China's zombie car factories continue to grow as buyers opt for electric vehicles

In 2017, Hyundai Motor invested US$1.15 billion to build a new factory in Chongqing, southwest China, with the goal of producing 300,000 internal combustion engine vehicles annually.

But six years later, sales have stalled as Chinese consumers have rapidly switched to electric vehicles, forcing the automaker to sell factories in December for less than a quarter of the value of the investment.

“The Chongqing factory continues to suffer losses and the Chinese auto market is facing an oversupply problem,” said Lee Hang-joo of the Jeonbuk Automotive Fusion Technology Research Institute, a South Korean research institute. “No one wants to pay a high price to buy the plant.”

The plant is one of hundreds of “zombie factories” that analysts predict will hit China's auto market over the next decade. China's auto market has been the world's largest in terms of sales, production and exports since last year. China produced 17.7 million internal combustion engine vehicles in 2023, down 37% from the peak in 2017, according to Shanghai-based consultancy Automobility.

Bill Russo, former president of Chrysler in China and founder of consulting firm Automobility, said the “sharp decline” in sales of internal combustion engine vehicles means half of the industry's installed capacity – about 25 million of an annual production capacity of 50 million – – is not used.

While some old factories will be converted into plug-in hybrids or pure electric vehicles, others will never make cars again, posing problems for both foreign and Chinese companies.

Russo said that many auto groups in China ultimately face two choices: “Let the factory be mothballed, or produce some output and then ship it to Russia and Mexico.”

Hyundai's exit from Chongqing comes as sales of Hyundai Motor and its Kia unit in China dropped from nearly 1.8 million units in 2016 to 310,000 last year as sales of internal combustion engine vehicles plummeted. Hyundai, which makes cars in China as part of a joint venture with government-backed BAIC Motor, declined to comment on its China operations.

China's fierce price war will only put more pressure on traditional automakers including Toyota, Volkswagen and General Motors, which have been slow to launch popular low-cost electric and hybrid models , and is rapidly losing market share to companies such as BYD and Tesla.

Until recently, foreign auto groups could only enter the Chinese market through joint ventures with local partners. According to Chinese media outlet China Business News, among 16 joint ventures between Chinese and foreign automakers, only five have capacity utilization rates above 50%, and eight have capacity utilization rates below 30%.

In response to the deteriorating domestic market situation, Chinese companies have been increasing exports of cheap gasoline vehicles to Russia. After Russia's full-scale invasion of Ukraine, many international automakers have withdrawn from the Russian market.

However, analysts question whether these sales can generate meaningful profits for Chinese companies, how long those profits can last, or whether other developing markets can help absorb China's non-electric vehicle exports.

Foreign brands are also increasingly trying to export more products from Chinese factories. But experts say companies that do so could make their own factories in other markets less competitive.

Volkswagen, the largest foreign automaker by sales in China, declined to provide figures on China's excess capacity but said the market for gasoline-powered cars remained lucrative.

Volkswagen believes growth will come mainly from China's hundreds of smaller cities, which typically have populations of 3 million or less. This is partly because car ownership is high in larger, more developed cities, and restrictions on buying new gasoline-powered cars are already in place. But another key factor is the lack of charging infrastructure in poor cities, which is hampering the growth of the electric vehicle industry.

“Car ownership in China remains low. While here the average is only 185 cars per 1,000 inhabitants, the United States has almost 800 cars per 1,000 inhabitants and Germany has about 580 cars per 1,000 inhabitants,” Volkswagen express.

Volkswagen announced last year that it would invest 5 billion euros in China with the goal of increasing the production of electric vehicles. It has begun converting some factory lines in China to produce electric vehicles. The group will also work on “gradually hybridizing combustion engine models to transform them into electric new energy vehicle fleets,” it added.

But Volkswagen is an exception in its decision to double down on the Chinese market — where most other foreign automakers' spending has stalled.

Industry executives say the biggest pressure facing all traditional automakers in China is the rise of new electric vehicle factories that use radically different approaches to vehicle manufacturing.

In Hefei, west of Shanghai, a factory owned by NIO illustrates the challenge. When the factory opens in late 2022, founder William Li is betting that EV customers will increasingly demand cars with customized features rather than the mass-market products offered by dealers.

The factory offers different configurations — both physical design and software features — in eight different NIO models. Cars can be delivered to customers in China within approximately three weeks of ordering, and in Europe after 90 days.

NIO's Hefei plant will soon have the capacity to produce 300,000 vehicles per year – a goal set by Hyundai Motor's Chongqing plant less than 10 years ago.

John Jiang, a NIO factory manager who has worked with General Motors in China, said all automakers in China are fighting for survival: “Not every brand will succeed in the end.”

Additional reporting by Song Jung-a in Seoul and Gloria Li in Hong Kong