Japanese carmakers are losing ground as China surges ahead in the EV race

Japan's iconic auto industry is going through a rough patch, and now two of its most important companies are considering merging as they fight for survival.

Nissan and Honda are set to negotiate a possible merger, according to multiple reports on Tuesday, as they mull combining forces to stave off the growing threat of Tesla and China's electric vehicle makers.

It comes after the two companies and major rival Toyota reported slumping profits in their most recent earnings, as they grapple with ferocious competition in China and a bumpy transition to electric vehicles.

Nissan announced it would cut 9,000 workers amid falling sales, while Honda reported a 15% drop in operating profit in the second quarter. Toyota, the world's largest automaker,

saw profits for the quarter ending in September drop to 573.7 billion yen ($3.7 billion), down from nearly 1.28 trillion yen ($8.3 billion) over the same period last year. All three companies face a similar problem; they are failing to sell enough cars in China.

Toyota's sales in China were down just over 10% in the first nine months of the year, with the company blaming "severe market conditions" such as "intensifying price competition."

Still, a Toyota spokesperson told Business Insider that its declining profits were not only attributable to China; it also saw weakness in Japan and North America.

Honda flagged a decline in sales in China in its most recent quarter, dragging down its total group sales. While Nissan reported a drop of over 5% in retail sales in China in the first half of the fiscal year — the largest drop of any of its regions.

Like other foreign automakers, Japan's car giants are being squeezed in China by local rivals. These rivals have rapidly gained market share by offering a range of affordable but high-tech EVs and hybrids.

BYD, Zeekr, and Nio have reported bumper sales recently, as European automakers like Mercedes-Benz and BMW are being squeezed in this region.

Many of China's EV champions are now expanding overseas, something Felipe Munoz, auto analyst at JATO Dynamics, told BI was putting the likes of Toyota and Honda under growing pressure.

"The real battle is happening in the emerging markets. And that's exactly where the Japanese car makers are suffering the most," said Munoz, pointing to the rapid expansion of the likes of BYD in Southeast Asia and Latin America.

"Japanese carmakers have a strong presence in Southeast Asia. And Southeast Asia right now is a hot market for Chinese cars," he said.

Electric woes
Japanese automakers have taken a broadly cautious approach to the transition to EVs, focusing instead on hybrid vehicles.

That approach has mostly paid off as EV demand has slowed, with Toyota reporting bumper profits on the back of strong hybrid sales in the US earlier this year.

However, Munoz said that while the hybrids-first strategy may have worked out in the US and Europe, it has created problems for Japanese automakers in China, leaving them without a strong lineup of EVs that can compete with local offerings that can cost less than $10,000.

"China is definitely shifting to fully electric. And this leaves out all of the car makers that are not competitive with their electric cars," said Munoz.

He added that Toyota, Honda, and Nissan are at risk of becoming overly dependent on US and European markets, which are experiencing stagnating growth while losing out in expanding markets like China.

"At the end of the day, the hybrid strategy worked in Japan, worked in the US, and worked very well in Europe, but that's not the case in China," he added.

There are signs that Japan's auto giants are changing their strategies.

Nissan has pledged to accelerate the introduction of new EVs in China and hybrids in the US, while Toyota is reportedly planning to expand production in China as it attempts to take on local firms.

A Nissan spokesperson told BI that the company is taking measures to meet the market's and customers' needs, including introducing new products.

They added that the US remains a priority market for Nissan, and that the company was expecting an increase in sales from new models.

Shares of the carmaker jumped after news of the potential merger with Honda broke, rising as much as 24% in early trading on Wednesday. Nissan's shares are down nearly 25% this year.

Japanese automakers will likely face new challenges in the coming years, especially in the wake of Donald Trump winning the US presidential election.

Speaking on an earnings call in November, Honda executive vice president Shinji Aoyama warned that Trump's proposed tariffs on vehicles imported from Mexico could have a huge impact on Japanese automakers, many of whom have factories in the country.

Honda did not respond to a request for comment, sent outside normal working hours.