‘Transformers 4’ Shines Light on China’s Auto Industry

Viacom (NASDAQ: VIA  ) /Paramount's Transformers: Age of Extinction grossed a whopping $302 million on its opening weekend, scoring the biggest box office opening of the year. Despite poor reviews, Paramount proved once again that there's still a massive worldwide audience for robots changing into cars, dinosaurs, and jets.

What's interesting about Transformers: Age of Extinction is its focus on China -- a movie market that Ernst & Young forecasts will become the world's largest by 2020. Paramount co-produced the film, which partially takes place in China, with Chinese partners China Movie Channel and Jiaflix Enterprises. Li Bingbing, one of China's top actresses, also stars in the film.

Source: Paramount.

Chinese cars, like Guangzhou Auto's (NASDAQOTH: GNZUF  ) Trumpchi GS5 SUV, appeared alongside the Autobots, which transformed into American vehicles from General Motors (NYSE: GM  ) . This product placement of Chinese vehicles, which is rare for a major international film, highlights the rising importance of the Chinese auto industry, which overtook the U.S. as the largest new car market in 2010.

China's auto industry at a glance
Guangzhou Auto, now dubbed the maker of the "Transformers 4 Chinese car" thanks to the film, is one of China's largest automakers, along with  FAW Group, Chang'an Motors, Dongfeng Motor, and SAIC Motor. Other notable competitors include Geely, Great Wall Motor, Chery, Hongqi, and BYD Auto, which is backed by Warren Buffett's Berkshire Hathaway.

Chinese automakers are facing intense pressure from overseas competitors -- including Ford (NYSE: F  ) , Hyundai, Volkswagen (NASDAQOTH: VLKAY  ) , and Kia -- which have now claimed 60% of China's auto market. Chinese automakers have mostly lost market share within China due a reputation of low-quality vehicles and poor customer service.

Another problem is that cheap, locally made cars, which often lack air conditioning and power windows, are no longer desirable to the increasingly affluent middle class. This has throttled the growth of Chinese automakers, even as Chinese consumers bought a record 17.9 million vehicles in 2013 -- representing a 15.7% gain from 2012.

Geely's Gleagle. Source: Drive.com.au

To address these issues, Chinese automakers have invested heavily in foreign brands to improve their technological capabilities.

Geely purchased Volvo from Ford in 2010. Dongfeng recently invested $1.1 billion in struggling French automaker Peugeot-Citroen. Auto parts maker Wanxiang acquired two bankrupt U.S. businesses -- battery maker A123 Systems and hybrid sports car maker Fisker Automotive -- over the past two years. A FAW Group subsidiary recently signed a $200 million joint venture with EcoMotors, a start-up backed by Bill Gates, to manufacture environmentally friendly engines.

Escaping the stagnant domestic market by expanding overseas
Stuck in a rut back at home, Chinese automakers are looking to boost overseas exports. Chinese vehicles are generally exported to lower-income emerging markets that still require low-cost vehicles, such as Africa, South America, the Middle East, and Russia.

Many Chinese automakers have set ambitious targets for the end of 2015. Chery and Geely both plan to export a million vehicles. Great Wall expects to export half a million vehicles, and Chang'an expects to generate 20% of its revenue from overseas markets by then.

Chinese automakers have avoided the U.S. and Europe since they are highly saturated, developed markets. But that could change soon, as Chinese automakers launch higher-end vehicles on par with American, Japanese, and Korean cars. The "Transformer car," the Trumpchi GS5, is considered one such higher-end vehicle, with a sticker price between $24,000 and $37,000. In terms of features, the GS5 is comparable to Volkswagen's Tiguan and Honda's CR-V.

The Trumpchi GS5. Source: Wikimedia Commons.

According to Bloomberg, Guangzhou Auto intends to export the Trumpchi GS5 "as quickly as possible." Guangzhou Auto has already exported Trumpchi vehicles to the Middle East, South America, and Russia, with solid results. This year, the company expects sales of the brand to hit 135,000 units, topping its earlier estimate of 110,000 units. By comparison, Honda's CR-V, the top-selling SUV in the world, sold 700,000 units worldwide in 2013.

If Guangzhou Auto delivers the SUV to the U.S. as well, it would be the first Chinese automaker to successfully enter the U.S. market.

Do Chinese cars stand a chance in the U.S.?
It might be easy to dismiss the notion of cheap Chinese cars gaining market share in the U.S., but naysayers said the same thing about Japanese and Korean cars in the past.

SAIC and Chang'an have quietly expanded their production facilities in Detroit recently. This indicates that they won't simply export Chinese-made vehicles to the U.S. They intend to manufacture them in Motor City -- just as Toyota (NYSE: TM  ) has done over the past few years. This strategy is intended to attract top talent from Michigan-based automakers to assist in the improvement of Chinese designs.

Chang'an's R&D facility near Detroit has already contributed to design improvements in its Eado car and CS35 SUV. In an interview at BBC, Wei Li, Changan's U.S. board chairman, noted that Detroit had "a lot of opportunities" with "skilled people" and "rich resources."

This slow and steady approach will likely be more successful than Guangzhou's simple export model for two reasons. First, Chinese automakers must shake the stigma that "Made in China" is synonymous with low-quality goods. It could do this by following Hyundai's example in the 1980s, when the South Korean automaker heavily discounted its cars but backed up their cheap prices with generous 100,000 mile warranties. Second, manufacturing them in Motor City makes them "partially American" as well. Nissan, for example, successfully adopted this strategy with the Altima -- a vehicle that was originally designed by American designers and built in Tennessee.

The Foolish takeaway
The appearance of the Trumpchi GS5 in Transformers 4 is certainly clever product placement for audiences in China and emerging markets, but it is also serves as a glimpse into the upcoming paradigm shifts in the U.S. auto industry. Chinese cars might not be well-known in America yet, but Japanese and Korean makers have shown that gaining market share with cheaper and safer vehicles is certainly achievable.

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