How Ford Will Cut Its Losses In China

A few years ago, Ford Motor Company (NYSE:F) was having a lot of success in China. That has changed: Over the last couple of years, Ford's sales in China have slipped sharply, hurting the company's relationships with its Chinese dealers as well as its own bottom line.

In late 2017, Ford outlined a turnaround plan for its operations in China. That plan didn't help Ford's bottom line in 2018 -- in fact, Ford's wholesale shipments to dealers fell 42% in 2018,enough to push its once-solidly profitable China business into the red. Equity income from Ford's China joint ventures fell from a $916 million profit in 2017 to a $110 million loss in 2018, a swing of over $1 billion.

But Ford executives say that even though sales were down sharply last year, the actions it took in China in 2018 were essential to its long-term turnaround effort.

How Ford made progress on its China turnaround in 2018

As announced in December of 2017, the key points of Ford's plan to turn around its Chinese operation were these:

• Lots of new products between 2018 and 2025, including eight all-new SUVs and at least 15 "electrified vehicles" (including both hybrids and pure electric models) for both the Ford and Lincoln brands.
• More local production. Right now, Ford imports Lincolns from North America to sell in China. It said it will build more of its vehicles locally, using domestic Chinese suppliers to help reduce costs and boost profitability.
• Connectivity. Ford promised that by the end of 2019, all of the new vehicles it sells in China will have the ability to connect with the internet, either via an onboard modem or by using the driver's smartphone.
• A major overhaul of its dealer distribution network. There are two separate joint venturesbetween Ford and Chinese automakers that produce Ford-brand vehicles. In the past, those ventures had separate distribution networks, confusing dealers and customers; Ford promised to unify them and streamline the ordering process.
• Cost reductions.

During Ford's fourth-quarter earnings call, executives emphasized that Ford made a lot of progress toward those goals in 2018, even if the progress isn't yet visible on the bottom line.

For starters, global markets chief Jim Farley said that Ford has made a great deal of progress in improving things for its Chinese dealers, which weren't making enough money -- or in some cases, any money -- as inventories grew.

Among the problems: The dealers had excess inventory, especially of Ford's so-called "C cars," the compact Focus and the Escort (a lower-priced China-only model based on the Focus). The two have been Ford's best-sellers in China for several years, but sales fell as the models aged -- and cars began to pile up on dealer lots.

Farley said that Ford was able to reduce its "aged inventories" -- vehicles that have been on dealer lots for more than a couple of months -- by roughly 60% between the end of October and the end of the year. That has helped make room for all-new versions of the Focus and Escort, which have begun arriving on dealer lots -- and which are commanding significantly higher transaction prices, he said.

A new management team, and more locally built products

Ford also put its China operation under new management in the fourth quarter. Anning Chen, who was previously CEO of Chinese automaker Chery Automobile, took over as CEO of Ford China (a newly created position) on Nov. 1. He moved quickly to hire new leaders for Ford- and Lincoln-brand marketing and sales efforts who are, like him, veterans of China's auto industry.

During Ford's earnings call, CEO Jim Hackett said that "localization" is next on the agenda for Ford China in 2019. Ford currently imports the Explorer SUV to China from the United States, but the all-new 2020 Explorer will be built locally in China. Ford will also begin building Lincolns in China for the first time -- starting with the Aviator SUV later this year.

That alone should boost sales of those models. Right now, the Explorer and Lincoln SUVs are very expensive in China, because of tariffs and shipping costs. Building them locally, using local Chinese suppliers, will reduce the costs significantly -- allowing Ford to sell them profitably at significantly lower prices.

So when will all of this pay off for Ford in China?

Ford isn't yet ready to put a date on when its China operation will return to profitability. CFO Bob Shanks said that while he expects that Ford's loss in China will narrow sharply this year, the timing of the improvements depends to some extent on external factors -- particularly the state of China's new-car market, which is in a slump at the moment.

But, Shanks said, all of the changes that Ford is making will create momentum as the year goes on -- and whether it happens in 2019 or later, Ford is moving aggressively to return China to a sustainably profitable growth path.

This article originally appeared in The Motley Fool. The Motley Fool has a disclosure policy.

John Rosevear is the senior auto specialist for Fool.com.