Two Ernst & Young auto industry experts from Detroit, the auto hub of the US, sat down with Shanghai Daily to talk about what Chinese automakers can learn from Detroit’s experience. They are Michael Hanley, global automotive leader for the firm, and Jeffrey M. Henning, the global automotive markets leader.

Detroit has officially entered Chapter 9 bankruptcy protection. Do you think the local auto industry will be immune from the city’s financial breakdown?

Hanley: We do believe the auto industry here will stay out of the fray. The entire issue for Detroit is the municipal government’s huge liability for pension benefits after the tax base for the city has declined to the point of not being able to support the promises made to retirees. This has nothing to do with the auto companies, which just happen to house employees in the city. Those companies are doing extremely well and are profitable. I can see, as a Detroit resident, that what’s happening today will really enhance their opportunities to get stronger, and to invest, for those that moved out to the suburbs, back in the city.

Michigan Governor Rick Snyder paid a visit to China three months ago, during which he pitched Michigan, and especially Detroit, investment to Chinese auto companies. What kind of advice would you give to your Chinese clients?

Henning: The reason why so many non-American carmakers have located in Michigan is its significance as a base of talent, research, engineering and manufacturing. Don’t just look upon the region as an attractive investment from a real estate standpoint. Think about those people between jobs who know the industry well. The Chinese will very likely follow the footsteps of others, viewing the region as the best place to start business in the US.

Yes, some Chinese carmakers are using Detroit as a stepping-stone to crack the US market, but they don’t have much experience in a developed market like the US.

Hanley: It is really a tough market to enter because it is in a slow-growth zone and every single segment is highly competitive. Five years ago, before the financial crisis, there were still some opportunities, but all those gaps have been filled.

So why would Chinese carmakers explore a slow-growth market when their home market is still the fast lane? 

Hanley: Maybe they see it as a way to validate that their products are really state of the art and meet all the standards. A car with proven, successful record in a Western market can be a big attraction for buyers in China.

If a Chinese carmaker is undaunted by the challenges and planning to build a plant in the US, is that plan too ambitious?

Henning: It has to make sure its entry plan is well organized to be able to run a lot of processes simultaneously. The easiest part of that plan would be building a plant. Getting a car qualified from the regulatory point may take longer time than expected. Distribution is always an issue, considering the vast territory of the US. And financing services, which play a key role in the sales and leasing of cars, need to be established. The point is about building up an entire value chain.

Chinese auto-parts suppliers are also aiming at the US market. What do you think of their chances?

Hanley: We do see a huge presence by Chinese companies at auto-parts shows in the US. If their products reach a level comparable to those on the market, they will have a chance. But the country’s aftermarket is dominated by large retailers that have a huge amount of purchasing power. They have been putting tremendous pressure on components suppliers over pricing in the last five years.

Henning: I fact, US-based auto-parts makers themselves are looking at other markets to help improve their profitability because their home market is very difficult, whether it is from the standpoint of price or growth. The business opportunities with original equipment manufacturers are based on quality, price, deliveries and services. Chinese auto suppliers could potentially play in that space if they fit the criteria. US carmakers are thinking about their supply base strategically. They are not just looking for a regional player, but rather for someone who can support their platform whenever they produce.

Hanley: I think the biggest challenge for Chinese auto-parts makers in the US is logistics — how to transport components via a long distance and get them there on time. There is a trend among manufacturers of wanting to get closer to their suppliers. US carmakers are more focused on how Chinese suppliers can support them in China. That’s a big opportunity they should take.

I heard there was a time in the early 20th century when Detroit’s booming auto industry fueled up the land market. The real estate business was said to be more lucrative than carmaking for car companies. I don’t know whether this story is true, but it somehow reminds one of what’s happening in China, where some domestic carmakers put infrastructure development at the top of their agenda despite their lackluster sales growth. Could you comment on this issue?

Hanley: We don’t believe there was ever a time when land was the major business priority of US carmakers. Real estate was there to support the auto industry. What you describe is not a business strategy but a function of the economy. If real estate value is increasing, it will be an opportunity to offset the cost challenges caused by excessive production capacity. 

What you think of overcapacity risks faced by China’s auto industry?

Hanley: Overcapacity can happen just for a short term as long as people have the flexibility to make adjustments as they go through time. Because of the political and regulatory environment, there is no opportunity for Europe to reduce its capacity, which turns out to be a very challenging problem over a long period. But in the US, we are able to fix overcapacity very fast because our government really pushes for that. I think China’s car production capacity will continue to grow with its market. We don’t see the kind of crisis here as we see in Europe.  

Henning: My question would be how the capacity is split among different brands, rather than whether it is too much and should be permanently reduced.

Industry consolidation can be achieved through mergers and acquisitions, as well as bankruptcy. The latter is a word that doesn’t translate well in Chinese, meaning just “fail” or “dying.” “Too valuable to fail” describes the position some Chinese domestic carmakers, especially smaller ones, find themselves in these days. Since they are often the economic pillars of local economies and key drivers of GDP, local governments try their best to keep carmaking businesses afloat. Do Chinese officials need to learn to see the positive side of bankruptcy, which has helped some American automakers reinvent themselves?

Hanley: We like to use the term “restructuring” instead of “bankruptcy.” The word’s connotation is determined by each legal system. In Europe, it means liquidation — one goes out of business and there is no way to save it. In the US, it is a way for you to have a fresh start, which works very well for the auto industry. A problem occurs when you support a business without the reorganization part because it doesn’t change the way the business operates. There are no new business plans, new structures or reduced liabilities that can give a company the chance to be successful on its own.

Henning: When auto companies fell on hard times around the world, governments went out of their way to provide stimulus packages to prop the industry up. From a market standpoint, that only works if the business is sustainable on its own, based on market demand.