There is little doubt that China will become the largest aftermarket in the world. It's not a matter of if, but when. Given its impact on the global market, industry players need at least a basic understanding of the nature and scope of the China market, whether they are currently active there or not. China's market offers both opportunity and threat and will have an impact on your customers and your competitive landscape that will be important to understand.
We are currently in the midst of a very turbulent market environment, which has negatively impacted China's new-car sales (declining almost 3% in 2018 and forecasted to decline a bit more in 2019). Current trade tensions are clearly impacting the market and there is no clear end in sight. Given that the aftermarket has a "long runway," these short-term setbacks will have a diluted effect on the service and repair market over time. Our underlying assumption is that the market will eventually get back on track and return, and China's aftermarket will continue to evolve along the lines we forecast, give or take a couple years. While the next one to two years will be challenging for sure, leaders in the aftermarket need to keep their eyes on the prize for the long-term.
China's Light-Vehicle Parc
China's light-vehicle parc (LPV) will surpass the U.S.'s by the mid 2020s to become the largest in the world, an inevitable conclusion since China's new-vehicle sales overtook the U.S. almost a decade ago [see Chart 1]. As in any market in China, it is critical to understand segmentation. Virtually every global vehicle maker is active in China today, resulting in a very fragmented car parc based on vehicle-maker share, model proliferation and wide price differences. Foreign makers (joint ventures) share about two-thirds of the parc, but pure Chinese suppliers are evolving steadily. Your addressable market can be highly affected by the parc mix and your comparative coverage strength. High-end vehicles made by foreign joint ventures typically offer greater attractiveness based on the vehicles' higher value and tendency to consume leading branded components. But small and midsize sedans, more the domain of local Chinese vehicle makers, comprise a major share of the market. Penetrating these vehicle types will likely require a different value proposition [see Chart 2].
Today's car parc is concentrated on the East Coast with the top five provinces comprising more than 40% of the total LPV parc. Although tier 1 and 2 cities in the coastal regions display higher car parc density, movement to the West's developing second- and third- tier cities has been observed over the past five years, especially with incentives by the government to buy small-sized vehicles [see Chart 3]. The distribution structure in the coastal areas is relatively well-developed and new-vehicle sales have slowed dramatically with a shift from mid-low-end to high-end/luxury vehicles. Competition is fierce in these markets, making it challenging for new entrants and squeezing the margins of existing players. The parc's growth will depend more on the migration West, where new-vehicle sales are more robust - a recent slowdown in new-car sales is likely to recover in coming years. In addition, demand in these provinces for used cars is growing, with sales exceeding 13.8 million units in 2018 (roughly half of new-car sales volume). Used-car sales experienced per-annum growth of approximately 10% to 20% over the past four to five years and will continue to grow as the infrastructure and regulations improve. This market segment will be important to penetrate given the older age of the vehicles and greater need for service.
With a current vehicle age of about five years, the aftermarket in China is still heavily light maintenance and repair-oriented, but as the average age increases, technical parts and repairs will accelerate [see Chart 4]. The light-vehicle repair market is estimated to reach $200 billion (USD) by 2023 at an average 9% to 10% growth rate, or almost four times that of the U.S. market's growth level. We estimate that China will overtake the U.S. around 2030 in terms of overall aftermarket demand. While regular maintenance-oriented repairs have begun to level at the overall parc's growth rate, general repairs - those typically occurring after 100,000 KM in miles driven - will grow at a more robust 13% [see Chart 5].
China's auto service market (including the auto parts distribution structure it relies upon) is highly fragmented and unsophisticated in terms of equipment, processes and human resources. There are many players at all levels of the value chain, including both foreign and domestic companies [see Chart 6]. The OES channel still controls the majority of repair parts and service for the light-vehicle aftermarket, estimated at more than 55% share of the current market's value. This is because a significant share of the parc are young vehicles and still under warranty. Further, the credibility of the independent aftermarket (IAM) channel is questionable to many consumers, including the fear of getting wrong or fake parts. However, OES' share is under stress for a number of reasons. With the aging of China's auto parc, more consumers will naturally tend to go to the IAM for lower cost of repair.
In recent months, the government has dramatically changed the system and requirements for garages to be opened and classified, away from a registration system to a record-keeping system. They did away with the old Class 1, 2 and 3 garage stratification to a more simplified system, making it much easier to open a service outlet, removing barriers and red tape. Effective on June 21, 2019, the government issued new directives to bring more transparency and governance to how garages operate. Now, a garage must issue reports, which include parts prices, labor rates, etc. The government also plans to leverage the web to enable car owners to report service-quality experiences to the public (Chinese consumers are adept at using the internet to check the quality of shops, their reputation, pricing, etc.). The Chinese government has specified different penalties for wrongdoing by garages, such as selling fake parts, using reman parts sold as new and other tactics.
The repair and service market, which comprises almost 500,000 outlets, up from fewer than 300,000 some 10 years ago, will begin to consolidate into chains and community garages. A community garage locates in the same area where the car owners live with a focus on serving "the neighborhood." Thus, it needs to have good service and a good reputation. These kinds of shops cannot do major repair, but they will help the owner to find a suitable garage for any larger repair. The aim is to build up trust with the community shop, something lacking today. Given the lower barriers to entry, the number of IAM garages will likely increase. "4S" shops (dealerships) number more than 29,000 of the total service outlets but of course are more sophisticated and have larger scale. Their growth is lower-single-digit and mostly in central and western China, where new car sales are higher.
While single repair shops dominate the service shop mix, chains as a percent of repair shops are steadily growing at more than 20% per year [see Chart 7]. While international companies initially brought the chain concept into China, there have been few successes. Slowly but surely, domestic companies are increasing their positions. E-commerce platforms, such as JD.com, TUHU and Tmall, are investing heavily to get into the service business in order to provide a more integrated solution.
OEMs also are actively developing their own repair chain structures through both direct and franchised operations. Chexiang Home (owned by SAIC), Autoyong (owned by BAIC) and CareMore (Chegongfang - owned by SAIC-GM) are the top three brands, accounting for more than 90% of OEM service outlet market shares. Chexiang Home is the overall leader with more than 2,500 directly operated shops. ACDelco and Quick Lane lag far behind the market leader. Bosch, as one of the leading Tier 1 parts suppliers, has more than 1,300 authorized repair shops (BCS), now upgrading to the Bosch Service Program.
In addition, there are some 80,000 tire shops covering multiple tire suppliers in China. However, most of the tire shops are authorized by the top 10 brands such as Michelin, Continental, Pirelli, KUMHO, Goodyear, Bridgestone, etc. These specialty shops function both as repair (e.g. Michelin Tire Plus) and selling points for suppliers' goods.
Among most independent repair shops in China, parts sourcing is very basic to say the least, with little use of technology and a severe lack of complete parts information. Most repair shops employ multiple sourcing channels (OEM/OES, retailers, first- and second-tier distributors, local parts manufacturers, import agents, etc.) to get the parts they need. They will typically use the telephone and Wechat/QQ for ordering. Most shops now have computers and intelligent mobile phones and will not carry much inventory at all except for some simple, fast-moving parts like lubricants, additives, wiper blades, etc.
Pricing is increasingly becoming more transparent as well as competitive. Branded parts suppliers are aggressively trying to supplant genuine parts in the IAM channel. While a good-better-best offering is not as commonplace as it is in the West, more stratification in value propositions and price points is slowly evolving [see Chart 8].
In general, brand recognition and loyalty are low at the car owner level and even at the garage level. The car owner is still very unsophisticated (many are first time car owners) and relies on the garage for guidance or will default to genuine parts. The garage owner will similarly rely on the distributor for brand and parts guidance.
We expect the service structure to continually evolve as the aftermarket expands and matures, especially given the government's recent policies to help modernize and standardize the repair industry, which will both promote consolidation and improve operations. This pressure will cause some smaller service organizations to go out of business or to be swallowed up into a chain.
The topic of distribution is hotly debated in China as the market's infrastructure evolves and matures. Multiple business models are being implemented from the classic two-step and three-step parts flow through a more traditional distribution structure, to various e-commerce platforms and approaches. Like the service structure, distribution suffers from a high degree of fragmentation with thousands of wholesalers and retailers spread across the country, supplied by many parts suppliers and selling to a disparate group of service outlets [see Chart 9].
Auto parts cities remain the backbone of distribution to the IAM, though they struggle to keep up with the market's expansion. Auto parts cities in China evolved historically from the fragmented parts supply structure and were driven by the government as a means to organize and house the disparate number of parts dealers. Today, there are some 1,000 parts cities across the country, generally falling into two types. Regional parts cities, such as Shanghai Dongfang, where sub-distributors from neighboring provinces come to buy parts to bring back to their local markets. Turnover for the larger auto part cities can be more than $500 million and they may house up to 1,000 dealers. There also are more local parts cities, which are smaller in scope and primarily serve the local urban market, typically with 50 to 150 dealers. The market is replete with part suppliers, agents and retailers in these auto parts cities, which mix together to compete. Major auto parts cities are offering more services now, such as inventory mortgages, warehousing, etc. and trying to be more like platform service providers. Some industry observers believe the future role of auto parts cities will evolve to more of a logistics/warehouse service function.
China's traditional IAM distribution structure is multi-step and inefficient compared to the U.S.'s mostly two-step structure. With the exception of the more developed specialized distributors for lubricants, tires and batteries, most distributors are very small with limited scale and resources. Many only started in business in the early 2000s and are still run by first-generation management. Most of these distributors go through multiple channels where wholesaling, especially to reach smaller, surrounding markets, is a major share of their revenue. Revenue of $5 million represents a decent-sized distributor with very few over $100 million. Most distributors are locally oriented in terms of geographic coverage with some large, regional players and only a couple aspiring national distributors, like Carzone. Carzone has more than 800 parts supply points and can now be considered nationwide. Its objective is to have more than 2,000 shops by 2020 and achieve "30-minute delivery" to garages [see Chart 10].
Chinese distributors have many challenges to address as they attempt to serve the IAM market. With lack of scale they have limited leverage with suppliers and an insufficient revenue base to support their growing resource needs. Their technology level is low with minimal use of WMS/TPS, poor inventory management and unsophisticated business systems. The parc's fragmentation and dynamics make it very challenging to obtain the right parts in a timely manner, which is aggravated with no complete e-catalog available. Professional management is weak and there is a significant need for training, marketing skills, brand-development techniques and the like.
To address these challenges, distributors are exploring different business models. The smaller distributors are banding together to form platforms where they share some resources and combine their purchasing power. For example, a group of Audi-focused by-makes distributors may form an affiliation based on their common parts focus to share a DC or combine their purchases. Some of the established program groups from the West have now setup locally, such as the Alliance out of the U.S. and Temot out of Europe, which have joined forces to bring their program group model to China (CAAPA).
And, of course, e-commerce is attracting attention at all levels of distribution, including parts suppliers and independent e-commerce platforms like JD.com. China's embryonic and fluid aftermarket infrastructure provides fertile soil for the introduction of digital solutions like e-commerce. For example:
- A young and highly fragmented car parc that is difficult to service via a traditional distribution model
- Relatively naive (first time) car owners with limited repair service experience and no set behavior patterns who are relatively open to new buying methods
- Lack of trust between the car owner and parts and service providers, which encourages consumers to tap the web for information
- Digitally savvy consumers in most age groups
- Hot money driving investments in aftermarket digital platforms, including major existing e-commerce platforms from other industries
China's auto market is rapidly changing across the value chain, not only developing hardware businesses, but also building a new ecosystem for service businesses [see Chart 11]. Digital approaches are rapidly disrupting existing go-to-market channels. For example, China's No. 1 ride-sharing platform, DIDI, is a good example of an "automobility" player expanding its ecosystem to drive new value creation and control costs. Drivers are connected through online application to DIDI's big data system. To optimize the cost structure of individually owned cars and fleet operations, DIDI built offline service outlets, providing registration, car leasing, repair and maintenance, car insurance and other services.
China's e-commerce market size will continue to grow at a blistering pace over the next few years, driven by an expanding aftermarket and increasing e-commerce penetration rate [see Chart 12]. OEMs, traditional parts manufacturers, distributors and garage chains, as well as internet platforms, are flowing into this fast-growing e-commerce market with integrated online and offline channels, unique supply chains and big data. As an example, China's leading auto aftermarket e-commerce B2C platform, JD, has continuously expanded its product and service offering, and has built a closed loop of B2B2C from parts supplier to garage [see Chart 13]. Carzone, China's largest general distributor, joined forces with Alibaba and the Jingu Group in August 2018. Alibaba brings the platform, big name and IT technology, while Jingu brings some of its garage chain/service network (Jingu has its own garage chain and introduced a new garage chain, "Tmall Car Stop" in October last year). This type of structure shows a paradigm shift - from discrete investments in distributors, garage chains, quick repair chains and even car washes to a more vertically integrated approach using internet platforms. Another example is TUHU, which successfully established a new auto parts retail model via satisfying Chinese car owners' demand for "Effortless Purchase" online with its "Rapid Installment" program utilizing its roughly 13,000 strong national service outlet network with centralized supply of auto parts.
For those utilizing e-commerce, there are two main channels, B2C and B2B with different key platform players, product flow and channel requirements [see Chart 14]. For B2C, brand awareness and online promotion are two key drivers to attract end users' brand selection. Except for the top brands in a category, like Bosch, most brands heavily rely on the platform's online promotion to build traffic. In the B2B channel, offline promotion, driven by the platform's sales team, is needed to boost sales to garages. Further, there are different operation models within each main channel. In B2C, one can let the platform run the program, self-operate the online flagship store or use another third party to manage the operation. Each model has its pros and cons. Similarly, in the B2B channel, the auto parts brand can let the platform run sales (as a wholesaler) or it can operate a third-party online store on the platform.
These types of developments will create both challenge and opportunity. Some key challenges are:
- Fast evolving e-commerce business models and players necessitate that foreign auto players carefully select their Chinese e-commerce channel partners and their operation model
- In order to win in the e-commerce channel, auto parts manufacturers are required to have diversified digital capabilities, e.g. online marketing and services
- New entrants need to differentiate themselves to compete with well-known foreign brands that already have established partnerships with major e-commerce platforms
But opportunities exist as well, such as:
- Rapid e-commerce growth creates new market opportunities for auto parts suppliers in a more open playing field
- E-commerce platforms provide a shortcut opportunity for new entrants to cover China's highly fragmented auto aftermarket and circumvent traditional players without a big investment on channel build-up and the need to deal with numerous distributors
- E-commerce's "long-tail sales model" makes it an ideal platform for SME (small-to mid-sized enterprises) brands to test the water in China with more limited risk and effort
As you try to navigate this dynamic playing field, you need to address a number of key questions. What is the evolving ecosystem around my product and market space? Who are the key players? What is my competition doing? What share does e-commerce have in my product category and how will it grow? How can I leverage a digital strategy to obtain more market share? How do I integrate my digital strategy with my existing channel position and approach? What type of partner(s) or platform(s) could accelerate my penetration and mitigate my risk and investment? These are challenging questions that must be addressed or you may be left behind.
What are the implications of China's aftermarket development and how can companies better exploit the potential it promises?
As a starting point, let's consider some of the compelling reasons not only to participate in the China market but to take an aggressive approach [see Chart 15]:
- Large and growing market which will be the largest in the world. China will contribute the biggest incremental growth worldwide in the aftermarket
- The market still has many needs for brands, technology, business processes, etc. though the competitive differentiation of new entrants will depreciate as the market matures
- Your customers are likely there or are on the way. If you don't go with them, you are vulnerable to opening the door to new suppliers who will address their China demand
- No doubt your competitors are already there as well. What advantages will they gain (scale, customer access, new products, etc.) which they then can take back to your home market?
- There are multiple ways to play in the market that can be aligned with your resources and risk appetite. In general, there is a path available for most who are willing to take the plunge
- If you are actively sourcing from China, you have a beachhead which can serve as a starting point to penetrate the domestic market
- Lastly, one must consider the risks of doing nothing. Opportunities lost? Competitive threat?
International, as well as domestic players, need to consider these potential consequences of the market's rapid development. While your business model employed in the U.S., Europe and other more mature international markets can be used as a starting point, China is likely to define its own path forward which will necessitate that you "China-fy" your strategy. Several strategic and tactical areas are worthy of particular focus as you develop your China approach.
Determining your addressable market where your value proposition and product portfolio fit and where you can make sufficient margin, is a key first step to developing an effective strategy. The China market presents a diverse profile of needs, not all of which will be profitably addressable by your company. Determining where and how to play is critical and requires a deep and current understanding of a very dynamic market [see Chart 16].
The aftermarket will continue to expand geographically from Tier 1 and 2 cities to Tier 3 and even Tier 4 markets. Starting out trying to cover the nation is difficult. Rolling out your geographic coverage based on the nature and scope of your defined addressable market is a sensible approach. If you're in the early stages of development, focusing on the top 25 urban markets is the norm whereas established players need to have national coverage, including the more remote provinces where future growth will be more robust [see Chart 17]. Beyond working a traditional geographic coverage approach, leveraging the boundaryless e-commerce channel to access the national market also is a potentially practical tactic for small-medium-sized players to achieve broader coverage.
Securing, retaining and managing good distributors to achieve this coverage is a major challenge today for virtually all parts suppliers. Given the thousands of potential distributors in the market, a rigorous screening and qualification process needs to be done. Additionally, as most small distributors are unsophisticated and resources are thin, good distributor support is required including training, credit, promotion to garages, etc. Many parts suppliers experience a high turnover rate among their distributors. Dealing effectively with the evolving program groups and platforms will also be an important success factor.
Several other strategic issues deserve attention as well, such as:
- Vehicle coverage. Given the parc's fragmentation and prevalence of local Chinese vehicles, building adequate coverage for your products will be challenging.
- Brand development. There is limited awareness of brands at the consumer and even service levels. Development of brands will be an important strategic issue while also controlling counterfeiting (both in the local market and exports). It is an expensive and time-consuming process to clearly convey your brand's value proposition and to differentiate it from your competitors.
- Technical training. Given the market's youth, there is significant need for training at the garage level, which offers the opportunity for suppliers to differentiate their value proposition. Using cost-effective tools, including digital ones, is important to achieve this end.
- Supply chain competence. The distribution structure will eventually consolidate. You need to be aligned with the right supply chain partners employing the right business models. Companies like JD.com, TUHU, Tmall and Alibaba are changing the rules of the game regarding how parts and services are sourced and delivered.
- Management. Establishing a strong and stable team in China is difficult given a limited pool of experienced resources and very high turnover. Inculcating your value system and business processes is challenging but critical to success.
- Partnerships. Especially as new players enter the market, cultivating partnerships along the value chain can be the difference between winning and losing. Sometimes these partners may seem like strange bedfellows, especially some of the new entrants to the market, but they can effectively complement your value proposition and route to market.
Given the explosive emergence of e-commerce solutions to China, adapting your strategy to be digitally relevant will only become more necessary to thrive if not even survive. Here are some suggestions on potential digital tactics to consider.
- Leverage E-commerce channels e.g., thoughtfully setup online shops, partnerships with key digital players (JD, Alibaba, etc.)
- Strategically position product mix and/or implement a multi-brand strategy to cover both online and offline channels - ranging from premium branded parts to private-label for prioritized distributors
- Provide product and service package solutions including offering online to offline (O2O) installation and maintenance service connections to meet workshop and end-user needs
- Implement a digitalized Sales & Marketing strategy, e.g. use social media to directly communicate/sales to workshops/end-users
It also is important to consider that China can be an effective platform on which to expand into other Asian markets, many of which also are showing strong growth. You likely can leverage your manufacturing and sales resources in China to expand in the region, which also can provide a more competitive source against Chinese suppliers exporting to ASEAN.
Lastly, successfully doing business in China requires that you adopt some key principles of success:
- Pursue strategy before structure. Make sure you have a clearly defined and validated business case before considering mode of entry. Too often companies get distracted by joint venture discussions, building a factory or signing a master distributor agreement before a path to profitable business is laid out.
- Localize your business model as soon as you can. It is difficult to broadly compete in the local China market via imports alone or through a third party managed from thousands of miles away. China is too complex, dynamic and important to delegate your strategy to someone else. There are step-wise phases companies can pursue to localize which can fit resource availability and risk appetite [see Chart 18). We often say that in China, "Everything is possible but nothing is easy!"
- Observe the 6Ds, due diligence, due diligence, due diligence! You need to invest to do your homework. The market is opaque in many ways and changes fast. There is no substitute for quality and current market intelligence.
Developing a winning strategy for a large, complex and highly dynamic market like China needs to consider long-term development. China will be the largest auto aftermarket in the world. Today's turbulent market environment, while presenting challenges, also can provide unique opportunities to strengthen or even reposition your business model. Management needs to think creatively to successfully navigate the next few years and must consider innovative business models to elevate their company's market position above the more competitive and low margin trenches. A careful, well-researched and thought out strategy is needed to ensure a successful and sustainable market position. AMN