A new ‘ERA’: An action plan for the European automotive industry

The European automotive industry is a backbone of the region’s economy and welfare. It contributes 7 percent of GDP in the European Union, accounts for about €170 billion in exports, and employs about 13.8 million people, including through 3.5 million direct and indirect manufacturing jobs—8.5 percent of the region’s total manufacturing talent base.¹EU trade since 1988 by HS2-4-6 and CN8,” Eurostat, updated August 18, 2025; “Automotive industry,” European Commission, accessed August 29, 2025. In addition, the industry is on a trajectory toward zero emissions. At the same time, new developments in software, gen AI, connectivity, and self-driving technology are reshaping what the industry can offer. Together with decarbonization, this technological disruption represents the largest transformation in the industry’s history and creates opportunities for players across the value chain.²For more, see “Europe’s economic potential in the shift to electric vehicles,” McKinsey, October 3, 2024.

However, the European automotive industry faces headwinds. The technological disruption also creates new requirements, and combined with growing international competition, geopolitical issues, and high factor costs, this has challenged the industry. According to McKinsey’s recent article “Europe’s economic potential in the shift to electric vehicles,” the most disruptive scenario puts €440 billion in GDP—about one-third of the industry—at risk by 2035.³“Europe’s economic potential in the shift to electric vehicles,” McKinsey, October 3, 2024. The scope of these estimates includes the GDP impact on the automotive sector, updating last year’s reported GVA impact based on latest European Commission estimates for the automotive industry’s GDP contribution.

Automotive players and their supplier ecosystem, as well as financiers, regulators, and adjacent industries, need to come together to make structural changes and reestablish the region as a leading global automotive powerhouse. In this article, we discuss the challenges facing the industry and lay out a nine-point action plan building on our previous McKinsey report A road map for Europe’s automotive industry.⁴Andreas Cornet, Ruth Heuss, Patrick Schaufuss, and Andreas Tschiesner, A road map for Europe’s automotive industry, McKinsey, August 2023. This action plan is based on three key dimensions that will build a strong foundation for the industry’s future: successful economics, successful resilience, and successful decarbonization (abatement of CO₂), forming the acronym “ERA.” Additionally, digitalization and AI will be critical as enablers to succeed in this new era.⁵For more, see Europe in the intelligent age: From ideas to action, World Economic Forum in collaboration with McKinsey, January 2025.

Headwinds in the European auto industry

Although Europe has long maintained a strong global position in the automotive sector, the industry now faces a series of complex and evolving challenges.

• Technological disruption and transition pressures. Powertrain shifts, digitalization, and software-defined vehicles (SDVs) are reshaping the industry at a fundamental level. McKinsey estimates that 85 to 90 percent of the value added from a typical European internal combustion engine (ICE) vehicle contributes to the European economy, dropping to 75 percent for locally produced battery-electric vehicles (BEVs) and 15 to 20 percent for imported BEVs.⁶“Europe’s economic potential in the shift to electric vehicles,” McKinsey, October 3, 2024. The transition from ICE to electric drivetrains requires not only retooling production but also redefining value chains and core competencies. Meanwhile, software and electronics—particularly in areas in which non-European players are rapidly advancing, such as advanced driver-assistance systems (ADAS), vehicle connectivity, and in-vehicle user experience—are becoming key differentiators. A smooth digital customer experience has also become a nonnegotiable feature for many customers. McKinsey research shows advancements in digitalization and AI increasingly propel global market valuations, with the top ten European automotive companies (passenger car OEMs and suppliers) seeing a €71 billion drop in valuation since 2015 (a 19 percent reduction), compared to a quadrupling of US tech over the same period, based on the NASDAQ 100 index.
• Intensifying global competition and emerging tech leaders. European automotive incumbents have lost about a fifth of their global market share since 2017, while new entrants have doubled theirs.⁷Based on data from EV Volumes, S&P Light Vehicle Sales, and McKinsey Center for Future Mobility. As a result, each group now holds about a quarter of the global market. Incumbents face mounting competition, particularly from digitally native new entrants in the electric vehicle (EV) sector. These new players often benefit from faster development cycles, vertically integrated models, and even scale advantages, enabling them to develop increasingly advanced vehicles—often at double the speed and half the cost. While European brands still enjoy a strong reputation, the center of innovation is shifting globally, with Asia and North America leading in emerging technologies.
• Geopolitical and economic headwinds. High energy prices and volatility, particularly following recent geopolitical tensions, has made manufacturing in Europe more costly relative to other global regions; average European energy costs are double those of the United States and China.⁸“High cost of energy,” BusinessEurope, accessed September 8, 2025. The volatility of supply chains for critical raw materials such as rare earth elements (REEs) threatens the availability of essential inputs for EV motors and electronics, because more than 95 percent of EU REE imports come from China.⁹“Critical raw materials,” European Commission, accessed August 29, 2025. Batteries in particular are now treated as strategic assets, and China controlled over 80 percent of the global battery value chain as of 2023.¹⁰“China dominates global trade of battery minerals,” US Energy Information Administration, May 21, 2025. However, movements to localize supply have faced setbacks, with recent bankruptcies seeing nearly half of announced capacity vanish in the short term.
• Structural and regulatory challenges in the European operating environment. Restructuring and adaptation efforts, such as adjusting operating footprints and labor shifts, are more complex in Europe than in other regions because of a regulatory landscape with rigorous compliance standards and approval timelines.

Despite the challenges the region faces, the European automotive industry can seize the moment to regain its global competitive advantage and successfully transition to its next phase through targeted action.

An action plan for the European automotive industry

We have developed an action plan to address the challenges that the European automotive industry is facing and help accelerate the transition toward a sustainable and competitive future. Central to this vision of a new “ERA” is a balanced focus on three critical dimensions:

• Successful economics. European auto players can enable sustainable profits to secure the auto ecosystem, sustain jobs, and boost Europe’s GDP.
• Successful resilience. European auto players can build resilient value chains, reduce dependency on other regions, and maintain Europe as a supply chain powerhouse.
• Successful decarbonization (“abatement of CO₂”). The European automotive industry can achieve net zero by 2050 through zero-emission powertrains and effective sector coupling.

For Europe to achieve a successful transition along each of these dimensions, it will need to address three core pillars: transforming European automotive companies, future-proofing the value chain, and leveling the playing field to compete globally (Exhibit 1).

1. Transforming European automotive companies

Adapting for the future requires transformation. European automotive companies will need to continue investing to bring their pipeline of new vehicles to market, boost operational efficiency to cut costs and increase speed, and implement regionalized portfolios to cater to diverging customer requirements.

Invest more than €150 billion annually in the future of automotive

The European automotive industry plans to bring about 350 new EV models to market by 2032. Over 70 percent of these are expected to be BEVs,¹¹Based on data from S&P Global Light Vehicle Production Forecast and McKinsey Center for Future Mobility. with the rest being various electric hybrids, including plug-in vehicles, range-extended vehicles, and hydrogen fuel cell vehicles. In recent years, European OEMs and major suppliers have spent nearly €150 billion annually,¹²Elisabeth Nindl et al., “The 2024 EU Industrial R&D Investment Scoreboard,” European Commission, December 18, 2024. split roughly equally between R&D and capital investments. This makes the automotive industry by far the biggest driver of innovation in Europe, responsible for about 30 percent of total EU innovation spending.¹³“Sectoral R&D shares in the European Union,” ACEA, September 12, 2024."

Heavy investments in new production facilities and next-generation vehicle technology will continue to be required in coming years, but the sector can sustain this level of investment only if it continues to produce healthy balance sheets. While maintaining current investment levels is critical, directing these resources toward high-impact, differentiating factors (as outlined in following sections) will be essential. Diversifying funding sources could ease this burden: Increased M&A activity and venture capital inflows could unlock new opportunities, while EU-backed low-interest loans for crucial projects may provide additional support. Public–private partnerships could further help fund large-scale initiatives such as battery gigafactories and charging networks. By focusing on both effective resource allocation and innovative funding mechanisms, stakeholders can drive competitive advantages and long-term success.

Improve costs by 20 to 50 percent and cut time to market in half

Disruptors around the world have gained market share by working radically differently from incumbents, heralding a new industrial horizon. These newcomers outperform on their pace of product development and plant construction and use new manufacturing, battery innovation, integration, and design techniques. With these techniques, these players are putting vehicles on the market at a price point 20 to 50 percent lower compared to European competitors and bringing them to market up to twice as fast, according to McKinsey analysis.

Several key levers can help European companies keep pace with disruptors, evolving technologies, and changing customer preferences:

• Make radical technology changes. Adopting a next-generation “design to value” mindset focused on true customer differentiation can enable European automakers to prioritize features and innovations that reinforce brand distinction while shedding unnecessary complexity. Implementing advancements in battery technology, including optimizing form factors for efficiency, and pivoting to low-cost chemistries—such as lithium (with manganese) iron phosphate or sodium-ion technologies—can materially lower vehicle costs and improve supply chains. At the same time, simplifying the structural design through approaches such as cell-to-body integration can reduce part count, streamline assembly, and improve performance. Elevating functional integration—such as by combining multiple electronic controls, adopting bank loading, or deploying centralized domain and zone controllers—minimizes wiring and hardware complexity, further saving costs and accelerating build times. Finally, OEMs and suppliers can thoroughly review and stress-test their requirements, which often originate from legacy ICE business practices (for example, sensor redundancy, load factors, material thickness, and noise, vibration, and harshness requirements). Stakeholders can reassess these requirements, many of which have a limited impact on customer value, safety, and durability, while incurring unnecessary costs.
• Accelerate product development to decrease time to market. With rapid shifts in both electrification and software, accelerating development has become critical to stay competitive and control costs. Chinese OEMs have proved that time to market can be reduced to less than two years—more than twice as fast as established players. To close the gap with faster-moving global competitors, European automotive players need to fundamentally accelerate innovation and move from traditional sequential engineering to agile, asynchronous development models. By adopting trigger-based development—in which software is iteratively tested and refined, even alongside immature hardware—teams can compress critical paths, particularly for software-heavy components such as battery management, vehicle control, and advanced driving systems. This shift is especially valuable because these systems increasingly define product differentiation and require rapid, continuous iteration.
• Enhance supply chain efficiency and gain advantage from extensive supplier collaboration and partnerships. European automotive manufacturers can explore new working relationships and processes with suppliers, such as using an “open book” approach in which manufacturers and suppliers collaboratively shape requirements and designs early in the process, allowing for faster time to market. This vertical collaboration often means working side by side with suppliers and partners to quickly iterate and explore new solutions as well as integrating knowledge from the broader ecosystem. These approaches can help players make step changes in performance, cost, and time to market for technical solutions, as well as build localized, diversified, and resilient supply chains. Platform and component sharing among OEMs can also unlock economies of scale in the value chain.

• Optimize manufacturing footprints and processes. Manufacturers need to reassess where and how they produce vehicles and components. By optimizing their global footprints for maximum utilization of plants, cost-effective locations, and proximity to key markets, manufacturers can account for costs, fluctuating tariffs, and supply chain risks. Embracing manufacturing-optimized vehicle designs can help simplify process steps, reduce variability, and streamline production. Additionally, adopting advanced techniques such as gigacasting and unboxed or modular manufacturing can boost efficiency, enabling faster execution and cost savings.
• Embrace AI to unlock additional efficiency. Deployment of AI applications throughout vehicle development, production, and operational and administrative processes could unlock over €100 billion in total annual value and efficiency gains by 2030 for European OEMs, according to McKinsey analysis. European automotive companies can embrace agentic AI to boost productivity in engineering, sales, and administrative tasks; deploy autonomous robotics to handle a variety of production steps; and streamline processes from logistics to development cycles.

Greater economies of scale are essential to ensure these cost and efficiency levers deliver their intended outcomes. Market benchmarks for pure EV players indicate that positive margins through scaling require the production of at least 80,000 EVs per quarter, according to analysis by the McKinsey Center for Future Mobility. However, scale alone is not enough; best-in-class organizational efficiency is also required to unlock operating leverage. Streamlined, digitally enabled organizations with rapid decision-making, rigorous performance management, and lean overheads are better equipped to adapt to shifting markets and regulations—and to translate strategic intent into industry-leading performance and sustained leadership in the global automotive transition.

Implement a regional, customer-focused operating model

Regional automotive markets are diverging rapidly, propelled by major differences in electrification uptake, technology expectations, and consumer behavior. In China, nearly half of all new cars sold in 2024 were “new energy vehicles” (NEVs)—that is, vehicles mostly or completely powered by electric energy. Within total NEV sales, 28 percent were BEVs and 15 percent were plug-in hybrids (PHEVs). Sales also included a 6 percent share of extended-range electric vehicles (EREVs)¹⁴“What is an EREV?,” McKinsey, June 23, 2025.—which are often referred to in Europe as range-extended electric vehicles (REEVs)—a long-range hybrid EV almost unique to China that is quickly gaining popularity there. By contrast, in the same year, Europe saw BEV adoption at just 14 percent and PHEV adoption at 7 percent, with the United States trailing at 10 percent combined.¹⁵Based on data from EV Volumes, S&P Light Vehicle Sales, and McKinsey Center for Future Mobility.

China also stands out regarding expected future demand: 45 percent of Chinese consumers responding to a recent survey said they plan to choose a BEV as their next car, compared to only 23 percent in Europe and 12 percent in the United States. An additional 37 percent in China are considering a PHEV or REEV. Notably, only 18 percent of Chinese buyers expect their next car to be an ICE, compared to 49 percent in Europe and 70 percent in the United States. However, if long-range hybrids were widely available, 24 percent of European and 23 percent of US consumers said they would consider buying these—even though nearly all of these customers initially stated they would buy an ICE.¹⁶“New twists in the electric-vehicle transition: A consumer perspective,” McKinsey, April 22, 2025.

The demand for ADAS highlights an even starker contrast: Over 75 percent of Chinese consumers expressed interest in L2+ ADAS, and more than 65 percent are interested in L3.¹⁷L2+ and L3 designate levels of maturity for autonomous driving technologies. For more, see “Autonomous driving’s future: Convenient and connected,” McKinsey, January 6, 2023. This makes ADAS a top ten purchasing criterion in China, with premium buyers ranking ADAS even higher (top four). In Europe, ADAS is much less influential, with only about 40 percent interested in L2+ and about 30 percent in L3.¹⁸All consumer data in this section is based on McKinsey Center for Future Mobility’s Consumer Pulse Survey 2025.

Digital experiences and brand attitudes are also shifting the landscape. In China, smart cockpit features and voice assistants are key priorities, while these remain “nice to have” rather than table stakes in the United States and Europe. Chinese consumers show a remarkable openness to new brands, with 82 percent interested in Chinese EV disruptors and over 65 percent open to switching to a new brand for their next purchase, rating better advanced driving and smart-cockpit performance as the most important reasons for preferring a Chinese brand. However, while domestic brand loyalty remains strong in the West, 21 percent of Europeans and 25 percent of Americans said they would consider a new car from a Chinese EV brand.

Given these marked regional differences, European automakers’ traditional strategy of developing a single vehicle platform for global use is losing viability. They can switch gears by adopting a more localized development strategy, building regional supply chains, and tailoring offerings for distinct markets.¹⁹For more on the importance of customer centricity in automotive, see RACE 2050 – a vision for the European automotive industry, McKinsey Center for Future Mobility, January 2019. This addresses the unique regulatory, infrastructure, and consumer needs of different regions, as well as mitigating supply chain volatility.

However, it also increases complexity and can erode economies of scale, requiring strategic partnerships and alliances for a regionalized system to remain cost competitive.

Meeting these diverse requirements calls for region-specific product definitions, differentiated design priorities, and brand evolution. In software-defined vehicles, for example, it may be advantageous to establish dedicated, empowered capabilities within key local markets such as China to address each region’s unique pace of digital adoption and consumer demands. Cross-functional, data-driven teams with a customer-first mindset are critical to inform product design, pricing strategies, and localized customer engagement based on identified pain points, trends, and regional preferences.

Finally, collaboration within local ecosystems will play a pivotal role in successful regionalization. Strategic partnerships with local players can accelerate access to technologies, capabilities, and market insights. Vehicle differentiation developed in regional hubs—particularly in innovation-driven markets—can simultaneously satisfy local demand and contribute to global portfolios. In the context of increasing regionalization within the global automotive industry, such partnerships could pave the way for a new era of “regional globalization,” in which localized innovation drives both regional success and global competitiveness.

2. Future-proofing the value chain

In addition to transforming individual company operations within the European automotive industry, the ecosystem has to be strengthened to future-proof the value chain. This includes developing a competitive EU battery value chain, doubling down on critical future technology, and building partnerships to ensure a resilient supply of critical materials.

Develop a competitive EU battery value chain

According to McKinsey Battery Insights, Europe accounts for less than 10 percent of global battery cell production capacity—and even less in upstream activities—leaving European OEMs highly dependent on global supply chains (Exhibit 2). In 2030, European EV battery demand is expected to be between 600 and 800 gigawatt-hours (GWh), three to four times the nearly 200 GWh capacity installed as of 2024. Given initial production constraints (for example, ramp-up and yield issues), expected demand could even be four to six times today’s capacity. As of July 2025, about 600 GWh of announced battery production capacity has failed to materialize because of bankruptcies and project scale-downs. Exacerbating the situation, nearly all lost capacity came from European players, while remaining projects are mainly led by Asian companies. Additionally, there is a growing mismatch between the battery chemistries in demand—such as lithium iron phosphate (LFP) batteries, which are completely dependent on China—and current production plans, which remain focused mainly on lithium nickel manganese cobalt (NMC).

Europe’s battery industry needs a paradigm change based on a coordinated, strategic approach spanning the entire value chain. Achieving regional competitiveness will require targeted investment of about €200 billion to €300 billion by 2035, according to McKinsey analysis, as well as ensuring the required offtake becomes sufficiently attractive. This investment, especially when providing below-market financing mechanisms, could help compensate for regional cost differences to make Europe a compelling battery manufacturing destination for OEMs, suppliers, battery manufacturers, start-ups, and capital markets. In addition, faster approvals, particularly for critical mineral and material refining, along with measures to attract and retain talent, can play a key role in fostering this change. Getting this project off the ground will require concerted European-level effort—not local initiatives by individual countries and players.

Not all parts of the battery production chain need to be completely localized in Europe, but strategic control in critical areas could help ensure resilience against supply shocks. A higher share of localized processing across cell manufacturing and upstream activities could also significantly increase value within Europe. Providing incentives for supply chain participation, unlocking R&D capabilities, and facilitating skills transfers are all essential to strengthening these steps of the battery manufacturing chain within Europe. Offering joint ventures and attractive opportunities could draw in leading foreign players, with an emphasis on fostering technology-sharing partnerships, deep integration of world-class expertise, and accelerating technology localization. Public and private investment can work together to create incentives for such knowledge transfer and collaborative innovation. Only through a coordinated, partnership-driven approach can Europe establish a robust, competitive battery value chain and secure a resilient EV transition.

Double down on critical future technology

It is also vital to advance other key automotive technology fields, as McKinsey explored in the article “European automotive industry: What it takes to regain competitiveness.”²⁰“European automotive industry: What it takes to regain competitiveness,” McKinsey, March 10, 2025. Strategic activities such as in-house R&D investments, M&A, and partnerships could help Europe scale production and catch up or expand its leadership. Seven technology domains are emerging as particularly critical to prioritize:

1. Software-defined vehicles (SDVs). Software is becoming a key differentiating factor for vehicles and automotive business models. Despite stagnating global vehicle sales, vehicle life cycle revenues are expected to grow by about 30 percent until 2035.²¹ “Europe’s economic potential in the shift to electric vehicles,” McKinsey, October 3, 2024. Much of this growth is expected to be propelled, either directly or indirectly, by software-enabled functions, creating major opportunities to differentiate through software ecosystems. In new OEMs outside Europe, more than 40 percent of R&D employees specialize in software, compared with only about 15 percent at incumbent European OEMs.²²“European automotive industry: What it takes to regain competitiveness,” McKinsey, March 10, 2025. To remain competitive, European players can address the growing importance of software by building centralized electrical and electronic (E/E) architectures and scalable, cloud-native software platforms. A potential key enabler of this transformation is the development of a common, open-source middleware stack for foundational software layers. Such a stack could reduce complexity, lower costs, and accelerate innovation by providing a shared foundation for non-differentiating functions. While projects are already underway in this space, further collaboration among OEMs, tier-one suppliers, and tech players could unlock its full potential.

However, views on this approach differ. While a common middleware stack offers significant benefits, the ability to differentiate and maintain competitiveness remains essential. Companies must ensure that using a shared foundation enables them to focus their resources on developing proprietary, value-adding software features and ecosystems on top of it. Europe’s ability to attract and retain top software talent will also be a decisive factor in closing the gap with global competitors, highlighting the need to foster partnerships with universities and create attractive career paths for software engineers. By addressing these challenges, European players can accelerate product development, expand software-related innovation, and secure a competitive edge in the global market.

2. ADAS and autonomous vehicles (AVs). Europe’s subdued demand for advanced driving technology risks industry complacency and declining investment, potentially placing OEMs and suppliers at a disadvantage. EU players are facing issues including ecosystem fragmentation, system complexity, and high development costs. As with SDVs, European players can collaborate to create shared, open-source base stacks for key ADAS layers, enabling companies to develop differentiating functionality on top. Joint investment in AI training infrastructure, potentially with government support, can further strengthen this ecosystem. These steps could help lower overall costs, accelerate development, and reduce the risk of falling behind and losing market share.

As for autonomous vehicles, Europe lacks a robust L4 technology base, with few active players and low levels of funding.²³L4 refers to the level of maturity of autonomous vehicles as defined by the Society of Automotive Engineers (SAE). L4 vehicles can self-drive in specific areas, such as cities, but humans have the option to manually override them. Governments would need to commit significant resources—McKinsey estimates over €200 million per test zone is required—for a handful of locations across Europe to serve as test beds for shared autonomous fleets, targeting full-scale deployments by 2027–28. However, to avoid funding vehicles for large test fleets without achieving commercialization—and to avoid the pitfalls of many small-scale R&D projects—funding should be tied to real-world deployment (for example, by cofinancing every commercial mile driven), ensuring that investments directly support scaling AV mobility services. This funding can be structured as a co-investment, with the majority of the required capital coming from AV mobility players.

Creating an attractive environment for companies to launch AV mobility services in Europe will also be critical. This includes introducing an enabling regulatory framework, building supporting infrastructure, and accelerating type approval and licensing processes. Unified AD standards and streamlined compliance across the European Union will help cut adaptation costs and speed up market entry. Players can further accelerate progress by collaborating in test zones, developing common software layers, and attracting top software talent while fostering closer ties with universities.

3. Semiconductors. Semiconductors are critical to advancing in software-defined vehicles and automotive AI because they deliver the processing power required for advanced functions in vehicles and in cloud or edge environments.²⁴For more, see “The rise of edge AI in automotive,” McKinsey, August 25, 2025. Europe’s automotive industry urgently needs to shore up its semiconductor ecosystem; demand for automotive semiconductors in Europe is expected to rise about 25 percent toward 2030, according to the McKinsey Center for Future Mobility, and global expansion is accelerating, particularly in Asia and the United States. Europe is home to only about 10 percent of global front-end capacity and about 1 percent of back-end capacity, putting the region at risk of increased dependence on global supply chains.²⁵“European automotive industry: What it takes to regain competitiveness,” McKinsey, March 10, 2025. See also Semiconductor crisis, VDA (German Association of the Automotive Industry), 2023. To counter this, Europe can target strategic investments in design and front- and back-end capacity, tackle structural cost barriers, and leverage its strengths in early-stage R&D, equipment, and industrial and power electronics. Anchoring efforts on industry leaders, fostering collaboration between OEMs and the semiconductor industry, expanding software expertise (potentially through industry-driven semiconductor skills programs to attract, develop, and retain world-class talent), and better integrating start-ups and universities will be essential to secure robust supply chains and protect Europe’s technological edge.

4. E-powertrains. The market for electric powertrains (excluding their batteries) is currently highly fragmented, with over 50 suppliers for eDrive components alone, according to McKinsey analysis. Most of these suppliers are failing to profit because of high costs driven by extensively customized designs (despite limited actual differentiation) and complex tier-N value chains. Collaborations, industry-wide platforms, and certain standardized requirements could significantly reduce costs. At the same time, targeted innovations—such as advancements in power semiconductors and higher levels of functional integration—could further enhance efficiency. While OEMs and suppliers may be able to boost competitiveness by shifting select development activities such as power electronics to lower-cost regions in Asia, it is important to balance this with strategies that prevent overdependence on any single region and safeguard critical technological capabilities.

5. ICE components. Efficient internal combustion engines and hybrid powertrains are expected to remain in operation for decades in Europe (considering aftermarket), and even longer in markets outside of Europe, resulting in a market still worth €100 billion by 2035, according to the McKinsey Center for Future Mobility. The region can leverage its long-standing leadership in this technology to provide a stable industrial cash flow in the coming years. Effectively managing this gradual phaseout is critical. Establishing a hub for ICE expertise and operations, consolidating efforts with other players, and optimizing plant utilization through resource pooling and operational alignment can significantly enhance efficiency. These measures will not only support the industry during the transition but also enable a smoother shift toward low-emission powertrains as global demand for ICE technology steadily declines.

6. Alternative fuels. Europe is well positioned to lead the transition to hydrogen technology and sustainable fuels, leveraging its strong legacy of innovation in efficient combustion technology and industrial processes. By scaling up solutions such as renewable diesel, biogasoline, and e-gasoline, Europe could potentially phase out fossil fuels entirely by 2050. This transition is particularly important for areas that are harder to electrify, including the existing vehicle parc, shipping, and aviation. Sustainable fuels offer an additional opportunity for collaboration between sectors, providing relevance for material decarbonization, industrial production, and low-emission vehicle usage, though the long-term sustainability of sustainable fuels and their role in road transport remain subject to debate. A large share of biofuels currently comes from Asia. This creates some regional dependence in Europe, but it also contributes to a broader and more geographically diverse set of supply options (alongside fossil fuels and battery minerals from other regions), thus supporting resilience through supply spread. While these fuels are more expensive than fossil fuels, strong demand mandates and regulatory support could unlock significant volumes, leaving end users with a choice of decarbonization pathways while providing incentives toward electrification over time.

A factor to consider is that production capacity and value chain maturity vary by fuel type. While bio- and e-gasoline supply chains remain underdeveloped, other fuels, such as hydrotreated vegetable oil (HVO), benefit from mature supply chains and even temporary overcapacity. With clear demand signals, Europe can take a leading role in advancing zero- and low-emission fuels as part of a broader portfolio of solutions.

7. Circularity and secondary materials. Strengthening closed-loop systems could contribute to Europe’s sustainability and competitiveness aims, reducing supply risks and costs. Circularity will be critical for battery materials, given the region’s reliance on primary and refined resources from China. By 2040, half of European battery demand could be met by recycled materials.²⁶For more, see “Powering the energy transition’s motor: Circular rare earth elements,” McKinsey, July 24, 2025. Europe could be very competitive in this area, but it must act swiftly to establish a global presence by the early 2030s, when, according to McKinsey analysis, the availability of end-of-life batteries is expected to start to surge.

Build partnerships for a resilient supply of critical materials

Of the 34 critical and strategic raw materials the European Union has designated fundamental for security and sustainability,²⁷“Critical raw materials,” European Commission, accessed August 29, 2025. about 25 are relevant to the automotive sector and 14 are essential. Europe’s supply chains for EV production are particularly exposed, with needs ranging from lithium and graphite for batteries to a fourfold increase in REEs, primarily for the permanent magnets needed for electromotors. Although China holds less than 10 percent of the global reserves for most battery materials—apart from graphite—it controls, on average, over 40 percent of global mining operations across battery materials and more than 80 percent of refining capacity, according to analysis by McKinsey MineSpans. Critically, more than 95 percent of the European Union’s REE volume originates from China, with only limited final processing taking place within the European Union.²⁸“Critical raw materials,” European Commission, accessed August 29, 2025. This leaves Europe highly exposed to potential supply disruptions.

Europe’s security requires careful consideration of the strategic and geopolitical implications of these dependencies. Strengthening supply chain resilience for these critical materials is vital—not only to ease margin pressure for OEMs and suppliers but also to bolster regional independence. What could make a difference are strategic resource partnerships with countries rich in these materials, ensuring a sustainable approach to resource extraction. At the same time, industrial alliances can help secure critical areas of the supply chain for key technologies such as batteries and semiconductors. Enhancing local refining capacity, potentially through international collaboration, would reduce reliance on external processing and could be supported by streamlined permitting, incentives, and innovation to ensure scalability and sustainability. Additionally, building strategic stockpiles of materials such as rare earths, cobalt, and nickel could provide a buffer against future disruptions.

3. Leveling the playing field

To create the right boundary conditions to level the playing field with other regions, European stakeholders must accelerate infrastructure, grid, and renewable energy rollout; enable flexibility in the shift to zero emissions; and close competitiveness gaps.

Accelerate infrastructure, grid, and renewable energy rollout

While certain countries are powering ahead with charging-infrastructure rollout, other regions are still considerably lacking. To fully electrify Europe, the region’s DC charging network must be significantly extended to cover all EU member states. By 2035, charging infrastructure would need to grow about sixfold to ensure a ratio of about one charger for every 15 EVs, with variation between regions and based on charging capacity. McKinsey estimates about €350 billion needs to be invested in the charging network to meet electrification goals. These investments, including in adjacent technologies such as power grids and renewable-energy generation to supply green electricity to those charge points, would be required to support a ramp-up to 100 percent zero-emission vehicle sales in 2035. Well-established public charging networks underpinned by cost-efficient clean-energy production could reduce range anxiety and lower fast-charging costs, helping consumers embrace EVs and building a sustainable mobility ecosystem.

Several actions could accelerate infrastructure rollout. Streamlining permitting across the European Union could reduce delays in EV infrastructure and renewable-energy projects. Cross-industry collaboration with grid operators and renewable-energy generators could help players innovate, standardize charging infrastructure to ensure its interoperability, and synchronize grid upgrades with the rollout of charging infrastructure. Public–private partnerships could also increase funding efficiency.

As this infrastructure is rolled out, average use rates will likely be below targets because supply will have to be built out ahead of demand. For 100 percent of new vehicle sales to be electric by 2035, a widespread charging-infrastructure network will be essential. However, McKinsey Center for Future Mobility simulations show that about 25 percent of vehicles on the road are expected to be electric by then, meaning some regional networks can expect prolonged lower utilization. Public funding will thus be crucial to support network build-out in certain geographies and use cases. In the meantime, EV adoption is expected to happen faster in higher-density areas.

Navigate challenges on the road to net zero

Europe’s ambitious decarbonization goals include transitioning to zero-emission vehicles by 2035. Achieving this target will require the region to address several challenges (Exhibit 3). For instance, Europe’s battery industry and EV ecosystem face specific challenges in scaling up to fully support a complete transition to BEVs. Consumer demand also remains uneven, with only about 20 percent of consumers in Europe considering a BEV for their next purchase, while over 40 percent are leaning toward long-range hybrids and another 40 percent toward ICE vehicles.²⁹“New twists in the electric-vehicle transition: A consumer perspective,” McKinsey, April 22, 2025. One factor in this may be that EVs often cost 20 to 30 percent more than comparable ICE vehicles (excluding subsidies), according to McKinsey Center for Future Mobility analysis. This makes affordability, along with range, a primary concern among consumers. In addition, European electricity prices are high; the operating cost advantage of driving EVs compared to ICE vehicles has been a key factor behind EV adoption in China.³⁰Nic Lutsey, Hongyang Cui, and Rujie Yu, Evaluating electric vehicle costs and benefits in China in the 2020–2035 time frame, International Council on Clean Transportation, 2021.

If these trends persist, some consumers may delay the transition to EVs—either due to affordability issues or because EVs do not meet their needs. This is especially true for buyers of smaller cars and light commercial vehicles, as well as for those in regions with insufficient charging infrastructure. Such a scenario could slow progress in decarbonization efforts as higher-emission vehicles remain on the roads for longer; the average vehicle in Europe is nearly 13 years old, up from less than ten a decade ago.³¹The automobile industry pocket guide 2024/2025, Acea, September 2024; The automobile industry pocket guide 2015/2016, Acea, June 2015 Other effects may include a surge in last-minute ICE purchases before 2035 and a potential drop in vehicle purchases after 2035, challenging the economics of OEMs and suppliers.

To mitigate these risks, the EV ecosystem—in particular, charging infrastructure and the European battery value chain, including access to battery raw materials—needs to scale rapidly, supported by cost reductions on EVs. For example, deployment of charging infrastructure will need to accelerate by a factor of two to three, according to McKinsey analysis. The industry could also explore solutions that have worked well elsewhere. For example, long-range hybrid electric vehicles, including PHEVs and REEVs, are gaining traction in some markets, accounting for about half of EV sales in China. Many of these hybrids now offer sufficient electric range for daily activities—around 100 kilometers for average PHEVs and over 200 kilometers for some Chinese REEV models.³²Based on data from EV Volumes, S&P Light Vehicle Sales, and McKinsey Center for Future Mobility. As a result, they can provide more affordable electric driving most of the time while alleviating range anxiety for consumers by providing the fallback option of a combustion engine (which could eventually become powered by sustainable fuels). In regions with limited charging infrastructure, such vehicles could complement the broader adoption of BEVs by addressing consumer concerns and supporting regulatory goals for low-emission vehicles. Additionally, the smaller batteries in these hybrids could reduce demand for scarce materials and ease pressure on the European battery supply chain.

Emissions could potentially be further reduced through broader decarbonization strategies across the vehicle life cycle. Measures could include replacing older vehicles earlier, increasing the use of sustainable fuels, and providing incentives to use green electricity for charging. Further reductions from a “business as usual” scenario could be possible by increasing the use of low-carbon materials such as green steel and aluminum and manufacturing with renewable energy. This could not only reduce Europe’s passenger-vehicle emissions footprint but also accelerate development of local, low-carbon industrial production across Europe.

However, none of these measures can be implemented as last-minute solutions, as other regions have shown. Developing these value chains in Europe will require adequate incentives, long-term planning, and cross-industry collaboration to ensure the necessary scaling and investment.

Close the gaps

As Europe seeks to close the competitiveness gap—especially in comparison to the United States and China—it will need to address high labor costs and skills shortages, high energy prices and supply chain vulnerability, low productivity, underinvestment in growth, a complex regulatory landscape with long lead times, and lack of scale due to fragmentation.³³Mario Draghi, The Draghi report: A competitiveness strategy for Europe, September 9, 2024.

Substantial, coordinated investments will be essential. Overcoming chronic underinvestment and ensuring rapid scaling will require deep, integrated capital markets and targeted public–private co-investment, especially for new technologies. Improving access to low-interest financing for manufacturers and innovators will help Europe attract risk capital, support industrial champions, and drive long-term growth across the sector.

Investment is required to accelerate renewable-energy deployment and grid integration to provide Europe’s automotive hubs with access to stable, low-cost green electricity. Equally important is ensuring robust digital connectivity and data infrastructure, which underpin both advanced manufacturing and the rollout of AI-driven and autonomous vehicle technologies. Furthermore, Europe can invest in upskilling its automotive workforce and in ensuring that advanced digital and AI technologies are thoughtfully integrated into factories to boost productivity. Talent mobility programs such as expedited visas, housing assistance, and comprehensive reskilling could also help retain and attract needed expertise.

Overall, a unified approach is essential for Europe to close the competitiveness gap. Working together, European countries could explore a number of potential avenues, such as incentive scheme frameworks at the EU and national levels and demand-side actions such as reinstating local EV subsidies (including for secondhand vehicles) or fleet renewal programs to stimulate domestic demand and speed up the replacement of older ICE vehicles.

Drawing lessons from San Francisco and Shenzhen, Europe could accelerate its innovation cycle by creating dedicated innovation zones with streamlined administrative processes, integrated R&D funding, early-stage capital access, and public–private partnerships among industry, government, and academia.

Finally, for Europe to truly compete globally, it can harness the full diversity of its strengths across regions, deploying low-cost labor in some areas, affordable green energy in others, and access to critical minerals or advanced industrial hubs elsewhere. By strategically leveraging these complementary assets collaboratively (rather than each country acting alone), Europe can build integrated automotive value chains with greater efficiency, scale, and innovation.

As Europe works to strengthen its long-term competitiveness, it will need a level playing field, especially during today’s period of transition. As the sector evolves, industry stakeholders should stay abreast of international pricing practices and regional differences in labor, energy, and standards. Thoughtful and effective safeguards in these areas can help maintain resilience in the automotive sector as longer-term investments take hold and support healthy competition.

Reestablishing Europe’s leading position in the global automotive industry, future-proofing the value chain, and leveling the playing field demand immediate, full-scale, and coordinated efforts. The stakes could not be higher: Without radical and decisive action now, the risk of a severe economic downturn for the automotive sector—and the broader region—is immense. Companies must act urgently to undergo rapid and fundamental transformations by embracing new technologies, improving productivity, and adapting to shifting market dynamics. At the same time, the public sector must create the conditions for these transformations to succeed—through streamlined regulations, targeted incentives, and investments in critical infrastructure such as renewable energy, digital connectivity, and supply chain resilience. The time for incremental change has passed. Only bold, synchronized action between industry players and the public sector can revamp Europe’s manufacturing sector, safeguard its competitiveness, and secure long-term prosperity for the industry and the region. The moment to act is now.