Please ensure Javascript is enabled for purposes of website accessibility

Is Tesla, Inc. About to Build a Factory in China?

By Daniel Sparks - Oct 23, 2017 at 3:07PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Here's why Tesla is jumping at the opportunity to build electric vehicles in China.

Since electric-car maker Tesla (TSLA 1.24%) confirmed earlier this year that it is in talks with Shanghai Municipal Government about building a factory in the region, there has been little news regarding the matter. But The Wall Street Journal chimed in (subscription required) this week on Tesla's plans for China, saying the company has made an arrangement with Shanghai to build a wholly owned factory in the city's free-trade zone.

A factory in China is particularly important for Tesla as the company ramps up production of its most affordable vehicle yet, the Model 3. Management believes the $35,000 car will help Tesla transition from a low-volume manufacturer to one that competes with mass-market players. But Tesla will need to succeed in China if it wants to meet its aggressive production and sales targets.

Tesla vehicle production at the company's factory in Fremont, CA.

Tesla vehicle production. Image source: author.

A Tesla factory in China

By working with local suppliers and making products close to its end customers in the region, Tesla could significantly reduce supply chain logistics costs and delivery costs. But since the factory would be wholly owned, Tesla likely wouldn't qualify for an exemption from China's 25% import tariff, according to WSJ.

A wholly owned auto factory in Shanghai would be a first for a U.S. auto manufacturer, WSJ noted. China typically requires international companies operating in its territory to form a joint venture with a local manufacturer. Such a partnership allows U.S. automakers in the market to bypass the local government's 25% tariff on auto imports, but there is, of course, a downside: U.S. automakers are only entitled to half of any profits generated from the venture. However, with a wholly owned factory in China, Tesla wouldn't need to share the fruits of its growing business with a local manufacturer. In addition, Tesla would be able exercise more control than if the factory operated as a joint venture.

Given how fast Tesla's sales are growing, and given Tesla's wildly ambitious target of increasing vehicle production from an annual run rate of just over 100,000 units today to half a million next year and a million in 2020, having greater control could help Tesla make faster decisions and grow its operations in China more quickly.

Why China is key

It's no surprise that Tesla is taking China seriously. Its sales have surged in the market recently. Between 2015 and 2016, Tesla's revenue in the market more than tripled from $319 million to $1.07 billion. Thanks to this rapid growth, Tesla's revenue in China went from 8% of total revenue in 2015 to 15% of revenue in 2016.

A red Tesla Model S on a scenic road.

The Model S was the primary growth driver for Tesla sales in China in 2016. Image source: Tesla.

In addition, Tesla's strong appetite for market share -- even if it means forgoing profits today -- has led the company to adopt an unconventional pricing strategy in China. Unlike some other U.S. automakers that hike the price of their vehicles beyond incremental shipping expenses, taxes, and customs duties for their sales in the market, Tesla has committed to only increasing prices enough to cover these mandatory costs. This could help the company quickly gain an edge in the market.

But the best reasons for Tesla to build a factory in China are not company-specific. Not only is China the world's largest auto market, but the government has aggressively moved toward incentives and policy to support the adoption of electric vehicles. For growth-hungry Tesla, China is a massive opportunity.

Tesla expects to have more clarity on its China production plans by the end of the year.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Tesla, Inc. Stock Quote
Tesla, Inc.
TSLA
$681.79 (1.24%) $8.37

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
316%
 
S&P 500 Returns
112%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/03/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.