Mercedes-Benz’s recent results have seen a slump: sales in China plunged 27% year-on-year in the third quarter — a collapse that has the German luxury icon rethinking its approach to the world’s biggest auto market. CEO Ola Källenius has been blunt: “We are not naive,” he said, warning that the next few years in China will be “tough.” Those words reflect not just weakening demand, but a structural shift in China’s auto industry that foreign marques long took for granted.

A familiar pattern — for foreign players, an uncomfortable lesson

For decades the playbook for foreign automakers in China was straightforward: bring capital, design, manufacturing know-how, and advanced components; partner with local firms (often via joint ventures); sell into a market poised for decades of growth. That same structure is now part of the problem. The joint ventures, supplier ecosystems and training programs that once extended foreign capabilities into China also created a channel for Chinese firms to learn, localize and iterate rapidly — eventually producing homegrown brands that now outcompete many foreign incumbents on price, features, software and speed to market.

What the numbers reveal

Mercedes-Benz’s Q3 results — a global drop led in part by a 27% slump in China — aren’t an isolated misstep. They’re part of a broader pattern of pressure on legacy premium brands as Chinese OEMs and EV specialists pile on innovation and scale. Bloomberg, Reuters and others have flagged how Mercedes’s deliveries in China have fallen to their lowest levels in years, weighed by fierce local competition and softer luxury demand. For Mercedes, the China shock translated into an overall dent in revenue and profits for the quarter, underscoring how critical the market still is for global luxury carmakers.

How China turned the “learning” relationship into a strategic advantage

China’s strategy was never simply to import cars and pay royalties. Policymakers used industrial policy, subsidies, procurement preferences and regulatory requirements to build domestic capability across the auto value chain — from batteries and powertrains to software, infotainment and manufacturing scale. For many years foreign automakers were required to form local joint ventures to manufacture in China; those arrangements placed foreign engineers and managers shoulder-to-shoulder with Chinese counterparts, accelerating technical learning and creating a deep pool of skilled engineers and suppliers. Over time, that pool helped Chinese companies compress product development cycles dramatically — launching new models in months, not years — and to optimize costs at scale.

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Local champions: rise from copycats to fast movers

Names such as BYD, Nio, XPeng and Li Auto have matured from curious local upstarts into global players, leveraging lower costs, integrated battery production, competitive pricing and software capabilities that increasingly match or outstrip incumbents in areas Chinese customers care about (connectivity, range, and in-car tech). Some Chinese players have also harnessed vertical integration — owning battery production and critical component supply — which reduces dependency on external suppliers and allows rapid iteration. As a result, consumers who would once have considered a German badge now weigh local brands that deliver comparable technology at significantly lower price points.

The political and strategic dimension: market access was always conditional

From Beijing’s perspective, the goal was never to leave the market dominated by foreign companies. Rather, foreign participation was a tool — a way to import capital, global best practice and technological know-how while Chinese firms acquired the means to compete. Policies that once required foreign automakers to partner with local firms — and the incentives used to spur battery and EV manufacturing — were intended to build domestic strength. As Western policy debates focus on whether China “played fair,” it’s worth remembering that China’s industrial ascent was a policy choice that leaned heavily on turning foreign involvement into domestic capability.

Why foreign incumbents are vulnerable now

Several factors multiply the challenge: China’s car market is saturated with models (and price tiers), consumers are increasingly value- and tech-driven rather than brand-driven, and the transition to electric vehicles reorders incumbent advantages. European makers often move on longer product cycles, with higher development costs spread across regulated markets; by contrast, Chinese firms iterate quickly and ride local supply chains and government support. Add to that geopolitical friction, tariffs, and the cost of maintaining premium brand positioning, and you get a market where conventional strengths — luxury heritage, combustion-engine engineering — are less decisive.

What Mercedes (and others) can realistically do

Källenius’s “not naive” line signals realism rather than surrender. The options for Mercedes and peers are limited but clear: double down on products that justify a premium in China (top-tier luxury and personalization), accelerate software and EV development tailored to local tastes, partner selectively with Chinese tech firms without handing away strategic IP, and localize manufacturing and R&D where it makes commercial sense. Some European makers are already forming alliances, buying stakes in local tech firms or even opening engineering centers in China and Europe to blend strengths. But these moves buy time rather than a permanent shield — China’s domestic firms are still closing the innovation gap. 

The bigger picture: a changing center of gravity in autos

Mercedes’s 27% drop in China is symptomatic of a tectonic shift: the balance of power in the global auto industry is tilting. Where Western manufacturers once taught and dominated, now a new generation of Chinese OEMs exports ambition and product excellence. Europe, Japan and the U.S. still have advantages — brand equity, design, deep engineering — but they can no longer assume those will automatically translate into market share in China or in an EV-first world. Källenius’s warning is therefore both tactical and existential: expect a messy, competitive period while incumbents adapt, and don’t mistake past dominance for future security.

Not naïveté, but hard choices ahead

The Mercedes CEO’s refrain that the company is “not naive” is less a confession of failure than a recognition of strategic reality. China’s rise in autos wasn’t an accident — it was a policy and industry project designed to create domestic champions out of foreign partnerships. For Mercedes and other foreign players, surviving and thriving in the next chapter will demand humility, speed and an acceptance that the old rules no longer apply. The question is whether legacy automakers can reinvent themselves fast enough to remain relevant in a market that, in Beijing’s eyes, was never meant to be foreign-dominated.