The auto industry faces changes not seen in a century. Vehicle electrification, which began in , 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 , 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.
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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 , 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 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 , 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 to an average of one car every 10 s in , dragging down the ASP. Ford&#;s Model T cost only US$360 in .Footnote 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 s, 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.Footnote 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, 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 &#; 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 , and was completed earlier than expected in December , with the factory initially delivering China-made Model 3 vehicles. Tesla completed Model Y localization in China in early . 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:
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From the s to , 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.
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Between and , 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 s to the end of the twentieth century, the localization rate of JV automakers&#; auto parts increased from less than 10% to more than 80%.Footnote 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.
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Since , China has pursued the strategy of developing AFV as the only way to become a strong player in the auto industry.Footnote 6 Although China&#;s auto sales volume peaked in , 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 , accounting for 62% of the global AFV sales volume.Footnote 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 .Footnote 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.
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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.
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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.
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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.
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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.
Products that are made by Original Equipment Manufacturers (OEMs) tend to be sophisticated and defined by high precision. These products are especially useful for industries that rely mainly on heavy vehicles, commercial objects, and similar equipment. Contracting with an OEM firm enables these industries to maximize the productivity of their machines and reduce the total cost of owning product components.
There are many benefits to working with an OEM in China. As OEM is relatively specific to several industries, there is a lack of clarity among people about its role and purpose. In this article, we shall explore the meaning of an OEM and how it can be advantageous for a client to work with an OEM in China.
What is an OEM?
The exact meaning of OEM has transformed over the last few decades. Initially, the term Original Equipment Manufacturer referred to a company that developed a main product. This product was then purchased by another company and branded as their own before being sold to a user. This definition has expanded now to describe companies that buy products from another firm, rebrand them, and sell to other users.
There are two industries where OEMs can be found often. These are auto and computer industries. Sometimes, an OEM is a client of a retail organization that sells products directly to its customers. For example, a Hyundai vehicle might not have all parts made by Hyundai themselves. Some of its parts might be made by an OEM.
In this system, the seller of the finished product is known as the value-added reseller (VAR). This firm adds value to the original item by introducing new features and services to it. The value-added reseller interacts closely with the OEM that customizes designs on a product on the basis of requirements given by the value-added reseller company.
Initially, an OEM would work on sales that happened business-to-business. The VARs would publicize products for selling to the public. Whereas an Original Equipment Manufacturer manufactures original items, an aftermarket manufacturer develops products that resemble and function interchangeably with those developed by the OEM. Though more affordable in comparison, aftermarket products are usually not original and do not function as well as an OEM product.
Benefits of working with an OEM in China
As mentioned earlier, there are several advantages to working with an OEM. Most popular brands tend to utilize assistance from manufacturing companies in China for making their products. Not only do these products offer lower costs, but they also ensure high quality.
Today, factories in China manufacture private label products that are used by companies worldwide. A study reports that China had more than 80 million employees in the manufacturing sector in . By , this statistic had grown to over 100 million which contrasts against the employment numbers in the same field in the other countries. In this section, we shall explore some of the benefits of opting to work with an OEM in China.
Warranty
One of the most significant advantages of working with an OEM is that some manufacturers will offer a warranty until a specific period of time. If you receive a faulty product or notice it has other technical issues, you can contact the respective manufacturer and seek a replacement or another resolution for your issue.
Quick response
By utilizing the services of an OEM, you can be assured that you are receiving a prompt response to your inquiries. This is due to the fact that less time is needed for the identification and production of products. In most cases, manufacturers already have access to original drawings for a specific product which reduces the time to research and come up with a design plan. This results in a quicker delivery time for your products.
Lower manufacturing costs
The differences between opting to manufacture domestically and have your product manufactured from a provider in China apply to the costs as well. Depending on where you are based, domestic manufacturers will usually charge greater costs and come with a high turnover. The availability of more affordable products from China makes China an ideal candidate for any small or mid-sized business.
Several factors influence the costs you incur in manufacturing products domestically. These include training costs, equipment costs, and costs to cover possible complications in the manufacturing process. If you work with an OEM in China, there are chances to reduce operational failures that occur in domestic manufacturing. Production efficiency is high and defects do not always cause complications in the production process. This also ensures smooth functioning of your business and reduced expenses.
Service support
Various kinds of support can be availed through an Original Equipment Manufacturer. When you contact OEM support engineers in China for assistance, you can be assured of getting access to their engineering team which will design your products. By talking to engineers and technical support staff, you can have access to different types of knowledge that will enable you to form the best decisions about your parts.
Long lifespan
When you opt to have your parts repaired from a technician, you may or may not get access to the former level of performance that your product delivered. Working with an OEM manufacturer in China avoids this hassle from occurring by making sure that there is no degradation in product performance. In case of an issue, your manufacturer will ensure that you get a similar replacement product. Because they are unlike aftermarket products, OEM ensures better longevity through the high quality materials and testing protocol used to produce them.
High quality
Research indicates that products obtained through OEM are of optimum quality and build. When you try to replace a part within a product, you need to be assured that the replacement is of consistently high quality. This will enable the product to function well. OEM gives you this assurance since its parts are developed and tested to match the original design specifications. This gives them an additional level of protection and makes them more likely to be compatible with the needs of your industry.
Return on investment
OEM products made in China offer you the return on investment which you would normally expect from a supplier. All parts are developed to match and perform according to assigned design specifications. This helps to increase the life of your equipment. It also saves future expenses by continuously overseeing the performance of the product.
OEM factories in China will ship worldwide
Improved production capabilities
Factories that are based in China are tasked with manufacturing products for businesses worldwide. Due to their expanded production range, Chinese factories are more than capable of consistently producing goods in bulk amounts. When you are outsourcing to China, you work with people who are experienced with producing tested and quality products in large quantities.
Preventing scams
When you are working with an overseas manufacturer based in China, there are chances of you getting scammed. This is especially true if you have not met the manufacturer before and are relying on calls or messages to communicate with each other. Further, language barriers may also cause miscommunication in terms of what the product requirements might be.
Working with a reputable China sourcing agent or Chinese manufacturer is the ideal way to avoid these issues from happening. You can work with a registered organization in your community that works with local businesses and verified manufacturers to prevent scams from occurring. This system ensures that you are not being taken advantage of and getting access to only authentic manufacturers.
Lower costs of labor
When you decide to contract with a manufacturing firm in China, you receive access to the firm&#;s labor. This saves you the cost of recruiting and training employees within your own firm who can manufacture the desired product. It also saves you from incurring miscellaneous expenses related to hiring workers locally. Labor costs are lower in China by comparison which allows you to take advantage of this cost savings opportunity.
Opportunities for diversification
If you have been thinking about broadening your existing product line and offering new services to your consumers, outsourcing can enable you to accomplish that. With lower product prices and access to better production proficiencies, you can find ways to incorporate a variety of products into your present line of offerings. You can also find ways to sell this line to a more diverse international market. Outsourcing enables opportunities for you to expand your business in ways that traditional manufacturing methods do not.
Reduction in lead times
There are numerous ways in which you can reduce the time that it takes to deliver your products. You can choose to order them often and on a consistent schedule. By raising the frequency of receiving products, you will not be pressured by low inventory and will benefit from reduced delivery expenses.
You can also use a software to automate information about your orders so that it reaches your manufacturer in a timely manner. By sharing information with your manufacturer about how much supply you typically require, you can stay ahead of the delivering process.
Conclusion
OEM products are different in nature than ODM products or aftermarket products. They tend to offer many advantages to users. OEM products are often of high quality, affordable, and ensure longer lifespan in comparison to aftermarket products. There are many benefits of working with an OEM in China. These include warranty period, high performance and quality, a return on investment, better production abilities, cheaper labor costs, opportunities for expansion, and more. If you are considering manufacturing a product, consider talking to an Original Equipment Manufacturer today.
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