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Home » Opinion » Chinese Views
Low-end Geely to buy high-end Volvo in new business model
By John Gong |
January 13, 2010, Wednesday
|
Print Edition
Print Edition
FORD recently announced that it expects the sale of its Volvo unit to Geely to be completed in the first quarter of this year.
On the surface, the US$2 billion acquisition defies business logic by any standard.
Geely entered the auto business only about 10 years ago, while Volvo has a history of close to 100 years. In 2008, Volvo sold around twice as many cars as Geely did and its revenue was about three times more.
Volvo is a worldwide company, while Geely has virtually no experience in large-scale overseas operations, barring the negligible number of cars exported to some developing countries in recent years.
This begs the question: what is so unique about Geely that makes it think it can turn around an ailing but venerable auto brand that Ford could not make profitable?
Geely is likely to face the same set of challenges as Ford does, including the shrinking luxury car market worldwide, lack of scale economy and high production costs.
The answer is China, China, and China. Geely's entire business plan of turning around Volvo is based on the homologation, manufacturing and sale of Volvos in China, which surpassed the US to become the world's largest auto market in 2009.
Geely has announced that it will keep Volvo's existing operations intact, and will focus on Volvo's China project instead. The subtext for that is Volvo will continue to be a money-losing black hole, but Li Shufu, Geely's chairman, is betting that money made in China is sufficient to cover that hole.
This brings about a new trend characterizing the indigenous breed of MNCs from China. The phenomenon of scooping up distressed assets overseas and turning them around by leveraging off the strong domestic market growth seems to suggest a new model of emerging market MNCs' internationalization effort.
Earlier last year, Tengzhong's failed acquisition of Hummer Corp from GM is essentially based on the same theory. Another example of the like business model is the acquisition of Pierre Cardin textile and accessory business by a group of Chinese investors.
This, what I call the "domestically-driven internationalization" strategy, is not without its share of risks and challenges.
For Geely, the US$2 billion price tag is just the beginning of many more investment funds it needs for this big venture. To complicate things, Volvo's current OEM (original equipment manufacturer) arrangement with Chang An Automobile needs to be bought out, and the relationship with its existing sales network of 4S stores needs to be straightened out.
Chang An's OEM contracts for Volvo S40 and S80 are not going to expire until 2015 and 2018, respectively.
Geely is mainly relying on loans from three leading banks, Bank of China, China Construction Bank and China Import and Export Bank, and equity infusions from outside investors to meet these tremendous funding requirements.
The auto history has never seen a successful model of a lower-end brand acquiring a higher-end brand. All the major industry heavy weights, including Toyota, Honda and Hyundai, have risen to prominence via organic growth.
This unique internationalization strategy is a double-edged sword for Geely.
On the one hand, the successful integration of Volvo enhances Geely's technology capability as well as Geely's brand image among its customers.
On the other hand, it may damage the snob appeal of Volvo among the more affluent luxury goods customers, especially in overseas markets, and thus further accelerating Volvo's market erosion in Europe and North America.
But heck, Geely chairman Li has a history of waging big bets and making gutsy moves. And so far he has been successful. This is an entirely new business model in uncharted territory. Let's wish Mr Li all the best of luck.
(The author is associate professor of economics at the University of International Business and Economics in Beijing. The views are his own. His email: johngong@gmail.com)
On the surface, the US$2 billion acquisition defies business logic by any standard.
Geely entered the auto business only about 10 years ago, while Volvo has a history of close to 100 years. In 2008, Volvo sold around twice as many cars as Geely did and its revenue was about three times more.
Volvo is a worldwide company, while Geely has virtually no experience in large-scale overseas operations, barring the negligible number of cars exported to some developing countries in recent years.
This begs the question: what is so unique about Geely that makes it think it can turn around an ailing but venerable auto brand that Ford could not make profitable?
Geely is likely to face the same set of challenges as Ford does, including the shrinking luxury car market worldwide, lack of scale economy and high production costs.
The answer is China, China, and China. Geely's entire business plan of turning around Volvo is based on the homologation, manufacturing and sale of Volvos in China, which surpassed the US to become the world's largest auto market in 2009.
Geely has announced that it will keep Volvo's existing operations intact, and will focus on Volvo's China project instead. The subtext for that is Volvo will continue to be a money-losing black hole, but Li Shufu, Geely's chairman, is betting that money made in China is sufficient to cover that hole.
This brings about a new trend characterizing the indigenous breed of MNCs from China. The phenomenon of scooping up distressed assets overseas and turning them around by leveraging off the strong domestic market growth seems to suggest a new model of emerging market MNCs' internationalization effort.
Earlier last year, Tengzhong's failed acquisition of Hummer Corp from GM is essentially based on the same theory. Another example of the like business model is the acquisition of Pierre Cardin textile and accessory business by a group of Chinese investors.
This, what I call the "domestically-driven internationalization" strategy, is not without its share of risks and challenges.
For Geely, the US$2 billion price tag is just the beginning of many more investment funds it needs for this big venture. To complicate things, Volvo's current OEM (original equipment manufacturer) arrangement with Chang An Automobile needs to be bought out, and the relationship with its existing sales network of 4S stores needs to be straightened out.
Chang An's OEM contracts for Volvo S40 and S80 are not going to expire until 2015 and 2018, respectively.
Geely is mainly relying on loans from three leading banks, Bank of China, China Construction Bank and China Import and Export Bank, and equity infusions from outside investors to meet these tremendous funding requirements.
The auto history has never seen a successful model of a lower-end brand acquiring a higher-end brand. All the major industry heavy weights, including Toyota, Honda and Hyundai, have risen to prominence via organic growth.
This unique internationalization strategy is a double-edged sword for Geely.
On the one hand, the successful integration of Volvo enhances Geely's technology capability as well as Geely's brand image among its customers.
On the other hand, it may damage the snob appeal of Volvo among the more affluent luxury goods customers, especially in overseas markets, and thus further accelerating Volvo's market erosion in Europe and North America.
But heck, Geely chairman Li has a history of waging big bets and making gutsy moves. And so far he has been successful. This is an entirely new business model in uncharted territory. Let's wish Mr Li all the best of luck.
(The author is associate professor of economics at the University of International Business and Economics in Beijing. The views are his own. His email: johngong@gmail.com)
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