The Chinese government recently launched a series of anti-monopoly probes into Chrysler, Volkswagen's (NASDAQOTH:VLKAY) Audi, Daimler's (NASDAQOTH:DDAIF) Mercedes-Benz, and several Japanese automakers. Regulators stated that they would punish Chrysler and Audi for violating anti-monopoly regulations and also raided Mercedes-Benz's offices.
The investigations were triggered by consumer complaints about the prices of imported vehicles and auto parts. These investigations are also part of the government's wider effort to reduce prices from foreign auto, technology, pharmaceutical, and dairy companies over the past two years.
However, several foreign companies have stated that the investigations violate free-trade agreements and intentionally throttle the growth of foreign companies to aid domestic ones.
Do China's claims have any merit?
China's domestic auto market is struggling to compete against German, American, Korean, and Japanese automakers. According to the China Association of Automobile Manufacturers, domestic brands only account for 37% of the Chinese auto market. Ford, Hyundai, Volkswagen, Kia, BMW, and Mercedes-Benz are all gaining market share at the expense of China's top automakers, which include FAW Group, Chang'an Motors, Dongfeng Motor, and SAIC Motor.
The public perception of domestic automakers has improved in China, but demand remains stagnant compared to their foreign rivals. Meanwhile, the rising middle class in China has fueled demand for pricier status symbol vehicles from BMW, Audi, and Mercedes. To capitalize on that demand, many top foreign automakers manufacture vehicles in China through joint ventures with Chinese companies to avoid import taxes.
But for imported vehicles, the price differences are startling. BMW's X5 luxury crossover, which costs up to $103,000 in the U.S., costs $330,000 in China. Mercedes-Benz's E-class sedan costs $48,000 in the U.S., compared to $70,000 in China. Audi's A4 starts at $33,920 in the U.S., but its A4L variant starts at $44,490 in China.
The math doesn't add up
Automakers blame these price differences on import taxes, but the math doesn't add up.
China charges a 25% import tax on foreign auto purchases, a 17% value-added tax, and a consumption tax based on engine size. Those are a lot of taxes, but not enough to justify doubling or tripling the original price. Yet based on the foreign dominance of the Chinese auto market, there's clearly healthy demand for those vehicles even at higher prices.
LMC Automotive analyst John Zeng also noted in a recent AP report that foreign automakers charge as much as 5,000-6,000 RMB ($800- $1,000) in China for replacement parts that cost 200 RMB ($30) to manufacture. To foreign automakers, it's a matter of tuning the price for supply and demand. To the Chinese government, it's price gouging.
Foreign automakers notably reduced their prices ahead of the probe. In July, Audi slashed its prices in China by up to 38%. On Aug. 3, Mercedes reduced prices for windshields, pumps, and power steering by up to 29%. On Aug. 5, Chrysler reduced the price of its Grand Cherokee SRT8 and Grand Cherokee 5.7L vehicles by 20%.
Is China just propping up domestic automakers?
China's central and local governments pay about $700 million per year in subsidies to domestic automakers. Without those payments, many domestic automakers would buckle under competitive pressure from foreign automakers.
That's not to say that all Chinese automakers would wither and die without subsidies. BYD Auto, for example, was promising enough to attract a large investment from Warren Buffett's Berkshire Hathaway. Geely had enough cash to acquire Volvo from Ford for $1.8 billion. SAIC and Chang'an have been profitable enough to expand their production facilities to Michigan.
However, it's also obvious that if China publicly shames a few foreign automakers for overcharging Chinese customers, it might encourage them to buy domestic brands instead. As a result, China gets three wishes granted -- cheaper foreign cars, higher domestic sales, and lower subsidies.
The Foolish takeaway
These investigations, justified or not, could hurt foreign auto sales in China. That's bad news, considering that China overtook the U.S. as the world's largest auto market four years ago.
Another key lesson is that China isn't as friendly to foreign companies as it was a decade ago. China is clearly giving its domestic companies competitive advantages that could make it much tougher for foreign companies to compete in the future.
Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.