Volkswagen is the anti-Tesla and China is to blame

In Volkswagen’s heyday at the turn of the decade, then-CEO Herbert Diess and Tesla chief Elon Musk had an unusual bromance, often heaping praise on one another’s automotive achievements.

Diess hailed Tesla as the benchmark for success, while Musk went so far as to declare the Volkswagen boss was “doing more than any big carmaker to go electric.”

If only words could fuel a business.

Today, Musk is the world’s richest man (about 10 times wealthier than in 2020), and Tesla’s market valuation is 14 times that of Volkswagen’s. Diess, meanwhile, was fired in 2022; and far from being Tesla’s mass-market EV peer, Volkswagen is scaling back its electric plans and even thinking the unthinkable — shutting car plants in Germany.

Perhaps most illustrative of each company’s influence in 2024 is the diverging tariffs each faces in the European market.

Tesla successfully lobbied the European Commission for a separate investigation within its made-in-China EV probe, scoring a lower rate than Europe’s own brands. Meanwhile, Volkswagen’s China partner SAIC was lambasted for non-cooperation and slapped with the highest duty of 35.3 percent.

The driving force behind Tesla’s fortune and Volkswagen’s nightmare is the same: China.

But it didn’t start out like that.

The bigger they are, the harder they fall

Almost every automaker has exposure to China. When global car sales peaked in 2017, China was the world’s most profitable and fastest-growing market. But Volkswagen is uniquely vulnerable.

While China is the biggest market for most car brands outside of their home market, it is the biggest market in absolute terms for Volkswagen — nearly half of the 10 million passenger vehicles VW sold in 2017 went to China. Last year, however, its car sales in China were only 3 million — a third of VW’s overall sales.

In the first half of this year, Volkswagen’s sales in China declined almost 20 percent from the same period in 2023.

“If you lose your biggest and most profitable market, that’s going to affect the whole system,” said Bill Russo, an auto analyst who has lived in China for the past 20 years. “They rose the highest, and they have the most to lose.”

Volkswagen was one of the first foreign automakers to enter China in the 1980s, but the price of entry was taking on a Chinese partner that the German company would have to help nurture, and with which it would split profits. Tesla, meanwhile, set up its China operations in 2020 with no partner, thanks to Musk’s schmoozing with Chinese officials. 

Tesla’s entry revolutionized the Chinese market, kickstarting the EV craze that has left VW in the proverbial dust.

In 2020, electric vehicles accounted for just 6 percent of China’s sales, while in the first half of this year that figure stood at 43 percent. Over that period, foreign auto brands lost 27 percent market share in China, according to data from Russo’s consultancy firm. 

The trend is becoming a global problem for VW.

Of the top 20 EV brands globally, 16 are from Chinese carmakers. Tesla is the only non-Chinese company to have models in the top 10, according to Russo: Its Model Y is in top spot among all car types, with more than 1.2 million models sold. Volkswagen’s ID.4 is ranked No. 12 among EVs, selling a mere 193,000 units.

China is a notoriously fast-moving market, and despite its size, VW had long been the most nimble foreign automaker in China, Russo said, which is what fueled its success there for decades.

It did see the market shifting toward EVs, but that foresight didn’t keep it from making critical mistakes.

The car is the new smartphone

Chinese consumers want technologically advanced vehicles that are more akin to a smartphone with features like LCD screens and voice recognition. Domestic automotive brands have focused on the passenger experience instead of the driver, offering everything from massage seats to footrests.

But with the exception of Teslas, designed from the ground-up to be battery-powered, non-Chinese brands largely opted to take their existing models and make them electric — which hasn’t thrilled Chinese buyers.

VW is not the only German brand struggling in China — BMW and Mercedes are facing similar headwinds, but their premium market status gives them more of a buffer than a mass-market brand with smaller margins.

What underpins successful EVs, or any car in China, is the software and tech behind it. Diess, for his part, saw the direction China was taking and launched Cariad, Volkswagen’s software unit, in 2019 with a multi-billion euro budget and 6,500 employees in Germany.

From the start, however, Cariad was plagued by delays and false starts, endangering Volkswagen’s transition from a combustion engine-dominated company to a software EV competitor. In 2023 Cariad posted an operating loss of €2.4 billion.

VW’s first software-defined EV — the ID.3 — was meant to kickstart the new era at Volkswagen, but faced delays and unexpectedly high costs. The same issues plagued other VW brands Audi and Porsche, which have models that are more than three years behind schedule.

“The ID series was supposed to be what changed it all for them,” said Colin McKerracher, head of clean transport at BNEF. “If they’d had a home run [with the series], this would be a very different discussion.”

With their internal unit flailing, Volkswagen turned to partnerships, most recently with American EV startup Rivian. VW invested $5 billion in Rivian to create “next-generation software-defined vehicle platforms” for both companies’ EVs, according to a press release.

Lagging China

European brands have fallen behind China in the EV transition. Not only don’t they have the same battery supply chain as their Chinese competitors, but they also lack the necessary software platforms and chips.

When China experienced a similar problem in the 1980s, it invited foreign automakers to come in as long as they worked with a domestic brand. Now those Chinese carmakers have the technology and experience to become fierce competitors — and are turning the old arrangement on its head, setting up joint ventures in Europe.

Stellantis has such an arrangement with Chinese EV brand Leapmotor, with the two opening their first factory in Poland.

Volkswagen has a slew of partnerships, including with newcomer Xpeng to develop two EV models for the Chinese market.

But VW told POLITICO in March that it will not be opening its European factories to its Chinese partners. Asked again following the announcement that it could close its German plants for the first time in its 87-year history, the brand maintained the option is still off the table.

Taking on the unions

The famously anti-union Musk has benefitted from lower labor costs thanks to his China plant and a lack of worker organization.

Volkswagen isn’t as fortunate. 

This week the automaker ended its three-decade labor agreement with workers, setting the stage for a costly and ugly battle with its works council. The agreement had promised job security until 2029, but those protections will now be in place until June 2025 unless management and the works council can negotiate a new deal.

“The company finds itself compelled to take this action due to current economic challenges,” read an internal note to workers seen by POLITICO.

Going up against the workers is part of what cost Diess his job in 2022. The company’s governance structure remains a huge hurdle for executives today in terms of cutting costs and putting the brand on solid financial ground.

The enemy on the doorstep

Volkswagen and Tesla are alike in one way: They face the same challenge of overcapacity.

The Middle Kingdom is facing its own economic headwinds, with the EV boom having led to an oversaturated auto sector that is desperate to sell its cars abroad — including in VW’s European home market. Cheaper production costs, of course, mean Chinese models come with an appealing price tag.

In Europe, EV sales have dropped off, undercutting Tesla’s dominance. But Volkswagen has an additional burden — it still depends on combustion-engine car sales to prop up its revenue column, as EVs only accounted for 8.3 percent of sales last year. If that doesn’t change fast, VW will be hit with massive fines if it doesn’t meet new EU emissions requirements that take effect next year.

Europe’s car industry could face fines totalling €15 billion, warned Renault CEO Luca de Meo, who also heads European car lobby ACEA.

VW, along with Ford, faces the biggest challenge among European carmakers in meeting the 2025 target, according to an analysis by Dataforce.

VW has urged the European Commission to delay the targets, with current CEO Oliver Blume saying in an investor call that “it doesn’t make sense that the industry has to pay penalties when the framework conditions for the EV ramp-up aren’t in place.”

In an ironic twist, Volkswagen could end up paying Tesla to get its emissions under the line. Carmakers can pool their fleets with battery-only rivals to reach the target, a rule that has proven especially lucrative for Tesla, which earned $1.9 billion in regulatory credits in 2023.

Whether the Commission relents to Volkswagen’s pleading or not, the German automaker will have to push forward with its EV plans.

“There’s been too much procrastination, too much analysis-paralysis among foreign companies thinking ‘is [the combustion engine] going to come back?’” Russo said.

“That was a lot of wishful thinking.”