Title: Should Tesla enter the Chinese market and build Gigafactory 3?

Session: May 2020

Word Count: 1431

- Introduction (233)
- Analysis of findings (887)
- Conclusion (3s11)

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Table of Contents

1. Introduction ……………………………………..……….p. 3

2. Research Findings ………………………………………...p. 4

3. Analysis of Findings ……………………………………...p. 6

4. Conclusion ………………………………………………..p. 8

5. Bibliography ……………………………………………...p. 9

6. Appendix ………………………………………………..p. 10

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Introduction
The trade war is battering Tesla’s competitiveness by making the price of its cars more expensive over its
competitors. All the raw materials imported from China will be taxed, thus making the cost of production
to be much higher. The Chinese government has provided tax incentives or subsidies for the local
producers, however, Tesla couldn't benefit from this policy. For Tesla, China is a huge market that cannot
be ignored. Tesla is motivated to step into the Chinese market. The CEO Elon Musk predicts that in
“long-term we might sell more cars in China than in the US”. They eventually made the decision of
building Gigafactory 3, the first Gigafactory that is constructed outside the states in Shanghai, China. The
purpose of this commentary is to analyze the business decide by the Elon Musk, whether Tesla should
enter the Chinese market and build the Gigafactory 3.

Methodology

The commentary will be covering unit 1.3 organizational objectives, 1.4 stakeholders, 3.1 source of
finance, 3.2 costs and revenue, 3.4 Final accounts, 3.5 profitability and liquidity ratio analysis, 4.5 the
four Ps (product, price, promotion, place), 5.4 location, and 5.6 research and development. Tools such as
SWOT Analysis, Profit & Loss Account, the Ansoff Matrix, and theories such as quantitative reasons
when choosing a place will better help me analyze the business decision from a more complete aspect, so
that my analysis will become more thorough.

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Research Findings

Motive of building Gigafactory 3

Since 2012, as to encourage EV consumption, the Chinese government has spent more than $60 billion in
direct subsidies to lower the cost of electric vehicles for consumers. However, for Tesla, entering the
Chinese market is very expensive. They have import duties, transport costs, higher cost of labor in the US,
and notably no tax incentives or subsidies. Moreover, the trade war has increased even more taxes, which
eventually results in higher prices of their vehicles.

By building the Gigafactory 3 and producing the EVs locally, tariffs are evaded, and their own local
supply chain can be set up.

Mission Statement
To accelerate the world’s transition to sustainable energy.

Market size
China is and will continue to be the largest market for EVs. According to the International Energy
Agency, China owns half of the world’s EV stock. In 2017, China sold 777,000 new energy vehicles, a 53%
increase over 2016. In 2018 alone, 2.3 million units of EVs were sold, in which 1.1 million sales came
from the Chinese market. US EV sales that year were just 0.36 million.

Sales trend
According to the China Association of Automobile Manufacturers, in June, 2019, the vehicles sales drop
reach 9.6%, which marked the straight fall for the 12th consecutive month. Nonetheless, premium
carmakers are performing quite well. BMW sold 350,070 vehicles, which is a 16.8 percent increase from
last year. Porsche’s China sales increased by 28 percent in the same period. In the first six month of 2019,
EV sales increased by 48.3 percent from the same period a year ago.

Competition
Many companies are making EV’s in China. They range from large players like BYD and BAIC, to new
players like NIO. BYD is backed by Warren Buffet and BAIC is baked by the Chinese government.
Competition between foreign luxury brands is also intense. Porsche has the Taycan, Jaguar has the I-pace,
along with Audi and Mercedes are all releasing EV’s in 2019. They will compete directly with Tesla.

Brand image
Tesla Model 3 loses Consumer Reports recommendation over its reliability issues. Owners of Model 3
reported the problems they had discovered during the use of their cars. These include glass defects, body
hardware and in-car electronic problems. A Tesla spokesperson said ‘significant improvements’ have

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been made to fix the problems that the owners raised with CR. He stated, ‘we take feedback from our
customers very seriously and quickly implement improvements any time we hear about issues.’

Growth in sales
Tesla’s sales revenue has increased from $3.7 billion to $5.4 billion in the second quarter. Cash position
increased to $5.0 billion.

Business growth
Tesla is the first independent foreign auto manufacturer in China without needing a local partner. It can
own 100% of its operation, which no other global automaker has been able to do so far. By doing so,
tariffs are evaded, and their own local supply chain will be set up. An $80,000 Model S in the United
States runs about $ 140,000 in China after taxes. They can now lower the price.

Sources of finance
The Gigafactory 3 will almost be fully funded through local debt, as one of the external source of finance.

Safety issues
In April 2019, a Model S was self-ignited in the garage in Shanghai. Although no one was harmed, the
three cars beside it were all completely destroyed. According to analyst Alan Kang at LMC Automotive,
‘Tesla had fire incidents before but they didn't have a big impact on its reputation in China.

Product popularity
Model 3 was the best-selling car in the US in terms of revenue and the 5th best-selling car in terms of
volume.

P&L account

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Analysis of findings
Arguments for:

1- Better sales prospect and increase sales revenue.

Model 3 was the best-selling car in the US in terms of volume and the 5th best-selling car in terms of
volume. Tesla has localized the production of Model 3 as they are now produced in Gigafactory 3 in
Shanghai. The strategy that involves selling existing products into new markets can be seen as market
development from the Ansoff Matrix.

Through this strategy, a new distribution channel is gained. According to business times, China is and
will continue to be the largest market for EVs. In 2017, 777,000 EVs are sold in China. EV sales
increased by 53% compared to the same period last year. In 2018, 1.1 million EVs are sold, which
increased by 41.6%. For comparison, in the same year US only sold 0.36 million EVs. The demand for
Chinese market may continue to increase as the government is providing free car license plate as
incentive to purchase EVs. By entering the Chinese market, Tesla takes the advantage of a larger
customer base, which gives Tesla a better sales prospect. As a result, the sales revenue may potentially
increase. It is important to increase the sales revenue as the potential profit may increase. Commonly,
revenue is examined more often than profit when determining business growth. Moreover, when a
business request for a loan, a higher revenue figure can reassure the lenders that the business has the
ability to pay back the loan. For Tesla, Gigafactory 3 will almost be fully funded through local debt, an
external source of finance, which the sales figure is a determinant factor for the loan request.

2- Lower cost of production.

The benefit of lowered cost of production can be enjoyed. If Tesla produces its EVs in China locally,
custom duties can be exempted. As a result, the price of its EVs can be reduced, which helps Tesla to
increase its competitiveness among the intense competition in China. For example, before localize the
production, an $80,000 Model S sold in US could turn into $14,000 when selling to customers in China.
Moreover, localize the production can help save them transport cost and import duties, but also lower
labour cost will be generated. These factors may effectively help Tesla to reduce the COGS. It is very
important to reduce COGS because lowered COGS can increase gross profit and improve GPM for Tesla.

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3- R&D center can be established and contribute to its global R&D system.

Qualitative reasons such as government incentives are provided. A Cooperative Agreement was signed
between the Shanghai Municipal People’s Government and Tesla. Both sides will focus their cooperation
on jointly promoting technology innovation and industry development. It is expected that Tesla Shanghai
will achieve an optimized R&D, manufacturing, and sales operations which will make contribution to the
business itself. Tesla also signed an electric vehicle Investment Agreement with the Lingang Management
Committee, Lingang Area Development Administration and the Lingang Group, which aids the
establishment of the Tesla (Shanghai) Ltd. Electric Vehicle Development and Innovation Center. This
will become part of Tesla’s global R&D system. The center will actively promote the transformation of
innovative technology achievements for EVs. These achievements may help Tesla to stand out from its
competitors.

Arguments against:

1- Intense competition and negative trend in automotive sales.

SWOT analysis extract

Threats  Intense competition between foreign automakers in China.
 China vehicle sales has dropped for 12th straight monthly fall, down 9.6 percent year-
on-year in 2019.

According to the China Association of Automobile Manufacturers, in June, 2019, the vehicles sales drop
reach 9.6%, which marked the straight fall for the 12th consecutive month. However, in the first six month
of 2019, EV sales increased by 48.3 percent from the same period a year ago. A lot of Tesla’s competitors
are making EV’s in China. They range from large players like BYD and BAIC, to new players like NIO.
BYD is backed by Warren Buffet and BAIC is baked by the Chinese government. Nevertheless, as one of
the premium car makers, some of the real competition may appear between foreign luxury brands.
Porsche has the Taycan, Jaguar has the I-pace, along with Audi and Mercedes are all releasing EV’s in
2019, which will compete directly with Tesla. Although the external business environment does not show
positive signs, the sales trends of EV were still increasing which gives Tesla the opportunity to increase
revenue.

2- Reliability issues threatens brand image.

SWOT analysis extract

Weakness  Model 3 and many other Models lose Consumer report’s recommendation due to
reliability issues.
 Tesla EV has a few cases of self-ignition accidents, which Chinese consumers care
about.

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There was a self-ignition accident of a Model 3 on April 21, 2019 in Shanghai. Fortunately no one was
hurt in the accident. Although Tesla immediately sent a team to investigate this accident, its brand image
has worsened among the Chinese’s customers. Reliability issue had always been a weak spot for Tesla.
Earlier this year, Model 3 loses Consumer Reports’ recommendation as a number of problems are
identified, including problems with paint, trim and its body hardware. Chinese customers don't forgive
quality issues easily. Nevertheless, these problems were quickly improved by Tesla.

3- GPM didn’t improve as expected.

The profitability ratios examine profit in relation to other figures, they can show how well a firm has
performed financially.

Profit & Loss account extract

(in millions of USD) 31-Dec-18 31-Dec-19
Total revenue 21,461 24,578
Gross profit 4,072 4,069
Net income (Loss) (1,063) (775)

The gross profit margin (GPM) shows the value of gross profit as a percentage of sales revenue. It’s
calculated as (Gross profit/sales revenue) × 100. The GPM in 2018 was 19.0% and in 2019 was 16.6%.
Therefore, after opening the Gigafactory, GPM didn't increase as expected as the cost of production is
reduced largely for the Chinese-based cars. However, it’s limited to assess Tesla’s performance in China
just by examining the figures on the P&L account because this account represents the company’s global
performance. Although GPM decreases, net profit margin (NPM) improves from -5.0% to -3.2%. Overall
performance still improved as Tesla is now making fewer losses. In addition, according to the general
manager of Tesla China, Wang Hao, “Demand for the made-in-China Tesla Model 3s has been very hot.
We have a goal of selling every Model 3 that we produce in the Shanghai plant, and we are very confident
of achieving that goal”, therefore it is biased to comment on Tesla China’s performance based on the
GPM figure.

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Conclusion
By building the Gigafactory 3 in China, Tesla can benefit from a better sales prospect and thus
increase sales revenue. It is very crucial for Tesla to increase sales revenue, as it can be an
indicator for business growth.

Producing locally in China enables Tesla to be exempted from the custom duties, which
effectively decrease the price of the EVs. Thus its competitiveness increase. Moreover, cost of
production can also be lowered, which may improve GPM.

Tesla is able to establish its own R&D center in China, which help Tesla to achieve an optimized
R&D, manufacturing, and sales operations. It contributes to the construction of its own global
R&D system, and the special achievements made by the team may let Tesla stand out from its
competitors.

However, despite the positive sales trend for EVs, the competition in China is intense and the
trend in vehicle sales decrease. Many competitors are releasing their EVs into the markets in
2019, which compete directly with Tesla.

Reliability issues also occur in the form of self-ignition accidents or problems with the car’s
body hardware. The problem gets severe as Model 3 is losing its recommendation on the
Consumers reports. In terms of cultural context, Chinese customers are not so forgiving on the
reliability issues. This devastates the company’s brand image and may generate a loss in
customers.

Moreover, the GPM doesn’t increase as expected over a year’s performance. Nevertheless, it’s
not a specific report for Tesla China, so it’s limited to assess Tesla’s performance in China just
by examining the figures on the P&L account because this account represents the company’s
global performance. In addition, the manager of Tesla China said the demand for the made-in-
China model is huge.

In my opinion, I think Tesla should enter the Chinese market and build Gigafactory 3. Firstly, the
size of the Chinese market is large, and the demand keeps increase as the government provides
free car license plates as incentives for purchasing the EVs. The potential profit that Tesla can
gain is huge. Secondly, R&D center can aid the formation of its global R&D system, and
contribute to its unique achievements which may stand out its products. Thirdly, as soon as the
factory start producing Model 3 locally, demand is increasing. Although the GPM hasn't shown
obvious improvement yet, but I believe in the long run GPM will increase. Therefore, entering
Chinese market and build Gigafactory 3 is a win-win situation for both Tesla and Chinese
customers.

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Bibliography:

1. The SWOT Analysis.

2. Times, B. (2019). Tesla’s (TSLA) Sales Show Growth In China This Year. [online]
Business Times. Available at:
https://en.businesstimes.cn/articles/116185/20190730/tesla-tesla-sales-in-china.htm
[Accessed 12 Aug. 2019].

3. Shane, D. (2019). Tesla investigates after car appears to explode in China. [online] CNN.
Available at: https://edition.cnn.com/2019/04/22/business/tesla-explosion-
china/index.html. [Accessed 10 Mar. 2020].

4. Electrek (2019). Tesla announces Gigafactory 3 is already producing “more than 1,000
Model 3/week” - Electrek. [online] Electrek. Available at:
https://electrek.co/2019/12/31/tesla-gigafactory-3-producing-1000-model-3-week/
[Accessed 10 Feb. 2020].

5. Tesla Third Quarter 2018 Update. (n.d.). [online] Available at: https://ir.tesla.com/static-
files/725970e6-eda5-47ab-96e1-422d4045f799. [Accessed 10 Feb. 2020].

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[1]SWOT Analysis for Tesla
Strengths
 Mission statement - transition to
sustainable energy is widely
approved by consumers.
 Brand image is well established,
they solve customer’s problem
with good response.
 Model 3 was the best-selling car
in the US in terms of revenue
and the 5th best-selling car in
terms of volume.
Opportunities
 Market size – China owns half of
the world’s EV stock.
 Increase sales revenue-
manufacture locally in China can
deliver the cars at a lower price,
thus more consumers buy Tesla’s
EV.
 Cost of production is lowered as
transport costs are reduced and
import duties are freed
Weaknesses
 Model 3 and many other Models
lose Consumer report’s
recommendation due to reliability
issues.
 Tesla EV has a few cases of self-
ignition accidents, which Chinese
consumers care about.
 China accounts 20% of Tesla’s
annual revenue, but the market
share there is still tiny.
Threats
 Intense competition between
foreign automakers in China.
 Vehicles sales has been
continuously dropping for 12
months since June, 2018.
 China vehicle sales has dropped
for 12th straight monthly fall, down
9.6 percent year-on-year in 2019.
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[2]Tesla’s (TSLA) sales show growth in China this year
By Ritchelle Ann De Castro

Jul 30, 2019

Contrary to popular belief that Tesla, the leading electric vehicle (EV) manufacturer is having issues
selling to the Chinese market, it's 2019 sales prove otherwise with growth at 40% this year.

The early sale of Tesla in China was low but growth finally came, an important development because
China is and will continue to be the largest market for EVs.

The International Energy Agency states that China owns half of the world's EV stock.

In 2018 alone, 1.1 million sales at 2.3 million units of EVs came from the Chinese market.

Tesla's efforts to penetrate China started in 2014. After two years, Tesla grew its sales in the
country beating by 13% of the cars it delivered worldwide.
With the earnings of 2016, Tesla was able to finally join Fortune 500. Tesla's 2017 market
performance doubled and earned them $2 billion.
This 2017 performance put them on pace in the Chinese auto market gave the idea to the
company to work on a deal to become the first foreign automaker to manufacture in China.

However, with the tariff issues between the US and China in 2018, Tesla's profits will be at stake.
But since 2014, co-founder, CEO and product architect of Tesla, Elon Musk is aware of the
potential of the Chinese EV market.

a. Because of this, the company still went on with their plans and on July 2018, the deal pushed
through to put up Tesla's biggest investment and bet, it's Gigafactory 3.

To sustain Tesla's growth, it is betting on its first manufacturing plant in Shanghai, the
Gigafactory 3, to start production by the end of the year with 30,000 units per week.

However, Morgan Stanley's research team who had recently been in China said the factory can
start production in November with 35,000 to 40,000 units.

Even with the news of the Gigafactory 3, there were reports that Tesla's sales dropped in the
second half of last year. Still, growth is still being shown by the company in 2019 with the
release of the Model 3.

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Because the units coming out of Gigafactory 3 is not subject to import tariffs, Tesla announced
the price for the made-in-China Model 3 to be between 300,000 yuan and 350,000
yuan ($43,431-$50,670) before subsidies, cheaper than its US counterparts.
Musk is expecting 5,000 vehicles a-week-demand or the car in the longer term come next year.

[3]Tesla investigates after car appear to explode in China

Hong Kong (CNN Business) Tesla is investigating after one of its vehicles appeared to explode
in China.

A short video of surveillance footage posted on Chinese social media site Weibo (WB) showed white
smoke emerging from what looks like a white Tesla car parked at a lot in Shanghai. After a few seconds,
the electric vehicle bursts into flames and the clip ends soon afterward.

The video, which was filmed just after 8:15 pm local time on April 21, appears to show a Tesla Model S
sedan. It was posted on Chinese social media a couple of hours later and has since been shared widely.

Chinese Tesla rival Nio warns of weak SUV demand and scraps factory plans

Tesla (TSLA) would not confirm any of the details, other than to say it is investigating the incident
alongside Chinese authorities.

"We immediately sent a team on-site and we're supporting local authorities to establish the facts. From
what we know now, no one was harmed," a Tesla spokesperson told CNN Business on Monday.

The clip attracted a mix of derision and outrage on Weibo. "Us car owners demand an explanation," wrote
user Miao Hongyang. "Jeopardizing our safety in a moment's instant and the fact it ignited so quickly is
something we will not tolerate."

Another Weibo user registered under the name Your Dad, added: "One thing I've learned from this
incident: from now on, don't ever park next to a Tesla."

China is huge for Tesla

This isn't the first time one of Tesla's cars has appeared to burst into flames, but previous incidents often
involved moving vehicles or vehicles that had crashed.

"It seems strange that the battery, not charging, would combust on its own," said Tu Le, founder of
consultant firm Sino Auto Insights.

Tesla has previously said that gasoline-powered cars are 10 times more likely to catch fire than those
powered by electric batteries.

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Tesla is accusing a former employee of stealing self-driving tech and giving it to a Chinese rival

China is a hugely important market for Tesla. The country accounts for about 20% of the company's
annual revenues, or more than $2 billion in sales. But its share of this market is still tiny.

The company wants to supercharge sales in China with a new factory in Shanghai. Tesla eventually hopes
to produce 500,000 cars at the facility every year.

But Tesla is also grappling with a slowdown in the Chinese economy, which has already hit foreign
brands including GM (GM) and Ford (F). Import tariffs resulting from the trade war with the United
States have seen Tesla prices in China fluctuate wildly.

It also has to contend with heavy competition from Chinese players, such
as BYD (BYDDF) and NIO (NIO).

[4]Tesla announces Gigafactory 3 is already producing ‘more than 1,000 Model

3/week’

- Dec. 31st 2019 5:56 am ETTesla executives have confirmed that Gigafactory 3 has already
achieved its goal of producing “more than 1,000” Model 3 vehicles per week.

Over the last few weeks, we have observed Tesla steadily producing and shipping made-in-
China Model 3 vehicles out of Gigafactory 3 while it was awaiting sale approval for the new
vehicle.

Yesterday, they officially started deliveries and we recently witnessed Model 3 vehicles
overflowing Gigafactory 3’s parking lot.

After the ceremony to deliver the first few cars, Tesla China executives talked to the Chinese
press and confirmed some important details about the current production capacity of
Gigafactory 3 and the status of the made-in China Model 3..

Wang Hao, general manager of Tesla China, said that Tesla expects to sell all Model 3
vehicles that were already produced:

“Demand for the made-in-China Tesla Model 3s has been very hot. We have a goal of selling
every Model 3 that we produce in the Shanghai plant, and we are very confident of achieving
that goal,”

A production director told Global Times China that production is already exceeding 1,000
Model 3 cars per week:

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“Song Gang, production director of the Tesla Gigafactory 3, said that the factory produces
28 or more Model 3s every hour and works about 10 hours each day, which means that it
produces more than 1,000 cars each week. He added that the factory will be able to produce
3,000 cars per week “in the near future.””

Tao Lin, vice president of Tesla, announced that the Shanghai plant’s production capacity
will be further enhanced in 2020:

“Compared with traditional car manufacturers, Gigafactory 3’s production capacity will
ramp up at a speed that exceeds your imagination,”

The increase in capacity is not only about the total output of Model 3 vehicles, which is
expected to quickly reach 3,000 per week, but it’s also about manufacturing more parts
locally.

Tesla’s Chinese execs told the Global Times that currently about 30 percents of the parts are
sourced in China:

“The Tesla executives also disclosed that about 30 percent of the made-in-China Model 3
parts are sourced in China. The Model 3’s localization level will climb to about 80 percent
by around mid-2020 and the car will be totally localized by the end of next year, meaning
that all of its parts will be supplied by Chinese companies.”

A previous report stated that Tesla is considering significantly reducing the price of the
vehicle in China after the cost is reduced from sourcing the majority of the parts in the
country.

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