China this week reported a 47% plunge in auto sales in April from a year earlier as Covid-19 lockdowns wreaked havoc on the world’s biggest auto market and a major hub global manufacturer of auto parts and electric vehicles. Amid trade uncertainties following the country’s anti-Covid policies, “one thing remains certain”, China’s official Xinhua news agency said yesterday. “China will stick to its dynamic zero-COVID policy.”
So what’s next for the global automotive industry? I spoke on Tuesday with Bill Russo, founder and CEO of Automobility, a Shanghai-based strategy and investment advisory firm. The 18-year China business veteran and former head of North East Asia at Chrysler was on the ground in Shanghai during this year’s shutdowns until last week when he returned home to the States -United.
Industry supply chains will remain constrained for the foreseeable future, fueling inflationary pressure, Russo said in a Zoom interview. Winning brands will need to vertically integrate their businesses in semiconductors and electric vehicle batteries, while Tesla will likely overcome the current difficulties in the Chinese market due to its Apple-like tracking, he predicted. Excerpts follow.
Flannery: What is the impact of the pandemic on the automotive industry and market?
Russo: This is serious, very bad. It’s not just Shanghai. You have the Shanghai Corridor – the Yangtze River Delta and the largest port in the world. It is a supply base for vehicles made all over China and around the world. There’s a ripple effect from the disruptions that were already there before the lockdowns – the trade issues, then the chip supply issues, then the war in Ukraine – which are now compounding the problems and sending shockwaves down the chain supply. Although the lockdown is depressing demand, the biggest impact has been on the supply side, which involves the ability to move parts, bring people into factories, manufacture components and assemble vehicles . There are now strong constraints. Adding all the new logistical issues on top of that, you have a perfect storm of waves of disruption emanating.
Flannery: April sales figures in China this week continued to show year-over-year growth in electric vehicle sales.
Russo: Demand is not the main problem. But take into account that March EV sales were 465,000 and April around 299,000, so the market suffered a sharp drop of 36%. By comparison, sales of internal combustion engine vehicles have fallen by more than 50%. So overall the industry is taking a huge hit. The age-old shift to electrification is still here, but now affected by the inability to obtain components. And on top of that, you have all these inflationary forces driving up prices, which is going to have a negative knock-on effect on demand as prices go up.
Flannery: Does the impact differ between newcomers to the industry and older manufacturers?
Russo: NIO closed early and they’re not even in Shanghai – they’re based in Hefei but their R&D and a lot of their supply chain is in the Yangtze Delta region. Tesla for weeks could not produce anything. Now (Tesla) has a “closed loop” system, but the problem is getting parts. You can open the factory and build what you had in transit or in the factory, but if you can’t get key components crafted and delivered, you won’t be able to keep doing it for very long. You can sell from accumulated inventory, but we’re at the end of it in mid-May. Adding another shift won’t help make up for lost production volume, even if you have customers at the door. Brands like Tesla and electric vehicle brands faced limited supply, not limited demand. You can make it up, if you master it within six weeks. It’s not going to happen.
The industry therefore takes a big hit. It’s not just going to be felt in China – it’s going to be felt around the world. Tesla made 51% of its sales last year in China. They recently opened the giga factory in Berlin now, but they’re going to be running out of units reselling in Europe some nameplates like the Model 3 that historically originated in China.
Flannery: How long do you think the supply-side disruptions will last?
Russo: You can change supply chains, but it takes time. You either need to create new abilities elsewhere, or flex abilities that may already exist elsewhere. If it’s material shortages or price inflation due to shortages of nickel, manganese or lithium – which are real challenges right now, then you’ll need to open up new mining capacity. It takes years. So it will take years for the supply-side inflation issues and capacity issues to be worked out and resolved.
Flannery: Who benefits from the development of the offer?
Russo: Southeast Asia — Vietnam in particular; some would argue that other emerging markets are also closer to Europe. There is Mexico as a supplier to North America and there is even relocation to the United States or Canada. It is entirely possible to ensure that you have a controlled and reliable source of components, especially with EV batteries, as the demand for EVs has taken off. The automotive industry is now banking entirely on electrification. In this industry, you can’t afford to bet on two expensive multi-billion dollar horses. If you go for EV, you have to go all-in.
This means you have to control the supply chain in a way that you didn’t have in the era of internal combustion engines. Suppliers were pretty much tied to car manufacturers at the time. In the age of electric batteries, you no longer have that kind of family relationship – you compete with consumer electronics companies for the supply of batteries. We found that the same was true for crisps. The auto industry has seen this when it comes to chip vendors. They are not the big dog of the food chain. The key point of differentiation for today’s car is the sophisticated electronic features of the car. If you are a chip company like Nvidia, Intel, or TSMC, you have multiple vertical markets where you can sell your components, and the automotive industry is relatively small compared to other product categories that require their components.
The battery market is going to be a repeat of this, but on a much larger scale, as it would need to secure the supply of basic ingredients that today are historically not part of the automotive industry nomenclature. Automakers are generally far removed from mining companies. They don’t have a long history of relationships with the kinds of suppliers that are typically part of the battery assembly supply chain.
Flannery: So car manufacturers are going to integrate vertically? Tesla suggested it recently.
Russo: There is no choice. Otherwise, you’ll be completely dependent on battery manufacturers like CATL, Panasonic, or BYD as your top-tier supplier, and they’ll sell their capacity to the highest bidder. And that’s what’s happening right now.
Flannery: How has it been with semiconductors over the past year? We’ve been talking about it for a while.
Russo: More vertical integration. Play Apple Playbook with Apple Silicon chips. It was a decision to integrate vertically and take more control over the sophistication and differentiation of the user experience. The auto industry needs to do something similar. However, traditional automakers have historically sourced entry-level chips to cut costs. A big part of why they got into the problem they have today is because they relied on commodity chip vendors. Many of these chips are built with mature technology – four or five inch wafer technology. They don’t even make the (chip-making) equipment for it now. If you want to scale and that supply is taken by a consumer electronics customer – which happened during Covid, they can’t scale. The solution will eventually be to get yourself some custom ICs where you have the ability to control the buying and selling of those components. Battery and chip supply is the main battleground to secure your position in the future of this industry.
Flannery: What awaits Tesla? Will they have new models this year for China?
Russo: It’s like Apple. Tesla has the halo of being the pioneer company in its product category. They are the Apple of the EV industry. The VE buyer is fiercely loyal to the religion of Elon Musk. They release stunning numbers every month when their factories are running. We’re still talking about upstart Chinese EV brands, but Tesla sells them all combined except BYD. That is, when their factories are running.
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