Surging share

In the first five months, 9.84 million vehicles were sold in China, nearly 9 percent more than last year. But almost all luxury brands reported double-digit growth.

Mercedes-Benz surged 40 percent from a year earlier to more than 107,000 deliveries from January to May.

Its major rivals BMW and Audi reported year-on-year growth of 25 percent and 19 percent respectively during the same period. Along with luxury SUVs, small luxury models are also increasingly popular due in part to increasingly stringent emission standards, said PwC.

Growing concerns over traffic congestion and auto-related pollution have made small, entry-level models even more popular as price-effective entry points into luxury ownership for younger first-time buyers, said PwC.

Like luxury SUVs, sales of small luxury cars are forecast to grow substantially, from the current 110,000 to an anticipated 680,000 by 2020.

"As the luxury segment proliferates, global premium brands are scrambling to localize production," said Rick Hanna, head of PwC's Global Automotive team. "It is expected that almost all major luxury brands will have domestic assembly by 2016."

Localization has cost advantages including local sourcing, R&D and a streamlined supply chain within the country.

Localization can also offer long-term benefits in government and legislative incentives and minimizing additional import duties, said the PwC report.

Establishing a local operation not only shows commitment to the market, but also provides the ability to remain agile in a dynamic market where consumer preferences can shift quickly.

The latest example is Jaguar Land Rover, which established a local joint venture that will be operational in the fourth quarter. Its new factory built at an investment of 10.9 billion yuan, has an annual capacity of 130,000 vehicles and 130,000 engines.

The joint venture in Changshu, Jiangsu province with Chinese automaker Chery Automobile will make Jaguar and Land Rover vehicles as well as own-branded vehicles.

By the end of this year, Japanese premium brand Infiniti will begin production at its first China plant in Xiangyang, Hubei province. The company will first manufacture the long-wheelbase Q50 sedan and QX50 SUV.

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