When Volkswagen AG opened its first factory in China four decades ago, competition was, well, pretty much nonexistent. Jeep had just arrived, and a handful of locals with names such as First Auto Works and Second Auto Works, which mostly specialized in heavy trucks and buses, had made occasional detours into proletarian people movers like the East Wind and the Red Flag. So VW’s Santana—a boxy, no-frills sedan based on an early version of the Passat—quickly became the preferred mode of transport for ambitious corporate chieftains, political bosses and, later, the growing middle class. The German company soon became the leading brand in China, and in some years its operations provided almost half of VW’s global revenue.
Like other foreign brands, VW was required to sign up joint-venture partners that would officially control the operation, a strategy aimed at transferring design, engineering and marketing chops to local companies. (Today, VW has three: in Shanghai, Jilin and Anhui.) Those partners, and newer companies started by people who once worked at them, have proven to be very adept students. Today, China’s domestic automakers control half of the market, up from a quarter in 2008. VW’s sales have dropped by more than 10% this year alone after falling from 4.2 million vehicles in 2019 to 3.2 million last year. “The technological progress made in that country is really outstanding,” Oliver Blume, VW’s chief executive officer, said during the company’s earnings presentation in March. “This constitutes a major challenge.”
The trend is being accelerated by the rapid growth of battery-powered vehicles, with EVs and plug-in hybrids on track to reach about 40% of China’s vehicle deliveries in 2023. That’s been a boon to BYD Co., China’s biggest EV maker, which in the first quarter jumped ahead of VW in passenger car sales. Profit at BYD, which is backed by Warren Buffett, more than quintupled last year, to $2.4 billion, and the company is on course to become China’s leading car brand by December, ending VW’s two-decade run at the top.
Blume is visiting the Shanghai auto show, which opens on April 18, on his third trip to China since taking VW’s top job in September. This time, he’s bringing the company’s board for a better understanding of the challenges VW faces in its largest market. At the show, the automaker says it will exhibit 20 EVs across its various brands and highlight partnerships aimed at creating cars tailored to China. The star of VW’s lineup will be the all-electric ID.7, a sedan intended to appeal to the Chinese preference for roomy cars. In a separate pavilion, Porsche AG will present VW Group’s other debut for the show: a revamp of its Cayenne SUV—with a combustion engine (the all-electric version isn’t expected until 2026).
While Chinese manufacturers have largely lagged behind foreigners in selling gasoline-powered cars, the government has boosted local EV champions by giving consumers incentives to buy their vehicles. That effort has benefited BYD, Nio and Geely, as well as companies such as CATL (Contemporary Amperex Technology Co. Ltd., the world’s biggest EV battery maker) and Ningbo Tuopu Group, which has made components for Tesla and now serves dozens of customers. “The Chinese push for electrification was mostly a way of leveling the playing field between the incumbents and the Chinese players,” says Jefferies analyst Philippe Houchois.
Increasingly, VW finds itself competing with its own JV affiliates. Its Shanghai partner, SAIC Motor Corp., has joined with internet giant Alibaba Group Holdings Ltd. to form EV specialist IM Motor. The company says it was able to get its first model, the L7 SUV, to market in less than two years, well under half the time VW took to start production of its electric ID.3. On April 18, Volkswagen said it's investing €1 billion ($1.1 billion) in a new research facility in Hefei aimed at cutting development time by roughly a third. “We have to become faster,” Ralf Brandstaetter, VW’s China CEO, said in February. “The market demands the pace.”
China’s growing ranks of software engineers have helped domestic rivals jump ahead of VW in emerging technologies. Xpeng Inc. is focused on autonomous-driving features that it says are better than Tesla Inc.’s on China’s roads. And Nio Inc.’s coupes, sedans and SUVs feature a dashboard robot called Nomi with an animated face that can be programmed to entertain kids in the backseat by waving, winking and making funny expressions. Parents can use the feature to adjust the temperature or open windows via voice command.
VW has been beset by complaints of connectivity glitches and screens that abruptly go dark—issues the company acknowledges and says it’s working to fix. “People see that Chinese brands have the technological advantage,” says Jing Yang, a research director for Fitch Ratings in Shanghai. Yang, who owns a Mercedes-Benz combustion car, says she may switch to an EV and is leaning toward a local brand because they offer superior autonomous driving features.
The local automakers’ rise has been helped by China’s tech giants, which together have plowed more than $19 billion into car-related technologies since 2021. Telecommunications equipment maker Huawei Technologies Co. and search-engine king Baidu Inc. are working on autonomous-driving tools and so-called smart-cabin features focused on the safety and comfort of the driver and passengers. And smartphone giant Xiaomi Corp. is developing its own car, expecting to start mass production next year.
VW aims to fight back by more than tripling its EV production capacity in China to 1 million cars a year by mid-decade. The company says it’s planning to launch a half-dozen more fully electric models in the country by 2025, and it expects to have over 30 by the end of the decade. Its software division, Cariad, is forming a partnership with local coding house ThunderSoft to beef up in-car gadgetry such as entertainment systems. And it’s developing autonomous-driving technology with a Beijing company called Horizon Robotics Technology R&D Co. The automaker said in October that it would invest €2.4 billion in a joint venture with Horizon to make semiconductors that will form the backbone of such systems.
VW will need to dramatically reorient its Chinese operations toward EVs by producing models that prove as popular as its combustion cars, says Jochen Siebert of Shanghai consulting firm JSC Automotive. This was never going to be easy, and it’s getting harder as domestic rivals grow stronger and build ever-better cars. But VW’s abundant cash flow and massive scale mean it’s got as good a chance as anyone of making the shift, Siebert says. “Volkswagen has gone through rough times before,” he says. “From a historical point of view, they know how to get out of it.”Read next: A Chinese Battery Supplier Plans Five European Plants
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