The acquisition of the automotive assets of Aviation Industry Corp of China (AVIC) by Chang'an Automotive Group earlier this month is a significant development in China's automotive industry.
The move creates the third-largest automotive conglomerate in China with capacity of more than 2 million units, strengthens the number-two player in the light commercial vehicle segment and expands the reach of Chang'an Auto Group in passenger cars through its joint ventures with Ford, Mazda and Suzuki.
It might also signal a quickening in the pace of consolidation the nation's highly fragmented automotive industry. While that conclusion would be welcome in Beijing, where policymakers believe global competitiveness depends on a more rational industry structure, it would also be premature.
The pace of change is likely to be slow and deliberate, influenced by the market as well as government pressure.
For starters, let's consider whether the structure of China's automotive industry is irrational and in need of consolidation. It could be argued the industry's current structure is basically rational, given the future prospects of the industry - forecasts range as high as 30 million units by 2030 - the low cost of labor, the ready access of technology and the varied interests of the individual industry participants.
Ambitious companies with backing of investors - both private and State-owned - are taking the risk of ownership fully confident they can win the competition for the hearts and minds of Chinese auto buyers. The benefits they reason will accrue over time in one form or another: profits, taxes, employment, know-how. Some will be right and some will be wrong.
Adam Smith described the market mechanism as the "invisible hand". Smith believed that producers and consumers, acting in their own self-interest, would naturally arrive at a market price, dictate an industry structure and lead to optimal benefits to society as a whole.
In Smith's world, producers that could meet the demands dictated by the invisible hand would prosper. Those that failed would be forced from the marketplace.
The mechanism is at work in China. Customers are making choices based on products on offer and producers are making decisions based on the optimal means to deliver on the consumers' choice.
A wide range of factors goes into the decisions for both consumers and producers. The sum of these factors, while seemingly chaotic, is the market mechanism at work.
Everyday, vehicle producers in China are considering their ability to meet customers' demands, today and in the future. Based on their self-assessment, they are making decisions on a course of action. Should they invest in technology or partner with a foreign company? Should they invest in new products, new people, new training?
A decision to improve their competitive position by merging with or acquiring another company is part of the market mechanism.
Chang'an Auto Group gave up 23 percent of its shares to acquire the assets of AVIC. Despite the high price, we should not assume the result will be a more competitive company. Let's not lose sight of the difficulty involved in making an acquisition or merger work.
The strain caused by mixing different cultures, different systems and different management styles has doomed many a merger in the history of the global automotive industry. There are risks for Chang'an.
All this is to say that perhaps the China automotive industry structure is not as irrational as commonly assumed. Unfettered, the industry will consolidate at a pace consistent with the perceptions of companies as to the cost benefits of change, as well as their individual competitiveness.
In today's business environment, with vehicle sales expanding at a blistering pace - up nearly 40 percent year to date - most companies are finding customers for their products. The rate of capacity utilization has increased dramatically since early 2009, margins for manufacturers have improved and Chinese manufacturers remain optimistic about the future.
The market mechanism is exerting pressure on only the most realistic of companies, indicating no imminent upturn in pace of industry consolidation.
Advocates of a more active role of government believe the market mechanism will certainly arrive at a price and industry structure, but perhaps not the optimal structure to maximize benefits to society.
Producers and consumers left to their own devices will arrive at a structure that optimizes benefits under prevailing conditions, but result in short term gains and the expense of long-term opportunity. At a minimum, the lag time between today and the arrival of the optimal structure could be shortened.
Nearly 80 companies compete for a slice of the light vehicle market in China. Government officials and most industry analysts believe this is too many. The fragmented structure of the industry hurts competitiveness, they argue, and keeps it from achieving global standards of quality, innovation, and manufacturing process.
A look at export numbers may support their argument. China's vehicle exports are down by 56 percent through the first 10 months of 2009. At 250,000 units through the end of September, exports account for only 2.8 percent of total light vehicle production, compared with 17 percent for India, 44 percent for Thailand and 66 percent for South Korea.
China's vehicle exports are mainly light commercial vehicles to developing markets. Penetration of the developed markets by Chinese-built vehicles is non-existent.
The Chinese government wants the automotive industry to group into four major companies and four minor companies. A time frame is not stipulated in government communications nor is a process for gaining the cooperation of industry players.
By reducing the number of competitors active in the China market, government officials envision improvement in economies of scale and in the pricing power of the remaining manufacturers. The resulting increase in profits could then be plowed back into the business improving the technological know-how, independence and global competitiveness of Chinese companies.
Commenting on the Chang'an-AVIC deal, government officials promised more deals are in the works. The comments suggest a commitment by Beijing to raise the pressure on industry players and to perhaps turn their political horse-trading to effect the change.
Consolidation in China's automotive industry will happen. The interaction of the market forces and political pressure will determine the pace of consolidation. We can expect government pressure to lead to a few minor deals going forward, but major change won't happen until the growth rate of sales slows down.
The author is the senior director of JD Power Asia-Pacific Forecasting