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The attack on the Western auto industry explained

Published at: 25-05-2024

Posted on: May 25th, 2024 by RaduC No Comments

The Western auto industry has been under a sustained attack by Chinese electric car manufacturers for over two years. The explanation present on most media channels refers to the alleged subsidies that the Chinese government gives to local manufacturers to offer cheap electric cars. But what no one is asking is: why did the Chinese become so competitive only now? Why didn’t Chinese cars with internal combustion invade Europe based on subsidies from the Chinese state? After all, Chinese steel, for example, has been suspected of being subsidized for a very long time.

In reality, the trend was reversed. In the last decade, until recently, Europe exported more and more cars to China. The fact that the subsidies have only now had such a dramatic effect on the European car industry suggests that they are only an approach that takes advantage of a certain context. And the context is actually the one who makes the difference.

Those who have watched both Formula 1 and Formula E races will immediately understand this difference. Formula E races are races similar to Formula 1, only that the competing cars are electric . Watching the two races one will notice a major difference. While in the Formula 1 races the distances between the competitors can exceed more than one lap, in the Formula E races the cars remain grouped all the time, with relatively small distances between them. Which leads us to an obvious conclusion: the difference in competitiveness in a Formula E race is no longer provided by the quality of the cars, but, above all, by the quality of the drivers.

In the case of Formula 1 cars, engineers must find innovative and preferably unique solutions to increase the performance of engines or gearboxes through an exceptional design of hundreds of component parts, so many reasons for one car to be much better than another. In the case of electric Formula E cars, all these differentiating elements are much fewer. After all, in a simplistic approach, we are talking about a car that works on the basis of electric motors and batteries. This and nothing more. It’s hard to make a car very much different compared to the other competitors.

Practically, this is also the big problem of European manufacturers with a whole history of sophisticated engineering behind them. The simplicity of electric cars makes all the know-how related to the mechanics of internal combustion cars largely irrelevant. It’s a “reset” in which it becomes almost impossible to differentiate yourself by the quality of the engineering with which one used to produce engines or gearboxes. And there aren’t too many strategy alternatives.

Professor Michael Porter from Harvard Business School talks about the existence of 5 generic strategies that a company can use to achieve its goals. First of all, those based on cost (targeting the whole market or a segment of it) through which a company produces products of similar quality to the competition, but at a significantly lower price. Secondly, those based on differentiation (targeting the whole market or a segment of it) through which the company offers products or services of a higher quality than the competition for which customers will be willing to pay higher prices. Thirdly, a combination of the two by which a qualitative differentiation is attempted at a slightly lower cost. This and nothing more. There are no other miraculous options.

Starting from this model, the problem of European manufacturers becomes obvious. When producing internal combustion cars, a differentiation strategy was possible compensating for the fact that European cars were not cheaper than Chinese ones. As long as the European engineering know-how was superior to the Chinese one, the differentiation strategy could not fail, European cars being appreciated for their quality.

The appearance of electric cars fundamentally changed the picture and the strategic context. The simplicity of the construction makes differentiation much more difficult in the case of electric cars. And when differentiation is still attempted, it is based on the IT applications that these cars have, an area in which companies in the area of digital applications are better prepared than traditional car manufacturers. Automobiles cease to be engines on four wheels and become IT applications on four wheels. It is no coincidence that a number of electric car manufacturers in China come from the IT field.

But this way of differentiation is not sustainable in the medium term, as many of the applications can be copied relatively easily by competitors. Under these circumstances, unlike the world of internal combustion vehicles, the main strategy that matters in the world of electric vehicles is that of cost competition. This is why, this time, the subsidies of the Chinese state, together with the proximity of the mineral resources used in the manufacture of batteries and components, have a devastating effect on the European car industry. Competition is no longer done by differentiation, but by cost.

In this context, Tesla continues to benefit from the image of Elon Musk and the aspirational brand that he managed to become. But we see that even this leading company is aware that in the long term, a strategy based exclusively on differentiation, while the price gap with the Chinese cars are increasing, cannot work. Production volumes matter for reducing costs, and they can only be increased by approaching much wider segments of the market. In the end, the differentiation limitations offered by electric cars are the same even for Tesla, which is left only with the brand created through its pioneering. But for how long?

Policies and negotiations aimed at limiting the influence of Chinese subsidies must definitely be applied. But these will only partially solve the problem of European companies. Because the rules of the game have changed substantially, and tradition in the automotive industry has become less relevant. The game starts from scratch.

Have a nice weekend!

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