Insights

China Automotive Industry Risk Study

Enhance auto dealership's capability to survive in L-shaped economy

China Automotive Industry Risk Study: Enhance auto dealership's capability to survive in L-shaped economy is designed to understand the current operation and development of auto dealerships in China through an analysis on dealers’ financial and operational data, then further incorporating Deloitte’s survey results on dealer's operational performance. Based on the financial data of China’s listed dealers (group) and Deloitte China Dealership Excellence database, the study examines the risks from the industry, policy, operation and management perspectives and provides improvement recommendations for the OEMs, dealer groups and independent dealers.

Key findings

In the last two years, China automotive market has experienced a significant slowdown in the dealership sector. In 2015, the contradiction between the production and sales became increasingly prominent. The anti-monopoly investigations and constantly amended and released regulations on industry management as well as intensified competitions in the market singling a dimming future for auto dealers’ operation in China. The followings are the main takeaways from the report:

  • Auto dealers are in need of industry consolidation and business model innovation. Since 2015, 4S shops in China have experienced deterioration in operations with a wide range of loss. “Continued loss” has become a norm for some dealers. The unbalance between input and output will surely trigger the reform in operation models. An increasing number of dealers choose to introduce new businesses or seek capital cooperation to adapt to the changes in the market.
  • Dealers are facing significant compliance risks. Since 2014, the government authority has initiated a large scale of anti-monopoly investigations in the automotive industry, and at the same time, has modified and released a series of rules and regulations specific to the automotive industry to facilitate the fair competition and regulate the industry players’ operations. In June 2015, the Bureau of Price Supervision and Anti-Monopoly of NDRC initiated to draft anti-monopoly guidelines. As the first detailed rules guiding enforcement of Anti-Monopoly Law, these guidelines will define the abuse of intellectual properties, anti-monopoly regulations, leniency policy, exemption procedures, procedures of investigation suspension, and penalty calculation in automotive industry. It suggests that the full-scale deployment of Anti-Monopoly Law is on the agenda. The changes in the regulatory environment have forced the OEMs and the dealers to face the legal consequences for their long-standing business conducts which are against the newly released regulations. In the long run, the competitive landscape of the automotive industry will look rather different than what it is today.
  • The dealers’ profitability has dropped sharply. Over the past year, the contradiction between OEMs’ aggressive expansion on production capacity and the sluggish sales performance at the store front has become increasingly apparent. From January 2014 to December 2015, the cumulative undigested inventory of passenger vehicles in China reached 347,400, which was at high level and occupied a huge amount of working capital. In addition, since 2014, new vehicle sales has been depressing with the profit margin dropped constantly to 2.54 percent by the end of 2015. Meanwhile, confronted with increasingly fierce competition in the auto aftermarket, dealers’ profit margin was 35.61 percent for 2015, lower than previous years. Although dealers have adjusted their business structures to some extent in response to market changes, the situation is still grim.
  • Capital demand and cost of capital remain high. Dealers’ inventory coefficient has hit or even exceeded the warning line for several times. The distribution channels of several brand dealers are shaky. Dealers’ withdrawal from dealership network and bankruptcy have become commonplaces. Bad sales and wide price gaps of new vehicles lead to slow circulation of capital. While, OEMs constantly force dealers to increase inventories, making dealers spend large amount of liquid funds on buying new vehicles, and many dealers are on the verge of capital chain break. The cost of capital for different financing channels varies, therefore, being able to obtain cheap but quality loans becomes the key for dealers to solve the liquidity risk.
  • Lean management ability needs to be improved. In respect of expense management, as new vehicle market on the sell side is facing fiercer competition and the high inventory leads to a higher selling expense and interest, many dealers are struggling at the edge of break-even line. Then, in terms of operation management, dealers lack lean management on business units. Under the severe market environment, an increasing number of dealers are aware of crisis and the significance of performance management for improving dealers’ management. However, currently dealers’ understanding of performance management is limited to basic business data and financial statements, neither of them are adequate for the management decision making process. At the same time, the management usually only considers indicators directly related to the operating performance, rather than analyze them from the perspective of investors, not to mention to perform effective management.
  • Rapid expansion at the early stage leads to the absence of excellent management talents. The industry of auto dealers is adopting a model of merger and expansion under which the strong one will get even stronger. However, some dealer groups have neither fully considered whether existing resources can meet the needs of development when formulating the strategies, nor built an overall evaluation system. Meanwhile, as group brands diversify and cross-regional expansion develops, the scarcity of management talents at the group level as well as the single shop level becomes an issue.
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