There's no question that Tesla's future is all about China (TSLA)

Elon Musk China

• China could be Tesla's largest market in the future.

• The Chinese government is considering relaxing rules to allow foreign electric carmakers to operate their own factories.

• Tesla could amass much more market share in China than in the US or Europe.

China could be on the verge of a huge change in how it manages its auto industry — and Tesla could be one of the biggest beneficiaries.

For several decades, western automakers hoping to both build and sell vehicles in China have had to engage in a joint venture with a Chinese company. Effectively, the JVs have helped companies like General Motors and Volkswagen prosper while ensuring that Chinese consumers get better vehicles and Chinese carmakers gain expertise.

But China might soon allow foreign automakers to set up their own non-JV factories, to manufacture electric vehicles.

This would be a massive shift, for two key reasons. First, the Chinese auto market is already much larger than the North American market (the US and Canada combined). About 20 million new cars were sold in North America in 2016; in China, a staggering 28 million vehicles did.

And that tally is expected to grow rapidly in coming years, with some analysts predicting 40-million yearly sales market in the Middle Kingdom.

Second, the Chinese government is pressing to get many more electric vehicles on the road. There are numerous reasons for this, and it might not work out according to plan, especially given the Chinese consumer's penchant for American-style SUVs.

But China is clearly thinking long-term, and if an additional $10 million-$12 million in annual sales can be electric, China's EV market will be nearly as large as the entire auto market in the US. And China would be able to leap to EV dominance, potentially also becoming a large-scale exporter of EVs.

Tesla in China

Tesla Model 3

What does this all mean for Tesla? Well, CEO Elon Musk and his team are up against a daunting statistic: only about 1% of global auto sales are electric vehicles. That data point could improve and favor Tesla in the US, its biggest market, but the question is, "How much?" For Tesla to sell millions of cars, consumer interest in gas-powered vehicles would have to collapse, and there are no signs that will happen.

So Tesla needs to expand in other markets. China is perfect because of the growth prospects and the command-and-control economy. If the government wants millions of new EVs on the road, it can make that happen. And if Tesla doesn't have to go through the JV process, it can simply build a factory and start rolling cars.

That would be expensive and it's easier said than done. But Musk has stressed that Tesla wants to build, not just sell, cars in China, and if future China sales could be double what they in the US, then Tesla would be foolish to avoid doing everything possible to get up and running in the country.

Tesla's China ambitions have provoked criticism, but the real value in this market for Tesla derives from future growth and as a hedge against competition elsewhere. As Tesla gets bigger in the US and Europe, it validates electric cars as a transportation option and front runs the risk for other carmakers, who are now beginning to develop their own EVs — and introduce them ahead of some Tesla vehicles, as was the case with the Chevy Bolt that beat Tesla's Model 3 to market by a year.

A strong manufacturing presence in China would give Tesla the chance to capture more market share in the country than might be possible in, say, the US, where the company could end up being only number six or seven and in a fight for every sale.

A long time coming

A fleet of vehicles equipped with Baidu’s autonomous driving technologies conduct road testing in Wuzhen, Zhejiang Province, China in an undated photo. Courtesy of Baidu/Handout via REUTERS

Being the first successful new US car company in decades has been a PR boon for Tesla. A charismatic CEO has helped. The Tesla brand is powerful — far more powerful than the company is effective at building cars. But it's hard to put a price on goodwill, and in any case, the markets like the Tesla story enough to give the largely profitless automaker a market cap of over $60 billion.

Capturing and holding market share in the US will be another thing altogether. The market is hypercompetitive, with dozens of automakers divvying up sales; no single automaker controls more than 20%. And regardless of whether EVs massively displace gas-powered cars, that market share stasis will persist well into the century.

So for Tesla, maxing out the China opportunity makes perfect sense. There, Tesla can master its own fate, as new market dynamics develop. In the US and Europe, the markets are mature and even a prosperous Tesla would be under constant, costly pressure to innovate.

Similar pressures would be applied in China — other global carmakers would also be setting up non-JV plants and building EVs, and they actually have more cash to spend than Tesla does. But Tesla is already a world leader in EVs, with much bigger sales numbers to follow, thanks to the roll-out of the Model 3. In China, the company would be starting a lot closer to home plate.

There isn't much debate in the car business about China — it's the future. And for Tesla, the debate isn't about whether the carmaker should focus on China. It's about whether Tesla should make China the focus of everything it does moving forward.

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