Enter the EV Dragon

China’s Strategic Drive into the Global Auto Market

China wants your local car market. Absent trade barriers, it might just get it.

The key is the gradual shift to electric vehicles. China has no legacy auto industry to protect against the rise of EV. It can take advantage of an innovator’s dilemma, in which the world’s legacy car companies must keep producing their internal combustion fleets while also researching, developing, and making EVs. If EVs are indeed the future, and China can put in place a foundation to dominate that future, it could achieve an end-run to capture most of the auto industry.

Being state-backed helps in this regard.

China’s subsidized companies don’t need to manage the quarterly investor concerns that companies in capitalistic societies must manage. Quarters, years, even decades of low profitability can be fine on the road to a big payoff, but investors rarely have the patience for such a schedule.

An exception in the West is Amazon, which succeeded in convincing investors that losing money on every sale was fine on the way to becoming the everything store. Competitors — most of them now former competitors — complained, but Amazon turned short-term pain into long-term gain. That’s a rarity in Western capital markets.

It took Amazon nearly seven years to turn a profit, and it wasn’t a big one. From a January 2002 report in the New York Times:

“After losing $2.8B since it was founded in 1995, the online retailer Amazon.com said yesterday that it had made its first quarterly profit, $5M, validating at least in part its strategy to grow rapidly first and worry about profits later. …

“[The company benefits from] a business model that has high fixed costs — for technology and warehouse space — but relatively lower incremental costs as volume increases. The company said yesterday that it would offer free shipping for orders over $99.”

Amazon borrowed big, grew quickly, and today receives about half of online spending in the United States.

China appears to be following a similar game plan in the auto industry, but with less reliance on private banks and investors. Not zero, but less. More below.

The country can parlay revenue it generates as the world’s factory floor into undercutting foreign automakers. It doesn’t care about immediate profit, and all but scoffs at the idea of fair working conditions. Human Rights Watch says China has “so far shown hostility to the human rights and responsible sourcing policies many carmakers profess to apply across their businesses.” The organization is particularly concerned about China’s forced labor policies — great for low prices, not so great for forced laborers.

Chinese President Xi Jinping said in 2014 that he wanted to transform his country into “an automobile power.” It’s well on its way, and EVs are the key.

Already, China is the world’s largest car market and a quarter of new cars sold there are EVs. No car company can thrive in China without a strong EV offering, thanks in part to Beijing offering subsidies and tax breaks that encourage EV adoption. Legacy auto brands have faded into the background as the two EV leaders battle for market share. They are China’s BYD and America’s Tesla.

BYD was founded in 1995 as a maker of batteries. The “BYD” originally came from the initials of its Chinese name, but later the company back-formed the slogan “Build Your Dreams.” It is headquartered in Shenzhen, Guangdong, China.

In last year’s fourth quarter, BYD overtook Tesla as the world’s largest seller of battery-only cars for the first time, selling 526,000 to Tesla’s 484,000. Tesla derives about 20% of its sales from China.

Following the domination of their domestic market, BYD and fellow Chinese electric carmaker Nio have their sights set on Europe. BYD sells five models in Europe and plans to launch three more this year. It is building a new factory in Hungary, with plans to sell 800,000 cars annually in Europe by 2030. For comparison, the total number of cars sold in Europe last year was 10.5 million, 14.6% of which were EVs. Tesla grew its European sales by 89.2%.

I wrote above that, compared with Western rivals, China relies less on banks and investors, but they are still involved.

None other than Warren Buffett’s Berkshire Hathaway invested in BYD in 2008, buying a quarter of its Hong Kong-listed shares, or 9.9% of the company, for $232M. However, starting last year, Berkshire has sold more than 60% of its stake, reducing its holding to 8% of the Hong Kong shares. It’s unusual for Berkshire to sell long-term holdings. It prefers owning them forever.

A year ago, Buffett said he sold shares in BYD following its remarkable gains over the previous 13 years. He still thought it was a great company but that he could find a better use for Berkshire’s capital. Unmentioned was China’s destruction of Hong Kong and rising tensions between China and the US, but these may have played a part in the decision.

Meanwhile, BYD is gunning for Europe, and European automakers are worried.

BYD’s EV supply chain is vertically integrated, thanks to its origins as a battery maker. Tesla even partners with BYD, using the company’s lithium iron phosphate “Blade” battery cells in some of its EVs, including the Model Y. BYD can make batteries for EVs more cheaply than its Western rivals. As Der Spiegel put it: “In contrast to the German manufacturers, the Chinese control the entire production chain, from the raw material mine to the battery cell to the car dealership.”

The German magazine ran an in-depth look at Europe’s position in China’s EV crosshairs, noting the seriousness in Shenzhen.

BYD’s first dedicated massive cargo vessel, the BYD Explorer No. 1, delivered 3,000 EVs to Bremerhaven, Germany, and some of them made their way “to Stuttgart, the home of Mercedes-Benz and Porsche. … In two years, the Chinese are hoping to sell a six-digit number of electric cars in Germany.”

Production in China has gone through the roof in preparation for dumping overseas. Der Spiegel cites experts calculating that even at 80% capacity utilization, China will produce 15 million more vehicles than its own market can absorb, a figure exceeding the total annual demand for combustion and electric cars in Europe:

“The reason for the overproduction: Almost all providers in China have state investors, either as joint venture partners or as major shareholders. It is in their interest to keep the factories running, even if there are no domestic customers for the vehicles. … Chinese cars are pushing onto the global markets — and causing a price war that some car company executives have described as a ‘bloodbath.’ … BYD even ousted Volkswagen as a sponsor for the marketing of the 2024 European Football Championship in Germany.”

Victory may come down to pricing. BYD’s mass model costs just €10,000 [$10,800], and even at €20,000, the Chinese would still be undercutting all Western manufacturers.

In Europe, worry may spur action.

“Europe cannot just accept that strategically viable industries constituting the European industrial base are being priced out of the market,” Jens Eskelund, president of the European Union Chamber of Commerce in China, told reporters last month. “It is hard for me to imagine that Europe would just sit by and quietly witness [its own] accelerated de-industrialization … because of the externalization of low domestic demand in China.”

Last October, the European Union launched an investigation into China’s state support for EV makers, seeking to determine whether cheaper, Chinese-made vehicles benefit unfairly from state subsidies. European Commission President Ursula von der Leyen said Europe was open to competition but not for a race to the bottom:

“Global markets are now flooded with cheaper electric cars and their prices [are] kept artificially low by huge state subsidies. So I can announce today that the commission is launching an anti-subsidy investigation into electric vehicles coming from China.”

The probe is scheduled to last 13 months, with results arriving in November.

In the United States, President Biden issued a statement in February addressing national security risks to the US auto industry, from which:

“China is determined to dominate the future of the auto market, including by using unfair practices. China’s policies could flood our market with its vehicles, posing risks to our national security. …

“These cars are connected to our phones, to navigation systems, to critical infrastructure, and to the companies that made them. Connected vehicles from China could collect sensitive data about our citizens and our infrastructure and send this data back to the People’s Republic of China. These vehicles could be remotely accessed or disabled.

“China imposes restrictions on American autos and other foreign autos operating in China. Why should connected vehicles from China be allowed to operate in our country without safeguards?”

With Europe and the US possibly preparing new tariffs, China is refining its tariff-avoidance tactics.

Its strongest play in North America involves a US Customs and Border Protection rule called Section 321. It states that an import to the United States valued at less than $800 is exempt from tariffs. China has partnered with shipping companies, and storage companies in Mexico, to move bulk shipments into close proximity to the US and then individually package them at values of less than $800.

Whether an automobile could make it through this process is questionable, but the tactic shows that determined parties are good at finding ways around tariffs and trade restrictions. China is nothing if not determined on the EV front. Remember Xi Jinping’s decade-old ambition.

One person who hopes Western policymakers prevail is Tesla CEO Elon Musk. On Tesla’s earnings call in January, he called Chinese competitors “extremely good,” and warned:

“The Chinese car companies are the most competitive car companies in the world. So, I think they will have significant success outside of China depending on what kind of tariffs or trade barriers are established. Frankly, I think, if there are not trade barriers established, they will pretty much demolish most other companies in the world.”

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Sources

The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail
by Clayton Christensen

The New York Times
TECHNOLOGY; A Surprise From Amazon: Its First Profit — 1/23/02

Human Rights Watch
Asleep at the Wheel: Car Companies’ Complicity in Forced Labor in China

Nikkei Asia
BYD shares rebound on China's latest push for EV buying

The Guardian
China’s BYD overtakes Tesla as top-selling electric car seller

The Brussels Times
More than 10 million new cars sold in the EU [in] 2023

Markets Insider
Warren Buffett’s company slashed its stake in BYD

Der Spiegel
Der Elektro-Schock: An Existential Crisis in the German Auto Industry

CNN
A glut of cheap Chinese goods is flooding the world and stoking trade tensions

CNN
Europe probes China’s electric car subsidies as imports soar

The White House Briefing Room
Statement from President Biden on Addressing National Security Risks to the US Auto Industry

FreightWaves
How China skirts tariffs into the US

CNBC
Elon Musk says Chinese EV makers will ‘pretty much demolish’ most competitors without trade barriers