China Probes Audi And Mercedes Over Monopolistic Practices

China has been the most promising market in recent years for luxury vehicle brands such as Volkswagen AG‘s (OTCMKTS:VLKAY) Audi, BMW, Daimler AG‘s Mercedes-Benz, and Japanese brands such as Toyota Motor Corp‘s (NYSE:TM) Lexus and Nissan’s Infiniti. China is the second largest premium vehicle market at present, behind the U.S., but is the fastest growing. The country, which presently sells just under 1.5 million annual units by our estimates, is set to overtake the U.S. in the next couple of years in terms of volumes. Not only has China been a pivotal source of volume growth for luxury vehicle manufacturers, but the country has also boosted revenues per vehicle for them. Large-scale import of vehicles adds high import tariffs, transportation and assembly costs for automakers, who raise their product prices in order to protect profitability. However, according to a recent probe conducted by China’s antitrust regulator, the National Development and Reform Commission (NDRC), foreign companies such as Audi and Chrysler have been found guilty of monopolistic practices pertaining to highly inflated vehicle and spare part prices. ^[1] According to NDRC, although the high vehicle prices cover additional costs, including import tariffs and other taxes, they still fail to justify the unusually high prices of models sold in China, sometimes 2.5-3 times more expensive than their counterparts sold in the U.S. Audi and Fiat’s Chrysler will now be charged under China’s anti-monopoly law effective since 2008. The regulator has also launched probes into Japanese automakers and Daimler for the same.

In view of the investigation, luxury carmakers have reduced prices, particularly of auto spare parts, in line with China’s aim of maintaining competitiveness in the automotive industry and also protecting customer interest. Apart from an inevitable fine that will dent finances, this will effectively lower revenues per vehicle on the imported models going forward. Audi leads the luxury segment in China’s automotive market at present, while Mercedes ranks third. Both these companies recently scaled down prices of auto parts in the country significantly, which although reduces their spare parts revenues, might not impact margins.A higher proportion of local production for these companies and economies of scale could absorb the price-cuts, thereby maintaining profitability.

We have a $49.19 price estimate for Volkswagen AG, which is roughly 11% above the current market price. The company’s stock has fallen by over 14% in the last three months.

See Our Complete Analysis For Volkswagen AG

China Investigates Audi and Daimler

Antitrust regulators of China urge that certain foreign companies, which presently dominate the country’s luxury automotive market, have breached the anti-monopoly law by earning exorbitant profits owing to unusually higher vehicle and spare part prices. The German companies Audi, BMW and Mercedes together form over three-fourths of the premium vehicle volumes in China by our estimates. The NDRC and State Planning Commission of China are examining if these foreign companies exercise control over component-makers, owing to their strong market positioning, so they supply only to authorized dealers to keep the prices high. The NDRC will fine both Audi and Chrysler, while the probe into Daimler is also ongoing. Under China’s anti-monopoly law, the NDRC can impose fines of 1% up to 10% of the revenues earned by the companies in the previous year. ^[2] Apart from the German automakers, the Commission has also investigated 12 Japanese companies over similar anti-monopoly charges. This move also safeguards interests of Chinese automakers, who have suffered due to higher sales for the bigger foreign automakers, fueled by consumer preference for globally renowned luxury brands.

Lowering Prices Might not Impact Margins

Both Audi and Mercedes reduced their vehicle spare part prices by 15-40% in China recently. But despite this decrease, margins might remain protected. According to Bernstein, around 10% of sales in the global automotive market are constituted by spare parts. ^[3] If Mercedes sells 275,000 units in China this year, up 15% year-over-year, with an estimated average revenue per vehicle of $52,500 for 2014, the brand along with its China affiliates is expected to generate around $14.45 billion in the country this year. Given the fall in spare part prices by an average 15% in China, and 10% contribution of spare parts to the overall revenues, Mercedes’ China revenues will lower by roughly $0.22 billion this year, 1.5% of the estimated sales in the country. On the other hand, Audi and affiliates’ China revenues might be lowered by $0.5 billion, 2% of the estimated overall sales in the country. However, both the automakers believe that despite the slight decline in sales, profitability might not suffer due to larger benefits from local production and economies of scale. Sourcing parts locally can allow for the cost advantage to be passed onto consumers, thereby protecting margins.

We have a $87.12 price estimate for Daimler AG, which is roughly 10% above the current market price. The company’s stock has fallen by over 13% in the last three months.

See Our Complete Analysis For Daimler AG

Audi’s two manufacturing facilities in Changchun and Foshan in China are expected to have a combined annual production capacity of 700,000 units by 2017. ^[4] The brand sold over 490,000 units in the country last year, and if we expect a CAGR of 12% through 2017,  the same rate as the expected growth in China’s overall luxury vehicle market, Audi could sell close to 771,000 units in one year by then. This will mean that 90% of the vehicles sold by Audi in China will be locally produced. Around 83.6% of Audi’s volumes in China through June were formed by locally produced models. ^[5] On the other hand, Daimler, which owns 12% stake in China’s BAIC Motor, will invest around $5.5 billion in the country through 2015, one-fourth of which would be dedicated to capacity expansion and opening new engine production facilities. ^[6] Presently, just over half of the vehicles sold in China are locally produced, and Daimler aims to increase this proportion in the coming years. With expansion of local production, both Audi and Mercedes could benefit from economies of scale and lower costs of material sourcing. Along with protecting profitability, lower spare part costs will boost after-sales services, providing further incentives to customers for purchasing these luxury automobiles. The effect of lower spare part prices might not have a significant impact on the bottom line for both Audi and Mercedes, but the inevitable fines by the NDRC are expected to hamper finances.

See More at Trefis | View Interactive Institutional Research (Powered by Trefis)
Get Trefis Technology

1. Audi, Chrysler to be punished over monopoly practices in China, wsj.com [↩]
2. China’s anti-monopoly law [↩]
3. Audi lowers spare parts prices in China, bidnessetc.com [↩]
4. Audi in China [↩]
5. Audi sales in China through June [↩]
6. “Daimler annual report“ [↩]