China’s car industry is too large for its own good

Their show of force at the Munich auto show is not just another reminder of their undeniable technical prowess and growing global dominance. It’s also a sign that some 20 years after the Chinese car industry kicked into high gear, the sector is now looking for new markets because it’s too large and unwieldy at home. Regional and local governments, which are often behind these companies, are part of the problem. The outcome has been a destructive price war that can only be resolved by allowing consolidation and encouraging the least competitive firms to fold.

After all, this is what happened 100 years ago in a comparable market: the US. The Chinese industry’s capacity for production, created by too many players, remains far above its output. The situation was fine more than 10 years ago when sales were still growing reliably in the double digits.

In those heady days, the smart strategy was to invest in capacity ahead of demand. If carmakers failed to do that, they would have lost the ability to grab market share ahead of rivals that lacked the same firepower. However, demand started slowing by 2011, and though there have been some good years, many carmakers appear to be in denial that the glory days have ended.

“The production capacity has been built out ahead of demand, and the demand never realized,” Stephen Dyer, managing director at AlixPartners and a former executive at Ford in Shanghai, told me.

That’s why—though it appears to be a juggernaut from afar—China is plagued at home by neijuan, or involution: a broad social concept that refers to intense competition marked by price wars that can have far-reaching consequences beyond the immediate participants.

According to Bloomberg Intelligence, the monthly average price discount (excluding imported cars) has hovered between 15% and 17% in the first half of this year—the highest in the past five years. That’s despite efforts by Beijing to shut down extreme competition.

The ferocity of the onslaught by smaller players has caught market leader BYD by surprise, forcing it to cut its annual sales target by 16%, pummeling its share price. Tesla, the first to reduce prices in late 2022, is still in the fray, again offering discounts to undercut rivals.

This level of competition is not unprecedented. According to the auto historian James J. Flink, 485 companies—many of them carriage or wagon makers—began making cars in the US in the first decade of the 1900s. By 1908, when Henry Ford introduced the Model T and William Durant founded General Motors, only half were still active. The number dropped further as the industry matured. By the 1930s, buffeted by the Great Depression, only Detroit’s Big Three, including Chrysler, remained, paving the way for the golden age of the US auto industry decades later.

China’s car sector is going through its own tortuous transition. The country had some 500 registered EV makers in 2019. As of two years ago, about 80% had exited or were in the process of going bust. But there hasn’t been much consolidation since.

Consolidation is a must for profitability to rise. But this process has been slow. Unlike the 1920s, when hundreds of small American carmakers disappeared due to market pressures, readily available funding from well-resourced investors in China is keeping the less competitive players alive.

The desire to find and fund the next Tesla or BYD is understandable, given how promotions for government posts are often linked to key performance indicators like job creation. Carmaking is a pillar of the economy. As it employs about 5.6 million people, it has outsized importance during a downturn.

The US industry was able to successfully consolidate by shrinking the number of players without affecting the number of cars sold. Though circumstances differ, it’s hard to see why China can’t follow a similar path. Automakers should feel empowered to do away with underperforming lines and maximize their efficiency.

He Xiaopeng, co-founder of EV-maker Xpeng, made waves by saying in a recent podcast that consolidation would take about five years. He predicts only five local players will be left by the end of the “knockout round.” The prediction may be a tad extreme, but it’s a sobering reality check for an industry that needs to shrink in order to stay ahead. ©Bloomberg

The author is a columnist for Bloomberg Opinion’s Asia team, covering corporate strategy and management in the region.