Growing demand for SUVs lifts production in China

Drive outside the city limits of Chongqing, China, and it hits you immediately: This is SUV country.

In fact, Chongqing, along with many other cities and small towns of inner China, has become one of the hottest markets for automakers to market utility vehicles.

"Like most other parts of the world, we see strong SUV demand," said Dieter Zetsche, Daimler (DAI-DE) chairman and head of Mercedes-Benz's car division, at the Shanghai Auto Show on Monday. "SUVs are clearly growing stronger than sedans and other body types. Therefore, the SUV market is clearly the place to be."

At the Shanghai Auto Show, which opens to the public on Wednesday, Zetsche unveiled two new utility vehicles that Mercedes will sell in China: the GLC and GLE. The GLE is also being built in Beijing.

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The models, which fuse together elements of an SUV and a coupe, are the latest two to latch onto the boom in utility vehicles. Last year, automakers built 4.32 million utility vehicles in China, a 36.7 percent increase, according to the consulting firm IHS Automotive. By 2018, IHS estimates SUV production in China will top 7 million, with a high percentage of them headed for buyers living deep inside the country.

The reasons are twofold.

For one, the growing economies in China's smaller cities are driving overall auto sales higher, including those of SUVs. For another, Chinese consumers are similar to American auto buyers, in that they want bigger vehicles with more utility.

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"It is all about the SUV in the inner part of China and the smaller cities," said James Chao, an analyst with IHS Automotive in Shanghai. "Sedans are of course very popular, but SUVs have really caught the imagination of the Chinese consumer in those core markets."

And given Chinese drivers' similarities to those in the U.S., who better to respond to the call than American automakers Ford (F) and General Motors (GM)?

GM, the second-largest automaker in China, is in the midst of opening four new plants there, which will build a combination of SUVs and sedans.

Meanwhile, Ford sales in the world's top auto market topped 1 million vehicles for the first time last year, thanks in part to the success of a small SUV, the Kuga. Ford will expand its SUV offerings in China when it starts selling the Explorer there later this year.

While foreign automakers are building more SUVs in China, much of the growth in production is being fueled by Chinese automakers, which are selling entry-level and lower-priced utility vehicles for customers who want more space but can't afford higher-priced foreign brands.

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But is there enough demand to keep sales of SUVs humming?

"I think over the next three or four years you will see a shakeout in that segment," Chao said. "You will see some of the lower-quality players, and some of them will be local Chinese brands, start to see declines in that segment due to a lack of staying power."

CEOs including Renault (RNO-FR)-Nissan (7201.T-JP)'s Carlos Ghosn are watching the market closely to see if automakers will start to push higher incentives, to goose sales in a more crowded market. So far, he hasn't seen that happen.

"I don't think you have any kind of bubble where all of a sudden people say, 'Oh my god, this is the end of this market,' " he said.

Questions? Comments? BehindTheWheel@cnbc.com .