Volkswagen AG (VWAGY.US), once dominating China's auto market with over 50% share, is now making a bold $3.5 billion (€3 billion) investment in Hefei—a central Chinese city with about 10 million residents—to build its largest R&D hub outside Germany. The German automaker is placing a high-stakes bet in the world's largest and most competitive car market, though the outcome remains uncertain.
This marks a radical departure from foreign automakers' decades-old China strategy of localizing overseas-developed models and transferring technology to local partners. That approach has been marginalized by rapidly rising domestic rivals, who have significantly eroded foreign brands' sales. "This business model is dead," said Thomas Ulbrich, CTO of Volkswagen Group China.
Ulbrich calls it a "paradigm shift." In 2022, Volkswagen initiated its latest major strategic overhaul for China, developing vehicles specifically for Chinese drivers—models that may never appear on European roads but could be exported to the Middle East and Southeast Asia. As these new models roll out, Volkswagen will test whether this investment can help it catch up with Chinese automakers like BYD and Geely and regain lost market share.
Morningstar European auto analyst Rilla Susskind said this strategy is critical for regaining competitiveness in China but cautioned: "It may help Volkswagen maintain its current market share rather than recover what it's lost in recent years." The bigger question is whether Volkswagen can turn a profit amid cutthroat competition that has driven prices to bankruptcy levels.
Audi, a Volkswagen Group brand, led the charge this year by launching its new "AUDI" brand. Volkswagen also plans to debut China-developed models in 2026, officially described as "born in China, for China." "Whether this strategy works is the million-dollar question," said Claire Yuan, head of China auto corporate ratings at S&P Global Ratings. "We need to keep watching, but at least they're on the right track to catch up."
China's auto market has transformed dramatically over the past five years, leaving foreign automakers struggling. EVs now account for about half of new car sales, and consumers expect cutting-edge digital features—from iPad-like screens to self-parking assist systems. This key market, representing nearly one-third of Volkswagen's global sales, is no longer dominated by "people's cars."
Forty years ago, Volkswagen partnered with state-owned SAIC to begin car production in Shanghai. For decades, basic models like the Santana and Jetta dominated taxi fleets and became many urban residents' first cars. Now, Volkswagen must update its lineup at "China speed." Bill Russo, CEO of Shanghai-based consultancy Automobility, said in this fiercely competitive market, "the ability to quickly launch new models and features is existential."
Chinese EV makers take just 12-18 months to bring new models to market, compared to 3-5 years for global automakers. "This speed isn't optional—it's a survival necessity," Russo noted. "This intense pressure is forcing global automakers to raise their game."
China has become an innovation hub. In the mid-1990s, when Ulbrich worked in northeast China, Volkswagen's joint venture with FAW imported everything from seats to rims. Three decades later, nearly all parts are made locally—now even designs originate in China. To accelerate development, Volkswagen's headquarters has delegated decision-making to its local unit.
Other foreign automakers have responded differently to market changes: some scaled back operations, while others exited China entirely. Like Volkswagen, Toyota Motor (TM.US) has also transferred some authority to its China team to speed up decision-making, granting "unprecedented autonomy in product planning and development," Yuan said.
Volkswagen is also learning from Chinese EV startups. Its partnership with XPeng (XPEV.US) aims to launch models faster and develop its own electronic architecture—the internal computing system governing all vehicle functions. This reflects foreign automakers' growing recognition that China can be both a technology recipient and a source of innovation.
For many companies, Chinese firms' ability to rapidly turn ideas into products—slashing development costs while meeting diverse consumer demands—is key. "The knowledge flow between China and Germany is bidirectional," said Martin Hofmann, a Volkswagen executive and chairman of the German Chamber of Commerce in North China. A recent chamber survey of over 600 member companies found about half expect Chinese competitors to become innovation leaders within five years, while 9% believe they already are.
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