Brazilian success story is deciphered

 - July 3, 2008, 4:54 AM

While other major manufacturers are struggling to find the right production organization or have spent years changing their minds about what product to launch next, Embraer has been quietly reaping the fruits of a sound management strategy, according to independent financial analysts. The Brazilian company has launched no fewer than five new business jet programs in three years (see timeline on page 60), although this covers just two clean-sheet designs: the Phenom 100/300 and the Legacy 450/500 families.

Since launch, every program milestone has taken place on time. This is remarkable, given the generally negative record of program delays in the aerospace industry.
“Embraer management people certainly exert strong pressure on themselves, since it is even more difficult to acquire credibility when you work in an emerging country,” said Andrea Goldstein, a Latin America economics expert with the Organisation for Economic Cooperation and Development.

Many executives from established manufacturers viewed Embraer’s late 1980s decision to launch a small regional jet family in a developing country as an outlandish bet. Few would argue that the Brazilians have far outstripped expectations to pose a serious and concerted challenge to European and U.S. rivals.

The way Embraer has been managed seems to have helped keep programs on time. “A big difference from Bombardier is top executives have no distraction from aviation,” commented Alex Hamilton, a senior analyst with investment bankers Jesup and Lamont. Unlike Bombardier, he noted, Embraer is not involved in other markets, such as trains.

Moreover, Embraer’s technical execs may feel less financial pressure. Analysts view other companies’ obsessions for creating value for shareholders as sometimes resulting in unrealistic program schedules. By contrast, Embraer’s close-to-zero delay record may be the result of a more realistic attitude to program management. “It is much easier when you do not have financial people breathing down your neck,” said Teal Group analyst Richard Aboulafia.

However, Hamilton qualified his comments by pointing out that Embraer jets are not engineering feats in the same league as new-generation aircraft such as the Airbus A380, the Boeing 787 or the Eclipse 500. These three programs, all very innovative, are among those that have suffered the most serious setbacks in recent years. “Technology advancement is not at the same level in recent Embraer programs,” Hamilton said.

Money No Object?
At $452 million, investment at Embraer was at an all-time high in 2007. Spending on property, plant and equipment stood at $213 million, while research and development accounted for $239 million.

Where does the money come from? “They earned money with small regional jets; they invested it into bigger regional jets and the money they have earned from those is now reinvested into business jets,” Aboulafia summarized. He estimated that regional jets have never been a very profitable market but growth has helped. “Strong growth translates into big money, even though you make low margins,” he explained.

There has been a longstanding dispute with Canadian competitor Bombardier over alleged subsidies for regional jet programs. Since the late 1990s, the two countries have complained about each other to the World Trade Organization. “Canada complained about Brazil’s export funding, while Brazil complained about Canada’s production funding,” Goldstein recalled. The WTO ruled against both countries. “From a judicial standpoint, the matter is going on, but from a practical standpoint it is over,” Goldstein said.

Ironically, Embraer, Bombardier and their respective governments could now find themselves united in the face of new challengers from the east. Should Japan’s support for the Mitsubishi Regional Jet, Russia’s for the Sukhoi Superjet 100 or China’s for the ARJ-21 be deemed unfair, Brazil and Canada may jointly complain to the WTO, Goldstein said.

Embraer’s ability to recruit large numbers of skilled workers has also sometimes puzzled the aerospace industry. Between 2002 and 2008, its workforce has doubled and now stands at almost 24,000. “They are educating and training their own people; they are an example for other emerging nations,” Aboulafia said.

As part of the educational effort, Embraer has created a company university onsite. This policy has been so successful that it was surprised, in 2005, when it had to deal with employee illiteracy issues at its Portuguese subsidiary OGMA. The company had never encountered the problem to that extent at its Brazilian facilities, Goldstein recalled.

In general, Brazil has invested a lot in workforce training, which has been one factor persuading Italian car maker Fiat to establish its biggest factory in that country. According to Hamilton, as the industry leader, Embraer finds it easier to attract talent whether from Brazil or abroad.

Looking at Embraer’s financial results spanning from 2002 to 2007, Hamilton noted that profits held up well despite the workforce doubling and deliveries climbed by roughly 30 percent. “This means the company is highly efficient,” he said, referring to tight cost controls being in place.

What about labor costs in an emerging country? “They are slightly lower than that of Canada,” Goldstein said, pointing out that social security is more expensive for the employer in Brazil. Goldstein also noted that Embraer employs significant numbers of people in other countries such as Portugal, the U.S. and China.

Last, but not least in Embraer’s success, factors the way it organizes its production process. “It has been really skilled in building a network around the company,” Goldstein said. Its pioneering risk-sharing strategy looks more successful than that of Boeing and Airbus, he argued. Other analysts countered this point by saying that outsourcing large modules may be easier when producing regional jets rather than bigger airliners.

In any case, Embraer effectively has had no choice but to outsource on a risk-sharing basis. First, it could not afford to fund entire development programs alone. Second, there are fewer aerospace suppliers in Brazil than in the U.S. or Airbus’ home countries, hence, Embraer’s need to find major partners in France, Japan, Spain, the U.S. and elsewhere. This cosmopolitan approach has brought the additional benefit of providing an in-built mechanism to hedge against unfavorable currency fluctuations since multiple currencies are involved in each program.