Global Business 3rd Edition by Mike Peng

Exercise 7

How does Embraer grow to become a global leader in the highly competitive aircraft manufacturing industry?
In 1994, when Fernando Henrique Cardoso was elected as Brazil's new president, the economy was unstable and experiencing hyperinflation of about 2,000% per year. As a finance minister in the previous administration, Cardoso and his team had introduced economic measures centered on the Real Plan. This plan was very successful and by 1997 inflation had been brought down to international levels. Macroeconomic reforms and price stability revived the economy. Brazil had been the world's economic miracle of the 1970s and most of the 1980s. With a steady course, it could now look forward to a new era of growth. An important part of the reforms was the privatization of key stateowned enterprises (SOEs). One of them was Embraer, the short form for Empresa Brasileira de Aeronautica, S. A. (Brazilian Aeronautics Company). Embraer's stock is traded on the Sao Paulo Bovespa and has been listed on the New York Stock Exchange (NYSE: ERJ) since 2000.
Origins
Embraer was created in 1969 by a military government determined to provide Brazil with the capacity to produce military aircraft. The company was set up as a mixed enterprise, with the Brazilian state retaining a 51% majority of the voting shares and the rest held by private investors. Production started in 1970 and the company became profitable the next year and remained so until 1981. Propelled by government procurement and fiscal support, Embraer soon produced internationally successful models, such as the turboprop models EMB 110 Bandeirante transport aircraft and its larger, 30-seat successor, the EMB 120 Brasilia, as well as the Tucano military trainer.
The company is located in San Jose dos Campos, in the state of Sao Paulo, in the corridor between the cities of Sao Paulo and Rio de Janeiro. This part of Brazil is called "Technology Valley," with industrial clusters in the aerospace, telecommunications, automobile, and petroleum sectors. Educational centers have been created in the area offering aerospacerelated programs. Embraer's distinctive competencies are the areas of R D, design, product development, system integration, assembly, and technical assistance in aircraft manufacturing.
Product Range
Embraer's product range includes commercial, military, and corporate aircraft, with commercial sales in 2009 accounting for 66% and the fast-growing corporate segment (also known as executive aviation) representing 14% (see Exhibits 1, 2, and 3). By comparison, commercial and corporate sales represented about 80% and 6% of total sales in 2002.
In 1989, Embraer introduced the 35-seat ERJ 135 and the 50-seat ERJ 145 regional jets to meet increasing demand for jets to replace turboprop models. Regional jets are smaller and less costly to acquire and operate than larger jets such as the Boeing 737. They are a cost-effective alternative to serve mid-range routes and to feed passengers from smaller airports to major hubs replacing larger planes that were underutilized in short-haul flights. Sales of Embraer's new family of regional jets took off rapidly.
By 1994, Embraer had reached world market shares of 31% and 42% in the regional jet and the military trainer markets, respectively. However, it was facing severe challenges. A downturn in demand in the airline industry had led to a serious decline in commercial aircraft sales, while export financing was drying up due to the expiration of the Brazilian government Finex program. These and other factors contributed to a sense of disarray at Embraer at a time when major reforms such as privatization were transforming the Brazilian economy. In December 1994, Embraer was privatized, and acquired by a consortium of Brazilian institutions headed by a local investment bank. The Brazilian government retained a golden share that allowed it to veto certain strategic actions such as a takeover by a foreign company.


By 1998, buoyed by the success of its ERJ family of jets introduced in 1989, Embraer had become the world's leader in the regional jet market, surpassing its main rival, Bombardier of Canada. In 1999, Embraer became Brazil's leading exporter and accounted for about 7% of all of Brazil's exports of manufactured goods.
In 1999, after a $1 billion investment in development, Embraer introduced the E-Jet family, consisting of the 80-seat ERJ 170, the 110-seat ERJ 190, and the 122-seat ERJ 195 airliners. They are comparable to Boeing 737 and DC-9 airliners. These jets proved to be very successful and the first one was delivered in 2002. Bombardier had no comparable models to compete against this new line of Embraer planes. Currently, Bombardier offers the original jet series, the 50-seat CRJ 100 and CRJ 200, which are identical except that CRJ 200 has more powerful engines. Bombardier also developed the CRJ 700, CRJ 900, and CRJ 1000, which are simply stretched versions of the CRJ 200 and have a capacity of 70, 90, and 100 passengers, respectively. However, in July 2004, Bombardier announced the development of the C Series consisting of the CS 100 (100-125 seats) and the CS 300 (120-150 passengers). The launch year has been set as 2013. The C Series jets are comparable to the Boeing 787 and the Airbus 350.
Supply Chain
Embraer's production structure gives the company a competitive edge. Its supply network consists of three layers. At the first level, risk (or strategic) partners carry most of the risk of innovation and operate on the basis of long-term contracts. At the second level, international suppliers provide equipment, systems, and components. At the third level are the national subcontractors that supply services and products following Embraer's specifications. They are retained on the basis of purchase orders and can be easily replaced. Embraer trains employees of these suppliers. They represent a diversified local network of about 30 small and medium-sized firms mostly located in close proximity of Embraer, and are typically founded by previous employees of the company. The number of these suppliers has gradually been reduced. For instance, while the ERJ 145 program had about 400 suppliers, the newer ERJ 170/190 program had around 20. Suppliers must be ISO9000 certified.
Embraer develops new products using a "co-design" approach that involves risk partners that carry most of the risk of innovation. Risk partners are also responsible for aggregating subsystems and components into modules (complete, recognizable subunits of the airplane). This modular assembly system reduces the number of suppliers and shifts risk and costs from the company to suppliers. These supply chain innovations provide Embraer with a competitive edge resulting from reduced levels of risk, reduced R D costs, reduced complexity of the production process, increased quality, increased innovation, and-in the case of ERJ 170/190-a 33% shorter product development process (from 54 to 36 months).
The new family of regional jets, the ERJ 170/190, was designed through a cooperative system. Embraer's design process consists of three phases: (1) the initial definition phase that is performed before the risk partners are selected, (2) the joint definition phase that is carried out by all risk partners and involves assigning the design of different parts of the aircraft to different partners, and (3) the detailed design and certification phase during which the risk partners finish all details and the aircraft seeks certification in different national markets.
Over the years, Embraer has attempted to address issues of strategic importance such as dependency on international suppliers, low local content of its products, a lack of government support for R D, and a lack of an internal market intelligence unit. To alleviate these obstacles, Embraer has engaged in corporate capacity building at various levels.
The level of dependency on international contractors is illustrated by the fact that about 95% (by volume) of the equipment, materials, and components are purchased on international markets. The total national (Brazilian) content in each airplane is only about 40%, with risk partners accounting for an additional 38% of the total cost of an airplane. Embraer is attempting to increase local sourcing, mainly by attracting international suppliers to set up operations in Brazil. Some progress has been made in this area. For example, in 2003, Japan's Kawasaki opened a wing production plant within Embraer's Gaviao Peixoto facility, joining other international companies that have set up plants in Brazil, such as C D Aerospace, Sonaca, Goodyear, and ELEB. In 2008, Embraer took full ownership of ELEB, a former joint venture (JV) of Embraer with Liebherr of Germany, and this subsidiary now exports landing gear and hydraulic equipment to aerospace firms in the United States, Asia, and Europe.
Embraer faces hurdles in the creation of knowledge and specialized suppliers. It lacks a targeted government program focusing on R D and the creation of small high-tech suppliers to the aerospace industry. In addition, the company's relationships with universities are rather informal and not comparable to the structured ties found between companies and university based R D centers in the United States and Europe. In order to expedite the process of innovation and knowledge creation, Embraer is considering creating its own corporate university.
For many years, Embraer had relied on external consultants to produce market studies of the commercial aircraft industry. In 1998, it established its own market intelligence unit, with the ultimate goal of producing good estimates while at the same time internalizing market analysis into the company's competitive strategy.
International Operations
Embraer sells civil and military aircraft around the world, and has established plants, sales, and maintenance centers in China, France, Portugal, Singapore, and the Unites States. A new dimension in Embraer's relations with the outside world was initiated in 1999 when the company established a strategic alliance with a French consortium formed by Dassault, Aerospatiale Matra, Thompson-CSF, SNECMA, and EADS (the parent company of Airbus). These companies acquired about 8% of Embraer's equity. The pact would have allowed Embraer access to new military and civil aviation technology. Among other projects, the agreement envisaged the assembly of France's Mirage fighter jets in Brazil. However, EADS sold its equity in 2007 and the Mirage project was never carried out. In 2005, a consortium consisting of Embraer and EADS acquired control of OGMA, Portugal's formerly state-owned aerospace firm. OGMA would provide service and perform certification procedures for Embraer aircraft in Europe.
In 2002, Embraer established a JV with Aviation Industry of China II (AVIC II), opening a plant in Harbin, China, to produce ERJ 145 regional jets. The first jet was produced in 2003, and a total of 25 would be delivered to Hainan Airlines by 2011.
Challenges for the Future
As of 2010, Embraer can look back to major achievements that have turned it into the world's third largest commercial aircraft manufacturer in terms of sales, surpassed only by Boeing and Airbus. However, many significant challenges lie ahead.
Embraer is preparing to face another difficult year as the world economy and commercial carriers experience the worst crisis since World War II. Many orders have been downsized or cancelled, and Embraer is expecting a 10% sales decline for 2010. The company is reacting to the crisis by cutting staff and adopting other cost-reduction measures, but there is no end in sight for the downturn in the world economy. To make matters worse, Bombardier has received several orders for its new C Series jets due for delivery starting in 2013, and Embraer, whose models go up to 122 seats, has nothing to offer in the 149-seat range. In addition, the Brazilian real appreciated by 35% against the US dollar in 2009, and this will ultimately show as increased costs at Embraer, where about 40% of expenditures are denominated in the real.
There are a few bright spots in this otherwise bleak landscape: Sales of the expanded line of corporate jets are growing fast and making up for lost revenue in other areas, and domestic sales are expected to reach $500 million in 2010 driven by purchases by the new Brazilian discount airline Azul (founded by Brazilian-born David Neeleman, the previous CEO of a US discount airline JetBlue). Azul ordered 76 of the 118-seat ERJ 190. In addition, new lines of financing have been offered: China's CDB Leasing Co., a unit of China Development Bank, awarded Embraer a $2.2 billion loan for the sale of Embraer planes, and the Brazilian state bank BNDES plans to step up financing of Embraer sales from the previous level of 30% to as much as 60% in 2010. With an order backlog of about $18 billion at the beginning of 2010 and new sources of financing lined up, Embraer is confident that it can weather the current crisis and grow again.
Case Discussion Questions
How can Embraer's international operations be upgraded to increase its competitiveness?