case study embraer

18
ISB PGPMAX Brazil Term Embraer: in Search of Sustainable Competitiveness Prof. Carlos Arruda; Prof. Georges Blanc; Profa. Erika Barcellos Revised Version January 2011

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Page 1: Case Study Embraer

ISB PGPMAX Brazil Term

Embraer: in Search of Sustainable

Competitiveness

Prof. Carlos Arruda; Prof. Georges Blanc; Profa. Erika Barcellos

Revised Version January 2011

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PRODUCING AIRCRAFT FOR THE WORLD IN BRAZIL

EMBRAER: IN SEARCH OF SUSTAINABLE COMPETITIVENESS

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PRODUCING AIRCRAFT FOR THE WORLD IN BRAZIL

EMBRAER: IN SEARCH OF SUSTAINABLE COMPETITIVENESS

“Some years ago our competitors used to say: How dare these “ugly ducklings” from South

America try to sell an aircraft in the Northern Hemisphere? Fortunately, they

underestimated us.”

Satoshi Yokota, Vice-President of Engineering and Development of Embraer

“Embraer is a company that is trim, aware and competitive.”

Michael Boyd, chairman of the Boyd Group, consultancy company in aviation

The Chinese, the Russians and the Japanese are developing aircraft. They are countries that

are trying to develop their own aircraft industry and that will obtain slices of the market,

especially in their own countries.”

Mauro Kern, executive vice-president of Embraer

In June 2008, Embraer had climbed to third position among the world manufacturers of

commercial aircraft. With a backlog of orders of up to four years for some of its commercial

and executive jets and growing domination in the sector of commercial aircraft of 70 to 120

seats, the company had overtaken the Canadian Bombardier, occupying a position nearer

Airbus and Boeing, the two largest manufacturers of commercial aircraft in the world. In

spite of this success in the business, the value of its shares continued low (Annex 1).

With head office in São José dos Campos, around 100 km from São Paulo, Embraer

possessed five factories in three municipalities of the state of São Paulo. Abroad, it was

present through subsidiaries, offices, technical assistance and parts distribution centres,

located in Australia, China, Singapore, the United States and France. In factory terms, it

operated in Europe with a maintenance and repair structure for civil and military aircraft

and, since 2003, has been operating its first complete industrial unit located outside Brazil,

under the Harbin Embraer Aircraft Industry joint venture – HEAI – in the North-East of

China (Annex 2). Intended for the assembly of aircraft of the ERJ 145 family, in 2007 the

joint venture was already a profitable concern.

In the global industry of aircraft manufacture, Embraer had the position of a low cost

manufacturer focused on the narrow market of regional jets, which represented around 8%

of the world aircraft market. Its suppliers were large international companies such as

Honeywell, Liebherr, General Electric, Kawasaki, Parker, Gamesa and Hamilton Sundstrand.

These companies were risk partners, which not only supplied more than 85% of the parts,

but favoured Embraer cost control. In this way, the Brazilian company was successful in

putting in first place dedication to aircraft projects, and the coordination of product

development.

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In spite of its more than 40 years’ experience as a commercial jet manufacturer, Embraer

was still small in comparison with the two global leaders. While its revenue in 2007 had

been US$5.2 billion, Boeing’s sales and those of the controlling company of Airbus had

reached US$67 billion and US$60 billion, respectively.

With sales of commercial aircraft representing almost 70% of its business, the Brazilian

company had decided to invest in the market of executive aviation. Its objective was to

become one of the five largest manufacturers of executive jets in 2015, and, with this

intent, it had already initiated the development of five aircraft.

Embraer also sought expansion of its global reach and had announced, in May 2008, its

plans to invest US$50 million in the construction of a factory for the assembly of executive

jets in the airport of the city of Melbourne, in the state of Florida. The intention was to

transfer orders from American companies and individuals to the USA unit, by getting closer

to its principal market. Another objective, in view of the fact that the increase in value of

the Brazilian currency against the Dollar had caused a negative impact on Embraer’s

financial results, was to reduce company costs in Reals.

In the United States, the company already maintained one business unit in Fort Lauderdale

(Florida) and maintenance centres in Texas. Expansion of activities abroad also included the

assembly of three new after-sales service centres (substitution of parts, maintenance,

etc...) for executive jets in the United States, and another in France. Other investments

were directed towards warehouses for stocking parts in Singapore and China. In addition,

in partnership with the Canadian CAE – manufacturer of flight simulators – a training centre

was planned for pilots and mechanics of jets belonging to the executive aviation segment.

In addition to operating in the commercial and executive aviation markets, which

corresponded to 64.4% and 16.6% of net revenues in 2007, respectively, Embraer supplied

aircraft for the defense and government markets (6.6% of net revenues in 2007) and

aviation services (10.1% of net sales in 2007). Other related business represented 3.0% of

the net sales of US$ 5,245 million in 2007(see 2010 data in Annex 7).

The company had its shares negotiated on the São Paulo Stock Exchange since 1996 and,

from 2000 on, American Depositary Receipts – ADRs – negotiated on the New York Stock

Exchange. In 2006, it was included in the Business Sustainability Index – ISE – of the São

Paulo Stock Exchange. In the same year, after becoming a company with pulverized capital,

without the figure of the Controlling Group or shareholder, it had obtained Investment

Grade with Moody’s and Standard & Poor’s (Annex 3). In 2007, when it obtained a net

profit of US$ 489 million, Embraer was employing approximately 23,700 people, of which

88% were located in Brazil (Annex 4).

BRAZILIAN INDUSTRIAL POLICY AND THE FOUNDATION OF EMBRAERi

The history of Embraer is an intrinsic part of the efforts of the Brazilian Government to set

up a strong local aeronautical industry. In 1941, the Brazilian Government created the

Ministry of Aeronautics to supervise both civil and defense aviation. In the mid-40s and

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mid-50s, the Air Force Technological Centre – CTA –, for the purpose of carrying out

projects in the aircraft industry area was set up, together with the Air Force Technological

Institute – ITA –, to train aeronautical engineers, and an institute of research and

development, the IPD, to take in 50 German specialists in aeronautics contracted after the

end of the Second World War. All these institutions were set up in São José dos Campos –

SJC –, a small town 88 km from São Paulo, the most important industrial centre in Brazil.

In August 1969, the Brazilian Ministry of Aeronautics created Embraer, to produce military

and commercial aircraft in São José dos Campos. Embraer was to combine the resources of

a state company with the business agility of a private one. The most important of the

proponents of the new company, Ozires Silva, graduated from the ITA and an officer in the

air force, became its first president. The presidential decree that instituted Embraer

stipulated that the Brazilian Government would control at least 51% of its capital. It also

granted to the company some special privileges. Federal institutions should buy from

Embraer, instead of from its competitors, whenever possible. Embraer would not pay taxes

or charges for the importation of raw materials, parts and equipment not available locally.

In addition to this, Brazilian corporations could invest annually 1% of their obligations

relative to federal income tax in Embraer shares. This scheme helped the company to raise

capital estimated at $350 million between 1970 and 1985.

Embraer quickly entered three segments of the aviation business: regional passenger

aircraft, military aircraft and aircraft for special purposes. Among the first products were

the Xavante (1971), a jet aircraft for training and ground attack assembled under licence

from the Italian company Aermacchi to fulfil an order from the Brazilian Air Force – FAB;

the Ipanema (1972), an aircraft for crop spraying that the IPD research institute of the CTA

had started to develop, and the Bandeirante (1973), a turboprop aircraft with a capacity for

19 passengers, also derived from an IPD project. In two years, Embraer sales started to take

off due to the orders for the Bandeirante made by Brazilian regional aviation companies.

EXPANSION

With the support of the government, Embraer signed a licensing contract to manufacture

the Piper aircraft in Brazil. In exchange for the license, the Brazilian Government increased

from 7% to 50% the charges on the import by competitors of the Piper. As a result,

Embraer sold more than a thousand Piper aircraft in the four subsequent years. This

irritated Cessna, which had dominated the Brazilian market previously and that,

subsequently, lobbied against the attempts of Embraer to sell the Bandeirante to North

American airline companies.

Embraer’s first export orders came from Uruguay and Chile, but the company soon started

to scan the horizon further. At the end of the 70s, it embarked on a wave of exportations

after obtaining the certification for the Bandeirante in the United States, France and the

United Kingdom. Sales in the American market, for example, grew by five aircraft, in 1979,

by 39, in 1981, the year in which Embraer created a subsidiary entirely controlled by her in

the United States to concentrate the sales efforts there. At this time, Embraer had already

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captured 46% of the turboprops regional aviation market and the Bandeirante, nicknamed

Bandido (bandit, in English), had overtaken the former leader, a Fairchild.

After the success of the Bandeirante, Embraer started to work on the Brasília, a pressurized

double turboprop, with a capacity for thirty passengers. Certified in 1985, the Brasília,

when launched, was the fastest and lightest aircraft in the 30 to 40 seat segment.

In military aviation Embraer developed, in the 70s the Embraer EMB-312 Tucano, a

turboprop training and light attack aircraft. Its first flight was made in 1980, and the first

units were delivered in 1983. Designated in the Brazilian Air Force (FAB) as the T-27, it was

intended for the intermediate training of pilots, and also used as a light attack aircraft

being designated the AT-27. A modern aircraft with seats in tandem (back seat higher than

the front), it was one of Embraer’s greatest successes, with a production of over 600 units

of which 127 went only to FAB.

At the start of the 80s, Embraer established a partnership with Aeritalia (later known as

Alenia-Aeronáutica) and Aermacchi, both Italian aircraft manufacturing companies, to

develop a supersonic combat jet. This project, known as the AMX Program, allowed the

access of Embraer to new technologies, which played an important role in its future.

FIRST CRISISii

The end of the1980s and the start of the 1990s were bad for Embraer in the same

proportion as the previous years had been good. The end of the Cold War, which led to

drastic reductions in worldwide disbursements with defense, the new Constitution of 1988,

which reduced the support of the Brazilian Government to the aeronautical industry,

combined with a global recession, were the principal challenges faced.

Embraer, initially, reacted to these challenges intensifying action that had worked in the

past. Historically, the in-house executives looked on Embraer as an engineering company,

believing that the manufacture of aircraft based on high technology was sufficient to

guarantee success. This strategy led the company to try to extend and perfect the line of

turboprops. US$280 million were invested in an exceptional model, the CBA 123 in

partnership with the Argentine FMA, even although the market had started to order short

range jets instead of turboprops. The jets made less noise, were faster, flew higher

(avoiding the bad weather) and had a reputation of being safer. “It made more sense for us

to develop a jet version than to set off on the Brasília project, but we continued to do what

had worked in the past”, says one Embraer engineer. Two prototypes of the aircraft were

built that made their inaugural flight on 18 July 1990. Considered one of the most modern

aircraft of its time, it included cutting edge technology in avionics, aerodynamics and

propulsion. The prototypes were dismantled after the premature end of the project that

came about because of the high costs that made the aircraft unfeasible for the civil market.

Even so, the knowledge acquired resulted in the modelling of the very successful jet, the

Embraer ERJ-145.

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PRIVATIZATION

At the start of the 90s, with sales in free fall and debts scaling new heights, Embraer was

passing through the worst crisis of its little more than two decades of history. In 1991, after

five years out of the company, Ozires Silva returned, took a series of measures to make the

company economically feasible and started to prepare the privatization process. Ozires

Silva reduced the number of staff from 9,000 in 1991, to 6,200 in 1994, he interrupted the

CBA 123 program (keeping part of the technology for use in a jet version of the Brasília). He

also managed to persuade the government to assume US$700 million in debts and inject

US$350 million cash into the company before its privatization, in 1994. The company

president could have taken more drastic steps, but was under restrictions from the

government, which wanted to preserve jobs.

Privatization occurred in 1994, when the share control was assumed by a consortium

formed by the BozanoSimonsen group and by the two largest Brazilian pension groups:

Previ – the pension fund of the staff of the Bank of Brazil and Sistel – the equivalent for

Telebrás. Privatization has changed the situation of Embraer, which was soon obliged to

become slimmer due to the financial problems faced. The government, however,

continued exercising influence in the management of Embraer, even after privatization.

The participation in some strategic decisions (veto on the change in the main business of

the company, veto on the change of the name, creating or altering defense programs,

change in the share control, etc..) continued to be possible through the rights inherent to

the Golden Shares that it held.

NEW MANAGEMENT

In September 1995, MaurícioBotelho took over as principal executive of Embraer. This

mechanical engineer was already an experienced executive, coming from the Board of

Directors of the principal member of the consortium that had bought Embraer. Botelho

soon concluded that Embraer had concentrated too much in perfecting its technology, and

had consequently lost sight of the customers and the capacity to develop products that

met the needs of these customers.

To stress the importance of orientation towards the customer, Maurício Botelho took as an

example the CBA 123, an Embraer aircraft that was not sold in spite of its technological

superiority. According to the president, the CBA 123 was an aircraft modelled by engineers

for pilots, and ignoring the customer. They say that Botelho insisted on having a photo of

the CBA 123 in the Embraer offices, as a constant reminder of the dangers of forgetting the

customer.

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Building organizational agility at Embraer

August 24, 2010 5:59am | http://blogs.ft.com/donsullblog/2010/08/24/building-

organizational-agility-at-embraer/

As a state-owned enterprise, Embraer had long suffered under stifling bureaucratic

processes. One long-time employee recalled, “Embraer was subject to many procedures,

norms and government audits, which contributed to bureaucratizing the company, setting

barriers to its efficient operations.”

Founder and long-time CEO Ozires Silva initially wanted to establish Embraer as a private

firm, and resorted to government funding only after failing to persuade private investors to

finance such a risky enterprise. Under Silva’s leadership, Embraer was not as bad as many

other state-owned enterprises in Brazil: bloated infrastructure, over-politicized

appointments and lack of long-term financing. But it still suffered from the bureaucracy

that often plagues state-owned enterprises.

However, government influence prevented Embraer from promoting employees based on

merit, responding quickly to changing market conditions, or developing sophisticated

financial engineering strategies. Nevertheless, his successor dramatically increased the

organization’s agility through a number of steps.

- Delayer and organize around customers. To reduce the distance from the top to the

bottom of the organization, Botelho reduced the number of managerial levels from seven

to five. By 1996, Botelho transformed the hierarchical structure into a matrix organization

in which teams were organized around projects designed to increase autonomy,

participation and flexibility. Project teams were organized to solve specific customer needs.

Labor stations were made up of cross-functional teams working for specific customers. Top

management constantly stressed that what mattered most were not the traditional “lines”

of reporting but one line that went from customers to shareholders.

- Manage ad hoc projects and initiatives as a portfolio. During a transformation, many

companies are overwhelmed by initiative overload that dissipates resources and stretches

employees too thin. To coordinate various projects and initiatives, Embraer launched an

Organizational Transformation Project around the implementation of enterprise resource

management software. The project - based structure and increased employee participation

– allowed Embraer to reduce time to develop new projects and increase its reaction speed

to new information.

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- Bring in new blood. Embraer’s senior executives further increased flexibility by replacing

hidebound employees with new managers and workers. Botelho started at the top, and

replaced most of Embraer’s senior managers, bringing half of them from outside and

promoting the rest from within. Over time, he also shifted the composition of the

workforce. At the time of the privatization, 80% of employees had worked for more than

10 years and 50% for more than 20 years. The initial headcount reductions targeted senior

employees, who were eventually replaced with younger employees. By 2001, Embraer had

more employees than it did before privatization (11,500), at an average age of 34 years. To

attract new employees, Embraer adopted an aggressive profit-sharing programme in which

workers as a group could receive the equivalent of 25% of the dividends paid out to

shareholders.

- Invest in training general managers. Embraer has further increased the flexibility of the

workforce by increasing their average educational attainment. More educated workers can

be transferred between functions more easily. In 2002, 37% of all employees had

undergraduate degrees, and 7% held a masters or PhD diploma. The company also invested

over $60 million over three years in training at all levels. The company established an in-

house MBA course that trained 35 of the most promising leaders per year. A school

specialized in aeronautical engineering was also established, where 200 recently minted

engineers spent a year and a half on supplemental studies of aeronautics. The first class

received 6,000 applicants, a number that increased to 9,000 for the second class.

• ERJ 145

Consultancy studies carried out before privatization demonstrated that the regional jet

segment should expand drastically over the following years, propelled by the growth of the

small air companies that had arisen after deregulation of the field in the United States. In

addition to this, the company could benefit from the growing pressure of passengers for

companies to exchange their turboprops for jets, more comfortable and less noisy, in spite

of being less economical in terms of outlay with fuel.

Embraer therefore started to concentrate its efforts on a new product, the 50 seat jet ERJ

145, appropriate for the regional jets market. The rapid development of the ERJ 145 gained

the status of Embraer’s principal effort, and was called the “program of salvation” of the

company.

Unlike Bombardier, Embraer had no old jet to redesign, which allowed the engineers to

accomodate the suggestions of customers, such as the division of the seats two-one, so as

to give passengers more space. Ironically, the competencies in CAD/CAM and other

innovations that had increased considerably the costs of development of the turboprop

CBA 123 were ideally suited for the project and construction of the ERJ 145. In parallel,

Bombardier simply widened their executive jet, turning it into a commercial jet with 50

seats, so that the new aircraft carried more than one and a half tons of extra load, offering

outdated systems and unnecessary operational characteristics.

In 1996, Embraer concluded the development of the ERJ 145 commercial jet and, to ensure

proximity with their 75 main customers, opened offices in Australia (1997), China (2000),

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Singapore (2000) and a new distribution centre in Dallas. The comfortable modern regional

jet, launched three years after the entry of Bombardier in the market, was two tons lighter,

three million dollars cheaper and 15% cheaper to operate than Bombardier’s $21 million

model (Annex 5).

The principal objective of the company became customer satisfaction, in the attempt to sell

new aircraft.

I knew that the ERJ was a good aircraft… but aircraft are very similar. You can have

one better than the other under specific conditions, but technologically speaking they

are very similar products. So what I said was that, if we had 75 customers, then we

should know their names, their nicknames, their families, how they run their business,

what each demands, which is what is needed to know them profoundly, to understand

their deepest desires and to react accordingly.” (Maurício Botelho)

Although not the first in the market (Bombardier had already been in the market for three

years), Embraer started to obtain enormous success with the sale of the ERJ145. Embraer

delivered one hundred aircraft in the two years that followed its launch, a mark that

Bombardier took five and a half years to reach. In 1997, the regional jets already accounted

for 60% of Embraer sales, making the company profitable once again.

• Development of the Internal Processes

From then on, the strategic focus turned inwards again, in the search for efficiency and the

improvement of managerial processes. In 1996, the hierarchical structure of the company

was transformed into a matrix organization in which teams were formed around projects

conceived to increase autonomy, participation and flexibility. The project teams were

organized to resolve specific customer needs. Work stations were set up with

multifunctional teams specific for each customer. The adoption of a projects-based

structure and the increase in staff participation helped Embraer to reduce the

development period of new projects, increase the speed of reaction to new information

and improve the loyalty of its staff(see Donsullblog/Building organizational agility at

Embraer).

The company was reorganized into five new profit centres. Three of these centres were

focused on specific geographical regions; the fourth was for light aircraft and the fifth for

government sales. Each profit centre was placed under the responsibility of an executive,

with the specific task of developing relationships with customers.

No drastic changes in personnel were made. For example, instead of bringing in new

professional marketing personnel, the option was made of training the company engineers

themselves in the development of ability to understand customers' needs and

expectations. However, staff that still adhered to the old, outmoded ways of working were

substituted by new managers and workmen who were open to new approaches. MBA

Programmes were also launched for the company managers, in addition to other

programmes to increase the average educational level of the workforce.

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To generate motivation, the company adopted an aggressive programme of profit sharing,

which earmarked the equivalent of 25% of the dividends paid to shareholders for the

employees.

• Strategic Alliance

In 1999, Embraer formalized a strategic alliance with a group formed by the largest

European aerospace companies (Dassault Aviation, EADS, Snecma and Thales), which

acquired 20% of the voting capital of the company. This initiative was related to the

intention to reduce the dependence on the sales to commercial aviation companies,

expanding the defense product line. Contracts in this area had been vital for the Company

up to the end of the Cold War, when they plummeted to less than 5% of revenue.

However, the attempt to increase the share of defence in its business was to consume a

large initial investment, and the project of new products was to create technical risks and

risks related to customer satisfaction. The association with the European companies

allowed Embraer to diversify its sources of revenue. The company also managed to share

with the partners the risks of development and the market. In 2002, the company delivered

to the Amazon Surveillance/Vigilance System– SIVAM – its first aircraft endowed with

advanced systems of intelligence, surveillance and reconnaissance.The aircraft is based on

the ERJ 145 structure.

• Financial Management

In July 2000, Embraer started to negotiate paper on the New York Stock Exchange, raising

US$446 million. The company also adopted a very conservative financial posture, avoiding

going into debt and accumulating a capital stock that reached US$696 million in its June

2001 balance sheet. The critics said that Embraer’s financial policy was too cautious for an

expanding market, particularly at a time when competitors were becoming massively

indebted.

THE E-JETS (EMBRAER 170/190)

After the success of the ERJ 145, Embraer ordered a survey, in 1998, with the 50 largest

airline companies that, together, represent more of the half of the market. The survey was

conceived to test demand for a larger regional jet. The conclusion of the study was that

there was an enormous hiatus in the demand for jets in the 70 to 110 seats range. The

reason for this gap had nothing to do with technology and everything to do with the airline

employees’ trades unions. In the United States (the largest air transport market in the

world), many agreements with pilots trades unions restricted the number of smaller

aircraft that each company could operate. These pilots’ contractual clauses prevented the

air companies from operating regional jets, as the pilots received higher salaries for flying

larger aircraft. If regional aircraft became more common, the pilots would receive lower

salaries or the air companies would have to employ new pilots prepared to fly regional jets,

reducing, in this way, the flight times of the pilots of larger aircraft. Embraer foresaw that

the restrictions would end in the near future, as the airline companies were pressured by

the shareholders to reduce costs and, in many cases, to avoid bankruptcy.

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In January 1999, the company Board of Directors approved the business plan for the

Embraer line 170/190 of larger size regional jets (denominated E-Jets), for 70/78 and

98/108 passengers. The company then started to compete not only with Bombardier (its

traditional rival), but also with the smaller Boeing and Airbus aircraft.

Development costs were estimated at US$850 million to conceive a new platform from

scratch, instead of trying to adapt another model. This made-to-measure project could

produce benefits in weight and in ideal design, and the Embraer executives believed that

the aircraft would be significantly more economical than those of their competitor. In

addition, they built a larger regional jet with the concept of family, with a large number of

parts in common, so that the airline companies that used the complete range of products

could economize in components stocks and training. This allowed Embraer to offer a

complete family of regional jets from 37 to 108 seats.

Embraer’s experience in working with partners that share the risk helped it to follow up the

opportunity offered by the larger size jets. The company executives knew that one key

factor in the success of a new family of aircraft, in a most competitive market, would be the

speed of its development and the need to integrate the most advanced technologies into

the product.

To develop the new product line, the company increased the number of strategic partners

responsible for the delivery of complete subsystems instead of just components, in this

way encouraging the development of closer relationships with a reduced number of

suppliers. The series of medium regional jets developed from 1989 to 1996 used 350

suppliers and only four risk partners. For the larger regional jets, the normal number of

suppliers was reduced to 22, and the number of risk partners was increased to 16. These

partners bore 66% of the total development costs, against 33% of the previous generation,

being responsible for the project and the supply of the structural segments and the aircraft

systems. The risk partners would receive a previously agreed amount per unit sold,

updated in accordance with cost indexes relative to the industrial sector, plus the larger

part of the spare parts business. However there was no profit or revenue sharing with the

suppliers.

Embraer, being responsible for the integration of the whole project, in addition to the

design and development of the aircraft, the manufacture of part of the fuselage and the

assembly of all the parts, identified and involved partner companies to act in the

conception and development of the other components. In the structural part, Kawasaki

Heavy Industries, from Japan, participated, as also the Belgian company Sonaca, the French

Latécoère and the company Gamesa, from Spain. The interior was supplied by the

American company C&D Aerospace. (Annex 6)

As to the main systems partners, in addition to GE, which developed a new turbine model,

also part of the program were Hamilton Sundstrand, Honeywell and Parker, all American, in

addition to the German Liebherr, which, like Sonaca and C&D, opted to set up in Brazil,

nationalizing part of its supply, reducing the cycles involved.

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The result of all this effort of integration was the fact that the Embraer 170 made its first

flight in February 2002, 30 months after the launch, in June 1999: a record development

time for products in this field.

Outsourcing permitted Embraer to obtain greater quality and cheaper components

worldwide in relation to its more verticalized competitors and horizontally integrated, like

Bombardier. This strategy also resulted in greater flexibility for dealing with inevitable

market recessions, according to Satosho Yokota, vice-president of engineering and

development of Embraer: “We have a more flexible model. All our assembly of parts is

outsourced. Bombardier does this internally. With our chain of suppliers and assembly

process it is very simple to determine the rate of production. Not much investment is

necessary to increase our production speed.”

The Embraer 170 enjoyed wide acceptance in the international market, in spite of the crisis

in the aviation sector that started in 2001.

SECOND CRISISII

After the terrorist attacks of 11 September, the aeronautical industry, as a whole,

witnessed a severe decline in air travel. This was translated into acute reductions in aircraft

purchases and cancellation of sales contracts, while aircraft manufacturers, like Embraer,

had already committed significant resources to construct aircraft. Infour months, from 31

August to 31 December 2001, inventories at Embraer grew from US$600 million to US$1.1

billion, draining half a billion dollars in cash. The president of the company stresses: “if we

hadn’t had ready cash and were not flexible, we would probably be dead now”.

The operational improvements in Embraer also provided the flexibility to respond to the

market crisis, which forced the company to dismiss 1,800 staff (14% of the total) and to

reprogram its production line. Embraer also sought to take advantage of the growing

demand from the defense sector that followed on the terrorist attacks. These adjustments

allowed the company to stay in the black in 2001 and 2002, at the same time as it balanced

its efforts to produce the new family of jets on schedule.

SUCCESSION

In April 2007, Botelho passed the executive baton over to Frederico Curado, the successor

that he had prepared, and stayed on as Chairman of the Board of Directors, which made it

possible for him to continue contributing to the formulation of strategy. Frederico, who

had already worked in several areas of the company, had been prepared in a planned way

to be Botelho’s successor.

When I came in, he was commercial director. I made him vice-president of strategic

planning, planning and organizational development, placing him at my side, so that

he could see at first hand all the stages of the turnaround. Afterwards I learnt that he

had almost died of frustration through me taking him out of the front line to work in

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an internal area. But he started to look at the issues like a businessman and to

develop. After four years, he returned to the front line, with a wonderful piece of

work. Today he is ready for this cut-throat competition in the area – so cut-throat that

today we have four manufacturers of world-class level; 20 years ago, there were 15.

And the Russians, Chinese, Japanese are coming along, with plans for the 70 to 90

seat aircraft category”, affirms Botelho.

CAPITAL PULVERIZATION

In March 2006, Embraer became the first Brazilian company of some size with pulverized

capital, doing away with the figure of the controlling group or shareholder, maintaining,

however, the Golden Share of the Brazilian Government.

This was the most important corporate change since the privatization of the company,

because it created a basis for sustained growth and company’s long term sustainability, in

giving it free access to the world stock market, thus increasing its capacity to obtain funds

to sustain the development of expansion programs.

“We had one big problem: I could no longer call capital. The corporate structure was

such that we had 34% of ordinary shares, 66% of preference shares, with no more

space for the issue of only preference shares, because the corporation law establishes

a minimum proportion of one third of ordinary to two thirds of preference. I could

likewise no longer call ordinary capital, because, within the group of three controlling

companies, there were two pension funds, Previ and Sistel, with rules that limited

their investment to the maximum of 20% of participation in any company and to 5%

of their net worth. These two funds already had reached their limit. And it would not

be possible for only Cia. Bozano to subscribe the capital increase, because this would

alter the balance between the three controllers”, says Botelho.

The change also prevented the entry into the company of controlling shareholders with

another profile that would change the focus of the management, as the shareholders'

agreement came due in July 2007 and it was possible that it would not be renewed.

EXECUTIVE JETS

At the end of the 1990s and start of the 2000s, analysts forecast a growing market for

microjets – small aircraft with a capacity of less than 20 passengers. These aircraft were,

normally, acquired by companies for their top executives, or by operators of air taxi

services, in spite of some being bought for personal use also. Executive jets, however, were

not necessarily small, in spite of being utilized for such purposes.

At this time, Embraer started a survey process to evaluate the opportunity of expansion for

this segment. In July 2000, the company announced its entry into the executive aviation

segment.

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Embraer products were respected for their technological quality and performance. Its

experience qualified it for going forward, but did not guarantee that potential buyers

would include the Embraer brand in the list of alternative executive jets. Were it not for the

wings and turbines, it would be possible to say that executive and commercial jets are two

totally different worlds. Commercial jets were sold in lots to corporate entities in search of

a good product that would meet their needs. Then, the brand of the airline company was

fixed on it. The case of executive jets was different, as these were sold to individuals, and

one at a time.

Because they are a status symbol, they demanded glamour. The brand that mattered was

that of the manufacturer of the aircraft – the same phenomenon as luxury cars. In this

field, the competition was heavy: Bombardier (world leader of this segment), Cessna,

Gulfstream, Dassault. Instead of discussing only the cargo compartment, the owner of a

small jet wanted a place for his golf bag. Quality was merely the entry ticket to this world.

The studies of Embraer Market Intelligence team focused a lot on this challenge. And they

came to the conclusion that there were niches in the executive aviation segment as

important as that of the most expensive executive aircraft. Among them were corporate

aviation, charter flights and air taxi companies.

In record time in the industry of aviation, the company’s first executive model, the Legacy

600 jet, based on the platform of the ERJ 145, flew eight months after its announcement, in

March 2001. It was a 16 seat aircraft with a range of 3,250 nautical miles, which competed

with Bombardier’s model Canadair Challenge. In the month of September following, the

first aircraft was delivered. Up to mid-2007, there were 110 Legacy jets flying in 20

countries. In their Supermidsize category, the Legacy reached 13.6% of market

participation, with a forecast of reaching and staying at 15% in the next ten years,

considering the firm orders booked.

The second step of the strategy took a concrete form in May 2005, with the announcement

of the launching of two others jets in the categories “Very Light” and “Light”: the Phenom

100 and Phenom 300, both with a capacity of eight or nine passengers. The aircrafts of the

Phenom family were conceived with an intelligent fuselage, providing greater space in the

cabin. The Phenom 100 made its first flight in July 2007. The cabin’s interiors have been

designed by BMW Design Works, of the United States, and, according to Embraer, have an

elegant and modern appearance.

The first Phenom 100s were delivered in December 2008 with prices from 2.95 million

dollars. This was considered a low investment and low operating costs in the executive jet

aviation category. The Phenom 100 opens this market to new customers. The first Phenom

100s were delivered, for example, to the air taxi Algar Aviation, of Uberlândia, Minas

Gerais, to Wellborn Participations, of Londrina, in Paraná, and to LocarGuindastes e

Transportes Intermodais, of São Paulo. Up to mid-2010 158 aircraft of this category had

been delivered and there were still more than 600 aircraft on the order book.

The Phenom 300, launched in the light jet category, is priced from 6.85 million dollars and

its first delivery occurred in December 2009.

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In May 2006, the executive jets’ family gained its fourth member: the Lineage 1000, in the

“Ultra Large” category, a model that gave priority to luxury and comfort. It could take up to

19 passengers in 115.7 cubic meters of cabin space. It is equipped with two engines and,

with eight passengers on board, it can fly, non-stop, from London to New York, Moscow to

Tokyo or Quebec, from New York to Paris, and so on.

In its basic design, the value was 42.95 million dollars. The company made delivery of the

first aircraft in May 2009 to HE Aamer Abdul Jalil Al Fahim, of Abu Dhabi, in the United Arab

Emirates.

In an interval of only six years, the company launched four aircraft for the eight categories

identified in the executive segment. The aggressive strategy of launches showed to the

market an unequivocal position and an effective commitment to executive aviation. The

revenue from executive jets in relation to that of the other areas of the company more

than doubled in 2006, in relation to the previous year: from 7.3% to 15.7% of total

invoicing. In spite of continuous absolute growth, this percentage reached 14% in 2010,

considering the strong growth of services these 4 last years (Annex 7). Based on firm orders

for executive jets on its books, Embraer was planning to establish itself as one of the

principal players in the segment by 2015.

However, the competition in this segment would probably be intense. Some of the

companies that manufactured microjets were Eclipse Aviation, Cessna Aircraft, Adam

Aircraft and Honda Motors.

• The futureiii

In spite of Embraer having presented an excellent performance since its privatization, there

were doubts about whether its future would be calm. Since the start of the 2000s, the

majority of air companies were negotiating with their pilots to remove some of the

contractual restrictions imposed to the operations of regional jets, but little progress had

been made. The only companies that did not have problems with scope clauses were non-

unionized air companies, especially the low cost ones, like JetBlue. The fact of the ERJ 170

being spacious was one factor that could help. The intelligent design of the fuselage

allowed the jets to have ample front space, like those found in larger jets, providing more

comfort for the pilots, as for the passengers.

Another question potentially problematic for Embraer was the return to popularity of the

turboprop aircraft, more economical over short flights, in the context of the increase in fuel

prices in 2003-2004. In 2004, delivery and backlog of turboprops increased after a decline

that had lasted several years. (Annex 8) In 2005, orders for turboprops manufactured by

Bombardier and ATR increased 240 per cent to 151 aircraft, while new orders for small

regional jets were 25. An increase in demand for smaller jets was expected in growth

markets, such as China, Russia and Africa. Embraer and Bombardier were suspending their

production of small regional jets. It was expected that the growing interest in turboprops

would cause a greater impact on Embraer than on Bombardier, as the latter was

manufacturing turboprops as much as jets. Embraer, on the other hand, which had stopped

manufacture of turboprops after its privatization, was analysing, in 2008, the possibility of

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developing a new commercial turboprop aircraft for the small regional aircraft market.

Orders for the ERJ 145 family had declined drastically from 2004-2005, and the company

had only registered net positive orders for its E-jets family in 2005.

The family of E-jets however also had its own problems. The certification of the E-170

delayed almost two years due to complications involved in the integration of its electronic

systems with other systems. However, in mid-2006, most problems with the E-jets had

been resolved and the air companies that used them demonstrated satisfaction with their

performance.

A growing competition was forecasted in the regional jets market with the entry of

manufacturers from Russia, from the countries of the Commonwealth of Independent

States and from China. The joint venture of Embraer in China, however, facilitated its

access to the Chinese market and avoided the 6% Chinese taxes for imported aircraft. In

addition, it provided a good base for Embraer to manufacture aircraft for other air

companies from the growing market of the Asiatic region. Analysts affirmed that

Bombardier would have to cut costs drastically to be able to compete with Embraer in

China. On the other hand, after the decision of the WTO in relation to subsidies on Brazilian

exports, it would be more difficult for Embraer to compete on the basis of low prices.

The great dependence of Embraer in relation to exportations in general and specifically to

the commercial aircraft market was a concern, due to the great sensitivity in relation to the

currencies changes in the international economic scene (Annex 9). For example, the

devaluation of the dollar in relation to the real, of around 8% in 2006, had a negative

impact on the company, that had 95% of its revenue and 85% of its costs tied to the dollar.

Another problem was that the air companies generally made many isolated purchases, only

when they needed to update their fleets. Consequently, there were large fluctuations in

sales from year to year.

However, in 2005-2006, Embraer announced that it would increase systematically its focus

on the defense and government aircraft sector, with the goal of expanding the contribution

of this segment from 11% to 20% of its sales. In 2005 Embraer announced the signature of

a Memorandum of Understanding with the Defense Research and Development

Organization – DRDO- of the government of India, to provide support for the development

of the new AEW&C system (Airborne Early Warning & Command/Control) of the Indian Air

Force. The new system has its base the platform EMB 145 ISR (Intelligence,

Surveillance/Vigilance and Reconnaissance), one of the most sold in the world. Embraer’s

great experience in similar projects had been a key factor in the decision of the DRDO.

Analysts said that this agreement represented a return of Embraer to its roots, as it had

started its operations with military contracts.

In 2007, Embraer commenced the development of the military aircraft KC-390 (Annex 10),

whose market potential was estimated at 700 aircraft for 77 countries, with focus on the

spare parts market. The aircraft competing with the KC-390 available in the market had

prices between US$35 million and US$120 million for the transport, respectively, of 37 tons

to 10 tons of cargo. The estimated price of the KC-390 of Embraer is US$50 million. The

first take-off is planned for November 2014. The first flight of a series-produced unit will be

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made two years later, in 2016. The FAB (Brazilian Air Force) is the main investor in the

program. In April 2009, R$ 3.028 billion were authorized for the development of the

project and the production of the two preliminary models, with a duration of seven years.

In July 2010 the FAB announced its intention to acquire an initial number of 28 KC-390

aircrafts. Using the current value of the equipment of the same class, this business is

estimated at R$ 3.04 billion. Other countries including South Africa, Argentina, Chile,

Colombia, France, Portugal, Czech Republic and Sweden expressed interest in evaluating

and buying the new aircraft for tactical transport to substitute the aircraft Lockheed C-130

Hercules developed in the 50s and with more than 2,200 aircraft operating in around 60

countries.

After entering the medium-sized aircraft sector with success, carving out a share of 46% in

the 30 to 120 seater aircraft sector, Embraer could consider, in the future, the

development of larger aircraft, such as those of Boeing and Airbus (Annex 11). However,

most analysts believe that Embraer still has a long way to go before it can be considered in

the same class as Boeing and Airbus. The main question is the need of very large

investments for the design and manufacture of large aircraft and the fact that Embraer

would have difficulty in obtaining financial resources in the low-developed stock markets of

Brazil. Capital pulverization of the company, carried out in 2006, could, however, help in

this sense.

i This part was adapted from:

GHEMAWAT, P.; HERRERO, G. A.; MONTEIRO, L. F. Embraer: The Global Leader in Regional Jets. Case Study.

Harvard Business School Publishing, Boston, 2000.

ii This part was adapted, but directly extracted from:

SULL, D. N.; ESCOBARI, M. E. Sucesso made in Brasil: os segredos das empresas brasileiras que dão certo. Rio de

Janeiro: Elsevier, 2004. iii This part was adapted, but directly extracted from: REGANI, S. Embraer – The Brazilian Aircraft

Manufacturer’s Turnaround and Growth. Case Study. IBS Research Centre, The ICFAI Business School, Kolkata,

2007.