China has bcome a growing concem to bankers, the corpoEte executives and monetary officials aror.md world.tu I{apid gror-th espccially with regard to infiastucture improvements has tur-dedChina into a major oil and commodity importer. With commodity prices dsidg, and its cunency peggedto the low-flying dollar, China's impoft costs bave soared. Overa.ll, prices for raw matedals and energy in China jumped 8.3 per cent in the first quarter of 2004, while overall input costs for China's manufacturing incrcased by 4.8 pe. cent- Othcr inllationary pressuresfacing China are its npidly groe/ing motrey supply and a new genelation of hypelactivc consumers whose spendiBg drove up retail salsby 10.7 per cent in the first quar-ter 20M.'' o1 In response to lj1ese pfessurcs, the government of China instituted policies to restrain demand in specific sectoN that seemed to be overhealing. Thc motor vchicle sector became one of the targets for this rcstaint, and dre govemment imposed restritions on loans dade to finance the pu-rchase ofmotot vehicles. In other natjons, inflatioDary pressuresr,\'ereoffen met with monetary and frscal policics, but the governmnt of China felt constrained in its ability to use these economy-uide measures. The governmenl lacked experience il both fiscal and monctar' policies and had not yet dcl'clopcd thc many systcms on q'hich these policies rclied. -fo raise laxes as a me:lns of restraining aggregate demand, lbr examplc,u,ou1dbe a novel exerciseuith ruclear results. It seemcdto bc a,1 inappropriate timc to reducc govemment expenditues, when the grorllh process had been so succcssftl. China required new infiasfucture exprdifurcs, particularly for the mpidly gowing cities along the coast, but also for huge inland Fojccts like the Three Gorges project that would be necessaryto generatehydroelectric power. At rhe samc time, tens of millions of people were &ifting inlo une|nployment, both with a shift of populatio! fiom ruJal areas to the cities and also uith exlensive employee lay-offs as enlerpriss strove to increase effrciency both publicly o\mcd cnterprisesand the increasing number ofprivatized firms.
Pressures Fast Ti@g Apn|10.20A4,12. '"'tnflatanary Ris]].''g in China,'Tai@t " J K u n z n a n ," | s C h n a G o i n g l h e W ayol B razl l ?" E u.o& anB usi nessForun.S unner2qA 4| 18,95

The *rcat existed ofboth bllation and unemployment, crcating a difficuli choice in ma.roeoonomic policy di-rcction. Monetary policy o{Tercdlimitcd hope bccause ofthe ftagile state of the banking system and because of the loss-making, state-o\'\!d enterprises lb resfain credit and ftise interest rates on an economy-wide basis might cause a financial and business collapse. In October 2004, the govemment did experime l irt rnoneEry policy by raisidg interest Iates 27 basis points (a basis point is one onehundreddrofa pr cellt). The world's media immedialely erupted u'ith concems The Financial fimes rar a ftont-page headline that read, "China rate rise sends markets into a spin. Centlal Bank's fircr move in nine years hits commodity prices and stocks arcund the world."23 The govemmerit's short-term priority is to slow the cutenl rapid rates of cDP grorttr without triggeriog a damaging hard landing for the economy. To this end, tighteniog measures have ben taryetd ruther than broad-based,aimed at cooling particular types of spending itr individual iDdustries nolably investrDent expenditure in the reai-estate,steel, aluminum and ccment seclors -- rather than the economy as a whole. Specifically, the govenmeol has raised resen'e requircmcals for banks, and imposed administrative limits on iending to .urd investmcnt in the offending sectors. This focus on the abilit' of banks to supply funds is scnsible. China's capital markets are still irrurature, so it is largely baaks that are financing the curent bout of overbeating. Of course, the authorities could try to easedemand for firnds by raising interest mtes, but tilis would probably not just bc ineJlbctive but even counter-productive- 1he sharp rise in bark credit 1(l partioular sectors appears1() be based not purely on thc 1ow cost of capital but on rclationships at local ievels bet$een govenrment officials, banks and companies.Arguably, a sharprise in interest rates would end even some of this icnding, but such a change $'ould also discoumge investmeflt in scctors that are curertly 'Iot overhealed.2e Alother force underlying the inflationary pressurcs was the dccision ol the govcrnmenl to peg the renmiDbi to tbe U.S. dollar. As Exhibit 2 indicates, China was cxpedencing a positive current accouqt balance as well as huge capital infows. In a ftcel!' floatiDg foreign exchangema*et, the dernand for the Chinese cwiency would havc driven up the value of the reiminbi. Ho\lever. the governmenl wished to maintain an undervalued currency in order to stimulate its
Hamey, "China Rate Rjse SendsMerkels inlo a Spk," Finarcial Times O.lobet 29, 2004,1 . '1BAhxandn a"China Counw Aepan," ELtl&erDL Ausust2004.yw.eru cad

exporis and iestrain imports. Herc aga!4 the basic motivation was a politica need to createmillions ofjobs and to expand the economy The govemment was able to keep the renminbi peggedto the U.S. dollar by selling the leominbi on tllf foreign exchangemarket in refiirn for U.S. doltaxsand other currencies that it then in as accumulaled an incrase its resenes As Exhibit 2 indicates, China's foreign exchangereservesincreasedfrom US$l58 billion in 1999 to US$408 billion in 2003. The govemment of China used these reserves to buy bonds, to a large degree in the United States, a process that enabled thc Udted States to maintain lor^' itterest rates in spite of its ]alge US$400 billion to US$500 biilioo Iiscal deficit. This process also increased China's money supply and thereby crealed an additional iDflation theat. Othcr nations that followed a policy of maintaining an undenalued curency could deal with the resuitant inllationary thxcat tlrcWh a tight money policy rhat u'ould restain aggregate dcmand. But, as noted abo!'e, there were political and egooomic reasons for beiag concemcd about the impacts of such monetary restmmr, Somg analysis felt that China's macrocconomic policies had paiDted the countr) into a precaxiousposition in terms of impending inflation and the difficulties and dange.s of fiscal and monetary resbaint. An additional element in this situation was the cotrcem of other govem$ents that China's policy in maintaining an undervalud cuIrency \s causing job losscs in their corn des. 'Ihis was a widespread concem in the United States,,nilere it seerned that China's maaroeconomicpolicigs were causiDglhe "offshoring" of U.S. jobs at a dme of relatively high U.S. unemployment- some administratiol officials - particularly the U.S. Trcasury Sccretary, Johr Snow - publicly urged the government of China to allow its crlrrency to ris in value. By tbe fall of 2004, the U.S. dollar had devalued substantially against the euro, and this meant that the Chinesc rervdnbi had devalued by a similar percentageagainst the euro. consequently, it was likely that Europeru govemment leade$ q'ould soon add their voices to that of the United States calling for an upwardrevaluation in ofthe rcnminbi. without such action, it lias possible that govemments in North Amedca and \ltstcm Europe might imposenerv import restdctionson goodsfrom Chira in order to protect$eir nations'jobs. Fo. GM and other foreign invstors in China, the undervaluation of tbc reaminbi had offered protectiol against competitive imports. In this sense, the unden?luadon of the renminbi had acted as the tarilf, supporting their initial businessenterprises.By the fell of2004, ho$ever, the threat of the revaluation of the renminbi and/or thc tlueat of ncw protectionist measures the part of foreign on govemmentsbad creatednw concems about the apgopriale China stratega. The danger of a hnancial crisis and economy-*'ide depression,though remoie, seemed a possibilit-v.

9805M007

All this tlough, has raised a buming question. ls China's bo,om, like those in 19th ceotr4'America, merely the prccursor ot an irnminent bust? Ot is il thc harbinger of a more sustainablc economic take-oft? The lack of consensusis strikmg. Despito the optimism that attends China's foreseeable economic future. there are a couple of scenalios under \'r'hich Beijing'r best laid plais could b thro\ n off-course. 'lhe first concems the possibility of shortagesof coal, elcctricity, ra\^ matedals, polt and .ail capacity coalescing into an inflationary tlend. If this happened, the central baak would have to laise intercst rates and the Gnminbi would probably appreciate. .!\ill Eventually, eithcr an ill lr'ind or a swfeit of domestic success causeCl]ina's stellar phaseofgrowth to abateor crumble just es it has in every emergitg economy in history. 'itren that day comes,thc falloul may be spectacular."

CHINA AN EXPORT BASE AS Analysts were pointirg to China's low labor costs and rapidly improving skill levels as the basis for motor vehicle expotts. Many saw Clina as a new global player in the seclor at a time \\'hen there was arlreidy a rvorld glut of production facilities. China had the potential to disrupt existing global production and marketing pafiems- llere as Pell, GM was quickly approaching a crossroads. Should it stand by while its partner SAIC and oihels cteated a vibrant expofi base. becoming GM comptitors tlroughout the world? Or should GM takc thc inilialive and use its China facilities to export to Norih America and ljurope? IIoq should Cbina lit ir GM's global stralegy? lt appearedthat Honda had already nladc the sfategic decision to use China as an export base: First, the home markt. Nex1,the Vrorld. t,'hina is poised to beconle a significant car exporte. as Foduction standardsrise and costsfall. wilb Honda's new plant, there's a difTerencc:The cars rolliJlg o{f its a-ssemblylines by early next year are heading not for the Chinese rnitrket. but to Europe - the first big push by a foreign camaker to produce in China for export. lf successful, Honda's Guangzhou ventue will be a significanl demonstration of the ability of China-based matrufacturing lo climb the value chai!. Specifically,il *ould sign:Ll China's debut
tJ Kynge, 'rhe Chnose baon is bound la and in t6are qul it might nat end lot anolher 1A yeats . wnhBunps Alang lhe Way " Finahciailntes. MQrch24, 2004, 13

as a car expoict, based on what Tim Drume of Automotive Resources Asia. a cat industry consultancy, describes as the "marrying ol JapanesemaDufactudng et'Iiciency with cheap labor in China." Produclion costs at Honda's Guangzhou plant are cxpectd.to be 2fflo lorryer than those in Japan, say factory offlcials."'

THEWAYAHEAD The govemmcot of China had crcated a motoi vehicle shategy that had attained outsanding initial success- Domestic 6rrns lacked design capability, modem technologies and mEdagerial capabilities. Allowing foreign iovestors to create joint ventures with donestic flrms had quickly overcome these challenges. By 2004, the question had ariseu as to whether this stategy should tle modified. What slbuld be China's next stepsio its motor vehicle slrategy? For GM, predicting thesenext steps1{'ouldbe critical in determining its corporate strategy. [n many rcspects. the business enviro.ment it faoed was changing fuamatically. Ne$'competitors from abnrad and heightened competition from domestic firms were bfluencing the industry sfructure. Demadd aad supply projections seernedsubject to greal uncertainties. Itsjoint veolures r-ift SAIC had been extremely profitable for both partrers, but should CM trust this relationship to continu hdefmirely? In Thailand, \Iherc GM had substantial asscmbly operations, there were no joint ventue rcquiremeDts. Mea ,\,hile, India had a population nearly as large as Chioa's, as vrell as low wages and optimistic gro$'th folecasts. Should Gl{ diversiry its China risks by investing heavily ir lrdia and other Asian countries?

tt David Muryhy, 'DnwDgAmbidon,'Far Eastsm Eotnor.ic Raview.Atay27, zOU, V. 161.t.21, 28.

Page 22

9805M01,1

ExhibitI TIARKET SHARES ITIANUFACTURER BY Shangahi\l/ Shanghai GM GZ Honda TjanjinFAW Changan Suzuki Beijing Hyundal Geely Chery Dongbng Citroen Others 15./"
110/r 11./o 5% 50 4Yo 5o/o
4a/o 4a/o

31%

Soutr*: 'Chinas Autamonveand Conpaoents Market2004,"KpMc, Septenber2OO4

Exhibit2 CHINA ANNUAL IT.IOICAf ORS ts99

GDPat fiarket pdces{Rmbbn) GDP (Usg bn) RealGDPgro\4lh (%) priceinflaiion Consumef (av;%) Populalion (m) Exports goodsf.o.b.(US$bn) of lrnporlsofgoods f.o.b.(USgbn) Curenlaccountbalance (US$bn) Foreign-exchange reserves exctgotd(USSbnl Totalenernaldebt(USgbn) Debt-seNice ratio,paidi%) E change rate (av)Rmb:USg Inwa.dFDr(Usg bn) a Actual. E@nod'sttnrethgenA es/'.ales b lJnn Soum EIURepatl, Chha,Scptenbet mU

2000

2001

2CO2

2003

8.206.60 8,94680 9,731.50 10,479 10 11,975.80 '1,2* 1 9S1.4 1,080.7 1,1757 1,445 9 7.1 8.0 8.0 93 (1.s) 0.4 (0.8) 07 1,250.50 1,261.80 1,273.10 1.284.34 1,295.20 1.7 249.1 266 1 325.7 438.3 (158.7) 12147',) (232.1) (281.5) (393.6) 21.1 20.5 174 35.4 459 157.t 168.3 2156 291.1 40E.2 '152.1 145.7 170.1 168.3 1891 11.7 9.3 8.1 4.6 8.3 8.3 8.3 E.3 8.3 3E8 344 44.2 49.3 53.5

Page 23

9B05Itl01,l Exhibit3 CHINA, INCOME DISTRIBUNON

45

/o
35 30 = 25
I

m
15

E 10

Quintile ot Populatlon

PaEe24

9805rrfi4 Exhibit4 KPMG SU'{ ARY OF 200,tMOTOR VEHICLE RULES

will Forign Ownership remain
China obtained an exemolion f.om the WTO on

maoy rulesthatban limitsplacedon foreigninvestment, automanufadure6\,!rehopingChinawouldeventually

relent lhis does l|ot aDDeaa be the to

Ttu nuhbr ofjoi.l vntures a manufaclurer allowedto is establish remains two per at vehiclesgmenl(sedan, and bus
A minifium investment of

givsdomeglic more This rgulation manutaclurers opporlunity developtheirowntschnologyand to rd prcduci'on the bases 'ncreas'ng bdnrer foreign by on invesimenls increases marketenlrv lhe in China The oolic1/ maksit moredifrcull for non-aulomotive inlo companies divercity business |t'e faslgroung to thetr autonotivemarketin China
lmpoit duty on venid$ will be Fyable upon entry to China. An irErersFin lol manufaclunng sourcrT ts and expeded, foreagnaulomolive nranufadurers are likely 10 continue lo slep up eflods io identiiy local sources of pans in odr to have price compeiitive producls This is already forcing some adomakers lo turther localize

Inveslmenl Size

bi[ion(US$241 nillbn) is Licence trdnsfer fromexisling vehicleprcductoncompanbsto non-aulomolive olerrFises nol is

From 2005 (no specifrcdate menlioned), imported vehid$ csn no looger be slored in boflded wahousesin China Cedain impoded paris will be subject lo the sme level of impod ianffs as complete vehides (cu.rently, larifis on impo.lod cals are 30 pef ced 1038 per ceot while tanfs on pads range from 10 per cenl to 23 per cenq Cals with major subassembljes (e g. chassis, engine) thal a.e imporled msy be laxed as

Soudng and

R&Dpenseswillbe tax deduclible thetuture in iR&D)

s frolicy is expecled to conunue Io encourage foreign companies loeslablishdomestc R&D cenves 3s wellas encouge localR&D activities andlhe developmenl of prcpeny,fof example localintellectual . Gl\,i has akeady established {s own R&D centre 1n Shanghai . Al present,Nissanand Dongienglv{otols are bui|dinga new R&D cen!@in Guangzhou, which will be ready at