Germany's once-thriving car industry now burdens its struggling economy.

• Germany's car industry was renowned globally for its superior combustion engine vehicles. However, this is no longer the case.
• A variety of challenges, including regulation, macroeconomics, China, and EVs, are impacting the industry.
• The automotive industry's problems could impact the broader German economy, which has been facing challenges for a while.

The German car industry was renowned globally for its superior combustion engine vehicles. Possessing a German car signified luxury and social standing. Consequently, car manufacturers flourished, contributing to the country's economic growth.

But the picture has since become bleaker.

Volkswagen has announced that it may need to end its employment protection agreement in Germany, which has been in place since 1994, and is considering plant closures in the country.

According to Dr. Andreas Ries, global head of automotive at KPMG, German carmakers, who have been the dominant technological leaders in the automotive industry for nearly 140 years and faced little competition or concern about sales, are now facing an unfamiliar situation.

Now, the industry is undergoing its biggest transformation yet, he added.

How are German automakers faring?

The automotive industry has experienced fluctuating sentiment in recent years, with sentiment reaching negative 24.7 points in August, according to data released on Wednesday. Ifo stated that business expectations for the next six months are "extremely pessimistic."

Volkswagen is not alone in its struggles.

Mercedes car division and BMW's automotive segment both reported lower profit margins than expected in recent earnings releases. Porsche, however, attributed its 2024 outlook shortfall to a lack of special aluminum alloys.

The automotive industry's problems could impact the broader German economy, which has been in recession for the past two years, with a 0.1% decline in GDP in the second quarter of 2024.

According to KPMG's Ries, the statement "When the German automotive sector has a cough, Germany has the flu" accurately describes the current situation.

The auto industry comprises not only major corporations but also numerous small, medium, and tiny businesses nationwide, making it a crucial sector in the country, he stated.

'We are facing multiple challenges'

Experts and industry bodies say that a variety of factors are affecting the market.

"The German Association of the Automotive Industry (VDA) spokesperson informed CNBC that the industry is facing various challenges, including the aftermath of the Covid-19 pandemic, geopolitical tensions, and high bureaucratic requirements at national and European level."

The VDA stated that weaker domestic demand resulting from the German economy's overall state has negatively affected car production, in addition to wider macroeconomic trends impacting the auto sector.

The two frequently discussed topics in the German car industry debate are China and the transition to electric vehicles, and how they intersect.

Despite the expectation, EVs are performing poorly, as demand has been lower than anticipated and competition has increased, according to Horst Schneider, head of European automotive research at Bank of America, in a translated interview with CNBC.

German automakers have not experienced the market rebound in China as their competitors have captured market share, according to Schneider. He also pointed out that German EVs are too expensive, while Chinese products are more affordable and have some advantages.

The market is being affected by tensions between the EU and China over trade and import tariffs.

"Schneider stated that German producers are highly exposed to trade politics, with previously 40-50% of their earnings coming from China. However, the Chinese market is starting to close, which presents a "double issue" as they also have a higher percentage of EVs that are not as profitable as combustion motor cars."

"If China's earnings remained high, you could handle the EV profitability issue, but since they are declining and Chinese earrings are also decreasing, there is overall earnings pressure and margins are shrinking," he stated.

The VDA stated that the conclusion of the EV subsidy program in Germany has had an impact on markets. A plan to implement new tax cuts to encourage EV usage is currently being developed.

What's next for the German auto industry?

KPMG's Ries stated that some hopeful signs have emerged amid the difficulties. For instance, hybrid vehicle technology is predicted to be utilized for a longer duration than anticipated, and the sales of combustion motor cars are gradually recovering, he added.

To address issues like regulation and refocus on quality, politics, business, and researchers must collaborate, according to him.

VDA similarly sees a need for different production conditions.

"The association's spokesperson stated that instead of regulation, we need political reforms and pragmatism instead of micromanagement. They advocated for a modern mix of market-oriented economic policy and shaping industrial policy."

The spokesperson stated that market conditions will remain difficult for at least the next year.

Schneider from Bank of America stated that many automakers have guidance suggesting their performance in the second half of the year could be better than in the first.

The investors are not fully convinced about the profitability, which has led to fear of profit warnings in Q3. This uncertainty raises questions about the future of 2025, he stated.