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Global Strategic Management December, 2006 Case Analysis Embraer: The Global Leader in Regional Jets

Global Strategic Management December, 2006

Case Analysis Embraer: The Global Leader in Regional Jets

Global Strategic Management December, 2006 Case Analysis Embraer: The Global Leader in Regional Jets
Global Strategic Management December, 2006 Case Analysis Embraer: The Global Leader in Regional Jets

Introduction

This case analysis examines the major issues and ideas from the HBS case Embraer:

The Global Leader in Regional Jets 1 and identifies the key attributes and characteristics

of a successful international aircraft company from Brazil. Despite many challenges and

the fact that Embraer is based in a developing country, Embraer has grown into one of the

world‟s most successful airplane manufacturers.

This paper discusses the nature of the

aircraft industry and competition, the key elements of Embraer‟s strategy, how Embraer

is adapting to address future market changes. Finally, the paper analyzes the paradox of

Embraer‟s rise and explores what that may imply about its home country.

Overview of the Commercial Aircraft Industry

Porter‟s Five Forces framework 2 provides a convenient way to analyze the dynamics of the commercial aircraft industry. The figure below shows a high level view of the key forces, barriers to entry, supplier power, buyer power, rivalry and the threat of substitution. This brief analysis does not take into account the military jet, corporate jet and the emerging “tiny jet” markets that also impact the strategies of aircraft manufacturers.

Barriers to Entry are extremely high with large initial capital investments required along with extremely high fixed costs. are extremely high with large initial capital investments required along with extremely high fixed costs. Additionally, highly skilled workers are required and learning curves for workers and companies are long. Because the value chain is highly integrated, that is partners and suppliers work very closely with the incumbent manufacturers, a new entrant is at a distinct disadvantage. There is a high degree of customer loyalty, coupled with very high switching costs for customers.

Supplier Power is variable. Suppliers with proprietary technology or extremely specialized expertise have high power. Suppliers of is variable. Suppliers with proprietary technology or extremely specialized expertise have high power. Suppliers of certain special materials and coatings also have high power. Some commodity suppliers of materials and services have relatively low power.

Buyer Power is extremely high causing severe pricing pressure on aircraft manufacturers. The industry often experiences periods is extremely high causing severe pricing pressure on aircraft manufacturers. The industry often experiences periods of over capacity which puts further downward pressure on prices. Customer preference and flying trends may help bolster the power of buyers in negotiating with manufacturers who have long development cycles and may have inventory which may not meet the current trends and needs of the buyers. On the other hand, switching costs for buyers are very high and have a fairly long time horizon.

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Threat of Substitutes are low with no cost effective alternatives available for commercial jets. are low with no cost effective alternatives available for commercial jets.

Industry Rivalry is very high with two major duopolies dominating the industry: Airbus vs. is very high with two major duopolies dominating the industry: Airbus vs.

Boeing in large jets and Embraer vs. Bombardier in regional jets.

times mean that every new model is critical to the success of the vendor and any misstep could spell disaster. Long development lead times mean rivals can plan counter-moves well in advance and catch an emerging trend while a competitor may already be committed to a

Long development lead

certain direction.

   

SUPPLIER POWER

 
Specialized Suppliers Importance of supplier partnerships Impact of inputs on cost or differentiation Lack of

Specialized Suppliers Importance of supplier partnerships Impact of inputs on cost or differentiation Lack of substitute inputs Some Threat of forward integration Ample set of technology providers

 
 

BARRIERS

 

RIVALRY

THREAT OF SUBSTITUTES

TO ENTRY

Strong rivalry between players Duopolies in 2 segments (Boeing vs. Airbus Large Jets Embraer vs. Bombardier Regional Jets) Cyclical Industry Intermittent Overcapacity High Switching Costs Brand identity Long Development Cycle Times (Rivals can plan counter- moves)

 
Very High Costs of Entry Initial Capital Investment High Fixed Costs

Very High Costs of Entry Initial Capital Investment High Fixed Costs

No compelling or adequate substitutes for commercial jets:

Trains

   

Automobiles

Long Learning curve Government support required Skilled Engineers/Technical Brand Loyalty Customer Switching Costs Access to technology partners (Integrated Value Chain) Incumbent Retaliation Proprietary Products

Ships

Helicopters

Customer Switching Costs are very high

Ships Helicopters Customer Switching Costs are very high   BUYER POWER   Customers - Bargaining leverage
 

BUYER POWER

 

Customers - Bargaining leverage Buyer Power is High Buyer has transparent information Brand identity Price sensitivity Require Product differentiation Buyer concentration vs. industry Buyers' incentives(option)

   

Diagram of Porter's Five Forces for the Commercial Aircraft Industry

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Core Elements of Embraer’s Strategy

Embraer‟s core strategy can be summarized by the following bullets:

Interdependence with Brazilian Government Focus on Regional Jet Market “Family” Approach to Product Development Cultivate relationships and risk share with technology partners and parts suppliers Focus on “Intelligent Systems”, Engineering Project Management Risk Partner and Supplier Strategy “Intelligent Systems”

Interdependence with Brazilian Government

Embraer was founded by the Brazilian government and the company is a source of

national pride.

In 1994, after privatization, the Brazilian government continued to

provide subsidies in the form of loans to Embraer to provide capital funds to start new

initiatives.

As quoted by Embraer CEO Botelho, “We want to keep on being the

technological and industrial arm of the Brazilian government, although of course, we

have to make profits.” 1 Embraer recognizes the role its home country plays and the fact

the United States, home country to its largest customers, is not going to offer the type of

the support that the Brazilian government will provide.

Focus on Regional Jet Market

In the commercial aircraft market, Embraer produces planes exclusively for the

Regional Jet market.

Embraer provides aircraft that are less expensive to produce and

operate than its main competitor, Bombardier.

Airbus and Boeing make larger aircraft

and do not compete in the regional jet market.

In the past few years, Embraer has

expanded its strategy to also focus on the 70 to 110 seat market as portrayed on their

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Embraer‟s campaign points out the

inefficiencies of flying planes that are too large for regional flights or too small to handle

increasing demand. Their claim is that the 70 to 110 seat plane fills a void for customers.

Embraer not only provides less expensive planes, they have developed roomier planes

with innovations such as the “double-bubble” design 8 that allows more head room and

larger cabin space for passengers.

Another part of Embraer‟s strategy is to use larger

regional jet aircraft to replace the aging fleet of planes that may be too large to operate on

the increasing number of short-haul routes. In a sense, Embraer is preparing to compete

with Airbus and Boeing, but their approach is subtle: create/identify the market, fill a

void and replace aging aircraft that are going to be retired.

Product Families

Embraer‟s method of managing its product lines is based around “families” of

aircraft.

Rather than developing a single model, Embraer designs it products based on

platforms than can be scaled to larger or smaller capacities allowing for parts reuse and

reduction of learning curves for its staff and the staff of its customers.

This strategy

keeps costs low and improves time to market.

The platform or family approach to

product management reduced time to market by two to three years, allowing Embraer

aircraft to be introduced in less than half the industry standard time that new plane

projects require 6 .

The platform approach to product management works hand in hand with Embraer‟s

strategic partnership strategy. Embraer‟s strategy can be broken into three parts 6 :

Embraer‟s strategy can be broken in to three parts 6 : Choose Technology Areas aimed at

Choose Technology Areas aimed at product innovation and fulfilling the needs/requirements of customers

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Identification of risk partners for supply of parts and subsystems (“technology packages”)Cultivation of local subcontractors for engineering services, chemical coatings, milling and other specialized aircraft

Cultivation of local subcontractors for engineering services, chemical coatings, milling and other specialized aircraft technologiessupply of parts and subsystems (“technology packages”) Strategic Partnerships For key technology areas, it is not

Strategic Partnerships

For key technology areas, it is not important that Embraer manufacture every key

technology, but rather the company leverages its core capabilities in systems integration,

marketing and technical services coordinating the risk partnerships. The risk partners are

enlisted to supply key components of the aircraft and are required to invest their own

funds for development, thereby taking on some of the risk of the project.

Partners are

rewarded if the project is successful in supplying primary components and spares for the

life of the new aircraft line.

Most of the risk partners are located outside of Brazil, but

co-locate engineers in São José dos Campos.

Local subcontractors are used extensively

for engineering services, milling, and coatings. Many of the local firms were founded by

former Embraer employees, resulting in an aircraft industry “cluster”.

Intelligent Systems

Instead of attempting to build an entire aircraft and develop all technologies within

Brazil, Embraer has chosen to focus on key aircraft technologies while building core

expertise in aerodynamics, fuselage and systems integration. 6 The decision to focus on

the fuselage was driven partly because this technology could not be easily sourced

outside of Brazil and thus it provided a good area for Embraer to develop its own

expertise.

This became part of Embraer‟s determination not to outsource the aircraft

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cockpit nor “anything that was not integral to its longer term strategy of concentrating on

the provision of „intelligent systems‟” 1 . Embraer‟s recognition of the fact that increasing

its competency in systems integration is more important than the ability to create or

manufacture all of the technologies in an aircraft, provided it with a realistic approach to

competing globally.

Disruptive Innovation?

Another useful

framework

for

analyzing

the

commercial

aircraft

industry and

Embraer‟s strategy is from the point of view of “disruptive technology” described by

Clayton Christensen 4 .

The commercial aircraft industry is dynamic and subject to the

effects of Porter‟s five forces as described earlier.

Vendors in this industry need to be

cognizant not only of economic factors that impact buyers (airlines) but also of

passenger preference trends.

A keen awareness of passenger trends allows vendors to

understand market dynamics and sustain or improve their current position. Furthermore,

an appreciation of the role disruptive innovation may lead manufacturers to discover new

opportunities and grow future sales.

As applied to the aircraft industry, Christensen‟s model could be represented as in the

graph below:

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From the analysis, Embraer could choose to compete with the Airbus 320 and Boeing 737

From the analysis, Embraer could choose to compete with the Airbus 320 and Boeing

737 in some sectors.

With superior operating margins, Embraer presents a compelling

case for airlines to consider Embraer aircraft to assemble lighter and more fuel-efficient

fleets. Based on the previous Porter analysis, the reaction of the incumbent vendors must

be considered. Although one would expect them to “defend” their “turf”, the Airbus 320

and Boeing 737 are larger aircraft and more expensive to operate. One could argue that

Embraer has already eaten into some of the market share that would have been been

attained by Airbus or Boeing by filling the 70 to 110 seat void with lower cost aircraft.

However, according to Embraer CEO Botelho, entering the 135 seat aircraft market is not

in the cards for Embraer as this would mean “jumping into the big dogs‟ market”, a

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reference to Airbus and Boeing 8 .

Rather, he would prefer to diversify into the defense

market and expand in the business jet market.

Alliances and Partnerships A new strategic direction or logical outgrowth?

From

their

founding,

Embraer

formed

strategic

relationships

with

technology

partners.

The first Embraer jet trainer licensed technology from the Italian firm

Aermacchi for a product to be used by the Brazilian Air Force.

Other technology came

from the Brazilian Aeronautical Technical Center‟s (CTA) Institute of Research and

Development (IPD).

Embraer learned to incorporate technology from different sources

while strengthening core competencies in intelligent systems, systems integration and

project engineering.

The use of risk partners not only benefits Embraer from a

technological point of view, but also from a financial and capital structure point of view.

Based on Embraer‟s past with the turbulent Brazilian economy of the early 1990‟s to

Botelho‟s restructuring in the middle 1990‟s, to the WTO dispute, Embraer has always

faced difficulties with respect to funding projects. In addition to the regional jet market,

Embraer participates in competition for defense business in Brazil and globally.

While

Botelho would like to expand Brazil‟s share of the defense business, his success has been

limited.

The 1999 announcement of a strategic alliance with a group of French aerospace

companies was a logical outgrowth of Embraer‟s overall strategy of risk partnerships.

Embraer had already embarked on an effort to work with fewer key suppliers on the ERJ-

170/190 (only 26 vendors vs. 45 for the ERJ-145) 6 . The US defense market had proven

difficult to break into.

An alliance could provide extra capital funding, technological

resources and credible partners to bolster business in this important sector not subject to

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WTO restrictions. Also, this move was consistent with Embraer‟s core strategy to

develop “Intelligence Systems”.

Defense Systems” 1 .

In the defense context, this translates to “Intelligent

The new alliance provides the capability for Embraer to transfer in technological

know-how for supersonic aircraft, and allows expansion into defense systems for naval

and ground support 1 .

An alliance is also a good alternative to being acquired which

would most likely be defeated by government veto. Overall, in terms of diversification in

product lines, capital funding sources, and acquisition of new technological capabilities,

the alliance is a good fit and is consistent with Embraer‟s core strategy.

A Global Leader from an Emerging Economy

According

to

Porter,

companies can do that.7

catalyst and challenge”.

“Government

cannot

create

competitive

industries;

only

In the case of Embraer, the role of government is to act as "a

Embraer can credit part of its success to “government-

sponsored institutional and technological developments dating back to the 1950s” 6 .

Embraer implemented much of the IPD technology to its advantage but created its own

methods of technological innovation and internal learning to carry it forward. Embraer is

responsible for increasing the size and capabilities of the São José dos Campos region

and creating a local aircraft design cluster for Brazil.

Even with government help, the appearance of Embraer in a developing country such

as Brazil appears to be an anomaly.

However, in the context of Porter‟s analysis of the

Competitive Advantage of Nations, some of Brazil‟s lack of endowments actually created

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the necessity out of which Embraer was born. For example, Brazil has large amounts of

land

through

difficult

terrain

and

wide

rivers

but

limited

surface

transportation

infrastructure. Aircraft are a natural way to overcome these challenges.

In applying Porter‟s Diamond Framework to Embraer, we can analyze the success of

the company and attempt to understand the reasons for this success.

and attempt to understand the reasons for this success. 1. Firm Strategy, Structure and Rivalry Embraer

1. Firm Strategy, Structure and Rivalry

Embraer has no domestic rivals in the aircraft business. Embraer was founded by the

government and later was privatized. There is an active aircraft industry in the local

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suppliers to Embraer in São José dos Campos which mirrors the technology cluster

that the United States has in the area surrounding MIT.

2. Demand Conditions

Embraer has very demanding local and global customers.

Locally, the Brazilian

Defense Force and Brazilian Airlines do not automatically choose Embraer.

They

must compete and win on a level playing field. Brazil‟s domestic buyers are just as

discerning as global buyers.

3. Related Supporting Industries

In São José dos Campos, Embraer enjoys geographic proximity to upstream and

downstream industries.

This facilitates the exchange of information and promotes a

continuous exchange of ideas and innovations. These local suppliers are also free to

compete globally.

4. Factor Conditions

Brazil did not inherit any key factors to help them enter the aerospace business. After

World War II, highly skilled and specialized labor was cultivated. Embraer never had

easy access to capital or benefited from a strong Brazilian infrastructure. Over time,

Embraer has developed core competencies and has helped São José dos Campos to

grow,

creating

specialized

factors

and

conditions

helping

to

foster

sustained

innovation and investment from overseas. These factors are difficult to duplicate and

have created competitive advantage.

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Implications for Brazil

Embraer‟s success demonstrates that with the proper mix of government support,

strong

corporate

leadership

and

sound

strategy,

Brazilian

companies

can

succeed

globally.

Embraer is a great source of national pride for Brazil and serves as a shining

example of how a Brazilian company can compete on a global basis. However, the

company faced adversity and was able to overcome it through strong leadership,

partnerships with and incentives from the government, along with global risk partnerships

structured to allow technology and capital to flow into Embraer.

By adding value and

leveraging technologies from other countries, Embraer was able to build its own core

competencies and achieve global leadership in the regional jet market. Other businesses

in Brazil are equal candidates for success, specifically satellite and fuel technologies. As

Porter points out, the government may act as a catalyst, but only companies can create

sustained competitive industries.

Managers that recognize the fact that their home nation is integral to their success will

promote continuous innovation while welcoming the formation of clusters of like

competitors to create national centers of excellence.

These clusters will lead to what

Porter calls the “Diamond of National Advantage” which is a self-reinforcing construct

that is difficult for other nations to imitate.

Ultimately, nations that wish to be

competitive effectively on a global basis need to realize that “only companies can achieve

and sustain competitive advantage” and that the “capacity of its industry to innovate and

upgrade” is essential.

Armed with this knowledge, national policy makers can make

decisions to foster an environment conducive to supporting industries that will be able to

take advantage of the lessons described above.

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References

1. Embraer: The Global Leader in Regional Jets, Pankaj Ghemawat, Gustavo A.

Herrero, Luis Felipe Monteiro, Harvard Business School, 9-701-006, October 20,

2000

2. How Competitive Forces Shape Strategy, Michael E. Porter, HBR Article, March- April 1979.

3. Designing and Implementing a New Supply Chain Paradigm for Airplane Development, Yun Yee Ruby Lam, MIT, June 2005,

4. Global Collaboration and Implementation World Aerospace Symposium-2005, Tim Bowler, www.aviationweek.com/conferences

5. The Innovator‟s Dilemma, Clayton M. Christensen, Harper Business, 2000, New York

6. Transfer of Technology for Successful Integration into the Global Economy, A case study of Embraer in Brazil, José E. Cassiolato, Roberto Bernardes and Helena Lastres, UNCTAD, United Nations, New York and Geneva, 2002,

7. The Competitive Advantage of Nations, Michael E. Porter, HBR 90211, 1990

8. The Little Aircraft Company that Could, Russ Mitchell, Fortune Magazine, November 14, 2005

9. Airbus vs. Boeing Revisted: international competition in the aircraft market, Douglas A. Irwin, Nina Pavcnik, Journal of International Economics, 28 August 2003,

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