CHINA'S automotive industry has experienced spectacular growth since 2000, expanding by a factor of 10 in the first decade of the new millennium. As China's vehicle parc crosses 80 million units in 2011 and surpassing Japan as the world's No.2, the implications could be even more far-reaching than when China became the world's largest new vehicle market in 2009.

The vast number of vehicles in operation will invariably create huge demand for aftermarket services, the need to trade-in old cars for new ones, and various forms of infotainment, navigation and assistance, etc. With an increasing car population, the demand for a host of automotive services is expected to skyrocket in the next few years.

At present, the automotive service sector in China is still at its early stage of development, characterized by high growth, high profit, high fragmentation, low penetration and under-regulation. It is also confined mainly on a regional basis. Cross-regional operations or national chains have yet to be established.

In the automotive retail sector, polarization of auto dealerships has been speeding up in recent years. As profit margins from new vehicle sales are being eroded by fierce competition, dealers are now aiming at capturing growth opportunities in after services. Though services and the sales of spare parts only account for about 15 percent of dealerships' total revenue, their contribution to overall profit have reached about 45 percent or even more. Visionary dealers have already started transforming themselves from being purely sales agents for OEMs into full-fledged service providers. Domestic and overseas investment communities are hot on the investment trail of Chinese automotive distribution. Their entry into the market will propel more M&A activity and industry consolidation in the segment.

After-service sector

In the after-service sector, many different service providers co-exist in the market. OEM-authorized 4S dealerships are still the dominant channel, accounting for slightly more than half of the market, and the rest are chain-stores, independent "mom-and-pop" stores and full-service garages.

In many after-sales service sectors, the industry remains highly fragmented as many small, stand-alone, mom-and-pop players coexist with emerging bigger players as they enjoy significant cost advantages.

However, as the market matures and consumers become more sophisticated, requirement for service quality and brand reputation will definitely grow in importance. The competitive advantage of bigger players through economies of scale/scope can been seen only when the market really takes off and reaches a critical mass.

Looking forward into the future, we believe chain stores will account for an increasing share of the market, though gradually in the medium term. Among many other factors, business model and growth pattern are the most critical success factors. For example, within the chain-store format, a "one-stop-shop" that offers a full line of services seems to be more robust than others, given its broad product offerings, relatively high entry barrier and higher gross margin potential. At the same time, the direct-control model also works better for many franchising systems in China. Therefore quite a few players have switched back to direct-control models, even if they have tried with franchising, so as to ensure service standard and management control, though slightly sacrificing the speed of expansion.

Above we are talking more about the B2C sector, while the other key aspects of auto-related services is B2B. Businesses within this sector include vehicle and parts logistics, collection and recycling of production scrap materials and waste, IT services tailored for the automotive industry (such as dealer management and CRM systems), parts refurbishment and end-of-life vehicle disposal.

B2B services

When configured and operated correctly, these activities serve two important purposes. Firstly, they help to enhance the overall efficiency and competitiveness of the auto manufacturers by reducing waste and shortening delivery time. Secondly, they promote a greener and "close-loop" industry through the recycling and reuse of scrap materials from production and end-of-life vehicles. Roland Berger estimated that China's automotive B2B sector in China was worth about 70 billion yuan (US$10.95 billion) in 2010. With an estimated value of about 55 billion yuan, automotive logistics services accounted for a lion's share of the B2B sector.

Due to China's vast geographic span and its still "work-in-progress" logistic system, high logistic cost is imposing great burdens on the auto industry. As new vehicle sales continue to grow and OEMs diversify their manufacturing footprint beyond traditional bases, market demand for reliable and cost-effective automotive logistic services keeps growing, and solution-oriented service offerings will become increasingly important in the future.

End-of-life vehicle disposal is also under-developed. This will become increasingly a critical issue to be addressed for sustainable industry development in the coming years. According to Roland Berger's estimation, China has only attained a meager 10 percent of proper end-of-life vehicle disposal compared with more than 75 percent in developed markets.

As China's vehicle parc is expected to reach 170 million units in the middle of this decade, achieving similar disposal rates would translate to between 8 to 11 million vehicles requiring proper end-of-life disposal annually. China needs to accelerate its effort in proper end-of-life disposal as leaving such a large number of aged vehicles running on the road poses significant safety and environmental hazards. The introduction of market-friendly regulations, appropriate incentive schemes and strict enforcement could open up significant end-of-life vehicle disposal opportunities for players that are well-prepared. This need for regulations to catch up with market developments is similarly pressing across many industries in the auto-related service sector.

(Shen Jun and Chin-Lim Ong are from Roland Berger Strategy Consultants)