Tesla's Chinese Gigafactory Redefines Chinese Automotive Manufacturing

January 7th, 2019 was an ordinary date for the world, but not for Elon Musk. Despite Shanghai’s winter chill and the dark cloud of a looming trade war overhead, this innovative and determined real-life iron man had a beaming smile on his face. It was the date of Tesla’s ground-breaking ceremony for its third Gigafactory. In the following paragraphs, we are going to briefly discuss Tesla new factory’s role in China, China’s EV market in general, and Tesla’s potential challenges and opportunities.

Tesla has always wanted to build a new factory to increase its production capacity. It is not rare for a Tesla buyer, who paid in full, to wait for as long as three months for its shiny EV to be at the door. In fact, this shortage of supply compared to demand was causing trouble for Tesla in both staying on top of the competition and holding favor on Wall Street. Moreover, with the Trade War building in the background, the new tariffs made Tesla’s price in China not competitive, sitting forty percent higher than in the US. Musk was hoping for a solution and a Gigafactory in China can solve these problems. China, as a relatively mature market for car manufacturing, has a huge potential for internal EV consumption. Moreover, China’s location can easily radiate Tesla sales to its surrounding regions. In fact, China has been on his target list since 2014. Why did it take Elon Musk so long to set his new factory up in China?

Because Elon prefers Tesla to own a hundred percent of its Chinese business.

In China, most of the foreign car manufacturers have to form a joint venture with Chinese companies in order to participate in China’s market. The joint venture means both companies have to share profit and potentially, technologies. In return, the Chinese counterpart can provide resources in domestic market retailing and provide advice to foreign manufacturers to successfully interact with local government. However, on April 17th, 2018, China announced the gradual abolishment of this requirement over the next five years. New energy vehicles manufacturers will be the first ones to enjoy this complete independence. This means Elon can own a hundred percent of his business, without sharing profit and more importantly, technology with a Chinese-owned partner.

According to JP Morgan’s “Driving into 2025: The Future of Electric Vehicles”, China is expected to account for 59% of EV global sale in 2020. It may be hard to believe that China, infamous for its smoggy skylines, is leading in this clean and renewable market. Due to its determination to tackle environmental problems, the Chinese government has announced its plan to fully popularize electric vehicles by 2030. It is now very clear why Elon Musk rushed to build a Gigafactory in China: the market for EV consumption is huge but of a fixed size; whoever taken up the market first is going to be a big winner. Since the groundbreaking ceremony in January, the Gigafactory is being built at an amazing speed. Within only a few months, part of the factory has already been roofed and the company hopes to be able to start production in the second half of 2019.

By producing in China, Tesla will be exempt from the tariffs and models that are made in China will be eligible for a subsidy. Furthermore, if Tesla sources some suppliers from China domestically, it is likely that the price may be reduced further. For example, a model 3 is expected to cost around $35,000, which is a price within an acceptable range for most consumers and similar to the price of the products made by Tesla’s domestic competitors. All of these factors put Tesla in a very good position in the competition for China’s market.

The reasons why China allowed Tesla into China are complicated. On one hand, China wants the smooth production of Tesla under China’s new abolishment of old joint venture requirements to serve a positive impact on getting more foreign investors to build manufacturing facilities in China. On the other hand, the Chinese government hopes to bring in Tesla to spur domestic EV makers to become more competitive globally. China has grand plans for electric vehicles in its “Made in China” program and it is more about development strategy than about the environment.

Electric Vehicles are much simpler in structure when compared to traditional fuel-powered vehicles. The power system consists of just a battery and electric motors, amounting to significantly fewer parts are required than a traditional car. EV manufacturing would be much “leaner” than the traditional internal combustion engine (ICE) since it needs fewer molds and corresponding machines. Even though China has a big car manufacturing industry developed in the past 30 years, the key technology of making transmission and engine motors was not independently created, relying on established makers from Europe and North America for key technologies. Hence, China hopes to seize the opportunity of the booming in electric vehicles to re-solidify and re-position its international status in manufacturing. The Chinese government has been encouraging the research and development of EV among domestic manufacturers by means of generous tax credit and subsidy. Under this strong encouragement, Chinese EV startups continue to grow and prosper. Some of them are making really solid products. The most notable company is BYD, a company backed by Warren Buffet, which exports its EV cars and buses to more than ten countries, including the US, in the world.

In the meantime, Tesla faces several challenges in the domestic Chinese market. While the Chinese government still provides tax benefit and subsidy to EV companies, many analysts predict the subsidy will stop in 2021. Once the subsidy ends, the competition will increase and those with the ability to produce cost-effectively will stay, with products and technologies proven by the market. Therefore, Tesla might have less but stronger competitors at that time. Secondly, besides domestic players, there are other foreign players in the Chinese market including Volkswagen, BMW, Mercedes-Benz, Toyota, and Honda. These companies have been in China for decades and know the market well. Companies like these, in general, have already formed a joint venture with Chinese companies. Even though the joint venture means less freedom and independence, it indeed provides these foreign companies to benefit in dealing with the Chinese government’s bureaucracy. Meanwhile, Tesla will be on its own. Finally, this challenge is general for the EV market in China: the limited available numbers of charging station in an area with high population density. The limitation in numbers of charging station is not yet seen as a prominent issue because the EV owners are not that many yet. However, as the popularity and availability of EV increase, the number of charging stations will be a bottleneck for the government as well as car manufacturers.

With China’s policy support and strong internal demand, it seems Elon Musk’s bet on China is a wise choice. A greener and cleaner future by new energy source is the picture that China and Elon both envision. Meanwhile, on the other side of the earth, President Trump announced the withdrawal of the US in Paris Agreement hoping to “create more jobs and a better economy”. After all, only the future results will be a true measure of success.

-Lousie Lu is an analyst at Seraph with a focus on international manufacturing relationships and the future of automotive. 

29 June 2019