Source: Barron Weekly, “Technological Self-Improvement: The Path to Ecological Advancement of China's Science and Technology Industry”
Author: Wang Yuquan
Core views
As one of the tech bull stocks with the biggest increase in the past ten years, Tesla's market capitalization skyrocketed from 100 billion to trillion dollars, mainly driven by the completion of the Shanghai Gigafactory and the subsequent reduction in manufacturing costs that exceeded expectations. What works behind this is the “Rye Law,” which is much less famous than Moore's Law, but is actually more predictable. Investor Wang Yuquan introduced the relationship between Laidai's law and China's manufacturing capacity in his new book “Technological Self-Improvement: The Path to Ecological Advancement of China's Technology Industry”, which also gave us a deeper understanding of Tesla's investment logic. This article is an excerpt from the relevant section of this book on Lai's specific laws.
The real understanding of China's mass production levels comes from the 2012 research report “Statistical Basis for Predicting Technological Progress” (Statistical Basis for Predicting Technological Advances) made by a group of researchers at the Massachusetts Institute of Technology and the Santa Fe Research Institute. This report attempts to find out what theories and rules of the past can actually predict the future.
The report counted 62 industries, including computers, communication systems, solar cells, aircraft, and automobiles, and analyzed the performance of 6 different laws in predicting cost changes in these industries. The 6 laws are: Moore's Law, Lyte's Law, Goodharth's Law, SKC's Law, Legrei's Law, and Nordhaus's Law.
Finally, it was discovered that there are only two laws with high prediction accuracy: one is Moore's Law, an empirical conclusion drawn by Intel co-founder Gordon Moore in 1965: “The number of transistors per square inch in an integrated circuit doubles every two years, and the cost is reduced by half.” The other one is probably not familiar to you, but it's even more accurate than Moore's Law. It's called Lyte's law.
In 1936, when analyzing aircraft production data, aeronautical engineer Theodore Wright (Theodore Wright) discovered that when aircraft production doubles, costs drop by 10% to 15%. He published his findings in the Aeronautical Science Journal (entitled Factors Contributing the Planes of Airplanes).
At first, this discovery was used more as a “learning experience” curve to explain how workers became more efficient as they accumulated experience. Later, the researchers gradually discovered that it also had a very good effect in predicting completely different industries such as automobiles, photovoltaic cells, and chips. From 1909 to 1923, the changes in the production and price of the Ford Model T almost perfectly followed Leigh's law: for every doubling of production, the cost dropped by 15%.
Ford has evolved to this day and still follows Lyte's laws. The researchers' statistics found that according to Lyte's law, after adjusting for inflation factors, the cost of a Ford dropped from about $3,000 per horsepower in 1903 to $135/horsepower of the 350 millionth car built in 2012, including today's Ford models such as Fusion, Focus, Taurus, and Fiesta, which almost perfectly matches this law.
Today, neither the electric vehicle industry nor the upstream lithium battery industry has escaped its defined scope; it is still in line with the trend of doubling production and falling costs in proportion.
Lyte's law is a law of experience. Compared to Moore's law, which uses time to derive changes in production and cost, Ryke's law uses output as a benchmark and is closer to the actual situation of manufacturing when measuring changes. Increased production can amortize the cost of more technology research and development, thereby driving down the price of individual products. Lower prices stimulate demand growth, which in turn digests more production, forming a virtuous cycle of spontaneous growth.
Law and automobile manufacturing in Lycra
There is a famous technology investment company “ARK Invest” (ARK Invest) in the US, founded by Kathryn Wood in 2015. Her bold and aggressive investment style has attracted a number of followers around the world, and many Chinese investors call her “Sister Wood.” When researching the technology industry, Ark Investment used Raibai's law as a practical standard for predicting the future of the industry. In its report Big Ideas published in 2021, it used Raibai's law to predict various fields of science and technology.
For example, in the field of power batteries, Fangzhou Investment believes that for every double increase in battery volume per unit, battery costs will drop by 28%. Because the biggest cost component of an electric vehicle is its battery, the factors that reduce battery costs are critical. In the field of gene sequencing, Fangzhou Investment believes that according to Rye's laws, the sequencing cost of long-read gene sequencing technology for each genome in 2020 exceeded 1,000 US dollars. By the end of 2025, with the increase in the production of sequencing equipment, this cost will drop to 100 to 200 US dollars.
In 2019, Tesla's annual sales volume did not exceed 400,000 units. The Shanghai Gigafactory has just started construction and is still in a critical period of mass production. In September of the same year, Ark Investment published an article “Rye's Law Predicted the Automobile Industry in '109, Now It's Tesla's Turn” (Wright's Law Rules 109 Years of Auto Production Decisions, and Now Tesla's), and made a prediction for Tesla using Rye's law.
According to Ryke's law, every time Tesla's cumulative production doubles, the cost of the Model 3 drops by about 15%. As of September 2019, the number of Model 3 manufactured by Tesla is 275,000, and production is expected to exceed 600,000 units by the end of 2020, so the cost of producing the Model 3 should drop by about 23%. The gross margin of the Tesla Model 3 will double over the next 18 months (that is, until the first quarter of 2021), reaching more than 30%.
Are ARK's predictions accurate? The smooth construction of the Shanghai Gigafactory helped Tesla achieve mass production. Analysts judge that the gross profit of the Tesla Model 3 in mainland China reached 39% in the second quarter of 2020, nine months ahead of ARK's forecast.
In the second quarter of 2019, Tesla's overall automobile gross margin was 14.5%; by the third quarter of 2021, the overall automobile gross margin had reached 30.5%. Instead, the selling price had dropped quite a bit from two years ago. For industry insiders, 30% gross margin is the exclusive standard for luxury cars in the world. It is higher than German luxury car manufacturers BMW and Mercedes-Benz, and also surpasses luxury brand car manufacturers such as Porsche and Ferrari.
Car prices have dropped sharply, and gross margins have instead risen. Inexplicable investors are trying to discover the secret of Tesla's falling costs from various signs. Some people think that construction of the Shanghai Gigafactory has started to help Tesla get through the dead end of volume generation; others think it has benefited from China's manufacturing capabilities, such as Lijin Technology's die-casting machines and China's electric motor manufacturing technology. But if you understand Raike's laws, you'll naturally understand the essential reasons for Tesla's falling costs and rising profits.
The Law of Lyme and Made in China
More than just the technology industry, this law also reveals the root cause of China's strong manufacturing capacity.
According to media reports, in July 2020, there was a campaign to boycott Chinese manufacturing in many parts of India, covering products from various industries such as consumer electronics, toys, textiles, and pharmaceuticals. However, after only 8 days of boycotting Chinese products, India began customs clearance and release Chinese APIs.
If you've seen the movie “I'm Not a Medicine Man,” you must know that India's generic drugs are famous all over the world, but the raw materials used to produce these drugs still need to be imported from China. Blindly boycotting Chinese APIs, India is also unable to produce generic drugs. In addition to pharmaceuticals, India relies on imports from China for many products. For example, although the Indian government has been actively promoting the localization of mobile phones, about 70% of the phones in the Indian market come from China.
When I was shopping with my family in the US, I observed the origin of various products in supermarkets and came up with a rule: everything that only requires five or less raw materials can be produced is supplied to the US all over the world, such as shirts made in Guatemala and Honduras, plastic pots made in India, tableware made in Vietnam... but as big as all kinds of electronic products, as small as ballpoint pens and lighters, if it requires five or more ingredients, this product must be “Made in China” (made in China). From the perspective of connecting with the world's cutting-edge technology, Chinese manufacturing is not number one, but the only one. In fact, many of the slightly less technology-intensive yet relatively complex products are made in China.
Why is it that China still has an advantage in manufacturing less high-tech things? Many people think it's because China's labor costs are low, and the main competition for this kind of product is the price. In fact, labor costs in China are not that low anymore. Labor costs do not account for a high proportion of the cost of complex products; they are not a decisive factor. The real deciding factor is the scale of production. It's not that things made in China are cheap so they can only be produced on a large scale; it is that China has achieved large-scale production, so the products are cheap.
According to Lei's law, as far as cost reduction is concerned, going through a learning curve and accumulating experience is a better means than reducing labor costs. At the beginning of the reform and opening up, China caught up with the wave of multinational enterprises moving out of the manufacturing industry. The development of the domestic manufacturing industry has so far accumulated sufficient experience, accumulated a large amount of manufacturing technology involving all walks of life, and established a huge and complex collaborative system between large and small manufacturing enterprises. As a result, the scale grew larger and larger, making it a global manufacturing base.
Tasks that cannot be completed abroad can be clearly broken down in the hands of Chinese manufacturing companies, including how to do them, how difficult they are, how much they invest, how much time is needed, etc. Every step is clear. It is almost impossible for other countries and regions to go through this learning curve and compete with China from the beginning.
Therefore, we can derive a “Made in China Law” from Lei's law: according to Lei's law, if the output of Chinese manufacturing enterprises expands tenfold, that is, doubles more than three times, then the production cost will drop by 10% to 15% three times to the original 61% to 72%. Meanwhile, China's unique manufacturing clusters, such as the automobile manufacturing industry in the Yangtze River Delta and the electronic and electrical appliance manufacturing industry in the Pearl River Delta, can also further reduce costs. Therefore, when the production volume of Chinese manufacturers expands to 10 times the original, the cost is often only one-half or even less. This is the main source of price competitiveness for Chinese enterprises.
As of today, the reason why Chinese manufacturing has been able to achieve high quality and low prices is the result of Chinese enterprises and the industry as a whole accumulated experience and application of advanced technology over a long period of time. I call Chinese manufacturers “technology makers” because they are well-deserved global experts in manufacturing.
Editor/jayden