22 Years, 9 Acquisitions: How Geely Went From a Cheap “Four Wheels and a Sofa” to Upending a Car Market Run by State Firms | QDaily Business History

Cheap imitation, overseas acquisitions, in-house R&D

Three days after Daimler, the parent company of Mercedes-Benz, disclosed that Geely had bought a stake in it, the whole thing is still unclear.

Whether the buyer is Li Shufu himself or Geely Group, and how the roughly $9 billion was raised — the accounts from Geely founder Li Shufu, from Geely executives and from Daimler don't quite line up.

Unlike the outright purchase of Volvo Cars eight years ago, this is no strategic partnership. Li simply bought Daimler shares on the open market, and he got no board seat. Bloomberg's latest reporting says Daimler is even trying to keep him off the supervisory board, a far less influential post. But he does hold about 9.69% of the voting rights, half again as much as the second-largest shareholder.

Getting this far is itself a measure of how far Geely has come. Geely only started in 1996, by copying other people's cars. As late as 2011, talking about a new model, the Freedom Cruiser, Li Shufu's idea of praise was that "it doesn't fall apart anymore." By 2017 Geely was selling 1.24 million cars a year, making it China's largest privately owned domestic brand.

The big companies in a market serve its most profitable customers. A new company starts at the low end, in the segment they look down on, and climbs from there.

Geely used cheap cars to take a small market the joint-venture brands did not want at first. As cars spread across China, that once-marginal market grew large. Geely then used a string of acquisitions — above all the risky purchase of Volvo in 2010 — to fix its technology and its brand, and finally passed the rivals that had been out of reach twenty years earlier.

After Several Businesses Built in the Gaps Left by Policy, Geely Started at the Low End of the Car Market

Before he founded the Geely Group, Li Shufu had already built several businesses in the gaps left by policy. But almost every time, he had to change industries once competition sharpened or the rules came down.

In the 1980s, Li Shufu, not yet 20, took just over 100 yuan from his family and opened a photo studio in his hometown of Taizhou. He then taught himself to extract gold and silver from scrap machinery, but the trick was easy for others to pick up, competition sharpened, and he switched to making refrigerator parts.

In 1986 he founded the Beijihua ("North Pole Flower") Refrigerator Factory, the company that became the Geely Group. At the time, China let only designated plants make home appliances like air conditioners, refrigerators and televisions, and those licenses went almost entirely to state-owned factories under the Ministry of Light Industry. The Qingdao Refrigerator General Factory, founded in 1984, was among the last plants to be granted refrigerator designation.

Li Shufu's refrigerator-parts business fell outside that rule. As China's refrigerator market grew quickly after 1985, the Beijihua factory piled up tens of millions of yuan in profit within a few years.

But around 1989, when Li Shufu began building whole refrigerators and hit an annual output value of 100 million yuan, the rules tightened. The Ministry of Light Industry decreed that only enterprises on its designated list could make refrigerators. "When the state drew up its list of designated refrigerator makers, we weren't on it," Li Shufu said. "If you weren't a designated factory you couldn't produce, so we simply stopped."

Once he could no longer make refrigerators, Li Shufu handed his private factory to the local government and went to Shenzhen to study. While there he heard that decorative building materials were highly profitable, and in 1991 he and his elder brother started making aluminum-magnesium curved panels. He then took the money he had made from refrigerators and building materials and threw it into the property boom then running in Hainan.

Between 1991 and the first half of 1993, average property prices in Hainan rose from 1,500 yuan to 7,500 yuan per square meter. Almost everyone flipping apartments owed money to a bank, and loans poured into the market with barely any vetting. In June 1993 the State Council tightened mortgage lending and stopped real estate companies from listing, and Hainan prices fell to 200-300 yuan per square meter.

In this game of pass-the-parcel, Pan Shiyi got out in time and went on to build SOHO developments around the country. Feng Lun got out too, and went on to back the Putian-network hospitals. Li Shufu did not get out in time, and tens of millions of yuan of investment vanished.

Still, the crash did not take everything he had. He went back to running his building-materials factory, and began thinking about making cars. In the 1980s China named the automobile industry — passenger cars above all — a pillar industry to be developed and supported nationally. But this was not a market anyone could enter: only eight companies were approved to build cars — the three big passenger-car bases, FAW, Dongfeng and SAIC; the three passenger-car production sites in Beijing, Tianjin and Guangzhou; and the defense-linked Xiali and Yunque brands.

Just as with the Beijihua refrigerator factory, China strictly barred any company outside the approved list.

So Li Shufu decided to start with motorcycles. In 1993 he founded China's first privately owned motorcycle factory, copying a Taiwanese scooter called Sunshine, and priced his bikes at less than half what mainstream motorcycles cost.

Three years later the Geely Group was founded in Taizhou, and Li Shufu still had his eye on something with four wheels. He bought Mercedes-Benz, Hongqi and Xiali cars one after another and took them apart to see how a car was put together.

But when he went to the Zhejiang provincial machinery department in 1997 to apply for a license to build cars, the answer was no. Private companies were still tightly barred from making automobiles.

So Li Shufu applied for an 800-mu (about 53-hectare) plot in Linhai, a county-level city under Taizhou, in the name of building motorcycles — and got it approved. "This project ate up nearly all the money I had," he said.

This time, unlike his earlier ventures, he did not change industries the moment he ran into a crackdown or a crowd of competitors. Lü Pingbo, editor-in-chief of Huaxia Times, met Li Shufu in 1997 and says he wanted to build cars all along — motorcycles were only a stopgap.

Geely's first prototype, the "Geely No. 1," was on the road before the new industrial park was even finished. It copied the four-headlight face of the Mercedes-Benz E-Class (chassis code W210), took its chassis layout from the Hongqi sedan, and used a Hongqi engine outright.

To build cars in volume, though, Geely still needed a manufacturing license. Li Shufu eventually tracked down the near-bankrupt, already-shuttered Deyang Prison Automobile Factory in Sichuan, put in 24 million yuan and set up Sichuan Geely-Boyin Automobile Co., with Geely holding 70%. In 1997 the first phase of the Linhai plant was finished and began turning out hatchbacks. A year later Geely's first mass-produced car, the Haoqing, rolled off the line. Li Shufu set the moment for 8 a.m. on August 8.

The Haoqing followed the old Geely formula of copying and stitching, transplanting major parts wholesale: the front end looked like a Mercedes, the body like a FAW Xiali, the rear like a Dongfeng Citroën Fukang, while the engine and transmission came from Tianjin Toyota and Fiat.

At a public event in 2011, Li Shufu said the Haoqing's molds were made of steel plate and epoxy resin, and that to cut costs the company later mixed in cement for strength. Each mold had to be scrapped after a few hundred stampings. Even so, Geely's production costs were far below those of the joint-venture brands.

"Another good thing about doing it this way was that it produced a lot of sheet-metal workers, because every stamped part had to be hammered back into shape by hand," Li Shufu said. The bad things were just as plain. The Haoqing's headlight housings leaked badly, the door seals were poor, and dust blew into the cabin as you drove.

Looking back in 2014, Li Shufu said, "We scrapped that whole batch of cars. That's right — they weren't good enough." The second batch was scrapped too, and the third was "hard to call satisfactory." Geely's second factory, in Ningbo, likewise turned out "very bad products, very poor quality" in 2000.

Joint Ventures Had It Too Easy at First, and Left the Cheap Car Market to Private Companies

Carmaking has an extraordinarily high barrier to entry. In the United States, from the 1960s until now, Tesla is the only new company to enter the car market and reach any real scale — and Tesla is still working through basic production problems, unable to build more than 100,000 cars a year.

Cars are also a scale business. Only centralized purchasing and manufacturing can spread the costs, and in a mature, fiercely competitive market a newcomer has almost no chance. But in China, Geely's rivals were not Toyota, GM or Volkswagen. They were those companies' joint ventures.

China's Seventh Five-Year Plan in the 1980s named car manufacturing a key pillar industry. In 1985 SAIC and Germany's Volkswagen each put up half the capital for China's first passenger-car joint venture. The hope was that trading market access for technology would fix what Chinese carmakers lacked: engines, chassis, transmissions.

Any carmaker entering the market had to play by those rules, or come in as an importer and pay tariffs of up to 150%. FAW-Volkswagen, SAIC-GM and FAW-Toyota followed, founded in Changchun, Shanghai and Sichuan in 1991, 1997 and 1998.

The joint ventures cornered a huge, fast-growing market almost by default. And because they had it cornered, their China-built cars sold well even at prices above what the same models fetched elsewhere in the world. So even as they took in a great deal of technology, the joint ventures never broke through to R&D of their own. They had no reason to.

FAW-Audi's A4 and A6, FAW-Volkswagen's Magotan, SAIC-Volkswagen's Passat, SAIC-GM's Buick LaCrosse — nearly every joint-venture brand had a wildly popular mid-size sedan. SAIC's annual profit was 700 million yuan in 2000 and had doubled to 1.4 billion yuan by 2006. The Audi A6L still reads as an official's car. At one point China accounted for half of the A6's global sales.

But as the economy grew and disposable income per person rose, a car stopped being something only the rich could afford. In 2005, sales of Chinese domestic brands grew 53%, far outpacing the joint ventures' 20%. By 2007, brands like Geely, Chery and BYD could push sedan prices below 50,000 yuan.

These cars might have no air conditioning, and every window was hand-cranked, but they were cheap enough to put most people behind a wheel. The China Association of Automobile Manufacturers reported that car sales grew 30% in the first half of 2007, and the fastest-growing segment was the 1.0-to-1.6-liter engine class.

In a market like that, private domestic brands beat the state-owned domestic brands on price alone, even though the state-owned cars had better equipment and performance — they cost twice as much to begin with. Foreign brands, meanwhile, had full high-, mid- and low-end lineups abroad, but in China one or two upper-mid-range models at 300,000-400,000 yuan were enough to make money, so they had no wish to bring in entry-level cars and thin out their brand premium.

A 2010 report on Chinese consumers from the consultancy Roland Berger found that when the same class of car came in both a domestic and an imported version, most people would pay only a 10-20% premium for the import. When there was no domestic equivalent, the share willing to pay a 20-50% premium rose sharply.

At the 100,000-yuan price point, domestic brands usually upended the joint ventures by exploiting a gap in interior space or vehicle class, because a joint-venture car at that price was typically a hatchback with poor sound insulation and weak power. To the Chinese car buyer, a proper car still needed a trunk — a "rear end" — to be worth driving. And that was exactly what domestic brands could offer.

For the same 100,000 yuan, a domestic brand would offer a B-class sedan 4.8 meters long with a wheelbase over 2.9 meters. Ford's competing product was the hatchback Focus, which a few years earlier had been nobody's idea of a popular choice in China. By the time the joint ventures started bringing in a wave of overseas models after 2010, some launching globally at the same time and cutting prices, they had already given up a large stretch of the market.

At a public event in 2011, Li Shufu said: "In the 1990s the state essentially monopolized car manufacturing, and that is exactly what gave cheap, lower-quality private carmakers room to survive. It also meant we needed less money up front."

After Entering the Market at the Low End, Geely Went Through Two Decisive Acquisitions

Grabbing share at the low end did not make carmaking easy for Geely.

Having passed through two stages of innovation — low-cost imitation plus small-scale production, then better manufacturing techniques plus streamlined production processes — the domestic brands began doing R&D, alone or with partners, still sharpening their low-cost integration while pursuing technical innovation and building brands that could compete.

But nearly every Chinese domestic brand hit the same wall along the way: defect rates that would not come down. Reports from the consultancy J.D. Power show that the quality gap between domestic and foreign brands did not start narrowing quickly until after 2013. Before that, year after year, domestic brands had nearly twice as many problems per 100 vehicles as imported ones.

With government support, private domestic brands around the country began buying assets abroad and recruiting talent. Geely poached a former vice president and the head of the research institute from South Korea's Daewoo, and when SsangYong went bankrupt in South Korea it took in a large number of Korean staff. A sales director at an engine-parts company told QDaily that when he visited Geely's R&D and manufacturing base in Hangzhou in 2015, the restrooms, offices and some signs inside the building were labeled in both Chinese and Korean.

Harder still was developing chassis, engines and transmissions. Doing it yourself takes a long time and shows results slowly. Geely both did it itself and tried to buy its way through — and acquisitions were also a shortcut to raising a domestic brand's standing. Li Shufu admitted as much in a 2014 interview with Forbes Asia: "No matter how hard we work, there will always be a gap between us and Western brands. I want to buy car brands and companies globally."

In 2006 and 2009, Geely bought a London taxi maker and the Australian transmission company DSI. The first gave Geely the whole supplier network of Britain's Manganese Bronze, along with experience in production management and auto financing; the second put it in full control of DSI's suppliers, sales, production equipment and research institute.

Geely's 9 Acquisitions

1997

Bought 70% of the Deyang Prison Automobile Factory for 24 million yuan, gaining a place on the auto-production catalog

2006

Bought a 20% stake in Manganese Bronze Holdings, parent of the London black-cab maker, gaining hands-on experience in overseas M&A and financing

2009

Bought the Australian transmission maker DSI for HK$257 million, helping Geely's own transmission R&D

2010

Bought 100% of Volvo Cars for $1.5 billion, gaining Volvo's technology, markets, brand and global supply-chain integration

2013

Bought the remaining stake in the London black-cab company for more than 100 million yuan

2017

Bought 49.9% of Proton and 51% of Lotus, taking control of Lotus and the right to use its brand

2017

Bought the flying-car company Terrafugia

2017

Bought an 8.2% stake in the Volvo Group, which makes commercial vehicles

2018

Bought 9.69% of Daimler, becoming its largest shareholder

During this period Geely began courting Volvo Cars, one of the few companies abroad then looking for a buyer.

Unlike MG or Roewe — "century-old" marques that by then amounted to little more than a trademark — Volvo had just posted a five-year sales high in 2006, still had factories and markets in Europe and North America, and had spent years earning a reputation on core safety technology. Handled properly, a merger could help a domestic brand in technology, culture, management, supply chain and design alike.

In the first two rounds of talks, Ford, which controlled Volvo, turned down Li Shufu's offers. The 2008 financial crisis gave him his opening. In that storm Ford, having lost $10 billion, badly needed cash to stay out of bankruptcy. It first sold Jaguar Land Rover to India's Tata Group, then set about selling Volvo.

Li Shufu put together an acquisition team of more than 200 people, including Rothschild for valuation and due diligence and Deloitte for accounting; Shen Hui, then vice president of Fiat China, joined as well. Geely stressed that although it was not a large company, it had China, the world's largest emerging car market. One big advantage it did not mention: the government's money behind it.

At the 2009 Detroit Auto Show, Geely met Ford's senior leadership again. This time Ford took Geely seriously and opened up Volvo's operating data. Around the point the deal moved into real negotiation, Geely submitted a report to China's National Development and Reform Commission, restating how important buying Volvo was for the Chinese auto industry and expressing confidence that it could return Volvo to profit.

With the government behind it, Geely got the money the deal needed. Its purchase agreement with Volvo was close to done in 2009, but the negotiations over intellectual property ran into 2010.

In August 2010, Geely, Ford and Volvo finally struck a $1.5 billion deal, and Geely took 100% of Volvo Cars. At least three Chinese banks — Bank of China, China Construction Bank and the Export-Import Bank of China — provided $1 billion in financing. Geely Group's net profit in 2009, before the acquisition, was about 1.32 billion yuan.

After Buying Volvo, Geely Used It to Lift Its Own Brand and Technology

When Geely first bought Volvo, skeptics doubted it could actually run the company: Volvo's 2009 revenue was six times Geely's, there was the distance between Volvo's famous safety record and the manufacturing standards Chinese carmakers were routinely criticized for, and there were the cultural differences.

The Wall Street Journal noted that Geely's lack of global management experience would make Volvo hard to digest, and that dealing with European labor unions would be difficult. It also warned that a Chinese corporate culture sometimes willing to sacrifice quality for faster product development could damage Volvo's reputation.

But from the start of the talks, Geely promised Ford and Volvo that Volvo's production lines would stay in Sweden and Belgium, and pledged to respect a corporate culture built on safety and efficiency. After the deal closed, Geely kept that promise. Broadly, it integrated Volvo in three steps:

• Leaving Volvo's day-to-day operations alone and keeping its existing management team;
• Folding Volvo's patented technology into Geely-brand cars step by step, and paying licensing fees for it;
• Building a Volvo production line in China, part of Volvo's global manufacturing system, supplying the Chinese market and exports to the United States.

Harvard Business Review called the deal a "textbook case of cooperation."

On R&D, Geely's board decided in 2011 to put $11 billion into Volvo over five years to develop an all-new platform, SPA. It is a modular platform on which different models share essentially the same chassis structure, suspension, electrical systems and drivetrain. Building SPA was meant to strengthen the long-term competitiveness of both Volvo and Geely.

Before that, all three of Volvo's technology platforms had depended on Ford. But Ford's own losses and its "One Ford" strategy meant Volvo went years with almost no investment, its lineup stagnated, and it grew less competitive — so much so that the new S60 Volvo launched in 2012 still ran a powertrain from the 1990s.

Volvo returned to profit in 2013, helped by a 46% jump in China sales and by cost cuts. Håkan Samuelsson, Volvo's CEO at the time, said Li Shufu's conduct turned out to be the opposite of what Volvo had feared.

As Volvo took Geely's money and returned to sales growth, it also gave Geely a lift in brand recognition and a stock of technology. In 2015 the two set up a new R&D center in Sweden, CEVT, to develop a next-generation platform for both the Volvo and Geely brands.

Volvo's exterior and interior designers also worked on new Geely models. To reach younger buyers, Geely launched the sub-brand Lynk & Co, held jointly by Volvo Cars, Geely Holding and Geely Auto. Its first production model, the Lynk & Co 01, was built on the CMA platform shared with Volvo and used a Volvo engine. A car's three most important parts — engine, transmission and chassis — go from Volvo to Geely and to its sub-brand Lynk & Co.

Geely's Latest Round of Buying: an Attempt to Build a Chinese Volkswagen

Before the Daimler stake, Geely closed three deals in 2017. In March it bought Malaysia's Proton and the sports-car maker Lotus; in November it bought the American flying-car company Terrafugia. At the end of last year it also paid for an 8.2% stake in the Volvo Group, which builds and sells commercial vehicles such as trucks and buses.

In that deal Geely used a complicated financial instrument known as an equity collar. The investment banks Nomura International and Barclays Securities put up the money to buy the Volvo Group shares, and once Geely had completed the agreed approvals they resold their entire Volvo Group holding to Geely Holding.

A similar structure was used for the Daimler stake, though the exact terms are unknown. The Financial Times reported that Bank of America advised Geely on the deal while Goldman Sachs advised Daimler. China Business News reported that Industrial Bank and Morgan Stanley financed Geely.

Geely Group CFO Li Donghui says the purchase cost less than the rumored $9 billion, but that regulatory conditions keep him from giving the figure for now.

Much about the deal is still unclear. Li Shufu has already gone to Germany to negotiate with Daimler, seeking cooperation on technology, sales channels and more. By his own account, the point of the trip is to build Geely into a Chinese version of the Volkswagen Group, and he says he is "very pleased to work with Daimler to become a leading global supplier of electric vehicles."

But Daimler's Mercedes-Benz already has two partners in China, BAIC and BYD (through Denza), and shortly after Geely's stake was disclosed it announced an 11-billion-yuan new-energy-vehicle plan with BAIC. Compared with the other two big German carmakers, Mercedes-Benz has been slow to develop electric cars, which makes any partnership with Geely less certain still.

Whatever cooperation follows this investment, it will be far more complicated than what followed the Volvo purchase in 2010.

Cover image/The New York Times