Volkswagen is making one of its biggest strategic moves in years by placing a $3.5 billion gamble on China, the world’s largest and most competitive automobile market. Once a dominant force in the country, the German automaker is now trying to fight its way back after losing significant ground to fast-growing Chinese rivals.

Volkswagen, which once controlled more than 50% of China’s car market, has invested 3 billion euros ($3.5 billion) in a massive research and development centre in Hefei, a central Chinese city with a population of around 10 million. The facility is the company’s largest R&D hub outside Germany and signals a major shift in how Volkswagen plans to operate in China.

For decades, foreign automakers succeeded in China by selling vehicles designed overseas while sharing technology with local partners. But that model has been overtaken by the rapid rise of Chinese carmakers, especially electric vehicle manufacturers, who are now leading the market.

“This business model is now gone,” said Thomas Ulbrich, chief technology officer of Volkswagen Group China.

Volkswagen began overhauling its China strategy in 2022, responding to what Ulbrich described as a paradigm shift in the market. The company is now focusing on developing vehicles specifically for Chinese consumers, rather than adapting models originally built for Europe. These China-focused cars are unlikely to be sold in Europe, though some could be exported to regions such as the Middle East and Southeast Asia. Volkswagen hopes this approach will help it compete more effectively with leading domestic brands like BYD and Geely. According to Rella Suskin, an equity analyst at Morningstar who follows Europe’s auto industry, this shift is necessary for Volkswagen to stay competitive.

“Such a strategy is key to regaining competitiveness within China,” Suskin said. However, she added that it may not fully restore Volkswagen’s former dominance. “It will enable them to maintain market share levels in line with current levels, rather than allow them to regain the market share that has been lost over the last few years.” Another major concern is profitability. China’s fierce competition has driven car prices so low that many manufacturers are struggling to make money.

Foreign automakers have struggled to keep pace with the rapid transformation of China’s auto market over the past five years. Electric vehicles now account for about half of all new car sales, and consumers expect advanced digital features such as large touchscreens and autonomous driving tools.

Volkswagen’s traditional models began to feel outdated in a country that represents about one-third of its global sales. The company has been active in China for over four decades, starting with sedan production in Shanghai alongside state-owned partner SAIC. For years, cars like the Santana and Jetta dominated taxi fleets and were often the first vehicles owned by Chinese families.

To survive, Volkswagen must operate at what industry experts call “China speed.” According to Bill Russo, CEO of Shanghai-based consultancy Auto Mobility, the pace of innovation in China leaves no room for delay. “Chinese EV makers bring new cars to market in 12 to 18 months, versus three to five years for global automakers,” Russo said. “The pace is not a choice but a necessity, and that pressure fuels global competitiveness.”

Volkswagen’s transformation also reflects China’s growing role as a global innovation hub. Ulbrich recalled his early days working in north-eastern China in the mid-1990s, when Volkswagen partnered with FAW (First Auto Works) and had to import nearly all vehicle components. “Thirty years later, nearly everything is made in China,” he said. “And now it’s being designed here.”

To accelerate development, Volkswagen headquarters has handed greater decision-making power to its China operations. This local autonomy is aimed at shortening development timelines and reducing costs. Other global automakers are following similar paths. While some foreign brands have scaled back or exited China altogether, Toyota has also shifted authority to its China teams. According to Claire Yuan, director of corporate ratings for China autos at S&P Global Ratings, Toyota has granted its local operations “unprecedented autonomy in product planning and development.”

Volkswagen is also collaborating with Chinese EV start-up Xpeng to speed up model launches and develop its own electronic vehicle architecture, the core computer system that controls vehicle functions. “It’s a million-dollar question whether this strategy will pay off,” Yuan said. “We have to monitor, but I think they are on the right track of catching up in the race.”

Volkswagen’s approach highlights a broader shift among foreign automakers recognising that innovation is no longer flowing in just one direction. “Knowledge flows are a two-way street between China and Germany,” said Martin Hofmann, a Volkswagen executive and chair of the German Chamber of Commerce in North China.

This view is gaining traction across the business community. In a recent survey by the chamber, around half of more than 600 companies said they expect Chinese competitors to become global innovation leaders within the next five years. Another 9% said Chinese firms already are innovation leaders.

As Volkswagen rolls out new models developed “in China, for China,” the company’s $3.5 billion bet will be closely watched. Whether it can reclaim lost market share and make money doing so remains uncertain. But one thing is clear: success in China now requires moving faster, listening closer to consumers, and accepting that the country has become not just a market, but a driver of global automotive innovation.