Oct 21 2007

China’s automobile market – an example of Economies of Scale

Published by at 9:28 am under China,Competition,Economies of scale

Gulfnews: Economies of scale should drive China’s auto market

Last week in AP Economics we introduced the concept of Economies of Scale. The graph below was created and added to our Wiki page by student Kevin Chiu to illustrate the concept, as well as two other concepts: constant returns to scale and diseconomies of scale. Notice that the section of a firms long-run average total cost curve over which ATC is decreasing is identified as the period over which the firm is experiencing economies of scale.

The idea is that as firms open new plants during these early stages of production, they increase their efficiency in production, thus experience a decline in their average costs. Click the “read the rest of this entry” link below to learn how the Chinese automotive market is struggling with economies of scale in their attempt to compete with each other and foreign car manufacturers…

The Long-Run Cost Curve - courtesy of Kevin Chiu

In a competitive industry, where a firm’s survival depends on its ability to minimize costs thus compete with other firms on price, achieving economies of scale often proves the most important obstacle to success. One such industry is the automobile market here in China, where the number of cars on the road has increased somewhere around 20% per year for the last several year. As China’s middle class grows, demand for cars seems insatiable, and dozens of foreign and domestic firms have entered this market, making it highly competitive and presenting Chinese car shoppers with a plethora of choices.

“There are 30 different Chinese manufacturers with cars on the market and 24 of those have a market share of less than one per cent, according to the consultancy JD Power.”

As the market continues to evolve, some of these firms will of course survive and thrive while others will struggle and fail. What determines which will survive and which will disappear? This is where the concept of economies of scale can be taken into account:

“Few of the Chinese brands are anywhere near achieving the economies of scale needed to guarantee long-term survival.

‘There are far too many competitors for us in this business,’ reflects Wang Yanhui, president of Chongqing Lifan Automobiles in central China.”

The major obstacle faced by China’s automotive companies is the lack of economies of scale. The word “scale” refers to size, and in a market with 30 car makers, only a few of those have achieved the level of plant size needed to compete with the larger foreign competitors, many of whom have been producing cars on a massive scale for decades overseas, and have brought their advanced capital and expertise to the Chinese market, making it very difficult for the small Chinese firms to compete on cost and price.

“In the long term, the Chinese industry will need to see a considerable wave of consolidation if there are to be many survivors.”

In the case of the Chinese automobile market, it appears that “bigger is better”, at least when it comes to achieving economies of scale.

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About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

17 responses so far

17 Responses to “China’s automobile market – an example of Economies of Scale”

  1. emilyyehon 21 Oct 2007 at 2:56 pm

    I think that China's lack of economies of scale may be a remnant of communist policies regarding industries. Before China opened up to wider global market, each industry was dominated by state-run companies with no other competition, and many of these firms still hold a lot of power despite less state-backing, and hence are capable of limiting the power of new firms to grow. All in all though, China's automobile market is still often dominated by foreign auto firms, especially as the Japanese take an active effort to take a slice of the huge market.

  2. Helenon 22 Oct 2007 at 1:25 am

    The article mentions a few factors of why it is so hard for Chinese automobile producers to achieve economies of scale, and they all boil down to a vicious cycle. For the small local producers to expand, they need "capital" (money speaking) to buy more efficient capital that generates greater output. But compared to the firms backed up by big foreign companies, these small firms can't compete. So while the big get bigger, the small get smaller (relatively).

    Relating this to the issue on quality – the small local Chinese firms will experience difficulty with attracting more customers after the first wave has gone since its poor quality, again, can't compete with the better quality automobiles produced by large firms. They therefore won't be able to increase output, since demand would be already down, and that's another obstacle on their path to expansion and economies of scale.

  3. Mike Fladlienon 22 Oct 2007 at 10:32 am

    A new menard's is being built next a super Wal-Mart that is 1.5 times larger. In Iowa where you can see corn forever, significant economies of scale will lower LRATC dramatically for the building and trades super store…The Menard's now sells groceries…

  4. Chan Min Parkon 22 Oct 2007 at 7:53 pm

    First in order to do this car manufacturing business, the costs are very big and thus not many companies tend to set foot in this industry. However in this industry although the number of companies is not that great, it is hard for them to be able to take up a big part of the market. Certain companies don't even take up one percent and thus will not be able to achieve economics of scale. Over time, many companies will fall out of the competition while some companies are going to start taking up a big part of the industry.

  5. kevinchiuon 23 Oct 2007 at 11:28 am

    There should be an expected dropout of a great deal of the small firms attempting to survive in the car manfacturing market in China, as their targeted consumers will begin seeking for better quality cars. However, there will still be a substantial amount of people who will not be able to afford the high-quality cars, so if the small firms do merge to form a larger company that can overcome the economies of scale,there will be a greater influence caused by local car manafactures in China.

  6. Jenny Kimon 23 Oct 2007 at 8:07 pm

    I think China's car manufacturing firms have a hard time achieving the economies of scale because of the foreign manufacturers that are already present in China's automobile industry. Consumers buy products from famous brands rather than the beginning brands, thus making it hard for them to achieve the economies of scale. Maybe because the consumers think that the smaller firms will have lower quality cars than the big firms. Effort to appeal to the consumers that their products are high quality automobiles will be important to those Chinese firms in order to achieve economies of scale.

  7. optional.xuon 23 Oct 2007 at 9:01 pm

    Well, of course China's newly developed privatized automobile companies are going to have trouble developing into large economies of scale. China's relatively young free market system only allowed them to exist for a short time while foreign automobile producers have had forever to develop the best techniques and obtain the most efficient means of production. These companies will have trouble if they cannot compete price-wise with the foreign companies. Chinese makers need to consider investing heavily in capital to even dream about competing with the top producers.

  8. Alex Goldmanon 23 Oct 2007 at 10:24 pm

    As the article mentions, "few of the Chinese brands are anywhere near achieving the economies of scale needed to guarantee long-term survival." Building on David's point, it is indeed unrealistic to aspire to compete with foreign cars. This is because the car market is an oligopoly, the major players being companies such as Toyota, GM, Hyundai, and Volkswagen. As we have learned, a market dominated by an oligopoly is hard to enter, especially for Chinese companies that do not have the technology, quality, prices, and brand names to compete with these giants. As it has been mentioned above, the Chinese need to consider investing heavily in capital to get on the same level as foreign producers.

  9. judychenon 24 Oct 2007 at 12:35 am

    i think Chinese automotive companies is having hard time achieving economies of scale, is because there were already many foreign brands exist before those small chinese brands exists. Therefore, normally, people trust foreign brands more since they are much famous and having better qualities. So, Chinese automotive companies should improve their qualities, captials and labor work in order to compete with foreign brands

  10. Jack Loon 24 Oct 2007 at 6:45 pm

    The Chinese car firms will have difficulty achieving economies of scale because of the presence of foreign companies. Foreign companies such as Ford, GM, or Toyota already have an established brand name and years of experience under their belts, not to mention the economies of scale they have already built up. I think that the automobile industry is somewhere caught between a monopolistic competition and an oligopoly (perhaps more towards oligopoly). It is very difficult for these new Chinese brands to enter an oligopoly market and to compete with these corporate beasts. If the Chinese automobile firms wish to survive, I believe that it would be in their best interest to merge into a larger company.

  11. kxc.024on 24 Oct 2007 at 10:18 pm

    The cause of these firms not having economies of scale originates from the nature of the government. Since China is a communist country (despite having a "free" economy), the majority of the people live in a lower standard of living. This also means that the resources in China is of lower quality than those around the world. Even though China is quickly catching up to the West techonologically, they will probably be never as successful if they continue using cheap materials that does not sustain for long. Therefore, if the government would just have less control over the economy (because currently, they still control some aspects of the economy), these automobile firms might have greater economies of scale.

  12. MichaelChowon 25 Oct 2007 at 9:23 pm

    The car manufacturing industry has many factors to be considered before deciding on whether or not to enter the industry. Costs of a car manufacturing industry is extremely high, with the account of the machinery and technology as well as labor necessary needed to make the company work. Like Judy I also believe that the Chinese car brands have difficulty in achieving Economies of scale, mainly because of the other foreign popular car brands such as BMW, Toyota, Nissan etc.

  13. Richard Tuon 25 Oct 2007 at 10:11 pm

    Entering the car manufacturing industry isn't easy, there are lots of costs to start up the company, while other firms that had been in the industry for a long time, they will have a lower cost for producing the same things that a newly entered firm. It takes time for a company to mature and developed in an industry such as car manufacturing. I agree with what Judy said, that Chinese car manufacturing companies are having difficulty achieving the economies of scale, because lots of famous foreign brands are already set foot in china, producing the products that consumers want; at this point, small Chinese brands will have a hard time catching up.

  14. timothysunon 26 Oct 2007 at 1:25 am

    The automobile industry isn't as large in China as in Japan. I would imagine that Japan is facing diseconomies of scale. I think this difference is due to the government differences. China only started having a free economy what, after Mao's death? On the other hand, Japan started decades before.

  15. Jessica Ngon 29 Oct 2007 at 11:43 am

    China's automobile industry is rather young, especially compared to that of Japan's, Germany's, and many other foreign countries. A lot of these foregin firms have already set factories in China, dominating much of the Chinese automobile industry. This oligopoly makes it difficult for new private Chinese firms to enter and expand into extensive economies of scale. These private firms economies proabbly has economies of scale that are exhausted quickly, then immediately followed by diseconomies of scale. Its minimum ATC occurs at a relatively low output. Compared with the larger dominating industries in which its ATC occurs at a very high output, these small private industries thus have to struggle in this competitive industry.

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    China’s automobile market – an example of Economies of Scale | Economics in Plain English