The Challenges of the Chinese Automotive Industry: Price Wars and Overcapacity

The Chinese automotive industry appears to external observers as an unstoppable force. Local brands like BYD and Geely have now supplanted international brands that, in 2009, helped make China the largest automotive market in the world. These Chinese manufacturers boast the most advanced battery technology on the planet, and the country has become the leading exporter of vehicles globally, prompting the United States and the European Union to impose tariffs to curb this expansion. Yet, despite these apparent advantages, some Chinese automotive manufacturers are heading towards an uncertain future. The main problem? A fierce price war that has lasted for over two years and transformed competition into a phenomenon known as "neijuan," a term that literally translates to "involution" and describes a frantic and self-destructive struggle.

The Price War Spiral

This rivalry has intensified to the point of becoming unsustainable. Manufacturers are not just competing on costs but are trying to outdo each other by offering extra features like integrated hotpot cookers in vehicles, multiple screens, free insurance, and loans at very low rates. According to estimates collected by Visible Alpha, the average price of a new car for a basket of six manufacturers, including Great Wall Motor and BYD, is set to drop to around $24,000 this year, a decrease of 21% compared to 2021. This pressure on margins is crushing the entire sector, with a particularly devastating impact on manufacturers focused on gasoline vehicles, the so-called "gas guzzlers."

Some players have already exited the market: Mitsubishi Motors, for example, has decided to leave China. Others are adopting alternative strategies to survive. Dongfeng Motor, for instance, is privatizing its core business and proceeding with a spin-off of its emerging electric vehicle brand, following a 14% drop in sales in the first half of 2025, which led to a profit warning. But even small electric vehicle manufacturers are not immune to this storm. According to consultancy AlixPartners, last year, for the first time, the number of EV-focused manufacturers that exited the market exceeded those that entered, with as many as 16 exits recorded.

Even industry giants are starting to feel the weight of this competition. BYD, the largest electric vehicle manufacturer in the world with a market capitalization of $136 billion, reported last week a nearly 30% drop in quarterly net profit. Last Monday, the company announced its second consecutive decline in monthly production, an event that had not occurred since 2020. To stimulate sales, BYD has offered aggressive discounts while heavily investing in research and development and building new factories abroad. A similar situation has hit Great Wall Motor, which saw a 10% drop in net profit for the first half.

Government Interventions: Futile Attempts?

Beijing has clearly expressed its desire to end this extreme level of competition. President Xi Jinping has openly criticized disorderly price cuts, and in July, the Ministry of Industry urged manufacturers to pursue "rational competition." Authorities are also modifying rules and guidelines to try to stabilize the sector. However, these measures have had little success and, worse yet, do not address the root cause of the problems: overcapacity.

According to consultancy Automobility, passenger vehicle sales reached 27.6 million units last year, but production capacity hit 55.6 million units, more than 50% higher than a decade ago, as reported by AlixPartners. Having double the necessary capacity compared to demand represents a massive financial hole, with fixed costs like factories and infrastructure weighing on balance sheets. Paradoxically, this overcapacity fuels a vicious cycle: manufacturers offer increasingly aggressive incentives in a vain hope of sustainably increasing market share, thus exacerbating losses.

The solutions to curb the excess seem obvious: discourage the construction of new factories, sell idle ones, and promote industry consolidation. But politics heavily interferes. The electric vehicle industry, in particular, has become a strategic asset over the past 15 years. The price war has even pushed some Chinese manufacturers to develop cutting-edge technologies, from batteries to assisted driving systems, to automated production lines. International competitors look on with envy: Ford Motor's CEO, Jim Farley, praised Xiaomi's new model, similar to a Porsche, calling Chinese rivals "far superior."

Political and Local Barriers

Reducing production capacity entails economic pain. Local governments, often short on cash, actively encourage manufacturers to build or expand factories, offering incentives like tax breaks, land, and subsidies. In some cases, they have even revived defunct groups. Even if a company loses money, provincial authorities can still collect VAT on the goods produced. Greenfield investments and job creation are highly desirable, even if the manufacturer does not generate profits, because local officials' goals revolve around GDP growth.

An emblematic example is Nio. When the brand, still unprofitable, faced financial ruin in 2020, it received a $1 billion infusion from a group led by state-controlled companies in Anhui province, where its factories are located – an operation described by Bernstein analysts as a bailout. Last year, Nio obtained approval to build a third factory there, bringing its annual capacity to about 1 million cars; however, sales in the previous year were only 221,970 units.

Another obstacle is employment: the sector employs about 5 million people, according to Commerzbank economist Tommy Wu. Along with other manufacturing sectors, automotive manufacturers have already begun reducing shifts and employee salaries, moving from full-time contracts to temporary workers, as reported by Reuters. But these are marginal interventions compared to what could happen. Although companies do not necessarily have armies of workers on standby for all unused production lines, consolidation and closures could lead to significant job losses. This is especially true for legacy manufacturers like Dongfeng, which may not have reduced capacity in line with the rapid decline in sales, and for ambitious newcomers whose sales have never taken off.

The Risks of Further Deterioration

The combination of price wars and overcapacity makes manufacturers vulnerable to a deterioration in sales, a risk that is far from remote. Domestic demand is fragile. It is true that car sales in China increased by 11.4% in the first half of 2025 compared to the previous year, but tax exemptions and government programs like "cash-for-clunkers" likely brought forward purchases. The National Bureau of Statistics' consumer confidence survey stood at 89 in July, well below pre-pandemic levels above 120, and Fitch forecasts a weakening of sentiment in the second half of the year.

Exports also face headwinds, having sextupled from nearly 6 million units between 2020 and 2024. Protectionism abroad and the plans of major exporters – BYD, SAIC Motor, and Chery – to localize production abroad will likely reduce demand for vehicles made in China.

If demand weakens further, market exits will accelerate and become more painful. Just five years ago, struggling automotive assets found buyers who viewed them as economic opportunities to enter the sector. For example, the failed real estate giant China Evergrande assembled an entire automotive business by acquiring fragments from Faraday Future, NEVS (formerly Saab), and others. But recently, such deals – including those for China Evergrande New Energy Vehicle in 2024 and for WM Motors, backed by Baidu – have failed.

Weaker players are less likely to own desirable intellectual property, and their production lines are worth little in a context of oversupply. Consolidation may still involve deals, but bankruptcies and layoffs seem inevitable. Without a sudden boom in demand, large segments of the Chinese automotive industry are heading towards financial ruin. In an industry that has symbolized China's economic rise, this crisis could mark a painful turning point, where survival will depend on radical reforms that, at the moment, seem hindered by political and local interests.