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 Jets1 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 worlds most successful airplane manufacturers. This paper discusses the nature of the aircraft industry and competition, the key elements of Embraers strategy, how Embraer is adapting to address future market changes. Finally, the paper analyzes the paradox of Embraers rise and explores what that may imply about its home country.

Overview of the Commercial Aircraft Industry Porters Five Forces framework2 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. 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 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 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. Industry Rivalry is very high with two major duopolies dominating the industry: Airbus vs. Boeing in large jets and Embraer vs. Bombardier in regional jets. Long development lead 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 certain direction.

SUPPLIER POWER
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 TO ENTRY
Very High Costs of Entry Initial Capital Investment High Fixed Costs 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

RIVALRY

THREAT OF

Strong rivalry between players SUBSTITUTES Duopolies in 2 segments No compelling or adequate (Boeing vs. Airbus Large Jets substitutes for commercial jets: Embraer vs. Bombardier Trains Regional Jets) Automobiles Cyclical Industry Ships Intermittent Overcapacity Helicopters High Switching Costs Brand identity Customer Switching Costs are very high Long Development Cycle Times (Rivals can plan countermoves)

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 Embraers Strategy Embraers 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 website: www.ruleof70to110.com/main/index.html. Embraers campaign points out the

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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 design8 that allows more head room and larger cabin space for passengers. Another part of Embraers 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 Embraers 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 require6. The platform approach to product management works hand in hand with Embraers strategic partnership strategy. Embraers strategy can be broken into three parts6:

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 technologies

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 So Jos 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 Embraers 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 systems1. Embraers 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 Embraers strategy is from the point of view of disruptive technology described by Clayton Christensen4. The commercial aircraft industry is dynamic and subject to the effects of Porters 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, Christensens 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 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 Boeing8. 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 Centers (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 Embraers past with the turbulent Brazilian economy of the early 1990s to Botelhos restructuring in the middle 1990s, 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 Brazils 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 Embraers overall strategy of risk partnerships. Embraer had already embarked on an effort to work with fewer key suppliers on the ERJ170/190 (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 Embraers core strategy to develop Intelligence Systems. Defense Systems1. 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 support1. 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 Embraers core strategy.

A Global Leader from an Emerging Economy According to Porter, Government cannot create competitive industries; only companies can do that.7 In the case of Embraer, the role of government is to act as "a catalyst and challenge. Embraer can credit part of its success to government-

sponsored institutional and technological developments dating back to the 1950s6. 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 So Jos 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 Porters analysis of the Competitive Advantage of Nations, some of Brazils 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 Porters Diamond Framework to Embraer, we can analyze the success of the company and attempt to understand the reasons for this success.

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 So Jos 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. Brazils domestic buyers are just as discerning as global buyers.

3. Related Supporting Industries

In So Jos 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 So Jos 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 Embraers 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, MarchApril 1979. 3. Designing and Implementing a New Supply Chain Paradigm for Airplane Development, Yun Yee Ruby Lam, MIT, June 2005, https://dspace.mit.edu/handle/1721.1/34854 4. Global Collaboration and Implementation World Aerospace Symposium-2005, Tim Bowler, www.aviationweek.com/conferences 5. The Innovators 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, Jos E. Cassiolato, Roberto Bernardes and Helena Lastres, UNCTAD, United Nations, New York and Geneva, 2002, http://www.unctad.org/en/docs/iteipcmisc20_en.pdf 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, http://www.dartmouth.edu/~dirwin/airbus3.pdf

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