Finding the X-factor

The BAT troika – Baidu, Alibaba and Tencent – are three of China’s best-known companies. But fast-forward five years and three electric vehicle (EV) companies in which the BAT has invested could be just as well known – NIO, XPENG Motors and WM Motor.

That is certainly what the auto start-ups are betting on as they raise billions of dollars in the race to replace companies reliant on the internal combustion engine (ICE).

The opportunity to work at the forefront of a technological and transport revolution has been luring plenty of financiers to their ranks too, including Robert Bao, who joined Alibaba-backed XPENG Motors last July after 20 years at Fidelity, most recently overseeing its $1.5 billion Fidelity China Region Fund from Hong Kong.

Bao is now strategy director at XPENG, which is called Xiaopeng in Chinese after its founder, tech entrepreneur He Xiaopeng (we first wrote about the company in WiC397).

XPENG’s founder made his name co-creating China’s most popular mobile web browser, UCWeb, before selling it to Alibaba in 2014. He is also a big fan of the company that XPENG has pledged to challenge: Tesla. WiC caught up with Bao to discuss how the company plans to do it.

Was it a big step quitting an established position as an international fund manager for a Chinese start-up that only had a four-year track record when you joined it?

No, it’s been really gratifying. As a former auto industry analyst and long-term investor in the automotive space, I’d been observing how the EV sector is transforming the transportation industry and how China’s been leading that globally. So I leapt at the chance to be at the heart of that process.

At XPENG, we passionately believe that EV is the future for drivers and for the environment, and the vehicle is the “entry” to the mobility ecosystem. We also think the industry is about to hit an inflexion point and we’ll be one of its leaders.

What about Tesla? You used its open source patents to design your first car, the G3. But later this year, you’ll have Tesla right on your doorstep once it rolls out production in China? How will you compete against that?

There’s no doubt that Tesla is currently the market leader in terms of technology. We benchmark ourselves against it in all technical aspects.

But we can do better than Tesla because ultimately we know China better. And we’re already superior when it comes to service.

How’s that? You only started producing your first car in December?

I think the best example of how we differentiate ourselves is autonomous parking. It’s not a fancy subject like acceleration speeds or battery life, but it’s fundamental to what customers want in China.

And yet XPENG and Tesla are the only two companies building this technological capability in-house. Everyone else is relying on tier-one suppliers like Bosch.

We’ve also gone down a different route to Tesla, which is using ultrasonic radar for autonomous parking. That’s great for spotting obstacles such as walls, but it’s not so good at working out where the empty spaces are.

By contrast, we’re combining inputs from ultrasonic radars and cameras in what we call “sensor-fusion” technology that dramatically improves the efficacy and accuracy of the application. When we recently tested about 260 parking scenarios, we discovered that our technology worked 70% of the time, three times more accurate than the most advanced brand available in the market.

There are dozens of other models, which claim to have autonomous parking. But we found they worked less than 10% of the time.

This is an area we’ve devoted a lot of technical resources to. We have 3,000 people working at XPENG and 70% of them are in R&D. No other company has that ratio. We also plan to have at least 50% of our headcount in R&D as we expand in the future. More importantly, no other foreign company plans to have that level of R&D in China. That’s what will be crucial to understanding Chinese customers. The EV winners will be the ones that learn how to manage their customer relationships and develop features that are more convenient and more thoughtful for them.

But you are coming from behind aren’t you? Tesla is years ahead of you.

Tesla has done a great job essentially creating the EV industry and while doing so, it has educated the market and raised the awareness of EVs.

When Tesla started everything was new – AI learning, battery technology, autonomous driving, etc. The supply chain was also virtually non-existent for Tesla at the time.

Today, there’s a well-established supply chain, battery technologies and charging facilities are more advanced and there’s genuine market acceptance of EVs.

Based in China, we are fortunate to have a world-class supply chain right at our doorstep. These key differences have enabled us to launch our first mass production model within a much shorter timeframe.

Our customer base is quite different from that of Tesla’s. Our target customers are the young tech-savvy generation in China who are keen to try new things. They care more about the smart features, less about the raw acceleration of the vehicle, or the prestige of a brand.

We believe we can excel in this market.

And yet even Tesla has struggled to ramp up production of its first mass-market car, the Model 3. What makes you think you won’t have similar problems trying to scale up?

If you recall, Elon Musk stated in one of the earnings calls that “production hell” was a direct result of over-automation. Reinventing the wheel too much in hardware and manufacturing process will slow down your production.

There are four main processes to car production – stamping, welding, painting and general assembly. The first three are already highly automated. The final stage relies on line workers putting on the wheels, joining the body with the chassis and so forth. Tesla tried to automate the last stage – general assembly – but that turned out to be a difficult bottleneck for them. While minor tinkering is a part of life for any auto OEM, we are not trying to reinvent the wheel (no pun intended) when it comes to mature industry practices.

To us, ensuring world-class production is one of our top priorities. And a key to achieving that goal is to avoid introducing more points of failure into the production system.

We’ve hired some of the best people in the industry to ensure our manufacturing processes are best-in-class. For example, Miyashita Yoshitsugu has joined from GAC Toyota to head production quality. He’s a black belt in Six Sigma and lean manufacturing. He was one of the key brains behind Toyota’s zero defects policy.

We’ve also just hired another industry expert to oversee the construction of our second production plant, which is about one and a half hours outside of Guangzhou. He was a key driver in building all of another Japanese car giant’s Chinese factories.

Another example is that our battery pack has successfully passed all 17 rigorous C-NCAP national safety tests, achieving a 5-star rating of 90.9%. Seven of these test results met standards that were equivalent to twice the national requirements.

Aren’t you outsourcing car production?

We are currently partnering with an OEM that has decades of manufacturing experience and also was Mazda’s previous Chinese partner.

That factory has an annual capacity of 150,000 vehicles and we’re just starting to ramp up production now. We had over 10,000 orders for our first compact SUV, the G3, and have delivered over 1,000 cars since our commercial launch on December 12.

That number will grow exponentially over the next 10 months. We’ve set a total production target in the tens of thousands range for the full year.

The second plant will produce our new model, which we’re unveiling in Q2 this year. It has a production volume of 100,000 to 150,000 vehicles per annum. We broke ground last October and expect to complete the construction in Q3.

Is Hon Hai involved? The Taiwanese company invested in one of your funding rounds?

Yes, it’s providing advice in terms of quality manufacturing.

What about battery production?

We don’t make the cells, but we do design and manufacture our own battery packs. We find it also helps with our battery management system, which is a combination of hardware and software.

Basically anything with a software component we’ll keep in-house. Software is where we’ll innovate and we feel we are in an advantageous position.

How’s that possible given the huge number companies trying to gain market share?

One of the unique aspects about our company is Xiaopeng himself. He’s a serial entrepreneur from the internet sector. He’s a software engineer and a product manager. So he’s absolutely meticulous about getting everything right.

For example, we were the first EV start-up to get a government licence to mass-produce. But we weren’t the first to actually do it because Xiaopeng said our debut product wasn’t good enough.

It caused some dismay internally. But he was adamant that paying customers shouldn’t be the guinea pigs for a product that wasn’t perfect.

He insisted on slowing everything down and so it took us 17 months from getting our licence to launching commercially. We believe that slow means fast. That’s our culture – prudent and meticulous.

Meanwhile the rest of the traditional auto industry is also going green at a rapid clip?

The transition from combustion engines to electric comes with a lot of burdens for the OEMs. You also need to have the right DNA to capture the market trends that are constantly evolving. That’s important because if you want to innovate and disrupt then you really need a different mentality.

We have a unique DNA. Our top management is a combination of top talent in internet technology, automobile engineering as well as finance.

Right now, all of the big OEMs source their profits from ICE vehicles. It’s very hard to give those profits up: to disrupt yourself. We’ve seen it time and time again across so many different industries.

The other differentiating point is our sales model. Traditional OEMs use dealers to sell their cars. But that puts a middleman between themselves and their customers. In the EV world, it’s absolutely crucial to know who your customer is and what they are doing because it’s all about the data. That’s why we have a direct sales model.

What’s that data telling you?

We don’t pretend we know everything about our customers yet. No one does. It’s still too early to tell what the winning features are.

But our sales model and technology means that we can anticipate what a customer wants and that puts us in a very strong position over the next five years.

Xiaopeng has assembled a team with the greatest odds of working it out because it’s the one that’s best positioned to adapt. If you come to our company, you’ll see that it looks nothing like an OEM, or one of the state-owned enterprises that have dominated car manufacturing in China to date.

We look like an internet company, a college campus. That attracts young, like-minded people. They’re highly driven individuals and share a common goal and they’re keen to experiment. Traditional OEMs may not have that kind of DNA.

So what kind of differentiating factors are you coming up with?

The basic philosophy is to stand out because of our smart features. We want to make the user experience peerless and unique. Our cars are going to be affordable, fun, intelligent and connected. They’re sleek and sporty. They also have a 360-degree rotatable camera on the roof, which no one else has. So your car can take your group selfie for you when you go out for the day with your friends. It’s the kind of thing which appeals to our target demographic – tech savvy 20- to 35-year olds, living in a tier-one or tier-two city.

We’ve also been trying out in-car karaoke, which works pretty well.

Then there’s voice-controlled GPS. No more trying to balance your smartphone on the dashboard, or twiddling with a lot of confusing knobs to work out how to get to your final destination.

Are you working with Alibaba? It holds a 13% stake thanks to its investments in various funding rounds.

Yes, Ali’s Vice Chairman, Joe Tsai, sits on our board. It’s the only board he sits on for a non-Alibaba-controlled company. It’s a tight relationship and we’re discussing lots of potential areas of partnership. Many of the apps we use come from them – music, mapping etc.

What approach are you taking to branding and sales?

We don’t advertise in the traditional sense at all. We’re one of the pioneers in the new O2O retail concept (online to offline). We have a pretty substantial online presence, with over one million followers on social platforms (Weibo, WeChat and Douyin). The key is to generate lots of leads through a bunch of online platforms and then make sure you don’t lose them at each step of the way to the final sale.

We’re also establishing our own stores and plan to have 70 direct outlets by the end of the year in nearly 30 tier-one and tier-two cities. We need to have a direct relationship with the customer. As I said before, it’s important to know our customers’ driving behaviours and their preferences so that we can provide more customisable services to each driver.

One thing, which stands out is how much less your G3 car costs compared to other Chinese EV models. There’s NIO at the high-end and BYD at the low end. How are you positioning yourself against them?

We’re not targeting the luxury market, but China’s fast-growing middle-market. History has shown that the odds are against you if you want to build a luxury brand in China in a short period of time. I can’t think of any successful examples. Starting from the top is very difficult, particularly for a homegrown Chinese brand.

I also think there are some dangers for domestic car manufacturers positioning themselves at the low end. A lot of sales to this demographic have been to people who want to get a licence plate in tier-one cities, or to Didi drivers. But as subsidies are reduced, these cars no longer look like such good value propositions. Instead of costing Rmb60,000, they’re more like Rmb140,000 to Rmb150,000. That’s the same range as us, but with none of the smart features.

So how is it that you’ve managed to produce a car that’s cheap but so technologically advanced? Are you planning to sacrifice profit margins?

This is a very good question and an extremely important one. The short answer is that we are absolutely not sacrificing our profit margins. We do not compete on price.

To give you an example, 98% of the orders we received are for the Core and the Premium version of the G3, not the Basic version. It tells you the G3’s smart features are what’s appealing to our customers, not the price.

As a start-up and potential disruptor to an established industry with dozens of well entrenched incumbents, XPENG needs to be highly selective in terms of what we do and what we don’t do as a company.

The key differentiator is our proprietary R&D and the smart cutting-edge features. Unlike many other EV makers who integrate different kinds of software from different suppliers, we build our own operating system from the scratch and develop all the key technologies proprietarily, such as autonomous driving, AI and internet connectivity.

It enables faster and smoother OTA upgrades, and is a huge boost to customer experience. That sets us apart from others.

Everything we do is to provide the best user experience. We are extremely focused on R&D, safety, best-in-class manufacturing, innovative smart features and how we look after our customers throughout the product lifecycle.

That’s how we win over a customer’s heart and achieve higher user stickiness. Customers are willing to pay for these value-added differentiations.

Apple products are probably the best example. The key to its success lies in its ability to provide the best user experience.

It’s not a coincidence that these also happen to be the same areas where the traditional auto OEMs are the weakest.

We do not attempt to innovate a lot in the areas of manufacturing or hardware production. That’s not what differentiates us.

As we become a more successful company further down the road, we will build out a smart mobility ecosystem and provide value-added services which often carry high margins.

This approach might sound intuitive but other EV startups are not following the same path as they try to make their own electric motors, build their own battery cells, or have very expensive sales and marketing campaigns and outlets, thereby ballooning their cost structure. Our cost structure is perhaps the lowest in the industry and not surprisingly we are able to achieve much greater capital efficiency versus our peers.

What challenges do you see facing the industry? The big one has always been the lack of a charging network.

Yes that’s right, although when people talk about the lack of a charging network they often compare China with the US. However, the only thing the two countries share in common is the fact that they are both large.

The fact is that Chinese drivers just don’t venture that far. The typical driver does 20km per day around a city. A 500km car would serve you for 25 days of driving.

We plan to go where our customers are and install our own super-charging network. We know where they live so it will be fast to get chargers in place. We are also the only Chinese OEM to build its own supercharging network.

Our second goal is to connect with 100,000 third-party charging stations by 2020. We also think the government might step in. There’s a lot of talk about what stimulus measures it might adopt this year. What better way to boost investment and hit its environmental targets than to speed up the installation of charging infrastructure?

What’s your view on hybrids as a stepping-stone from a conventional to an electric car? They also helpfully charge themselves.

I think that technology is obsolete. It’s the worst of both worlds. A hybrid has got a petrol engine and an electric system so it’s heavier, more complex and more costly. The reason they exist is because traditional OEMs can’t let go of a technology they’ve sunk billions of dollars of investment into.

All it takes is a little bit of education to go electric. It doesn’t take much to change someone’s mindset. Just think, only a few years ago, people thought it was mad to give their credit card details online. Now no one thinks about it.

We’ve talked a lot about competition. How many companies do you think will make it?

I think there’s going to be a fairly low survival rate among the start-ups. There’s dozens of them. But this is an industry with high fixed costs, which many companies won’t be able to make money from. They won’t be able to create a differentiated product and the funding will dry up.

What do you think about current valuations? You raised nearly $1 billion from your series B funding round last year.

We think valuations are still quite palatable. As a former institutional investor I personally see a lot of upside.

EV may be a relatively new industry, but the auto industry is pretty mature so it’s a fairly straightforward valuation model. Then it comes down to what credit do our future or current investors give us for value-added services such as insurance, auto-finance, entertainment; all the ancillary things we plan to do.

Yet Tesla’s share price has had a pretty bumpy ride of late…

Tesla has gone from a start-up to a $50 billion market cap company despite battling the highest level of short interest of any public company in history. So it’s been doing something right.

It’s provided the roadmap for equity investment in the industry. We believe we can deliver better results down the road.

The bears have always argued that Tesla has the same valuation as traditional OEMs, but that it has only been able to deliver a fraction of the cars. However, as a fund manager my job was not about looking backwards, but forwards. The key question is how many cars will companies like Tesla and us sell in five years time and how much profit we will generate from them. The base assumption is that our industry will continue taking market share from ICE-based competitors. If you believe that, then that’s where the value lies.

What’s your view on future fundraisings, or launching an initial public offering? Media has reported that the next fundraising round could top the $3 billion mark.

We haven’t decided about how and when to go public and we are monitoring the capital markets very closely. What we do want to do is list at a time of our choosing and from a position of strength.

We haven’t launched the next funding round officially yet either. What I will say is that I feel fully confident about the overall health of the capital markets. There’s a lot of dry powder for private equity deals in Asia right now. There are very few sizeable companies that have got a sound management team and an innovative product that’s already commercially launched. So we think we should be right at the top of the list.

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