Embraer Strategic Management

EMBRAER CASE STUDY : Resources and a nd Competance, Value Value Chain Competitors have claimed that Embraer’ Embraer ’s competitive advantage is unfair, sustained only  by ongoing direct and indirect government support.while government support was important in helping the firm evolve into a major player in the regional aircraft market, such support has also been available av ailable to Embraer’s competitors. Embraer’s success must therefore be attributed to other competitive advantages. Given its limited resources, especially during the reduction in direct gove rnment support, Embraer’s strategy has been to focus its R&D funds on key technologies that it can effectively produce in house. It has outsourced the production p roduction of components that other  companies can manufacture more efficiently. efficiently. Embraer has focused its R&D on the development, systems engineering and integration of the more than 28,000 parts and components that make up an aircraft. The company has also retained the development and production of the plane’s fuselage, arguably the most technically complex part of an airplane. To aid Embraer’s in-house technological development, the company invited international leaders in the field of aeronautics to  become minority shareholders. To offset the risk of developing and producing some of the most costly and technologically challenging components, Embraer has also formed risk-sharing  partnerships. Partners make major components such as wings, flaps and engines, based on Embraer’s design specifications. These manufacturers are international firms with headquarters outside of Brazil; however, as Embraer has continued to exp and, many of  them have set up operations in Brazil to supply parts in a timely and low-cost manner. In 2002, C&D Aerospace of the U.S. built a plant in Brazil to supply Embraer with cabin interiors for its jets. Sonaca, a Belgian company c ompany that produces fuselage equipment, instituted Sobraer in Brazil as a subsidiary solely focused on servicing Embraer. Pilkinton Aerospace, an American firm, built a plant to supply aircraft windows. And most recently recen tly,, in 2004, ENAER, a Chilean firm that supplies the rear fin and other parts, pa rts, and Gamesa, a Spanish firm that makes engine parts, have built a plant in Sao Jose dos Campos, where Embraer is headquartered.6 Subcontractors that receive raw materials and designs from Embraer c onstitute a third level of supplier. supplier. According to Embraer ’s statistics, statistics, 93.4 percent of the firm’s employees are employed in Brazil, 25 percent as engineers Embraer is betting that regional and low-fare airlines will extend their routes, creating competition with the legacy airlines and a demand for larger regional aircraft. So far, this bet has paid off, Commonality in the 70- to 110-seat market— An An important advantage that Embraer can use to leverage its first-mover advantage is the commonality co mmonality design of the new 70- to

110-seat jet family. family. Commonality is a set of shared parts and interfaces, which allow airlines to scale maintenance and spare parts inventory across several jet types in the same family. family. Commonality also allows airlines to avoid retraining pilots for different cockpit designs. Bombardier estimates that commonality features in its planes can save airlines 10 to 15 percent on operating costs. This strength will be especially important in the more dense markets of Europe, Asia and, eventually, the U.S. • Lower R&D and production costs— Clearly, Clearly, Embraer benefited in its early development from significant government R&D subsidies. Continuing government assistance for  military contracts supports development efforts for commercial jets as well. To a limited degree, Embraer may enjoy lower R&D costs due to the centralized supply network it developed over the past decade. Lower labor costs in Brazil helped contribute to Embraer’s EBITDA margins of 18 to 22 percent, compared to Bombardier’s 5 to 10  percent margins. This competitive advantage will likely dissipate as other governments continue to subsidize their national aircraft manufacturers and as the Brazilian labor  market develops. In addition, China, with its lower labor costs, could displace the advantages Brazil currently holds as a manufacturing center ce nter.. Bombardier could move  production to China and exploit e xploit that county’s labor cost advantage. Embraer could also increase its production capacity in China through its joint venture with Harbin to retain competitiveness. However, a relocation of Embraer’s production from Brazil to China would reduce Embraer ’s positive externalities to the Brazilian economy. • Easy access to financing— Finally, Finally, Brazil’s weak currency helps Embraer price its jets very competitively. competitively. In addition, add ition, generous government export financing terms facilitate transactions, although this is true for competitors like Bombardier as well. Both companies secured $1 billion in government gove rnment equity guarantees for export financing in the past year, indicating the commitment of both Brazil and Canada to financing their  respective domestic aircraft manufacturing industries. CHAZEN WEB JOURNAL OF INTERNATIONAL INTERNATIONAL BUSINESS- Columbia Business School  Prof. Moacir de Miranda Oliveira Jr. FEA – USP, USP, Faculdade de Economia e Administração da USP  The company develops and adapts successful aircraft platforms and  judiciously introduces new technology whenever it creates value by lowering acquisition price, reducing direct operating costs, or de livering higher reliability, comfort, and an d safety. A Knowledge Based Perspective • Risk sharing partnerships with some of the world's largest aerospace manufacturers and suppliers • 2/3 of financial investments for the development of new products comes from the international partners • Focus in the Marketing and Product Development competencies of the global value chain EMBRAER’s International Strategy SYSTEMS Strategic Partnerships HAMILTON SUNDSTRAND Air Management Electrical System PARKER Hydraulics PARKER  Hydraulics

Flight Controls Fuel System C & D Interiors LIEBHERR Landing LIEBHERR  Landing Gear HONEYWELL Avionics GEAE Propulsion System GAMESA Empennage & Rear Fuselage LATECOERE Center Fuselage III EMBRAER (LEADER) KAWASAKI SONACA Wing Stub, Pylon, Control Surfaces HAMILTON SUNDSTRAND Tail Cone & APU GEAE Engine / Nacelles EMBRAER  Forward Fuselage EMBRAER  AKROS Wing to Fuselage Fairing LATECOERE Center Fuselage I EMBRAER  AKROS Center Fuselage II

Clusters, Industrial Districts and Firms: The Challenge of Globalization (2003)by Andrea Goldstein, OECD Development Centre, Gilles Le Blanc, Ecole des Mines de Paris

Each of them pivoted around a lead firm: Bombardier in Montreal and Embraer in São José dos Campos. Successful entries in the close oligopoly of aircraft manufacturers dominated by the US and Europe. Supply Chain: A dramatic decrease in the degree of vertical integration over the last 30 years. Lead firms responsible for design and final installation of operating systems (such as wiring and electronics) …but fabrication of primary parts and assembly of major equ ipment are

outsourced to major Tier I partners with a myriad of sub-contractors. Huge investment (sunk costs), high market uncertainty (cyclical demand), long lead times, scale and scope economies: oligopoly structure with little vertical integration. Key competitiveness factors: labor costs and a nd labor flexibility, flexibility, government support, efficiency of the supply chain. Industrial Cluster - Aerospace Review of potential agglomeration externalities: Forward and backward linkages (e.g. suppliers and /or retailers transport savings) Labor market pooling Knowledge spillovers (promotion of innovation) Application to aircraft production: how to connect local innovation and productions systems with a global and concentrated industry Historical examples of Seattle, Toulouse. But less clear cut outcome for  information-based local externalities. Comparison with the auto industry and the diffusion of modular production models Main success factor: to identify the growth potential of RJs and to leverage existing technology and experience (AMX fighter, Brasilia small plane). Embraer contract with a small number of world first-tier suppliers (Chile, US, Belgium, Spain) sharing development costs and risks ($ 850m for ERJ170), and concentrate on design, de sign, assembly, assembly, and marketing/sales Local aeronautic SMEs: low capital base and high intensity of skilled labor, very dependent on Embraer (80% of turnover on average). However these 50 firms contribute to only 2% of the ERJ 145 final value, while the 350+ foreign partners account for 55% (Bernardes, Pinto, 2002). Efficient management of global knowledge and production flows was a key ingredient of the lead firms’ competitiveness. Crucial role of public policy directed towards the lead firms: direct capital investment, privatization, export subsidies, R&D programs, fiscal incentives Both clusters are based on a combination of local assets (skill, well-trained and comparatively cheap labor force) with the external knowledge acquired by the prime contractors. Strong dependency of SMEs. No specific policy articulated for the clusters.

When new programdevelopment does occur, oc cur, it can become a substantial cash flow burden. The required investment, even for a relatively modest size 90-100 seat aircraft is more than $2  billion, with estimates of up to $10-15 billion for a large wide body aircraft. With With such large sums of money at risk, major aircraft manufacturers have sought to shift as much of the development risk to others as possible. A rule of thumb is that about one third of the cost co st of developing a new aircraft will  be supplied each by the OEM, suppliers, and governments (direct support and through indirect means such as tax incentives).The global aerospace and defense market reached a value of $1,275.5 billion in 2005. Aruvian Research: Analyzing the Global Aerospace and Defense Industry. Most of Embraer’ Embraer ’s aeronautical engineers is from ITA. ITA. Aeronautical Technological Technological Institute, one of the world’s leading aeronautical engineering schools, run by the Federal Govt. Several reasons motivated Embraer to manufacture 70- to 120-seat planes. First, Embraer  identified a gap between capacity and demand for this range of planes. The absence of a true 70to 120-seat jet family had forced airlines to deploy planes that were either too large or too small to operate efficiently in the intermediate-demand market. In 2002, 61 % of flights in the United States departed the airport with loads appropriate for 70- to 110-seat aircraft. By Darden – University Of Virginia Virginia EMBRAER: SHAKING THE AIRCRAFT MANUFACTURING MARKET, 2008. The ERJ-145 is lighter, cheaper to buy, and 15% less expensive to operate than its main rival, Bombardier’s CRJ-200. Although it buys roughly half of its inputs abroad,making it the country’s country’s second largest importer,

Several European and American aerospace component suppliers chipped in as risk-sharing  partners for the ERJ-145, directly investing R$ 64 million (of a total equal to R$ 592.7 million, roughly US$ 300 million) in cash and materials and providing liquidity via deferred payment provisions. FAPESP- The State of São Paulo Research Foundation jointly fund key technological innovation. SMEs- Partnerships. While Embraer has not taken equity positions, some such firms were createdin the mid-1990s by skilled technicians laid off by Embraer and other aerospace companies.

In November 1999, Aérospatiale-Matra, Dassault Aviation Aviation and Thomson-CSF each eac h acquired a 5.5% stake in Embraer, and Snecma bought a further 3%, infused US$ 1 billion. The need to limit the degree of vertical integration was recognized early on as a key imperative, in order to avoid the risk of excessive fragmentation of business operations that had doomed  previous attempts at manufacturing aircraft in Brazil (Silva, 1998, p. 177).8 For the most part, Embraer shied away from manufacturing high-value, high-technolog y components and concentrated instead on designing the aircraft, producing fuselages, and assembling the final product.

Embraer : From National Champion to Glabl Player . Andrea Goldstein OECD Development Centre, Paris.

Core- Competance:

Relationship between Companies and Innovation and Learning Mechanisms The knowledge networks come from this level, where two important things occur: (a) a creative and integrated combination of R&D know-how and know-why; (b) the creation of competencies to innovate the product and the learning-byinteracting process. This phase was characterised by the project’s separation into its component  parts and by the distribution of tasks among the companies, followed by the definition of the airplane’s parameters between Embraer and the partners. The innovation of the ERJ-179/190  program resulted from a philosophy called “Collaborative Engineering Connected to Global Sites”, that is, an R&D network formed by b y labs and plants of the several international partners, centralised and coordinated by Embraer, in Brazil. Roberto Bernardes • Fundação SEADE, Passive innovation system and local learning.

The reas The reason onss that that led led the the comp company any to take take this this stra strate tegi gicc decis decisio ion n of maki making ng risk risk shar sharin ing g  partnerships are several: • Concentration of the activities in core competencies; • Need to reduce development time of its aircraft through shorter R&D cycles; Market opportunities achieved by means of having partners in different countries.

As such, with its excellence in design, integration capability and high aircraft technology, Embraer was able to attract partners on the global market who would take a stake in and invest in its projects. As for risk sharing partners, technology transfer by means of participation in the  project represented a major advantage.

Capability for Integration

Physical and simultaneous integration of various multidisciplinary and multicultural teams was decisive in some phases of the project, especially in the Joint Definition Phase. Embraer was able to coordinate the development process and establish a sequence of activities to save project time. Many of these complex development activities were performed in parallel. Usage of modern Informatio Information n Technology echnology tools such as extranet extranet communicatio communication, n, computer computer aided design and manufacturi manufacturing ng (CAD-CAM) (CAD-CAM),, Virtual irtual Reality Reality Center and electronic electronic mock-up mock-up were crucial crucial to assure integration of the project teams. 2. Mastering of key technologies The fact that Embraer was able to establish the project’s basic technical prerequisites permitted its autonomy as leader and enabled the choice of eventual partners. Concentration in core competences competences of design, design, materials materials engineering, system integratio integration, n, project project management management and supply of technical support to clients ensures independence of the company’s decisions and results in a sustainable competitive advantage. 3. Capability as a negotiator  The company was successful in making partnership contracts beneficial for both parties, in terms of participation in the projects, investments, budgets for the activities of each partner, clauses related to terms to be met, quality qu ality and adjustment requirements to the technical 4. Post-sale partnership services

Embraer’s partners also participate in client services, in the supply of replacement parts and services and even in training offered to clients. In a verticalized production process, this type of  activity may be offered only by the manufacturer, however in a shared design and manufacture  process it is important that partner companies be available, as they master specific technologies that the manufacturer does not. For Embraer the most significant learning during the ERJ-145  project was management of contracts between companies, not advantages related to technologies it did not have. Another thing learned was how to achieve cost reduction of the subcontracted   production processes. With the deverticalization process of production and balancing of its  production plants, Embraer created conditions to reduce the price of its products. The strategy that oriented the partnership program definitely is focused on costs and financial engineering. All this learning process led to an even more intense focus on the ERJ-170/190 program. Strategic partnerships were more integrated and complex. The project was carried out in codesign with partner companies. Another significant aspect that must be taken into account, the technical requisites of the new partners were determined prior to beginning of the aircraft  project, something that did not happen with the ERJ-145 project. Partnerships were made with large large multin multinati ational onal compan companies ies,, which which made made the aggregat aggregation ion of markets markets and distri distributi bution on of  develop developmen mentt costs costs easier easier,, thereby thereby minimi minimizin zing g capita capitall invest investmen ments, ts, enabli enabling ng acquisi acquisitio tion n of    busin business ess know-ho know-how w and commer commercia ciall and logist logistics ics infras infrastru tructu cture. re. To summar summarize ize,, the major  major  acquisitions in knowledge were:

• Develo Developmen pmentt proces processs integr integrate ated d with with inform informati ation on syste systems ms and networ networks ks interc interconne onnecti cting ng clients, suppliers and partners; • Ability to integrate project teams from various countries in a shared physical environment and later, in a separate environment; • Faster development of complex products, with shorter cycles; • Experience in the offering of post-sales services together with other partners; • Ability to negotiate strategic partnership contracts with other companies in the market; • Integration and products sales and services on global level, increasing the opportunity to internationalize business/markets. RISK SHARING PAR PARTNERSHIPS TNERSHIPS WITH SUPPLIERS: THE CASE OF EMBRAER by Paulo Figueiredo1, Gutenberg Silveira2 & Roberto Sbragia3* *University of Sao Paulo. Journal Of Technology Management and Innovation 2003. Productivity more than doubled in the years from 1995 to 1997, rising from US$84,000  per  employee to US$180,000 with a figure of  US$ 250,000 forecast for 1998. Production leadtime also showed significant improvement, falling from 12 months in 1995 to only six months in 1998