Can Volkswagen win back China?

In 1978, a Chinese delegation dressed in Mao suits travelled to Wolfsburg with a stunning message for the men running Volkswagen: Deng Xiaoping’s China was open for business.

Now, after four decades building the world’s biggest car market from scratch and profiting from the rise of an economic superpower, the automaker has suddenly found itself fighting for its position in China.

While the sprawling German group, which today includes Porsche and Audi, sells more cars in China than any other company, its flagship VW brand was recently dethroned as the country’s best-selling car by BYD, the Shenzhen-based conglomerate backed by Warren Buffett.

The German company is falling behind in the fast-growing electric car segment, where the VW brand sits in ninth place with a market share of just 2 per cent. BYD, which holds the top spot, has nearly 40 per cent and Elon Musk’s Tesla, in second, has more than 10 per cent.

Chinese makers of electric vehicles, which include plug-in hybrid and battery-powered cars, dominate in their own market and are also expanding aggressively overseas. China overtook Germany in auto exports in 2022 and is set to eclipse Japan as the world’s biggest car exporter this year.

VW, one of Germany’s largest and most prestigious companies, depends on China for at least half of its annual profits, which last year reached €22bn. Its position in the race for EV market share is placing the future security of those earnings in jeopardy.

Despite this backdrop, VW executives still did not appreciate the threat they faced in China, a Shanghai-based consultant to the German group said.

“A lot of people in Volkswagen have been working there their entire lives; I don’t think they can imagine Volkswagen not being in existence. That is actually what is at stake at the moment,” they added.

VW said that profitability mattered more to the company than volume. “Quality of business takes precedence over quantity,” it said.

The company last week reported better than expected sales for the first quarter, boosted by Europe and North America. But in China, deliveries fell 15 per cent. VW said it was confident its new model range and “China-specific technology” would help sales pick up in the latter part of the year.

Geopolitics further complicates the outlook for the company. Germany, which was forced to grapple with its reliance on Russian gas following Russia’s full-scale invasion of Ukraine, is worried about its economic dependence on China under President Xi Jinping.

Annalena Baerbock, Germany’s foreign minister, said after a brief visit to Beijing in April that China was becoming a “systemic rival”.

At the same time, VW risks angering Beijing by responding to growing western pressure over human rights abuses in Xinjiang, the site of one of its smallest factories.

This has not slowed VW down: in the past year alone it has announced investments in China worth almost €4bn. The company last year moved Ralf Brandstätter, its board member responsible for China, to Beijing to work in “close collaboration” with its three main joint venture partners, Chinese state-owned auto companies FAW, SAIC and JAC.

VW’s new strategy is touted as “in China, for China”, a plan to localise production in the country as a way to insulate against supply chain shocks and deepening divisions between the west and China.

When Brandstätter took the stage at the Shanghai auto show last month, he did not address the worsening geopolitical climate but instead sought to answer how the company plans to win back customers.

A new €1bn innovation centre would build on the €2.4bn investment in Horizon Robotics, a Chinese chip design company, announced late last year, Brandstätter said. VW’s software arm Cariad would also double its engineers in China to 1,200.

The multibillion-dollar spending plan would slash the time spent developing products by almost a third and give more autonomy for local decision making, he added.

“The needs of Chinese customers and requirements are different to other regions of the world,” said VW’s chief executive Oliver Blume, standing beside Brandstätter at the auto show wearing starch-white trainers. “It is very important for all of our developments to be very close to the customers.”

But among industry consultants, analysts and former VW staff, there is scepticism over the carmaker’s China plan.

Decisions over design and engineering problems get stalled between Wolfsburg and the group’s numerous Chinese offices and factories. VW cars are developed in Germany for European customers before models are tweaked to become China-made for Chinese consumers.

For years this set-up posed few problems. US and Japanese rivals did the same and Chinese consumers placed a premium on all things foreign. Yet today it has left staff feeling hamstrung and disempowered as their Chinese rivals unveil smart driving technologies and new EV models.

According to one former VW executive, who left the company in recent years to join a top Chinese EV maker, the company was paying the price for being conservative on EVs as other groups “tested the waters”.

Now, as it tried to pivot to electric models, VW remained “highly dependent” on major suppliers who made parts for internal combustion engines, the former executive said. This meant that it had fallen behind not only Chinese rivals but also Tesla, which was becoming deeply enmeshed in the local EV supply chain, they added.

“Volkswagen is a giant of fuel vehicles . . . It is like asking an elephant to turn around,” the former executive said.

The Shanghai-based consultant to VW said its China team was also suffering from an outdated software platform for new vehicles.

“They can offer beautiful cars also with an electric battery, that is no problem at all, but the software is just so outdated, it is just embarrassing,” he said.

“Maybe for Europe it is good enough for a few more years. For China very quickly that will run into a dead end. If they cannot solve that they will have a ‘hole’ in new product launches for maybe one or two years — that can really kill a company,” he added.

VW’s joint venture commitments in China pose another issue.

Spurred by Tesla’s commitment to build EVs in Shanghai, Beijing in 2018 lifted restrictions on foreign ownership of auto manufacturers. But analysts said VW and other foreign groups were afraid to upset their longstanding JV partners and the lucrative business they generated.

“They will continue to milk the cow, but the cow isn’t going to survive much longer,” said Bill Russo, the former head of Chrysler in China and founder of Shanghai-based consultancy Automobility.

Fears over angering Chinese partners and officials also complicate the future of the company’s plant in Xinjiang, the western region where the state has committed widespread human rights abuses against Uyghur and other Muslim groups.

VW has ruled out closing down the factory. It has ducked pressure from politicians, human rights activists and its own union, arguing that it must honour its contract with partner SAIC despite having already abandoned plans to use the plant for the production of a new model.

In an internal memo in February, Brandstätter told employees he had made his first visit to the Xinjiang factory, citing “deep concern” over reports of human rights violations.

While the memo did not address human rights abuse allegations at the plant, Brandstätter said the factory was ‘‘of a high standard overall”. He described a separate canteen exclusively for halal dishes and a “learning island” where workers can study the Uyghur language.

Just as VW’s China operations come under pressure, fast-growing Chinese companies such as Li Auto, Xpeng and Nio are pushing their mass-market cars ever closer to autonomous driving functionality.

The former VW executive in China said the company had been too “slow to grasp” just how technology-focused Chinese consumers had become, which had resulted in a wide gap between the services and features offered by China’s homegrown EV makers and those available in the German group’s cars.

“It is like comparing iPhones with Nokias 10 years ago.”

Additional reporting by Nian Liu in Beijing