Western car giants risk being left behind by China’s EV industry

Ryan Xu was a dream customer for Germany’s car makers. The Guangdong-based entrepreneur and her husband own a Porsche 911 and a Mercedes-Benz G-Class and were among the first buyers of the electric Porsche Taycan.

But her views on German cars have soured as Chinese consumers increasingly favour tech refinement over traditional selling points like horsepower and handling. The software systems in the Taycan, which costs well over $100 000, were “terrible”, the 36-year-old mother of three said. It was “just an electrified Porsche — and that’s it”.

Her assessment isn’t isolated. As China moves away from combustion-engine cars, Volkswagen, Mercedes-Benz Group and BMW are struggling to offer electric vehicles that appeal to customers in their largest and most lucrative market, putting €35-billion of investment on the line.

The latest warning signs came last week, when all three German manufacturers reported slumping third-quarter sales in China. BMW posted its steepest sales drop there in more than four years, a 30% plunge, and Mercedes’ deliveries declined 13% amid poor demand for its priciest cars, including S-Class and Maybach limousines.

Porsche’s sales in China tumbled 19% to its worst third-quarter performance in a decade as global demand for the Taycan nearly halved. Volkswagen — the parent of Porsche and Audi — reported a 15% decline. “The competitive situation in China is particularly intense,” said Marco Schubert, who oversees sales for VW.

After dominating the gas-guzzler era, German manufacturers became complacent, underestimating the threats posed by new rivals and reluctant to abandon the profits generated by big-engine cars. That allowed Tesla and local manufacturers led by BYD to speed by with tech-savvy and affordable plug-ins, and now China no longer needs or wants them there.

Turning point

“The turning point is happening now for these automakers,” said Stephen Dyer, a Shanghai-based MD at consultant AlixPartners. “They need to dramatically change their strategy in the market.”

The next challenge is already on display at this week’s Paris auto show, where Chinese manufacturers are stepping up their efforts to take market share in Europe. Companies including BYD and Xpeng will showcase their latest technology at the biggest European car event this year.

At least one response effort didn’t go as planned. The microphone and slideshow cut out for several minutes in the midst of Volkswagen’s presentation about future electric vehicles, leaving sales and marketing chief Martin Sander visibly frustrated.

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BMW CEO Oliver Zipse, meanwhile, pushed back against Europe’s plan to effectively ban the sale of combustion-engine cars from 2035, arguing it will lead to a “massive shrinking” of the region’s automotive industry.

It’s an emotion shared by drivers in China. After dealing with braking and other quality issues, the Xu family sold their Taycan and bought an ET5 from Chinese brand Nio. The car was about a third cheaper than a Mercedes EQE, which Xu also considered, but offered a more luxurious interior design, smooth voice controls and greeted their kids by name as they climbed in.

“German cars can hardly match” that level of technology, said Xu, who runs a business with her husband. Mercedes, BMW and Audi “can hardly be seen as luxury cars now”.

While German car makers still control nearly 15% of the Chinese market, that’s down from a quarter before the pandemic and worse yet, their share of EVs is less than 10%. Without a quick turnaround, the slump risks turning into a rout and tipping Germany’s Big Three into an existential fight. As it is, VW, Mercedes and BMW are each only worth about half of BYD’s stock market value.

Even more than other international peers, Germany’s car makers have gone all in on China. While some rivals have cut their losses, the Germans aren’t giving up, shifting more resources in an effort to claw back market share. But it looks like an uphill fight as Beijing actively seeks to build up its own manufacturers.

Volkswagen plans to play the long game. A spokesman for the Wolfsburg-based company said the Chinese car market has been marked by steep discounts, and it wouldn’t buy market share at the expense of profitability.

The company plans to continue its “in China, for China” strategy to protect its long-term prospects. BMW and Mercedes are also planning to stick with a localisation approach to appeal to buyers there.

The reasons for doubling down are clear. With Europe’s car market probably past its peak and the US saturated, there’s no viable alternative to China for a similar level of volumes and profits.

That raises concerns given their massive footprint in China. As a group, Germany’s car makers operate a network of over 40 factories — more than in their homeland. That’s too much investment to simply give up on — and explains why they oppose the EU’s plans to levy tariffs on China’s cheap electric cars.

Unthinkable

Pulling out of China — as smaller Japanese brands Suzuki and Mitsubishi have done — is almost unthinkable. And any restructuring would be complicated, given the operations are caught in a complex web of relations with government entities. That puts the focus on developing the kinds of features that Chinese customers want.

Urgency started to intensify in late 2022. After Volkswagen’s China chief Ralf Brandstätter warned the supervisory board that Chinese car makers had leapt ahead, the company then chartered flights to send hundreds of staff to the Shanghai auto show in April 2023 — the first installment after years of Covid lockdowns — to see for themselves.

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It was a sobering reality check. The German executives were confronted with a rapid roll-out of affordable Chinese models, tech-loaded products and an intensified price war. There was also a slew of gimmicky innovations like a hopping sportscar and in-car karaoke, which may have been quirky but reset the bar for Chinese consumers about the source of automotive trends.

Since then, there has been an intense competitive response. A few weeks after the auto show, VW CEO Oliver Blume ousted the head of software unit Cariad in the latest effort to accelerate and improve technology. Alongside new Chinese partnerships for autonomous driving, infotainment and user experience, VW also invested in Guangzhou-based Xpeng to underpin a plan to build cars using the startup’s EV expertise.

After a profit warning in September, one of the first actions by Mercedes CEO Ola Källenius was to fly to China to check on progress in reshaping its presence there including tapping CATL for batteries and Tencent Holdings for digital services. BMW responded by joining forces with Great Wall Motor to build EVs for its Mini brand.

The cumulative result is that German cars will become progressively less German in their largest market. The expansion is also exactly the opposite of the government’s aim to reduce exposure to China, according to Gregor Sebastian, an analyst at Rhodium Group.

Clinging to their position in China is “a huge gamble”, he said, noting that the German state might need to bail them out if it all goes wrong. “They’re hoping they’re too big to fail.”

While Chinese consumers eagerly bought up German cars for years, the market has changed and reclaiming that enthusiasm from a clientele that’s younger, more tech orientated than in Europe is a major challenge. With the switch to electrics, local brands have shown they can match VW, BMW and Mercedes on quality and beat them on price and technology.

What that means for Germany can be seen inside a production hall at Mercedes’ Sindelfingen site near Stuttgart. It’s home of the flagship S-Class, long a favourite of China’s nouveau riche. But demand has slumped and production has been reduced to a single shift for the first time.

While cost-cutting has started to roll over Germany’s motoring industry — most notably with VW’s threats to close factories in its homeland — Chinese operations are still insulated. It’s a sign that executives are hopeful for a turnaround. But they also have little choice.

The pressure is on

Downsizing operations in China is difficult because large-scale job cuts often need to be discussed with domestic partners and approved by local authorities, which have little incentive to be cooperative. More drastic changes like shutting a plant is even harder.

Land in China is owned by the government and that means a factory can’t simply be shut and sold — even if a buyer could be found. The case of Hyundai’s exit from a plant in Chongqing illustrates the risk. After several attempts to sell the factory building and the machinery, the Korean car maker ultimately accepted an offer from the local state-operated industrial zone for a fifth of its investment.

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That puts pressure on Germany’s car makers to revive sales, but the playing field has tilted in favour of domestic players. Beijing has directed several key state-owned car makers, including VW partner FAW Group, to prioritise technology and market share over profitability. That’s hardly an option for Germany’s publicly listed car makers.

Despite the structural headwinds, the downturn might have been prevented by more forward-looking investment in the Chinese market. But after decades at the pinnacle of the auto industry, Chinese rivals weren’t taken seriously and local insight was bypassed as decisions were funnelled through boardrooms thousands of kilometres away.

There also wasn’t enough attention paid to the fact that the switch to EVs was about more than swapping out one powertrain for another, and early software was buggy. For instance, VW only managed to turn on over-the-air updates years after launching its first Chinese electric model in 2020.

That meant owners had to send their cars to dealers for in-store upgrades — which could at times take days. To overcome resistance, some dealers offered cash incentives to encourage customers to fix faults.

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Zhou, an IT engineer living in Wuhan, had to endure the frustration after buying an ID.4 in early 2022. With screens going black several times in the middle of driving, he got glitches instead of German quality. Updates were also regularly behind schedule or available only via the dealer.

He’s now seeking a replacement. It will be another EV, but this time “I won’t visit any German dealerships”, he said. “I’ll only go for local brands, or Tesla.”  — Chunying Zhang and William Wilkes, with Stefan Nicola and Monica Raymunt, (c) 2024 Bloomberg LP

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