In 2018, Tesla CEO Elon Musk signed an agreement with the Shanghai regional government to set up the first Gigafactory in China. Here we discuss why Tesla decided to enter China, the competitive advantage it has over other local players and how Tesla’s entry in China will impact the domestic electric vehicle (EV) market.

Why China?

China is among the largest automobile markets in the world with annual vehicle sales of around 25 million. Long-term growth potential and supportive government policies for EVs make China an attractive market for Tesla.

• China is the largest EV market in the world, accounting for 1.1 million EV sales, out of the 2.2 million sold globally in 2019.
• EVs have strong government support in China. It aims to increase the penetration of EVs to 25% by 2025. Since 2012, the government has supported EV adoption through billions of dollars in subsidies. These subsidies have since been progressively reduced. From 2019 onwards, automakers are required to sell a specific number of EVs annually to earn tradable EV credits.

Competitive advantages

• Like Apple in smartphones, Tesla enjoys a strong brand image in the minds of Chinese car buyers. Tesla cars are perceived to be of better quality, better designed, offering a high range and relatively long-lasting when compared to other EV
• Tesla is technologically advanced compared to local EV Examples of Tesla’s advanced technology include:
  • Autopilot: Tesla’s autonomous platform is considered among the most advanced in the world.
  • OTA updates: The company uses over-the-air (OTA) software updates for maintenance and adding/loading new features.
  • Battery: Focus on improving battery technology, range and efficiency. The new LFP battery lasts a million miles.
  • Infotainment and connected services: Software update V10 provides advanced infotainment features like video and music streaming, and karaoke. It also includes a Smart Summon, or smart parking, feature.
• There are more than a million Tesla cars on the road globally. The company has the advantage of collecting feedback and data from these cars and improve its current software like Autopilot and Smart Summon. Not many automakers have sold so many EVs till now or have enough focus on autonomous cars/technology updates.

Shanghai factory

The key advantage of owning a factory in China is the cost savings associated with local sourcing and production. Utilizing parts manufactured by Chinese suppliers, rather than importing them from the US and paying additional tariffs, brings down the production cost. Around 30% of parts used in the China facility are sourced locally and Tesla plans to increase it to 100% in 2020.

Recently, Tesla reduced the price of Model 3 to avail government subsidies and remain competitive. Lowered costs due to localization and falling battery prices could encourage Tesla for further price reductions.

 Impact on Chinese EV market

• Domestic Chinese companies will continue to dominate the New Energy Vehicle (NEV) category as a vast majority of cars sold in the country cost less than $45,000, a price segment where Tesla does not compete. The share of expensive EVs (>$45,000) is limited in China.
• Start-ups like Nio and Byton, which focus on high-end EVs, will be most impacted by Tesla. These start-ups are already struggling to make sales and profits. Tesla is expected to give them competition with its global experience and expertise in EVs, batteries and technology.
• The price of Tesla Model 3 is expected to decline due to falling battery prices and localization. Automakers (especially premium EVs) would need to upgrade in terms of battery, build and technology to stay competitive.
• Increasing pressure to upgrade product quality will benefit the overall Chinese market. Despite many local Chinese brands in the conventional car market, international brands like General Motors and Volkswagen (with JVs) account for the majority of sales in the country. Chinese government restricted the entry of (standalone) foreign players, which impacted the overall evolution of domestic automakers. Companies like Tesla will change this and promote competition, forcing domestic EV companies to innovate.

Conclusion

Tesla sales will see significant growth in China due to the above-mentioned advantages. However, the current growth rate in sales comes from a low base and increasing competition is expected to slow it in the long term. New models like Model Y (possibly Cybertruck) will benefit sales in the mid-term.