China’s Auto Industry to Grow From Large to Strong

Abstract

The auto industry’s competitiveness relies heavily on economies of scale and technological advantages. As it pursues these twin goals, the auto industry has witnessed a century of production model transformations in brands ranging from Ford to Toyota to Tesla.

Deglobalization has posed major challenges to the global auto value and supply chains. The auto value chain is large and complex, relying heavily on global market demand and the integration of technology. As a result, trade frictions, the COVID-19 pandemic, and geopolitical conflicts may cause supply shortages in the global value chain, resulting in short-term production halts. China’s auto industry plays a vital role in the global value chain, and in the near term, we think its main goal will be to improve supply chain resilience and maintain scale advantage.

In the long term, the auto industry is undergoing restructuring as disruptive innovation is changing the industry’s technological foundation and market landscape. The smart electric vehicle (EV) technology revolution repositions vehicles as intelligent mobile terminals, overcoming traditional automakers’ technological barriers in engine and gearbox. In our view, an industrial landscape that is dominated by the traditional giants of the auto industry, including those headquartered in Germany, Japan, the US, and South Korea, is changing. This is creating opportunities for the emergence of China’s auto industry on the global stage, but we believe it may also cause overcapacity of outdated production model.

To develop its auto industry in the era of internal combustion engine (ICE) vehicles, China adopted a joint-venture (JV) strategy, attracting core automotive technologies and capabilities with its large market and localizing the production and assembly of overseas models. However, the Chinese auto value chain currently lacks core technologies, in our opinion, making it large but not strong.

In the alternative fuel vehicle (AFV) era, China has boosted domestic demand for AFVs through fiscal and tax policies, and by accelerating technological innovation and market competition in related fields, enabling its AFVs to gain scale and technological advantages globally. China now exports AFVs worldwide. In January–September 2022, the country accounted for 62% of global AFV sales volume, with Chinese brands accounting for more than 50% of the global AFV market. In the future, we believe that China may continue to leverage its economies of scale as a large economy and strengthen the technological accumulation of the auto industry by improving the national innovation system. In our opinion, these developments would cement the Chinese auto industry chain’s importance in the global market.

Amidst the backdrop of deglobalization, the Chinese auto industry’s weaknesses in key technologies are becoming more obvious. To improve China’s prowess in cutting edge technologies, the government and the market could work together. The technological transformation of the automobile industry will involve bulk raw materials, basic chemicals, machinery equipment, semiconductors, artificial intelligence (AI), and big data. Auto chips in particular may face a supply shortage. China's automotive semiconductor industry still faces challenges such as the low output of low-end products, mid-range capacity shortages, and a lack of advanced technology in high-end products. Improvements in these areas require advances in domestic technologies.

Authors of this chapter: DENG Xue, CHANG Jing, REN Danlin, SHE Jinglan, SI Ying, CHEN Yating. Translator: SUN Tong. Editors: Kenneth HO, Prashani RAMBUKWELLA, SI Ying, LIU Xinran.

The competitiveness of automobile products has been highly dependent on economies of scale and technological advantages since the dawn of the automobile industry 120 years ago. The auto value chain is large and complex, relying heavily on economies of scale and technological integration supported by globalization. Now, the global auto supply chain is confronted with significant challenges due to security threats, including from trade frictions, the COVID-19 pandemic, natural disasters, and geopolitical conflicts, which are disrupting scale and increasing cost volatility. China’s auto supply chain, which is critically important to the global auto supply chain, is also affected.

Meanwhile, the auto value chain is rapidly shifting from traditional ICE vehicles toward smart EVs. The technological and industrial focus of the global auto value chain is changing fundamentally, and a global market dominated by leaders from Germany, Japan, the US, and South Korea is being relegated to history. In our view, it is crucial for China to transform from a large contender that is a major contributor to global auto production and sales to a strong contender whose automakers have a high global market share. We also believe that it is vital for China to seize once-in-a-century opportunities through technological reform and globalization.

14.1 Global Auto Value Chain is Plagued by Supply Chain Issues; China’s Auto Industry is Large but Not Strong

14.1.1 The Auto Value Chain Relies on Economies of Scale and Technological Integration in Globalization, and Faces Significant Challenges in the Short Term

Auto manufacturing is at the heart of the auto value chain, with auto parts upstream and the aftermarket downstream. The core components of a vehicle include the powertrain, chassis system, body and interiors & exteriors, electronics & electrical products, general-use parts, and new parts such as smart cockpits and smart driving. Each core module has many sub-components that can be traced back to bulk raw materials, including steel, aluminum, copper, petroleum, and plastic particles. Automotive finance, insurance, leasing, repair and maintenance, automobile accessories, and used cars are all part of the aftermarket.

The auto supply chain has a network structure and a large and complex supporting system, with professional labor distribution and a high degree of globalization. Auto manufacturing is at the heart of the value chain, and original equipment manufacturers (OEMs) have tier-1, tier-2, and tier-3 auto part suppliers. Tier-3 suppliers mainly provide products for tier-2 suppliers, and tier-2 suppliers sell to tier-1 suppliers, which are system integrators. Tier-1 suppliers directly supply products and system solutions for corresponding components to automakers. They have a professional division of labor, and industrial clusters are formed. Tier-1 system integrators have closer ties with automakers and stronger capabilities in synchronous R&D. This allows them to offer value added products and services and remain at the center of the value chain network.

The auto value chain leverages its advantages in the professional division of labor and industrial clusters to benefit from economies of scale and higher efficiency resulting from globalization. However, in recent years, the emergence of force majeure risks such as trade frictions, the COVID-19 pandemic, natural disasters, and geopolitical conflicts has negatively impacted the security of the auto value chain.

As shown in Fig. 14.1, the COVID-19 pandemic in 2020 caused a widespread shortage in the auto parts supply chain, forcing most automakers to halt production. Global vehicle output fell for eight consecutive months, with monthly declines at one point reaching nearly 60%. The entire auto supply chain was fragile and out of control. In 2021, COVID-19 resurgence, natural disasters, and other factors caused a severe global automotive chip shortage, which led to a 13% decline in global vehicle output compared to 2019, with a monthly decline of 30% in August 2021. The global auto value chain was significantly shaken by COVID-19 resurgence in Shanghai in 2022, with monthly global vehicle output down 20% at one point.

Fig. 14.1

Source Marklines, CICC Research

The auto value chain has been hit by supply shortages in recent years.

The auto value chain, which relies heavily on globalization, faces significant challenges in the near term. China, as an important contributor to the global value chain, cannot escape such disruptions and impacts. Its auto value chain is one of the major industries that have been significantly impacted. Even after the COVID-19 pandemic, some Chinese automakers still face difficulties in producing specific models, delivering orders, or launching new models due to supply and cost issues pertaining to some particular components. As a result, the healthy development of the whole industry has been negatively impacted.

As the core supply chain in China has visible weaknesses, the supply of vehicles and integrated systems remains in danger of supply shortage. The scale advantage of China’s auto value chain has been influenced by production suspension, failed order deliveries, and even bankruptcy that once occurred. China’s value chain may face the risk of capacity relocation in today’s global market if it is unable to complete supply tasks or meet delivery demand over the long term due to shortages in core components and cost pressure.

14.1.2 China’s Auto Market is Large but Not Strong; Opportunities and Challenges Coexist in Electrification and Intelligentization

We examine the competitive landscape of the global auto value chain. China’s auto industry currently leads in sales as it benefited from and was deeply involved in globalization. In 2021, China sold 26.27 mn vehicles, accounting for 33% of the global total. However, China's auto industry has failed to obtain cutting-edge technologies, making the country a sizeable contender rather than a strong one in the global market. Japanese, German, and American brands dominate the global value chain with strong competitiveness and high output in overseas markets. They have a high proportion of overseas capacity and a low proportion of domestic capacity for exports.¹

In 2021, although China accounted for one-third of global vehicle output and sales, making it the largest producer and consumer, Chinese brands contributed only 45% of domestic output, as shown in Fig. 14.2. In 2021, Chinese automakers produced 8.44 mn units, with a global market share of only 10.6%, a large gap vs. Japan (26.3%), Germany (16.3%), and the US (13.9%).

Fig. 14.2

Note (1) Production-based sales are the sales of vehicles manufactured in a country; ownership-based sales are the sales volume of a specific country’s auto brands; (2) Japanese automakers include Toyota, Honda, and Nissan; German automakers are Volkswagen Group, BMW Group, and Daimler Group (now Mercedes-Benz); US automakers include GM and Ford; South Korean automakers are Hyundai and Kia; and Chinese automakers include Great Wall Motor, Geely, Chang’an Auto, GAC Auto, and SAIC Auto’s domestic brands, BYD, NIO, Xpeng, and Li Auto; (3) we evaluate a country’s auto brand and product exports by calculating the ratio of its auto brand sales to its sales of vehicles produced locally in 2021.Source Marklines, CICC Research

China leads in auto sales volume but lags in product and technology output.

The economies of scale for specific Chinese automakers fare even worse. As measured by a specific country's ratio of local brand sales volume to total sales of vehicles manufactured locally, Japan (469%), Germany (442%), South Korea (381%), and even France and Italy (249% combined) far outnumbered the 32% in China in 2021. To some extent, China's auto industry only serves as a market for finished products rather than an exporter of core technologies and products, lagging in brand power and technological expertise. We think China still has a long way to go before becoming a strong contender in the global market.

Aside from the visible gap in vehicle manufacturing, China’s auto parts market is crowded, but only a few strong brands exist. According to Marklines, China had over 18,000 auto parts suppliers by 2020, as shown in Fig. 14.3, putting it far ahead of other countries. According to Automotive News’ Top 100 Global Auto Parts 2021,² the Chinese mainland accounted for only seven of the top 100 manufacturers, with average annual revenue of US$3.9bn, significantly lower than the top 100 average. This illustrates that while China has many auto parts companies, most are small. In contrast, Japan, the US, and Germany are far ahead of China regarding the number of companies in the top 100 list and their revenue.

Fig. 14.3

Source Marklines, Automotive News, CICC Research

Leading system integrators (tier-1) from Japan, Germany, and the US lead the market with high revenue; China’s auto parts market is crowded but with limited strong players.

At a micro level, most Chinese firms are tier-2 and tier-3 suppliers at the bottom of the value chain. They are small and have a modest market share. However, most overseas auto parts leaders are multinational system integrators (or tier-1 suppliers) with a presence in multiple product categories, primarily in powertrain components such as engines and gearboxes, chassis system assemblies like steering and brake, automotive electronics, and body and interiors & exteriors. As conglomerates with a global presence, they are at the top of the value chain, with a sizeable revenue and value-added products and services.

However, China has the potential to grow from a large contender to a strong one. The auto value chain is rapidly shifting from traditional ICE cars to smart EVs. The global value chain’s technological and industrial focus is changing fundamentally, and a global market dominated by leaders from Germany, Japan, the US, and South Korea is being relegated to history. According to the latest analysis of the auto industry chain and value chain, the global auto market landscape is undergoing major restructuring, and China’s value chain is actively participating in and integrating into it. Based on the output value and profitability comparison of the global auto value chain in Fig. 14.4, we may have a more direct understanding of China’s status and opportunities.

Fig. 14.4

Note (1) For data comparability and availability, we use operating profit margin to show each economy's value chain positions in the traditional auto parts and AFV parts segments, and GM to show the value chain positions of system integrators (tier-1) and automakers in each country; we use ordinate data and refer to the financial data of related companies in the corresponding segment in 2021; (2) different colored bubbles represent different economies, and the size of the bubbles represents the sum of related companies’ operating revenue in each economy in the corresponding segment in 2021, thereby representing the output value of each economy in the corresponding segment; (3) in principle, the economies to which transnational corporations belong are subject to ownership. Source Company announcements, Capital IQ, Wind, Marklines, CICC Research

Companies from Germany, Japan, the US, and South Korea dominate the ICE vehicle value chain; China is not competitive in ICE cars, but it is taking the lead in AFVs.

First, traditional car manufacturing is clearly dominated by leaders from Germany, Japan, the US, and South Korea, each of whose average annual output value exceeds Rmb1trn. Their profitability is high due to strong brand and product positioning. Compared to foreign leaders, Chinese automakers have market shares of 45% in China and 11% globally, supported by China’s large car sales volume. They do not lead in product positioning, value for money, or scale, and they lag behind international brands in output value and earnings. The competitive landscape of system integrators (or tier-1 suppliers) engaged in core car manufacturing is very similar. As a result, the traditional auto value chain is dominated by leaders from Germany, Japan, the US, and South Korea. However, the AFV market is expanding rapidly, and Chinese and US AFV companies are rising. After a decade of development, Tesla now maintains high output value, earnings, and rapid growth. New Chinese AFV brands such as BYD, NIO, XPeng, and Li Auto are also growing rapidly. Compared to ICE manufacturing, China’s AFV manufacturing has taken the global lead in terms of scale. Chinese AFVs have entered the high-end market, and AFV makers’ operating quality has significantly improved.

Second, with the rise of Chinese automakers, the country’s auto parts value chain is enhanced by the transition to smart EVs. As the rate of localization (or even exports) of China's core parts value chain rises, so do the output value and operating quality of Chinese auto parts companies. By comparing the global operating data of four major auto parts (i.e., seats, interiors, lamps, and automotive glass, by order of rate of localization from the lowest to the highest), we note that Chinese companies are growing stronger. China has established a leading position in global market share and operating quality for power batteries, which are core components of AFVs. This illustrates that China’s auto value chain is at the forefront of this round of smart EV development. At the micro level, China’s AFV value chain has gained first-mover advantage in the early stages of the smart EV industry due to scale, technology, and manufacturing advantages.

14.2 Technological Innovation Leads Transformation of Auto Value Chain; New Globalization to Reshape Competitive Landscape

The auto industry faces changes not seen in a century. Vehicle electrification, which began in 2010, broke down the technical barriers of engines and gearboxes that protected traditional automakers. The industry embraced new entrants, brands, and models. The intelligentization of vehicles, which commenced in 2020, has increased the importance of technology in smart EV, and accelerated technological innovation, with iteration shortening the product innovation cycle. Emerging automakers like Tesla have expanded their technology and scale advantages. To compete with Tesla, traditional overseas automakers, and the growing number of tech giants in the industry, China’s auto sector faces the challenge of value chain reform led by technological innovation.

Due to government and policy support, Chinese auto brands have gained a leading advantage in scale and technology in the global AFV market. In January–September 2022, China's AFV sales volume totaled 4.36 mn units, accounting for 62% of global AFV sales volume, and Chinese brands successfully sold products overseas, occupying 80% of the AFV market in China and more than 50% globally. In our view, China will likely grow from a large contender in the global auto market into a strong one as its auto value chain accelerates the adaptation to technological changes while ensuring economies of scale and technological advantages.

In particular, facing complex changes in world politics and globalization, the global auto value chain will face new challenges such as the risk of value chain relocation (horizontally) and the lack of core technologies (vertically). The impact will be particularly severe on China's auto value chain, and investors should be wary of the risk of weakening economies of scale and technological constraints.

14.2.1 Tesla Leads Innovation in Automotive Technology and Changes in Industry Standards

Studying the history of auto value chain reforms may help us better understand changes in the global auto value chain. The automobile industry has undergone profound changes in demand and technology reforms over the last century, leading to major upheavals in the industry landscape. Automotive products have evolved from niche luxury goods to durable household goods, personalized consumer goods, and mobile smart terminals (a new definition for the latest iteration of vehicles).

Meanwhile, the auto value chain and industry landscape have undergone four major stages of change: (1) Small batch and all handmade production in the early days; (2) Ford’s vertically integrated mass production (assembly line), which supports mass marketing; (3) Toyota’s production system, which features labor division and outsourcing (lean production) and helps reduce costs and achieve customization; and (4) the smart EV revolution led by Tesla, with the firm introducing renewable energy and AI technologies to the automotive industry, adopting a vertically integrated industry chain, and redefining vehicles as smart mobile terminals.

Cars were produced in small batches after they first appeared in 1885 as they were handmade and could not be mass produced at low cost and with high quality. As a result, cars could only be a luxury for the rich.

In 1913, Henry Ford, founder of the Ford Motor Company, began mass-producing standardized models on assembly lines. Ford’s production efficiency increased from 100 cars per year in 1906 to an average of one car every 10 s in 1925, dragging down the ASP. Ford’s Model T cost only US$360 in 1916.³ Automobiles gradually became mass consumer goods as a result. Ford’s production line covered the entire supply chain from raw material procurement to product design, parts manufacturing, finished product assembly, and final product sales. The company has established a large, comprehensive, and standardized vertically integrated vehicle-parts production system that gives full play to the automobile industry chain’s advantages of standardization, large scale, and low cost.

Since the 1980s, the Toyota production system has aimed to eliminate waste and reduce costs, focusing on “just-in-time” production and automation to improve operations. The Toyota production system shortens the length of the value chain in which the firm is directly involved, focuses on vehicle assembly, and fully leverages its advantages in vehicle production scale.⁴ It also outsources parts and component businesses to third-parties to reduce internal organizational costs and improve operational efficiency. However, the firm controls the R&D, design, and manufacturing of upstream components through cross-shareholding, reducing external transaction costs and eventually building its own supply chain systems for components and raw materials, thereby maintaining a dominant position in the value chain and economies of scale.

As the automobile industry entered the twenty-first century, Tesla took the lead in the vertically integrated new smart EV value chain by meeting user needs with an industrial ecosystem that is able to respond quickly to market changes and is super-connected and efficient. It independently develops and manufactures a full range of EV software and hardware and expands to upstream components. Such a vertically integrated model has disrupted the Toyota model's horizontal professional division of labor and outsourcing. Tesla’s model is becoming a new industrial standard.

Tesla’s vertically integrated model is a product of the times and technological advances. (1) Technological reform triggers disruptive innovation, just as regulations to reduce emissions in the ICE vehicle value chain resulted in disruptive innovation in the form of smart EV technology. As the old auto value chain lacked the capacity and impetus to comply when the reforms were first introduced, emerging automakers such as Tesla had to develop and produce products on their own using new and disruptive technologies.

(2) Technological advancement (the process in which the design of the product is improved through repeated trial and review) is generally fast paced when a technology is first introduced, and the product iteration cycle is short. As technological innovation determines the limits of product power, emerging automakers such as Tesla have increased R&D efforts to maintain their leading positions in product technology.

(3) Competition for dominance in the value chain: Under the Toyota production system, OEMs have a shorter value chain and only have the technical reserves for manufacturing vehicles rather than specific components. In our opinion, Toyota’s smart EV value chain is poorly constructed. In the era of ICE vehicles, system integrators, or tier-1 suppliers, had strong bargaining power. The technological transformation of smart EVs has created significant demand for the large-scale production of new or higher-value components, resulting in vacuums in the upstream and downstream. Plugging these gaps requires the reconstruction of the auto value chain. Emerging automakers, represented by Tesla, expect to dominate the industry chain in the future.

(4) Digitalization and software applications allow Tesla to achieve high production and operating efficiency in vertical integration and independent R&D within the system, bearing lower internal communication and organizational costs compared to costs relating to transactions with external parties.

In our opinion, these are important reasons for Tesla to have adopted a vertically integrated model which provided the firm with an industry-leading position based on the new-generation industrial standard. However, Tesla’s success also relies on industrial innovation and technology and fully exploiting the scale advantage of China’s auto value chain.

Tesla CEO, Elon Musk, uses the first principles thinking model (questioning established assumptions about an issue before working on a new solution) to challenge the traditional auto industry’s development model and standards. He proposed a development strategy of first producing sports cars and using the profits to produce luxury cars, then using the earnings from the latter to produce cars with potentially high sales volumes. He has since proposed an ecosystem strategy based on AI and cross-sector integration of EV, photovoltaic (PV) energy storage, and robots. Tesla has a clear corporate mission, in our view, as well as a well-defined industrial strategy and development path.

In our opinion, the disruptive innovation introduced by Tesla dealt a blow to the ICE value chain while introducing smart EV technology and transforming the auto manufacturing value chain. In electrification, to achieve high-dimensional competitive advantages in power systems, Tesla has built a three-part electric system (the power battery, drive motor, and electronic control system) with leading performance and an advanced green energy charging network (including the SolarCity and Supercharger projects). In intelligence transformation, the firm has also integrated software and hardware and built a path to achieve autonomous driving using computer vision, AI, and chips. It creates a closed-loop training system featuring massive data collection, automatic labeling, and simulation capabilities.

The company plans to leverage its Dojo supercomputing system (the finished Dojo Pod contains 3,000 D1 self-developed training chips and has a total computing power of 1.1EFLOPS, ranking No.5 on the global supercomputing list), Optimus humanoid robot, and Robotaxi to expand AI application scenarios, making it the technological base for applications in the transportation and energy fields and achieving multi-dimensional cross-sector integration and innovation. The technological barriers for smart EVs that Tesla is building are becoming a barrier that competitors and traditional auto value chains may find difficult to overcome in the near term.

Tesla also innovates in all areas, including R&D, design, manufacturing, and sales services. It has become an absolute leader in the smart EV value chain from which everyone learns thanks to its: (1) Innovative technologies such as integrated die-casting, 4680 battery, and cell-to-chassis (CTC); (2) logistics and material-centered gigafactory; (3) product strategy for blockbuster products; and 4) new marketing approach combining offline experience stores and direct sales on its official website.

Tesla is an innovator and an integrator in the value chain. The high efficiency, low cost, and industrial cluster advantages of China’s auto value chain and the independently built Shanghai factory in China have helped Tesla achieve sales ramp-up and rapid scale expansion. The advantages of “Made in China” regarding speed and cost have been fully reflected.

Tesla suffered a delivery crisis over 2014–2020 due to constraints from battery production capacity and delays in production line transformation at its US factory. Since then, Elon Musk has visited China seven times to push forward the construction of the company’s Shanghai factory and the localization of its supply chain. Construction of the Shanghai factory began in January 2019, and was completed earlier than expected in December 2019, with the factory initially delivering China-made Model 3 vehicles. Tesla completed Model Y localization in China in early 2021. China's AFV value chain boomed as the Model 3 and Model Y vehicles became popular. China has since become Tesla’s largest single sales market and manufacturing base.

In short, the automobile value chain’s century-old pattern is being visibly restructured. The old barriers are collapsing due to the tremendous changes in product definition, the focus on technology, and the core of the value chain, while new barriers are quietly being built. Inevitably, smart EVs will see faster technological advancements, shorter product cycles, and fierce competition, in our view. We examine the possible policy measures for China’s auto industry and value chain, and changes in industrial standard in the face of innovation leaders such as Tesla.

14.2.2 Underperformance of “Market-For-Technology” Strategy; Adapting to Technological Changes; China’s Smart EVs May Overtake Others

China has failed to become a strong contender in the ICE era, but a new era of smart Evs has arrived. In our view, how China’s auto value chain adapts to electrification and intelligence transformation and doing so as rapidly as possible while ensuring economies of scale and technological leadership in smart EVs is the key to China’s transformation from a major player to a strong one and for China’s auto value chain to seize opportunities and take the lead in the market. However, due to rapid technological disruption and innovation, we are concerned about the potential overcapacity of ICE cars and parts in China’s auto value chain.

First, we review the history of China’s auto industry and the milestones, status quo, and outlook of the country’s auto value chain:

• 1. From the 1980s to 2000, China opened up to the outside world and introduced the JV model, hoping to attract core automotive technologies and capabilities with its large market and localize the production and assembly of overseas models. As the localization rate of JV automakers increased, China gradually improved its auto parts supply, resulting in the birth of non-state-owned domestic automakers like Geely and Great Wall Motor.

• 2. Between 2000 and 2014, China’s car demand grew rapidly as personal incomes increased and the government continued to support automobile consumption. China’s car sales increased from less than 2 mn to 20 mn units. Both JV brands and Chinese brands thrived amid substantial industry growth. JV automakers’ introduction of advanced products and new technologies stimulated market demand and pushed forward the development of China’s auto parts supporting system. From the 1980s to the end of the twentieth century, the localization rate of JV automakers’ auto parts increased from less than 10% to more than 80%.⁵ Some strong parts suppliers emerged in subsegments, gradually forming large and complete industrial clusters in China, laying the groundwork for building advantages in low cost, high efficiency, strong agglomerative effect, and abundant technical personnel.

• 3. Since 2014, China has pursued the strategy of developing AFV as the only way to become a strong player in the auto industry.⁶ Although China’s auto sales volume peaked in 2017, the industry was dominated by electrification and intelligence transformation and the rise of Chinese brands. China’s continued AFV incentive policies and stronger opening-up policies (e.g., the introduction of Tesla and the removal of shareholding restrictions on foreign investment in the auto industry) are improving the country’s AFV supply chain and supply of high-quality AFV models, driving strong AFV sales growth in a healthy way (no longer relying on subsidies). China’s AFV sales volume totaled 4.36 mn units over January–September 2022, accounting for 62% of the global AFV sales volume.⁷ The AFV market share of Chinese brands was as high as 80% in the Chinese market and more than 50% in the global AFV market. China is exporting AFVs overseas. Due to the rapid increase in AFV penetration, Chinese brands’ market share in China rose to 48% in 9M22 from 34% in 2014.⁸

In short, although China’s automobile industry was established much later than developed countries, after four decades of development, it has formed an automobile value chain featuring low cost, high efficiency, strong agglomerative effect, and abundant technical personnel.

China’s auto value chain is following Tesla’s pace of innovation and creating differentiated advantages. Taking Tesla’s lead, Chinese automakers are accumulating electrification and intelligence technologies. They have launched integrated electrical drive systems, improved the performance of power batteries, and improved their charging and swapping networks in terms of EVs. Regarding intelligence transformation, they have upgraded driver assistance systems and achieved redundancy of front-mounted chips with large computing power and high-level sensors such as LiDAR. Furthermore, they are adopting integrated die-casting technology and reaping the advantages of the direct-operation model in distribution channels. Apart from learning from their foreign counterparts, Chinese automakers are also creating differentiated advantages, maintaining scale advantages in sales volume and market leadership in niche markets of different price ranges by leveraging their brand and product positioning, strong EV technology reserves, rapid model iteration, and innovative breakthroughs in intelligence transformation.

Chinese automakers are adapting to the industrial revolution and vertically expanding along the value chain. BYD is the world’s only company capable of mass-producing both power batteries and EVs. It has mastered core electrification technologies such as power semiconductors, dual-core batteries, and motor and electronic control technologies, allowing it to integrate the entire EV value chain. Other Chinese automakers have increased their efforts to expand in EV batteries via equity investment, joint ventures, strategic cooperation, and independent R&D.

Regarding intelligence transformation, Chinese automakers are pushing forward the R&D of autonomous driving and expanding the industry ecosystem to upstream electronic and electrical architecture, chips, algorithms, and other components. For example, NIO, XPeng, and Li Auto upgraded their centralized domain control architecture, and traditional Chinese automakers have corresponding plans for upgrades to improve the user experience of intelligent automotive products. Furthermore, Chinese automakers are increasing their presence in autonomous driving through outsourcing, strategic investment, cooperative development, and full-stack independent R&D. Domestic automakers, however, are lagging in vertical expansion in the smart car value chain when compared to Tesla’s self-developed autonomous driving systems and chips.

We note that China’s auto value chain is favored by Chinese consumers, especially young car buyers, due to its flexible industrial architecture, strong insights into consumer demand, and rapid product upgrades. We expect China to adapt to technology reform as soon as possible, ensure economies of scale and technological leadership in smart EVs, and grow from a large contender in the global auto market to a strong one.

14.2.3 The Global Automobile Industry Faces Horizontal Risks of Supply Chain Shortage and Value Chain Relocation

The auto value chain is highly globalized, and in recent years, supply security has been impacted by trade frictions, the COVID-19 pandemic, natural disasters, and geopolitical conflicts. The supply shortages of some auto parts have disrupted the global value chain's scale, caused cost fluctuations, and increased the risk of production suspension and reduction. Such conditions are plaguing the global auto value chain and pushing automakers to adjust their industry chain expansion and supply chain strategies. How to effectively solve the supply chain shortage and improve the horizontal security of the value chain has become an urgent focus for the auto industry. Please see Fig. 14.1 for details.

As a major player in the auto value chain, China currently confronts risks related to value chain relocation and supply chain shortages, and it is necessary to be wary of losing economies of scale in the near future. Some overseas multinational automakers may shift orders away from Chinese suppliers to ensure supply chain security, resulting in the relocation of the auto value chain to foreign countries. Domestically, Chinese automakers rely heavily on upstream core components such as core equipment, semiconductors, and basic chemicals supplied by overseas companies.

However, we propose four reasons why it is unlikely that the auto value chain will retreat from China in the near term.

• 1. China accounts for one-third of global auto production and sales, and its biggest competitive advantage is its large demand. Multinational companies’ business in China focuses mainly on serving local clients.

• 2. Auto parts suppliers have high stickiness levels due to stringent requirements for automotive-grade products, and have high stickiness levels in the supply chain, while automakers are more likely to reduce risks by diversifying suppliers rather than moving away from a specific country.

• 3. The supply chain of labor-cost-driven components is more likely to be replaced and relocated to countries and regions with lower labor costs, such as India, Southeast Asia, and Mexico, while China’s advantages in transportation cost, technology, and manufacturing process-driven components are less likely to be substituted.

• 4. Insufficient industrial clusters in other regions. China’s auto parts industry clusters still enjoy clear economies of scale, while other regions and countries such as Southeast Asia and India export less auto parts and components, which means they are not yet able to handle large amounts of orders that may be shifted from China.

China’s auto supply chain should be well prepared to ensure long-term supply chain security and push forward global expansion. The country is building a secure supply chain by regionalizing and decentralizing, stockpiling inventory, and shortening supply distances. Domestic automakers should accelerate the implementation of the globalization strategy, in our view, introducing products and technologies to overseas markets.

14.2.4 Vertical Risk Exposure to Key Technologies in the Automobile Value Chain

Automobiles, as high-value end-market goods, are influenced by upstream and midstream industries such as bulk raw materials, basic chemicals, machinery and equipment, semiconductors, AI, and big data. We expect vehicles to become smart mobile terminals in the wake of technology reforms. Following technological upgrades, global automakers may suffer from production halts and shutdowns due to core component shortages and supply disruptions. China now has shortcomings in vehicle intelligence, including chassis-by-wire, auto chips, and AI algorithms for autonomous driving. It is necessary to pay close attention to these issues, in our view.

Reliance on imports and low localization rates are major issues for automotive semiconductors. ICE cars are mechanical products, with chips accounting for a low proportion of total value. As AFV's electric, smart, and integrated functions increase, so will their reliance on chip usage and performance. There are three types of automotive semiconductors. (1) Processing technologies for power semiconductors, microcontroller units (MCU), and sensors are mature, and the growth in market share of Chinese suppliers is accelerating. (2) System-on-a-chip (SoC) technologies are rapidly evolving. Domestic firms have made breakthroughs in low-performance, low-process products but lag far behind overseas peers. (3) AI training chips for autonomous driving, with high computing power and processes, are dominated by foreign companies as Chinese companies have not developed the technology.

14.3 Thoughts and Implications: Guiding the Market to Ensure Domestic Demand; Fully Supporting Technological Breakthroughs

Automobile products, as shown in Fig. 14.5, have consumer goods characteristics as well as high manufacturing technology requirements and a large and complex value chain. From a macro perspective, competition in the auto value chain relies heavily on economies of scale and technological strengths. Therefore, we draw some assumptions and implications by constructing a scale and technology-based competitiveness model for China’s auto industry:

Fig. 14.5

Source CICC Research

Competitiveness analysis of China’s auto industry based on scale and technology.

• 1. Technological factors: The core technological barrier of ICE cars has almost disappeared, and smart EVs have become the main direction for future automotive technology.

• 2. Regulatory factors: The industry needs policies to guide and encourage breakthroughs in core technologies and full competition in the open market to ensure economies of scale in China's auto value chain.

• 3. On the demand side, stakeholders in the industry should provide infrastructure and supporting services for automobile consumption to meet the needs of automobile popularization. Smart EVs far outperform ICE vehicles in terms of consumer experience and technology empowerment. Only by ensuring the supply of high-quality advanced vehicles from automakers can the industry create long-term stable demand, achieving economies of scale in a large market.

• 4. Regarding supply factors, the smart EV trend cannot be halted, and the catfish effect represented by Tesla is accelerating industry disruption and innovation. In open competition, more new entrants, technologies, and skilled workers may create a positive cycle in which business scale and technology drive each other’s development.