Through years of turmoil for General Motors (NYS: GM) , years that saw its products become laughingstocks and the company itself spiral into bankruptcy, there was one shining good story: GM was the undisputed king of China's booming auto market.

Even when it couldn't seem to get out of its own way in the U.S., even as its European subsidiary lost millions year after year, GM's success in China was a sign that the company still had the ability to do well.

But now, GM's market-leading position in the Middle Kingdom is coming under heavy pressure - and it exposes a key weakness in GM's business in China.


A battle of near-equals for market supremacy
While GM has, in fact, led the Chinese auto market for eight years, the reality is that the company has always been neck-and-neck with its bitter global rival, Volkswagen (OTC: VLKAY). Both companies had the good fortune to partner early with SAIC, the well-connected Shanghai-based Chinese automaker, and both had seen their joint ventures rise to dominate China's auto markets -- though GM has always been able to hold on to a small sales advantage.

But VW may be starting to turn the tables. Volkswagen's sales in China were up  21% in the third quarter, as Chinese consumers turned away from Japanese brands like Toyota (NYS: TM) in the wake of an international dispute. That was about three times the gain posted by GM -- enough to give VW the sales lead for the period.

GM still leads the year-to-date race by about 77,000 vehicles, and that might be enough for the General to take the sales crown, once again. But the dynamics of the Chinese market -- and the strength of its competitive position -- favor VW in a number of ways in the long run.

Why VW is arguably more successful than GM in China already
A lot of GM-versus-VW comparisons in China are essentially a wash. So far this year, GM has the two top-selling cars in China, while VW's Jetta ranks fourth behind the fast-rising Ford (NYS: F) Focus. But VW has five of the top ten best-sellers, while GM has only three. Volkswagen launched several new models recently, and saw sales perk up -- but GM has a bunch of new models on the way. And on and on. In many ways, the two are more or less evenly matched. Even if VW does take the lead for a while, GM is likely to seize it back at some point.

But in one important way, VW has been much more successful than GM: it's making more money in China. Here's why: About half of the vehicles GM sells in China are Wulings, inexpensive little vans used mostly by small businesses. They're very popular, in large part because they're cheap -- which means they aren't very profitable. And GM has to split those profits with the local joint-venture partners required by Chinese law.

Meanwhile, Volkswagen's Audi brand has racked up big sales in China. Audis are the hot brand in the white-hot Chinese luxury-car market, the favored ride of chauffeur-driven government officials. While VW has to split its profits on those Audis with joint venture partner FAW, the profit on a loaded Audi is much, much higher than GM's profit on a little Wuling van that sells for the equivalent of about $5,000.

A GM response could take years
This distinction hasn't escaped GM CEO Dan Akerson. Part of - maybe even most of - the reason for GM's big push to revitalize its tired Cadillac brand is a desire to capture more of the booming Chinese luxury market. Chevy and Buick are big sellers in China, but Cadillac is all but invisible, selling just a few thousand cars a month.

GM wants to change that, badly. The new Cadillac ATS is a strong entry in the lower end of the market, but what GM really needs is a big, luxurious car that's good enough to steal sales from Audi's flagship A8 -- one that can establish Cadillac as a high-status brand.

That car is coming, says the GM rumor mill, but not for a few years. Meanwhile, GM may yet hold on to its lead in the Chinese sales race; but more and more, VW is looking like the real winner in China.

GM's stock has risen a bit recently, but it's still not far from its post-bankruptcy low. But if Akerson can harness GM's potential in China, deal with Opel, and get the Feds to exit honorably, then GM's stock could have significant upside over the next couple of years. However, investors need to stay attuned to fluctuating demand and the ability of automakers like GM and Ford to respond in unison. For starters, one of our top equity analysts has compiled a premium research report with in-depth analysis on Ford's competitive edge. To find out what could propel Ford down the road, click here for instant access to this premium report now.

The article GM Falls Behind in China originally appeared on Fool.com.

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