Sometimes it can be hard to get your head around how a company like Tesla (TSLA -1.41%) can grow vehicle production 50% per year while the rest of the auto industry struggles to grow at all. It helps that Tesla is smaller than most of its established rivals, but the company has been able to leverage its popularity around the world to grow over the past few years to become the hottest electric vehicle (EV) stock on the market. 

And that brings us to the current crisis Tesla is facing in China. Authorities in China are investigating a braking malfunction, and that's led to protests at the Shanghai auto show, negative press in state media, and viral images and videos that are less than flattering for Tesla. I'm not going to get into the validity of those accusations here, which are still being investigated. But investors should understand why this saga -- and China specifically -- are so important to Tesla. To do that, we need to look at where Tesla's growth is coming from. 

Tesla Model Y driving with a city background.

Image source: Tesla.

Land and saturate

You can see below that Tesla has been a growth machine over the past decade. Management also predicts that production will grow 50% annually long-term, so the growth story should continue if there's demand to match production. That's the bullish case for the stock. 

TSLA Revenue (TTM) Chart

TSLA Revenue (TTM) data by YCharts

It's on the demand side that I think Tesla is facing the most interesting challenge. Looking at the company's regional results over the last few years, there appears to be a point at which Tesla's growth tapers off in each of its major markets. After all, there are only so many people who want to buy a Tesla, so once all of those customers are reached it's going to be difficult to grow without investing the money to add more models to the lineup or reach out to new customers through marketing campaigns. 

The first sign Tesla could find the current limits of its market was in Norway. The chart below shows Tesla's revenue in Norway from 2016 to 2019, when the company grew rapidly and then suddenly had a dropoff in demand. Interestingly enough, Tesla stopped breaking out sales in Norway following the drop you see below. But Forbes reported that registrations for new Teslas were down another 75% in Norway in the first 11 months of 2020 and are now being out-sold by  EVs from Audi, VW, and Volvo's Polestar. 

Chart of Tesla revenue per quarter in Norway.

Data source: Tesla. Chart by author.

Tesla clearly hit the Norwegian market running, but it appears to have hit a potential saturation point the market at a certain point and is now losing ground to competitors with newer models. So, is this a canary in the coal mine or an outlier for Tesla? 

Tesla's stalling growth in the U.S. and Europe

In the U.S. and all markets outside of China (mostly Europe), the growth story for Tesla is a little less clear. Between 2018 and 2020, Tesla's revenue rose just 2.3%, or 1.1% on an annualized basis, in the U.S. Revenue outside the U.S. and China was up just 8.1% between 2019 and 2020.

The numbers can be lumpy, but it's hard to argue that the U.S. and Europe, where most of the sales categorized as "Other" come from, are big growth markets for Tesla these days. Could we be seeing the early phases of saturation like Tesla experienced in Norway? 

Tesla revenue chart.

Data source: Tesla earnings filings. Chart by author.

What I would worry about if I were a Tesla investor would be that there's an upper bound on how many vehicles the company can sell in any given market. And once the market hits saturation, Tesla must move on to the next big market to find growth. 

So, where is the growth coming from if 2020 revenue was up 28.3% but the U.S. and Europe are starting to stagnate? The answer is China. 

China's importance to Tesla

In China, Tesla's revenue jumped 69.6% in 2019 and 123.6% in 2020. That compares with growth of 9.6% in 2019 and 15.2% in 2020 in markets outside of China. Not only is the rate of growth sharply higher in China, but nearly half of Tesla's incremental revenue growth on an absolute basis came from China. 

Chart of Tesla's revenue in China by quarter.

Data source: Tesla earnings filings. Chart by author.

This is why China is so important to Tesla. If the Chinese market sees revenue go flat or slow significantly like it has in the U.S. and Europe, it could shatter the growth story for Tesla. A decline in revenue would be nearly impossible to make up in Tesla's existing markets. And the company doesn't have any big, clear markets to grow into now that it's exploited the U.S., Europe, and China. 

The China story is a big deal for Tesla

The reality is that Tesla is facing pressure on multiple fronts in 2021 and the importance China plays in its future is increasing. In Europe, Tesla is already showing signs that it's losing market share to new competitors and has seen sales stagnate as a result. In the U.S. there still appears to be some growth, but the country isn't growing sales anywhere near the 50% management has projected for the future. 

Logically, growth has to come from somewhere, and that place is China right now. With over 1 billion people there's a lot of potential for growth. But if the Chinese market and Chinese government turn against Tesla, it could be devastating for the company's growth story because there aren't any easy markets Tesla could turn to for growth for existing models that haven't already been tapped.

Tesla could be banking on new vehicle driving grow as well. The Cybertruck could reach volume production in 2022. The Tesla Semi has been in development for years, an updated Roadster could hit roads next year, and there are updates to the Model S and Model X on the horizon. But I don't see any of these vehicles providing much more than incremental growth. After producing 180,338 vehicles in the first quarter, there will need to be a lot of volume from new models to make a dent in the 50% growth target. 

China is going to be worth watching closely for Tesla in 2021. If sales start to slump it'll be a very bad sign for the company's results this year. But CEO Elon Musk has faced challenges before and overcome them, so this could be just the latest example of Tesla pushing through a challenge and driving the growth machine further.