Volkswagen (VWAGY.US) is placing a $3.5 billion bet on research and development in China. Can they regain their lost market share?

Volkswagen (VWAGY.US) once dominated the Chinese market with over 50% market share. Now, it has chosen to invest 3 billion euros (approximately 3.5 billion US dollars) in Hefei, a central city with a population of about ten million, to build its largest research and development center outside of Germany. This German automotive giant is making the next big bet in the largest and most competitive automotive market in the world, China. However, whether this bold gamble will pay off remains unknown. This is a stark departure from the model of foreign car companies operating in China for decades: in the past, they produced overseas models locally and exported technology to local partners. Now, this approach has been pushed to the sidelines by rapidly rising local competitors, who have significantly eaten into the sales of foreign brands. "This business model is already extinct," said Thomas Ulbrich, Chief Technology Officer of Volkswagen Group (China). Chinese consumers have the final say Ulbrich calls it a "paradigm shift." In 2022, Volkswagen officially launched the latest round of adjustments to its China strategy. The company is developing models specifically for Chinese drivers - these cars may never appear on European streets, but may be exported to the Middle East and Southeast Asia. As new models are launched, Volkswagen will see if this investment can help it catch up with Chinese manufacturers like BYD Company Limited and Geely, and regain lost market share. Sukin, an automotive industry analyst at Morningstar Europe, said that this strategy is crucial for regaining competitiveness in China. But she predicts, "This may allow Volkswagen to maintain its market share at the current level, but it may not necessarily regain the lost ground in recent years." The question is, in a brutal competition that has pushed prices to bankruptcy levels, can Volkswagen still make money? Audi, a brand under the Volkswagen Group, led the way by launching the new brand "AUDI" this year. Volkswagen is also preparing to release new cars by 2026, developed in China for China, according to official statements. "Whether this strategy will be effective is a million-dollar question," said Claire Yuan, Director of S&P Global, Inc.'s China Automotive Enterprise Ratings. "We need to continue to observe, but at least they are on the right track to catch up." "China Speed" leaves competitors in the dust Over the past five years, the dramatic changes in the Chinese market have forced foreign car companies to retreat. Electric vehicles now account for about half of new car sales, and consumers expect them to be equipped with the latest digital features: from iPad-like screens to driving assistance such as automatic parking. This key market, which accounts for nearly one-third of Volkswagen's global sales, is no longer dominated by "Volkswagen cars." Forty years ago, Volkswagen teamed up with a state-owned enterprise, SAIC, to start car production in Shanghai; in the following years, basic sedans like the Santana and Jetta not only became the mainstay of taxi fleets, but also the first cars in the lives of many urban residents. Now, Volkswagen must update its product line at the so-called "China Speed." Bill Russo, CEO of Shanghai consulting firm Automobility, said that in such a fiercely competitive market, "the ability to quickly launch new models and features is a matter of life and death." Chinese electric vehicle companies can bring new models to market in just 12 to 18 months, while for global car companies, this process usually takes 3 to 5 years. Russo said, "This speed is not an optional choice but a necessary requirement for the survival and development of businesses - it is this powerful pressure that drives global car companies to continuously improve their competitiveness." China becomes a source of innovation In the mid-1990s, Ulbrich worked in northeast China, where Volkswagen and another state-owned enterprise, FAW, collaborated to produce sedans, with all parts imported from seats to wheels as local suppliers were inadequate. Thirty years later, almost all components are manufactured in China; even design is now done in China. To speed up product development, decision-making power has been delegated to local companies by Volkswagen headquarters. Facing market changes, other foreign car companies have reacted differently: some choose to scale back their operations, while others directly exit the Chinese market. Similar to Volkswagen's approach, Toyota Motor Corp. Sponsored ADR(TM.US) has also transferred some authority to its Chinese team, aiming to accelerate decision-making processes and give it "unprecedented autonomy in product planning and development," according to Yuan. Volkswagen also hopes to learn from Chinese electric vehicle startups. It has already partnered with XPeng, Inc. ADR Sponsored Class A(XPEV.US) to more quickly launch new models and focus on developing its own electronic architecture - a system that controls all vehicle functions like an internal computer. This move reflects a shift in the understanding of foreign car companies: they increasingly recognize that they can not only export technology to China but also gain valuable experience from China. For many companies, the key is China's ability to rapidly translate ideas into products, significantly reduce development costs, and meet consumer demand promptly. "The flow of knowledge between China and Germany is mutual," said Martin Hoffman, executive of Volkswagen and chairman of the North China Chamber of Commerce in Germany. A recent survey by the chamber of more than 600 member companies found that about half of them expect Chinese competitors to rise as leaders in innovation in the next five years, while another 9% believe that Chinese competitors are already leaders in innovation.