China: Rolling right along

French tyre giant Michelin started domestic production the only way it could -- by joining with a state-owned operation. Unlike so many other multinational tie-ups with SOEs, Michelin’s first, and second, have succeeded

Eric Jugier, chairman of Michelin (China) Investment, recalls reading an industry forecast in 1992 that China would become the world’s fifth-largest market for automotive vehicles by 2006. That forecast turned out to be quite inaccurate, but he was hardly disappointed: China reached that ranking last year -- four years early. And China is set to surpass France to become the world’s fourth-largest market by end-2003. Demand for passenger cars is rising exceptionally quickly (up 89% in January-May year on year, according to UK-based consultancy autopolis), but China’s vehicle market is strong across the board (up 34% in the same period).

Michelin now expects the market to pass the 10m vehicle mark by 2010. A more conservative estimate puts the figure at a still-high 8m (see graphics, “Rubber meets road,” below; and “Crossing lanes,” overleaf). This is good news for the company, which sells tyres for light and heavy trucks as well as passenger cars. Even better for Michelin is that it is prepared to take advantage of the growth.

Selling tyres to China since 1988, Michelin made its first equity investment in manufacturing there in 1996 in a brave tie-up with a dying state-owned enterprise (SOE) in Shenyang. Leveraging this experience, Michelin moved to take over another failing -- though strategically important -- SOE in Shanghai in 2001. Almost immediately thereafter, the market for passenger cars took off. Michelin’s China sales quadrupled between 2001 and 2003. How Michelin has gained traction is a tale of two cities, two brands and two markets.

Tyred in Shenyang

Eager to set up local production, Michelin began looking for a partner in 1995. It finally targeted an SOE in the northern city of Shenyang, located in China’s rust belt. The state-owned tyre factory had been closed down, its 1,400 workers sent home and its equipment mothballed. It would not have been everyone’s dream partner. Crucially for Michelin, though, the SOE was desperate -- and thus open to compromise. Michelin was able to gain a 90% stake in its 1996 joint venture with the Shenyang city government, Michelin Shenyang Tire Company. It was another full year before the operation was rolling out Michelin tyres.

That year cost Michelin dearly. According to Mr Jugier, revamping the SOE factory to turn out Michelin-quality tyres was “a matter of money”. The group sent nearly 30 expatriate staff to turn the SOE around and invested heavily in upgrading equipment and in training staff. It was also a matter of nerves. When the candid and sanguine chairman recalls his time in Shenyang, the restraint is evident when he describes it as “a difficult year”.

In that time, a technical team led the dusting off, re-commissioning or replacement of equipment, the institution of new processes and the deployment of new technology. Other overseas staff worked hard to restructure distribution, train retailers on merchandising as well as product knowledge, install a market tracking system (which remains in place today), strengthen brand support and wrestle with customers unaccustomed to paying on time. It was the human-resources challenge that Mr Jugier recalls most vividly, however. Re-hiring and re-training every one of the 1,400 laid-off workers from the original factory to make and sell Michelin tyres (priced twice as much as their previous product) would prove to be a most memorable task.

In late 1997, once the systems were in place, the workers competent and the expatriate staff largely sent home, Michelin Shenyang Tire began to roll (and within a year was producing at capacity). That same year Michelin invested in three additional Shenyang joint ventures, which doubled the company’s production of passenger car tyres to nearly 1.2m units per year. The Shenyang-made, Michelin-branded tyres were initially greeted with scepticism by the international market. Could Michelin really make world-quality tyres in China’s rust belt? Testing proved it could, and carmakers in North America, Japan and South Korea placed their orders. Over half of Michelin tyres produced in Shenyang now go to international carmakers.

Having convinced local as well as global customers to buy its China-made tyres, Michelin prepared to face another challenge: to meet the growing needs of the domestic market. The company realised the day would come when annual capacity for 1.2m passenger car tyres and 200,000 truck tyres just would not do. With their high-end product selling successfully at a price significantly higher than domestic tyre brands and 20-25% above that of the closest international rival (US-based Goodyear, which produces tyres in nearby Dalian), Michelin saw the need to improve economies of scale. This could work, as long as the brand sustained its premium pricing and sound margins.

By investing heavily in building distribution and brand in Shenyang, Michelin had paved the way for further growth. It planned to push greater volume and an expanded product line through its existing channels in order to maximise the value of the Shenyang investments and position the company for the coming boom in demand for cars.

Road warrior

In making the next step, Michelin considered three key factors. First, the China tyre market is not high-end and Michelin, so far dedicated to production of a premium brand, must adapt in order to collect a greater market share there. Second, while the operations in Shenyang had settled into a tidy mid-scale business, the market appeared ready for an ambitious large-scale supplier. Third, Michelin’s technology would not be fully utilised in China unless the company aimed beyond local success towards developing a global manufacturing centre.

In 1999, still fresh from the Shenyang SOE turnaround, Michelin initiated discussions with the Shanghai Tyre and Rubber Company, hoping it had found a way to address all three points. Already committed to investments worth US$150m in Shenyang, Michelin was about to take on a project in Shanghai that would occupy the management resources of four negotiation and support teams through 18 months of talks, require a change in Chinese law, and commit the company to what was essentially a US$200m bail-out of the largest SOE in the sector.

All this for a local company that was struggling to generate enough orders to keep its 2,350 workers employed and whose exports were brokered at low or no margins. For Michelin, however, there could be no other choice: Shanghai Tyre owned Warrior (Huili) -- China’s only national tyre brand -- and it was for sale. Though Shanghai Tyre was approached by other suitors, it was Michelin who ended up as the white knight.

The centenarian French company came with excellent qualifications. Michelin could point to its undertakings in Shenyang as testimony to its China-capable management. As the self-proclaimed “world tyre technology leader”, Michelin fit in with China’s desire to absorb foreign technology and know-how. And with 20% of the world’s tyre market, Michelin could claim both cash and a global customer base. Yet the reason Michelin eventually got what it wanted from Shanghai Tyre may have had as much to do with vision as operational competence. From its regional headquarters in Singapore, Michelin wooed Shanghai Tyre with talk of global dominance.

Treading on limits

With Michelin again bringing much to the bargaining table, it was able to effect astounding compromise. To join with the multinational tyre giant, Shanghai Tyre would have to give up a huge stake to Michelin -- and the central government would have to adjust regulations, which capped foreign ownership, to allow it. In order to gain the 70% stake it demanded, Michelin conducted simultaneous negotiations with the Shanghai and central governments, through numerous overlapping ministries, ministry-level organisations and agencies. The project team included a negotiating unit and two legal teams, one for contracts and one for regulatory approvals. All of this work would finally pay off in April 2001, when Shanghai Michelin Warrior was formed.

With negotiations under way, Michelin took the opportunity to streamline its China manufacturing base: in 2001 it merged its four joint ventures in Shenyang into a single entity, Michelin Shenyang Tire Company, in which Michelin held 85% of equity. To further consolidate the control structure, Michelin established a holding company, Michelin (China) Investment, in Shanghai. And while the legal teams worked to set up an operating platform, three other teams supported the Shanghai Warrior project in operations, communications and new business development. One achievement was a turnaround roadmap for the old Shanghai Tyre facility.

Transition planning was one lesson the tyre technologists had learned well in Shenyang. This time around there would be no nerve-racking, one-year wait for revenue. In fact, the company was able to leverage its experience, management and majority mandate in operations to continue production of Warrior-brand tyres during the takeover. On April 1st 2001, Shanghai Warrior’s first day as a legal entity, the factory produced and shipped Warrior-brand tyres. Just five months later, Shanghai Warrior had begun shipping Michelin-branded tyres as well.

As of 2003 Shanghai Warrior seems to be another success story. Its two brands are powerful with consumers: California-based marketing information services firm J.D. Power and Associates reports that customers in China in 2002 gave the top customer satisfaction rating to the premium-priced Michelin line, and the third position to the standard-priced Warrior. Moreover, the joint venture has launched its first locally developed tyre, the Warrior R28. The R28, which began selling in June, was developed at Shanghai Warrior’s new R&D centre.

Now Michelin has aggressive expansion plans and high ambitions. It aims to exceed sector growth, lead tyre technology in China and take a dominant share of both premium and standard segments of the car and truck tyre markets. It is off to a good start.

Michelin now has plans to increase investment in both Shenyang and Shanghai. The Shenyang facility is to triple its current truck tyre production volume -- to a targeted 600,000 units -- by 2004. Michelin Shenyang expects this capacity to allow it to win a greater share of the tyre market, especially given that China is shifting its standard technology from bias, which is what Chinese tyre makers produce, to radial, which Michelin produces.

Shanghai Warrior will maintain its focus on the two-brand passenger car tyre strategy, and capacity there will increase from its current 3m tyres per year, to 8m tyres by 2005. With passenger car sales nearly doubling year on year so far in 2003, there may be room for yet another SOE takeover.