What happened to the European car industry?

In today's analysis, we will take a closer look at the situation in the European automotive industry. For decades, Europe was known for its vehicles. Brands such as Volkswagen, Ferrari, Mercedes, BMW, Porsche, Jaguar and Lamborghini enjoyed recognition all over the world. Europe has already defended itself against the expansion of cars from Japan and South Korea. However, the current scale of the challenge seems much greater than a few decades ago. The first flood of cars from Asia did not undermine the perception of European manufacturers as one of the leaders in innovation. Today, it is different. Despite having huge capital resources, R&D centers or experience in scaling production, European manufacturers "missed out" on the revolution on the Chinese automotive market.

China Market – Litmus Test

Declining sales, rising production costs and increasing automation have resulted in 2020 jobs being lost in the European automotive industry since 86 (CLEPA data). This is not surprising considering that Europe's share of the global market has fallen from 000% to 16,5%. Particularly serious problems can be seen in the Chinese market, where a Copernican revolution has taken place. The local market was once dominated by foreign manufacturers. Two decades ago, the Chinese believed that foreign cars, electronics and mobile phones were much better than domestic products. However, the current generation thinks differently. This can be seen in the data provided by CPCA (China Passenger Car Association) and CAAM (China Association of Automobile Manufacturers) for H14,6 2024. According to them, the brands most frequently purchased by Chinese consumers were:

• BYD 1,607 million,
• Volkswagen 1,266 million,
• Chery 1,057 million,
• Geely: 955,
• Changan: 809,
• Toyota: 644,
• Great Wall Motor: 467,
• Honda : 444 700,
• Tesla: 426 600,
• SAIC: 331.

As you can see, the top ten car manufacturers in China include only 4 foreign companies (Volkswagen, Toyota, Honda and Tesla). In fact, Only Volkswagen defended the honor of European car manufacturers.

Even more about the change in the car manufacturers market can be seen in the graph below. In the 21st century, many car manufacturers decided to move production from Europe and the US to China. The reason was that the Chinese market offered low production costs and favorable taxation. However, foreign manufacturers had to establish JVs with Chinese entities. As a result The Chinese learned how to scale production and manage employees. After gaining experience, many former managers decided to create their own car brands. It must be honestly admitted that in the Middle Kingdom, competition on the car market was overwhelming. This forced cost control and competing not only on price, but also on quality and design. However, despite this, Chinese companies had problems convincing customers to their products. The reason was that consumers were not accustomed to new brands, and such as GM, Volkswagen had been known for many years.   

The Chinese are throwing down the gauntlet to the world

The Chinese government was aware that the cards had long been dealt in the combustion engine car segment (USA, Europe, Japan, South Korea). Ultimately, it was decided to "run ahead". The market for electric or hybrid cars was still in its infancy. Old brands had no advantage over new players. Each entity learned from mistakes to create a new "platform", which is something completely different from the classic "floor plate" in combustion engines. In EVs (i.e. electric cars), the platform is a system integrating the chassis, drive system, battery, integration with the charging infrastructure, etc. Thanks to this, the "technological debt" that Chinese manufacturers had was not as large as in the case of traditional cars.

READ: Chinese electric cars want to conquer the global EV market

In 2014, only 0,4% of cars sold were PHEVs (Plug-in Hybrid Electric Vehicles -> i.e. hybrids with the ability to charge from a socket) and BEVs (Battery Electric Vehicles). The market was small, and European manufacturers were mainly focused on creating new models of combustion cars, which generated most of FCF (Free Cash Flow). This was a typical manifestation of “shortermism,” i.e. focusing on the short term and neglecting long-term goals. Focusing on the traditional segment in 2014–2017 seemed like a good strategy, as EV shares grew to just 1,3% during that time. However, it was already clear then that Chinese electric and hybrid car manufacturers had a much greater appetite for growth than European, Japanese, or American manufacturers. After 2020, there was a sharp acceleration in the electric segment. The Chinese government has a lot to do with this. Why?

The Chinese government is strongly focusing on new “clean” technologies

The Chinese Communist Party is known for having long-term goals that it wants to achieve. Of course, they often involved pouring concrete and other investments that did not necessarily translate into increased productivity. However, over the course of several decades, China has become the new industrial center of the world. Initially, it specialized in producing cheap products, but after some time it began to compete not only on price, but also on quality. The problem, however, was that 10 years ago there were no strong consumer brands that would conquer European and American countries by storm. The CCP decided that one of the markets to be dominated by the Middle Kingdom was to be renewable energy and electromobility. In principle, these are mutually complementary drivers of development. Electromobility requires a large demand for energy, while renewable energy is, on the one hand, clean and increasingly efficient in terms of the unit price for the energy produced.

Investing in electric cars also had another advantage. It was that manufacturers were not limited by patents, because the creation of an effective platform for EVs was still in the construction phase. The Chinese government decided to introduce a classic policy that was supposed to help business development. It was a kind of combination of a welfare state and bloodthirsty capitalism. In other words, the classic: carrot and stick.

The first carrot was subsidies for car manufacturers. Their ease caused new manufacturers to spring up like mushrooms after rain. However, subsidies alone did not solve the problem. Someone had to buy these cars. As a result, it was decided to subsidize car purchases (up to 60 yuan) and eliminate the tax on the purchase of a new car (if it was an EV). According to estimates, the cost of eliminating the tax in the years 000-2014 is to amount to well over 2027 billion RMB (i.e. over 830 billion PLN).

The stick created itself. Huge competition on the market meant that companies could not operate solely on subsidies, but also on revenues from customers. The favorable legal and economic environment has given the EV market in China good prospects. Ultimately, several winners emerged: BYD, SAIC and Changan. Brands such as LiAuto and NIO have also gained popularity. We cannot forget about the attempts of a company such as Xiaomi or Huaweand. It must be said that Many Chinese manufacturers think of it as a “smartphone on wheels” rather than viewing the car as just a means of transportation. It can be said that this different approach has suited the tastes of the Chinese. European cars, on the other hand, are more analogue, which is why customers say they are “less practical” and simply boring. It is simply not enough to add a tablet to a car to make it “modern”. A system that makes it easy to use applications or communicate with other people while driving is now a necessity. It is hard to admit it, but in this respect the Chinese have outpaced the Europeans.

Another advantage of China is its well-developed vehicle charging network. This facilitates the use of electric cars and reduces the resistance to changing from a combustion car to an EV. The Middle Kingdom has significantly outpaced the EU and the US in terms of both fast charging stations (fast charges) and regular ones (slow charges).

China is thinking about expanding into Europe

Okay, someone might say that “China is far away” and there is no point in worrying about it. However, cost advantages and large subsidies mean that Chinese car manufacturers can supply the European market with cheap electric cars, which are also safe (according to tests). Europe tried to defend itself against potential competition from the Middle Kingdom with huge tariffs (from about 8% to even 35%). Finally, the tariffs were introduced in October 2024, but it is not known how it will ultimately end. Theoretically, they are to last until 2029. However, this does not mean that Chinese companies will not try to open production in some EU countries (e.g. Hungary) and thus throw down the gauntlet to European manufacturers.

The problem is also visible in Europe. In the first half of 2024 (according to JATO Dynamics), sales of electric cars from the Volkswagen brand fell by 14% y/y (market leader). In turn, Chinese car manufacturers increased revenues y/y by 26% y/y. Interestingly, in contrast to China, in the EU in the first half of 2024, EV registrations amounted to 12,5% ​​of all passenger cars vs. 12,9% a year earlier. The reason was lower subsidies and the underdevelopment of the charging station system in the EU. Without an efficient network, it is not profitable to use electric cars.

What is killing the EU automotive market?

The European car market is in a pre-infarction state. What is causing this? Among the most important things are:

• Technological backwardness;
• Advantage of Chinese car manufacturers;
• Poorly developed charging infrastructure;
• High prices of electric vehicles.

Chinese EV manufacturers account for more than half of electric vehicles produced. This gives a huge advantage over European companies. The more cars they manage to produce and sell, the more “feedback” they get to the manufacturers. As a result, the next EV models should be better and more refined. Another advantage of China is that the largest battery manufacturers (including CATL) come from the Middle Kingdom. China also has access to key raw materials for battery production (cobalt, nickel, lit). Chinese manufacturers are also beneficiaries of large subsidies and preferential loans. The Chinese government has allocated about USD 57 billion to the development of the EV sector between 2016 and 2022. The undermining of the profitability of the automotive sector in Europe is also a blow to the entire automotive segment (production of parts and semi-finished products). This in turn could destroy parts of the supply chain. Of course, the switch to electric vehicles means that old suppliers of parts and components will have to change their line of business. This will further undermine the competitiveness of the European automotive industry.

European car manufacturers are too far behind technologically and software-wise. As a result, not only the platform needs to be changed, but also the entire software, so that the car is more functional for millennials and "Z-s".

Another problem is the "green policy", which makes production in Europe simply expensive. Chinese cars are simply more attractively priced for consumers. For now, companies such as Volkswagen are saving the prejudices of European customers (just as Chinese smartphones had a poor reputation 10-15 years ago). When the prejudices fade, people will look more at the price-quality ratio. In time, Chinese companies will develop their own sales and authorized service networks. This will eliminate one more of the few advantages that European car manufacturers have on the Old Continent.

In turn, CLEPA concludes that the EU should establish an Automotive Innovation Fund, which is to amount to 0,5% of EU GDP. The funds are to be allocated to the development of the automotive sector in the EU.

It's bad, but many companies still have the potential to grow

Although the prospects of many European car manufacturers may not be optimistic, there are still companies generating huge profits. A great example is the previously mentioned Volkswagen, which can generate around EUR 12 billion annually. Currently, VW is valued at only a few times its net profit. This is due to the fact that the automotive industry is highly leveraged (high fixed costs). As a result, the drop in revenues may have a much stronger impact on the level of net profits. However, VW still has the means to transform its products.

Ferrari looks much better, but it operates in the luxury car niche. As you can see, the EV revolution has not yet arrived here. What's more, Ferrari has a very strong brand, which means that it has no problems maintaining margins and generating a huge amount of FCF. In the case of Ferrari, there is no need to worry about sales growth in the coming years.

Summary – Big challenges and painful adjustment

The European automotive industry is going through a deep structural crisis and a transformation of the business model is necessary. Without this, a significant part of the EU's GDP will be "plowed over" by China. In the case of a negative scenario, the European automotive industry may lose over 2035 jobs by 180. Volkswagen is already having to cut employment significantly. At the turn of 2024 and 2025, information appeared that production at VW plants is to fall by ¼, and employment at German plants is to decrease by 35 full-time positions. The loss of market share also means a decrease in revenues, profits and FCF. This, in turn, will have a negative impact on valuations. This does not mean that companies such as Stellantis (owner of FIAT, among others) or Volkswagen will go bankrupt. The problem, however, is the possible need for deep restructuring and finding the potential to create new, better electric cars.