PHOTO CAPTION: BYD Chaiman Wang Chuanfu (left) with MidAmerican's David Sokol at 2009 Detroit Auto Show.

The Look Inside Warren Buffett's BYD Bet

China economic experts Matthew Forney and Arthur Kroeber give their perspective on why MidAmerican and Berkshire Hathaway invested in BYD.

Published: 11-Dec-2009

Chinese car-maker BYD just announced plans to launch its much-vaunted electric sedan next year in Los Angeles—setting Silicon Valley buzzing about how China's new green technologies are gaining an edge over the U.S. But do Chinese companies really have an edge when it comes to developing eco-friendly technologies?

A closer look at BYD suggests that at least in this case, no. The company boasts a timely product mix of cars and batteries—specifically, lithium-ion batteries, the battery of choice for new-energy cars—and its share price has increased six-fold in the last year. But its batteries are produced using 15-year-old methods, its successful traditional sedans are the cheapest in every class in which they compete, and its new-energy cars face troubling hurdles.

Like most Chinese manufacturing companies, BYD excels in low-margin, high-volume businesses. BYD has so far achieved success in the battery business by using simpler technology than its peers. To undercut its Japanese competitors, which deploy expensive robotic arms to make uniform battery cells, BYD reverted to manual assembly lines with inexpensive labor. The result was cheaply produced batteries of inconsistent quality. Although the company can rightly be proud that it has never faced a battery recall, it scraps 15-30% of its batteries because they fail to meet quality standards—far above the industry average of under 5%, according to German consultancy Roland Berger.

Inconsistent quality is a small problem when making mobile-phone batteries of one cell each: You simply scrap the batteries that don't make the grade. But it's an enormous problem for electric-car batteries, in which hundreds of cells, each the size of a pack of cigarettes, must charge and discharge with exact precision. A car battery works only as well as its worst cell. It is far from clear that BYD's labor-intensive process can achieve the uniformity of quality required for electric car batteries.

BYD has yet to bring a single hybrid or electric car to market and has repeatedly missed launch deadlines. Every BYD car sold to consumers so far has a traditional gasoline engine, and its models are popular in China not because they are high-tech but because they are ultra-cheap. The company claims its plug-in hybrid, the much-vaunted F3DM, went on sale a year ago. But this model has yet to appear in any dealership, leading industry observers to speculate its battery is not ready for prime time. The all-electric e6 was supposed to reach the U.S. this year, a launch date subsequently pushed out to 2011. But the e6 still hasn't passed Chinese safety tests, let alone more stringent U.S. tests. Advance reviews of prototypes have been scathing: Car and Driver reported, "We drive faster in our driveways."

Investment has been pouring in nonetheless: BYD grabbed the world's attention a year ago when MidAmerican Energy Holdings, a company controlled by Warren Buffett, bought a 10% stake for $230 million. After that, BYD's stock price climbed seven-fold and made chairman Wang Chuanfu China's richest man with a paper fortune of $5 billion. Along the way, BYD promised to sell America its first purely electric sedan.

When MidAmerican bought its BYD stake, the media jumped to the conclusion that Mr. Buffett was placing a bet on electric cars. Cannily, Mr. Buffett and MidAmerican executives made no effort to dispel this impression. But all evidence suggests their interests lay elsewhere. MidAmerican Energy Holdings runs power grids that generate more energy from renewable sources than any major American utility. MidAmerican's subsidiary in Oregon, PacifiCorp, recently erected a building the size of ten 40-foot storage containers that houses BYD batteries. Those batteries are being tested for the storage of wind-generated energy. BYD's real contribution to Mr. Buffett's portfolio will probably be low-cost, relatively low-tech batteries that store wind and solar power for use on days that are breezeless and cloudy.

Make no mistake, BYD is a well-run company, and its chairman Mr. Wang is rightly regarded as a brilliant entrepreneur. But the true competitive advantage of BYD, as with most Chinese firms, is its ability to commoditize technology products, thereby making them cheaply available to a wider range of customers. This is a useful function, and it will be critical in ensuring that new-energy products can rapidly increase market share against traditional carbon-based technologies. But there is little evidence that Chinese companies are ahead in this new-energy innovation race.

Mr. Forney is president of Fathom China, a corporate research firm. Mr. Kroeber is the Beijing-based managing director of economic consultancy GaveKal Dragonomics.

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