Embraer Final Article Hira de Oliveira

COMPETITION & CHANGE, Vol. 11, No. 4, December 2007 329347

E-mail address: [email protected], [email protected]

2007 the Editors and W. S. Maney & Son LtdDOI: 10.1179/102452906X239501

Take Off and Crash: Lessons from theDiverging Fates of the Brazilian and

Argentine Aircraft IndustriesANIL HIRA1 and LUIZ GUILHERME DE OLIVEIRA2

1Department of Political Science , Simon Fraser University, 8888 University Drive,Burnaby, BC Canada V5A 1S6

2Universidade de Brasilia

What are the factors that allow for success or failure of developing countries attempts toenter high-tech sectors? We make a initial attempt to answer that question through a com-parative study of success and failure in manufacturing aircraft. Aircraft production is one ofthe key industries in the world today, as reflected in the intense Boeing-Airbus rivalry. It isalso one of the most cyclical, technologically-sophisticated, and capital-intensive industries,and therefore an unlikely place for a developing country to compete. But almost from thebirth of modern commercial aircraft manufacturing, Argentinas Fbrica Militar de Aviones(FMA) was at the forefront of production. Brazils aircraft industry was tiny in comparisonat that time. Yet, by the 1990s, Brazils Embraer had become the worlds third largestaircraft manufacturer, while the Argentine aircraft industry has virtually disappeared. Weexamine the history of each company to explain the differences in trajectories and their fates.Our analysis demonstrates that an evolutionary but consistent partnership between stateand firm, one attuned to both the exigencies of sectoral development and to changes in thenature of global markets, is necessary for success.

KEY WORDS Industrial policy, Technology policy, Technology transfer, Development,Aerospace, Statefirm relations, Argentina, Brazil

Introduction

In 2000, a very unusual case came to the attention of the World Trade Organisation (WTO)dispute resolution panels, the case of Bombardier of Canada versus Embraer of Brazil.More than the dispute itself, the case marked a unique development: the rise of a company inLatin America that can compete head-to-head with any other company in the world in thehigh- technology, high value-added sectors. Today, Embraer, a Brazilian company, success-fully competes with the behemoths of the industry located in the developed world, includingBoeing and Airbus. The same time period saw the dismantlement of the Argentine aircraftcompany, the Fbrica Militar de Aviones (FMA), that had once been the fifth largest in theworld, was organized earlier and had a technological lead on Embraer. This article providesnew information that compares these two companies. The key lesson from this articleconcerns the nuanced evolutionary but still crucial role of state promotion of new industries

330 A. HIRA and L. G. DE OLIVEIRA

and key companies. The complexity of such evolution cautions against a coherent successnarrative that fails to consider the dynamic role of states and markets, institutions andpersonalities, and preparedness for taking advantage of opportunities. This article reliesupon extensive field research including first person interviews and archival governmentand company documents in order to reflect appropriately the complexity of the evolvingrelationship between state and firm.

The Daunting Challenges for Developing Countries to Compete in the World EconomysCommanding Heights

By most standard accounts of development, indeed by the very definition of development,developing countries should not be able to compete with developed countries in advancedproducts, which are not in its comparative advantage. From both the dependency andmarket supremacy perspectives, the role of the state is inimical to the processes of develop-ment. Yet, there are a number of reasons to be skeptical about this conclusion. The foremostis the wide array of protection and cascading tariffs against commodities and finishedproducts of commodities (Oxfam 2002). The protection in the North is on top of the hazardsendemic to commodities, such as wildly varying prices and natural hazards. Even in com-modity production, developing countries tend not to be able to capture the value-addedsteps. They export the unrefined copper, not the end products.

This would suggest that developing countries should make a concerted effort to indus-trialize in order to diversify. This was an idea openly espoused in Latin America from the1940s (Hira 1998). However, where developing countries attempt to produce advancedgoods, they have often met with failure. For example, Chile, Indonesia, and Malaysia haveall tried to produce automobiles. Brazil tried to produce its own personal computer industryin the early 1980s. These attempts show a learning curve exists beyond the heavy produc-tion quotas of the post-Second World War Soviet Union and Indian planning models forincreasing total industrial production. Gains in raw industrial production did not lead tohigher welfare for the local citizens or industries that were anywhere near as efficient asinternational counterparts in the West. This led to the current neoliberal period of strongskepticism about the efficacy of the state in industrial leadership, and a renewed emphasison foreign direct investment as a means of development and technology transfer.

Nonetheless, the example of success in East Asia under state leadership over the pastthree decades warrants the consideration that other developing countries could move up thevalue-added ladder into more sophisticated production if their state policies were orientedtowards developing export industries as a form of dynamic comparative advantage(Amsden 1989; Hira 2007). The case for state intervention is made even more strongly?when we consider that whilst the US and Europe may espouse free trade for developingcountries, they intervene in a wide variety of ways to preserve their production in keyoligopolistic sectors, such as steel, computers, and automobiles, including protection,subsidies, and regulatory favoritism (Hira 2003). If we include the advantages of moreadvanced infrastructure, including educational and health systems, the hurdles for develop-ing countries to capture dynamic comparative advantage appear very high. The argumentis frequently made that increasingly globalized modular production means that the age ofsupporting national champions is over (Friedman 2005).

A developing country seeking to enter high-tech/high-value-added sectors also facesthe enormous disadvantages of the following: volatile macroeconomic conditions; political

331TAKE OFF AND CRASH

instability; limited domestic markets; shallow financial markets; and, an inability tosubsidize research and development or even higher education. The odds and conditions,then, of a developing country being able to compete in a high-tech sector as an OEM(original equipment manufacturer), especially one that requires high economies of scale,dynamic production processes, and sophisticated marketing and distribution, seemextremely low. Yet we are beginning to see successes Korean success in autos and elec-tronics and South Indian success in software. Perhaps the most intriguing case in terms ofthe level of sophistication required is that of Embraer. In both the cases of FMA andEmbraer, the state was ubiquitous. Yet, Embraer was only considered a success afterprivatization. The rest of this article addresses two questions: (a) did the state hurt or hinderhigh-tech industry development? Can we conclude that no state intervention would havebeen optimal?; and (b) do differences in the nature of statefirm relationships between thetwo cases help to explain the different outcomes?

The Strategic Importance of Aircraft Production

Aircraft production is not only one of the most technologically complex sectors, requiringheavy financial investment and suffering from business cycles, but it is also incredibly com-petitive and heavily protected by Northern countries. It is an important source of develop-ing advanced technological applications and also in regard to the backwards and forwardslinkages and supporting high levels of well-paid employment. There are clear links betweenthe development of military and civilian aircraft, indeed most of the major companiesproduce both. In this sense, the larger nations see a domestic aircraft industry as integral totheir defense plans. In terms of the constant need to outclass potential military enemies,then, the aircraft industry has always relied upon heavy state subsidies in order to continueto improve technology. Aerospace is also linked to several key industries, includingelectronics, information technology and telecommunications (Mowery 1987: 37).

The need for state protection and aid is compounded in the civilian industry by thelumpy aspects of the product market. Aircraft production requires enormous economiesof scale and sophisticated supply lines, and therefore tends towards a natural oligopoly.Aircraft production requires a highly skilled and concentrated workforce. On the demandside, the airline service providers face enormous payments for aircraft in comparison withtheir often volatile and small-scale revenue stream from flying customers, based on the pre-sence of conflict and business cycles. The development of new aircraft is therefore a highlycapital-intensive and risky venture. Thus, military orders have been key to maintainingbasic stability in the US aircraft industry. Moreover, given the agglomeration of jobsand linked industries, aircraft manufacturing has been linked to the health of regionaleconomies, such as Boeing in Washington State, sometimes using offsets (Pritchard &MacPherson 2004).

The competitive factors in the passenger civilian aircraft industry can be summarized asfollows, in no particular order:

there is the need for constant technological upgrading and innovation, there is the enormous capital investment required for both setting up and maintaining

production, and therefore the question of the availability of financing, there is competition in fuel economy delivered,


there is a question of quality related to the expense of maintenance, spare parts andrepair,

there is also the factor of speed, with the Concorde being the most important example ofan attempt to differentiate on this factor,

the cost of inventory is a final major competitiveness factor.

In sum, the financial, technological, and managerial aspects of this industry are quitedaunting.

Much of the motivation to build an aerospace industry in the developing world comesfrom defense-oriented anxieties and the desire to avoid relying on outside technology (Todd& Simpson 1986: 15). There have been some notable experiments in native aircraft develop-ment, for example in Indonesia and China (Hayward 1994: 3241). However, Embraerremains the unique success in the developing world, in stark contrast to its Argentine coun-terpart. In answering these questions, we trace out the role of statefirm relations duringthe evolution of the two companies.

History of Embraer

Stage 1: Creation of EmbraerDuring the 1930s and 1960s, we see three important aspects. In the earliest period, a privatesector based on operating foreign-made planes and kits begins to arise; however, it is far toolimited for the domestic market. In the second phase, the government steps in to provideresearch and development support for private industry. This also yields slow and haltingprogress. In the third phase, the frustrated Government steps in to create its own company,Embraer.

With its vast distances between regional poles of development, Brazil has a naturalmarket for aircraft. With that in mind, the Government set up the military-run CentroTcnico Aerospacial (CTA) in late 1945 to develop applied aeronautics research and educa-tion, modeled on MIT, under the guidance of MIT Professor Richard Smith (Botelho 1999).Brazilian firms have built military and civilian aircraft from the 1930s, however Bertazzonotes that through much of the early period of its development (the 1920s to 1950), theBrazilian aircraft industry was not economically viable. Bertazzo notes that many localprivate and public purchases were of US planes, on concessionary terms, in return forBrazilian cooperation during the Second World War. Moreover, planes manufacturedby private companies in Brazil were not technically viable, leading to losses and a lackof confidence when government procurement began to seek to support local industry(Bertazzo 2003).

The Aeronautical Technology Institute (ITA) was set up by the Government in 1950 toaddress these issues. The ITA trained aeronautical engineers, and the IPD (Instituto dePesquisa e Desenvolvimento de Centro Tcnico Aeronutico), a research and developmentwing, was created to house 50 German aeronautical engineers hired after the Second WorldWar in 1954, to work on applied aeronautical research. According to Botelho:

[A] can do attitude in technological research with a scientific base implemented by the ITAby researchers trained in MIT, was responsible for the major technological programmemespursued in the 1960s and 1970s (aeronautics, information technology, microelectronics andspace) [translation my own] (1999: 39).


These included designs for an aircraft completely made in Brazil as early as 1965 (Silva 2005:139). Despite building the human capital base, progress, dependent upon collaboration withthe domestic private sector, was slow. The two remaining companies, Aerotec and theInstituto Aeronutico Neiva, relied exclusively on government contracts as their weak tech-nical capability prevented success in civil aviation (Bertazzo 2003). Moreover, Bernardeshighlights that there was an a-synchronicity of government policies, which did nothing toprotect the nascent manufacturers from foreign competition or provide access to adequatefinancial resources (Bernardes 2000).

With limited design and no large-scale manufacturing capability in aircraft in spite ofextensive investments, the frustrated government created Embraer (Empresa Brasileira deAeronautica) in 1969, with the Bandeirante as the central project. Embraer was created asa mixed privatepublic enterprise, with the government holding a 51 per cent stake andCTA leading the push for manufacturing of its plans. CTA was motivated by US restric-tions on military aid and weapons sales following the military coup in 1964. The Braziliangovernment provided high tariff protection throughout the 1960s and the military boughtalmost all of the planes. Besides military procurement and tariff protection, Embraer wasexempted from paying a number of taxes and duties normally levied upon private com-panies. Brazilian corporations were allowed to invest up to 1 per cent of the income taxesthey owed each year instead into Embraer shares, providing a much needed infusion ofcapital (Abdelal et al. 2003: 89; Ghemawat et al. 2000: 2; Hayward 1994: 33; Mowery 1987:112117).

Stage 2: Embraer as a State-owned Enterprise (SOE)In this period of its evolution, Embraer as an SOE developed a high level of technicalcapacity, but struggled to develop financially viable products. Strategic decisions bymanagement as well as exigencies for financial independence in an increasingly chaoticmacroeconomic situation led it to move away from military aircraft and towards com-mercial exports. The need to develop competitive technology pushed it into internationalagreements. State support included purchases and protection.

In 1971, Embraer developed the Xavante, a jet trainer and attack aircraft assembledunder a licensing agreement with the Italian company Aermacchi to fulfill a Brazilianmilitary order. In 1972, Embraer introduced the Ipanema, an agricultural spray plane deve-loped by the IPD. In 1973, Embraer developed the Bandeirante, a 19-seat turboprop plane,from an IPD design, of which it eventually sold 500. The Brazilian military was the primarycustomer for most of the Bandeirantes, signing the first contract for delivery of 100 planes in1970. Ozires, the former CEO, states that the atmosphere in Embraer was one of a strongsense of activity and mission, as if a revolution were about to take place. He also states thatEmbraer realized by 1973 upon entering the civilian market that it would have to concen-trate on a few key products in order to be able to compete, and that Embraer would have toconvince the government, society, and its partners that it was effective to succeed (Silva2005: 271, 279, 333, 369). In a sense, the military guaranteed Embraer a learning curve andtesting ground for its planes, not unlike some of the early protectionism used in East Asia toaid their manufacturers. In fact, the Brazilian government as a whole at one point insistedthat all public sector planes had to be purchased from Embraer, and all travel should takeplace on Embraer planes.

At some point in the 1970s, Embraer made the strategic decision of orienting itselftowards exports. Bernardes states that in 1975, only 5 per cent of Embraers production was


exported, a figure that would rise to 53 per cent by 1980 and 60 per cent by 1994 (Bernardes2000). Embraer relies upon foreign parts including engines; an estimated 60 per cent ofBandeirantes were produced domestically. At the same time it produced small one and twoengine commuter aircraft under license from Piper. Goldstein points out that the Piperagreement was a reflection of the need to gain access to foreign technology. The BrazilianGovernment used the threat of import duties to incentivize Piper into producing the kits forits initial production (Goldstein 2002). The Piper agreement as well as joint production ofmilitary aircraft, including agreements with Northrop in 1974 for production of an F-5, ledto a transfer of production, but not engineering and design technologies. Ozires states thatEmbraer realized that partnerships with foreign companies could be useful for gainingaccess to Northern markets (a quasi-offset and aid in licensing hurdles) (Silva 2005: 169).Undoubtedly, the partnerships helped to establish the quality of the product as well.

Timing and government support were both key for the early success of the Bandeirante,which coincided with a growing demand for commuter aircraft. The Brazilian Air Forceorder in 1970 was crucial. Ozires notes importantly that, despite this early dependency,Embraers relationship with the Air Force was always at arms length, and a strong personallevel of confidence arose between him as CEO and Air Force officials. In fact, througha strong initiative on the part of the Minister of Aeronautics, Lt. Brig. Joelmir AraripeMacedo, the Bandeirante was converted to civilian use and the first sales to domesticcarriers VASP and Transbrasil were facilitated. The ability to sell the planes transformedthe initial trepidations about entering the civilian market in the company to an attitude ofconfidence. (Silva 2005: 474, 299, 310312). Several years were spent struggling to gainaccess to export markets, for which licensing is key. After the valuable experience ofproving its planes in the domestic market, Embraer was able to export to Uruguay andChile in 1976. The Bandierante was finally certified by the FAA in 1978.

Embraer had no knowledge of marketing. As Ozires tells, the solution came when BobTerry, the owner of Aero Industries and owner of Mountain West Airlines, upon hearing ofEmbraers frustrations, offered to be its sales representative and purchased the first planesfor his own airline. This opened Embraer up to the networks of airline executives; however,the lack of local maintenance and customer support remained a severe impediment. Thispushed Embraer to set up a US subsidiary and maintenance facilities in Fort Lauderdale,Florida, which set up a learning curve for that aspect of the business that was subsequentlymirrored in Europe (Silva 2005: 393407). Bandeirante sales in the US jumped from 5 (1979)to 39 in 1981. Embraer captured of 46 per cent of the international commuter turbopropmarket. As a result of the success of the Bandeirante, Fairchild, the former marketleader, filed a complaint before the US International Trade Commission requesting acountervailing duty of 3944 per cent to offset Brazilian government subsidies. The legalcase dragged on for two years, and cost Embraer millions in legal fees (Silva 2005: 412);however, the request was denied. By 1984, Embraer had managed to sell a total of 130Bandeirantes to the US alone, and had other sales around the world.

Embraer also introduced the Xingu, a pressurized corporate aircraft, in 1977, but it wasa commercial failure and was dissolved in 1984 (Abdelal et al. 2003: 89; Ghemawat et al.2000: 2; Hayward 1994: 33; Mowery 1987: 112117). Success in the military field helped toestablish Embraers reputation; the British Air Force order of 130 Tucano trainers in 1985was a major breakthrough (Silva 2005: 502). Also in 1985, Embraer introduced the Brasilia(EMB-120), a 30 passenger turboprop, whose design began in 1979 (Silva 2005: 296). From19851999, Embraer managed to sell 350 of the Brasilia aircraft. The Brasilia was a highlysuccessful venture, at one point capturing 26 per cent of international market share for


commuter planes. As a turboprop, it was attractive, using less fuel than jets. However, therewere questions about whether the market share success was matched by financial perfor-mance (Abdelal et al. 2003: 89; Ghemawat et al. 2000: 23). Providing financing forcustomers is a huge part of the business, and the US Ex-Im Bank and its European counter-parts provide a major competitive edge to their home producers. The role of the NationalDevelopment Bank (BNDES) was crucial in financing sales for Embraer, given the weakstate of Brazils financial system, currency and inflationary crises, and lack of access tocommercial credit (Silva 2005: 301, 470).

Stage 3: Embraers crisisDespite achieving international recognition for quality production, Embraer experienced amajor crisis in the early 1990s that unhinged state leadership. Embraers sales dropped from$700 million in 1989 to $177 million in 1994 (Abdelal et al. 2003: 9). Embraer was furtheraffected by the post-Gulf War slump in the market after 1991, and enjoyed a $407 millionrescue package from the government. (Hayward 1994: 33) As part of the new MERCOSURfree trade agreement with Southern Cone countries, Embraer agreed to develop the CBA123 plane with Argentine help. The Argentines would provide 33 per cent of the financingand technical support for key components (Halbritter 2004: 434435). The CBA 123 was ashorter version of the Brasilia with just 19 seats. The project was a major failure, accumulat-ing losses of $280 million by 1990 (Ghemawat et al. 2000: 3). According to Bernardes, theplanners of the plane never closely examined the market requirements for success. Thoughthe plane was technologically advanced, its asking price of $6 million was well above themarket price of $4.5 million for planes produced by competitors Beech 1900 and Jetstream(Bernardes 2000). In a sense, the CBA 123 was a technical triumph but a business disaster.

The 1980s debt crisis hit the Brazilian macroeconomy hard, with five-digit inflationresulting by 1990. Despite drastic workforce reductions from 13,000 to 6,100 average lossesin the early 1990s exceeded $200 million per year (Ghemawat et al. 2000: 3). With the rise ofneoliberal policies under the Cardoso government, privatization of Embraer came to beseen as an important part of the overall goal of reducing fiscal deficits.

Conditions of PrivatizationPrivatization was delayed by two years due to national protests. Privatization was sup-ported by the president of the company, Ozires Silva, who had been brought back (afterleaving in 1986) to turn around the company. Embraer was finally privatized in 1994. TheBrazilian Congress added a restriction on layoffs for the first 6 months, creating an esti-mated additional cost of $45 million to the new owners. The state assumed $700 million ofdebt, recapitalized another $350 million, set a low reserve price in the companys shares, andallowed partial payment in bonds that traded at approximately 50 per cent of their facevalue. The Brazilian government retains a golden share of Embraer that give it a seat onthe board and veto rights over a change in control of the company and significant policydecisions. (Ghemawat et al. 2000: 3) This presence is justified in terms of a veto power fordecisions that may affect national security (Oliveira 2005), but no effective interference inday-to-day operations is evident.

Stage 4: The TurnaroundAs a privatized company, Embraer now enjoys state support similar to its competitors, suchas Bombardier in Canada, with export financing subsidies and other indirect support.


Mauricio Botelho was brought in as the CEO of the newly privatized company. Botelhorevamped the entire management team, reduced the number of managerial levels, andinstilled a new focus on market-orientation rather than production and development.Botelho, with a strong finance background, proceeded to major workforce reductions andsalary cuts. He also increased outsourcing and refinanced at lower interest rates. As a result,operating losses were cut, but the company was still only at the break-even point due to theheavy debt burden. (Ghemawat et al. 2000: 5)

The company invested its future in the ERJ-145, a regional jet that updated the Brasiliadesign, utilizing technology learned from the CBA 123 and the AMX military plane(Oliveira 2005: 80). The ERJ-145 is a 50-seat regional jet that had been in development offand on since 1989. The BNDES provided $115 million in financing and another $100 millioncame from other external investors. The plane was certified by the FAA in December 1996.The main competitor is the CRJ-200, sold by Bombardier of Canada, which had been certi-fied in January 1993. The ERJ-145 apparently has more spacious seating as well as betteroperating costs, due principally to lower weight. The price is also more competitive $18.5million per plane as opposed to $21 million for a CRJ 200 (Oliveira 2005: 36). Large ordersfrom Continental Express and American Eagle ensured the success of the plane, and led tothe development of derivative jets, the ERJ 135 and the ERJ 140, both slightly smaller(Ghemawat et al. 2000: 6). Government export financing was decisive in gaining thesecontracts over Bombardier, and these deals ensured the financial turnaround of the com-pany (Cassiolato et al. 2002). The regional jet competition was fierce; both Dutch manufac-turer Fokker (founded in 1912) and Swedish Saab (founded in 1947) failed in 1996 and 1997,respectively.

Stage 5: A Global CompetitorIn its current stage, Embraer has developed its early need for private and foreign partnersinto an integral part of its strategy, setting the mark for global integration of supply chainsin aerospace, which even Boeing has now followed. Embraer has begun to graduate fromregional to long-distance jet competition, taking on Boeing and Airbus in the 100-seat rangewith the 170 and 190 models. It also began eyeing military crossovers with a military versionof the latter, tentatively the C-390. Finally, it has reinvigorated its entry into executive jetswith the development of the six-seater Phenom 300.

Brazils two largest pension funds, Brazilian financial conglomerate CompanhiaBozano, Simonsen (CBS), and Wasserstein Perella, a US investment bank, acquired a 45 percent stake in Embraer in December 1994 for $89 million. Between 1995 and 1996, the newinvestors, with help from public agencies coordinated by BNDES (including the Banco doBrasil, the Ministries of Finance and Industry, Commerce, and Tourism, and the SpecialAgency of Industrial Finance, Finame/Finamex) injected $500 million in fresh capital intothe company to help develop the ERJ-145 (Bernardes 2000). French aerospace and defencecompanies also acquired a 20 per cent stake in October 1999. The new alliance was seen as away to improve capabilities in the defense market, including expansion beyond aircraft(Ghemawat et al. 2000: 3, 1415). Embraers multinationalization began in 2002 with thecreation of a joint venture with China to produce planes for that most promising market.Embraer owns 51 per cent of the shares of the newly formed Harbin Embraer AircraftIndustry Company Limited (HEAI). Embraer made the strategic decision as China took a


page from Embraers book by threatening import tariffs of 23 per cent and beginning itsown competitive production (Gonzales 2005). This necessary step is also fraught withdanger as Chinese, Russian and Japanese plans to enter new aircraft into the regional jetsmarket seem in sight.

The downside of the globalization of supply strategy is that the levels of value-addedand local manufacturing have remained quite low, thus there is still a high level of externaldependence on technology and finance (Dagnino 1993; Oliveira 2005) With a stake inEmbraers success, these European and American companies provide a ready constituencyfor ensuring market access for Embraers aircraft. More importantly, it allows Embraer tospecialize in the design, integration, marketing, and the manufacture of certain components,reducing research and development costs and allowing for the ability to continually learnfrom long-term relationships with technological leaders in particular areas. According toseveral authors (Figueiredo et al. 2005; Oliveira 2005; Oliveira & Bernardes 2002), there arethree levels of the Embraerforeign partner network. The first level consists of partnershipswith multinationals to co-design and help finance a project. The second is of suppliers ofsystems, parts, and services for the planes; 98 per cent of these are foreign. Some membefs ofthis group have stakes through revenue-sharing and some are paid directly. These partnersare expected to make significant investments in research and development for the project,thus sharing the risk and responsibility. The third group includes outsourced suppliers, whoprovide labor in terms of engineering, machining, and chemical treatment; they receive rawmaterial and design from Embraer. Partners invested $550 million or 40 per cent of the total$1.4 billion cost for the development of the ERJ-170/90. Embraers strategy has changedover time; approximately 200 suppliers worked on the 145, while only around 30 areinvolved with the 170/90. Only 10 per cent of the suppliers are Brazilian 3):(Figueiredo et al.2005), sparking concerted efforts by both the So Paulo industrial federation (FIESP), thenational small and medium enterprise support programmeme (SEBRAE) and local businessassociations to increase local sub-contracting (Goldstein 2005). However, as authors havepointed out in regard to the aerospace industry, there is no ready logic in current globalaerospace supply chains that promotes local linkages (Esposito 2004; Niosi & Zhegu 2005).Embraers learning curve as a global integrator is summarized in Tables 1 and 2.

TABLE 1

Evolution of partnerships in the production of new models

EMB 120 ERJ 145 170

Embraer is sole manufacturer Partial risk sharing Intensive risk sharingVertically-integrated production Subcontracting of some Extensive subcontractingchain processesNon-automated planning Computer-based planning Computer-based mock up

and simulation of processesAssembly-line manufacturing Assembly line manufacturing Manufactured in docks and

then assembledTraditional manufacturing system Lean production Lean production

Source: Oliveira (2005)


Comparing Embraers success with Argentine FMAs failure

Stage 1: An Early StartDespite a surprising lack of documentation and resources regarding the Argentine aircraftindustry, through field research we can piece together some essential facts to complete thecomparison. The Argentine aerospace industry began to produce planes in 1927 in Cordobain the SOE Fbrica Militar de Aviones (FMA), on the basis of German designs. The planwas that the factory would serve as an industrial pole for the development of the country, aspart of the general context of import substituting industrialization.

As Prez Esquivel observes, the management of industries by the state was inherentlyproblematic, since:

public enterprises constituted tools for polyvalent and complementary goals: to promoteindustrialization, to regulate the market, to distribute income, and to stabilize the economy.The protection of national autonomy preceded the gravitation towards external capital, the

TABLE 2

Embraers strategy for the acquisition and development of technology

Phase/description Embraers technological strategy

ProductionProduction designIncludes cutting and fabrication of sensitive One observes a developing of capacity throughmaterials, assembly of metal pieces and parts. previous contracts with Aeromachi, Northtrop andOrganized by the Department of Product Piper. The learning process allowed for theEngineering. development of internal expertise related to the

coordination of risk sharing partnerships. Aspectsrelated to quality control, critical technology andthe organization of production were absorbed. Theeffort to internalize the learning of these processesand skills development is consolidated through thePEE (Programme of Specialization in Engineering).

Selection of materialsThe production of planes is sensitive to It is possible to historically verify that the use ofphysical considerations, such as resistance offset contracts was important, principally in theand durability of the material, and skilled development of the military segment. Here one canlabor must be developed to handle the highlight the contracts with Piper and Northrop.equipment and the material. Today, in the production of commuters, there is a

risk and development sharing partnership withother companies.

AssemblyThe partnership with Aeromachi was important fororganizational learning about assembly. TodayEmbraer has expertise in the integration andassembly of parts, with the currentmodel approaching the modular productioncharacteristic of the automotive industry.

Source: Oliveira (2005).


material base for geopolitical considerations of national integration, and the support ofnational defense policies [my translation].

Moreover, there was no real strategy to coordinate state enterprises, which had a tendencytowards constant expansion and negotiated separately with the Treasury. The militarysconstant interference created a conflict between the enterprises own objectives and meansand the demands of the Armed Forces (Perez Esquivel 2005: 2, 1011). The Argentinegovernments early interest led to Argentine civilians and military officials training abroadin the industry. Initially planes were assembled under license from foreign producers. Laloufreports that employment at the factory in 1930 was around 80 people. From the start,however, there was a great deal of turbulence in both economic and institutional terms.Heated technical arguments began within the militarys Aeronautical Service regardingwhether to continue to assemble planes or license or begin to design their own (Lalouf 2005:6263). Sadly, this argument was never really resolved until the privatization of the com-pany as discussed below. The argument came to a head at various times throughout the lifeof the FMA. In 1935, a Congressional initiative sought to kill the project entirely, placing indoubt the technical capacity of its directors and their activities (Halbritter 2004: 258259).

Paralleling the later Brazilian case, a more organized effort at domestic productioncame in 1943 with the founding of the Instituto Aerotcnico and the conversion of theAeronautical Service into the Argentine Air Force (FAA) under a new revolutionarygovernment, including Labour minister Juan Pern. The government created the NationalDoctrine, giving the state a dirigiste role in the economy, including industrialization andatomic research. These efforts were in line with the economic isolation of the Second WorldWar, which gave national production advocates the upper hand, albeit temporarily. SinceArgentina declared neutrality in the war, it was cut off from arms sales by the US (and later,from post-war aid). This motivated it to begin local sourcing of parts and production in avariety of sectors, including providing for its own aviation. Argentina recruited EmileDewoitine, a French aeronautical engineer, who had left following the fall of France, tobegin designing and building military planes for the Air Force. This led to the Pulqui I jetfighter in 1947, which was at the forefront of worldwide technological developments andproduction in aviation, though it could carry only limited amounts of arms due to very tightspace restrictions given the size of the fuselage (Lalouf 2005: 75, 94). In 1947, the Argentinejournal Aeronave stated that Argentina was building a jet fighter with the help of Europeanspecialists and that the technical capacity built up from the project would place Argentina inthe

immediate future not far from similar institutions among the three primary air powers of theworld (as cited in Lalouf 2005: 1).

A second wave of recruitment of German engineers centred on the recruitment of KurtTank, chief designer of the Focke-Wulf aircraft company, who was smuggled out of Europeby Argentine agents and recruited his own team from other fleeing Germans with thesupport of Pern. Tank suggested developing a number of projects, including new planes asfighters, trainers, bombers, and reconnaissance. He also suggested the development of analuminum plant to feed the aircraft industry. Finally, he proposed the development of acommercial plane for 30 passengers (called the Condor II, after the plane he designed inGermany). The main result was the development of the Pulqui II, the next generation ofthe fighter plane for which the prototype was competed in 1951. Fatal accidents with theprototypes led to revisions of the project; moreover, limits in terms of armament capacity


and speed as compared with contemporaries continued to fuel critics of the national plane.Internal dissension was also rife in that Argentine engineers felt displaced by the Germantransplants and they backed alternative designs (Lalouf 2005: 114116, 155160).

Stage 2: Institutional Chaos and TailspinDespite an early and promising start in developing native capacity (almost the same time asdeveloped nations), Argentina would squander it through a combination of governmentmismanagement and an unwillingness to accept the learning curve inferiority of nativemodels. Last but not least, the lack of interest to move towards financial viability throughcommercialization would perpetuate the industrys status as a pawn of shifting politicalinterests.

In 1952, the name of the FMA changed to Industrias Aeronuticas y Mcanicas delEstado (IAME), based in Crdoba. The new government, including Pern himself, began tochange priorities, seeing automobile production as more important than aviation andre-directing resources away from the latter sector. Pern believed that Argentina would oneday produce a million autos (Halbritter 2004: 261). The Crdoba plant began diversifyingindustrial production to a wide variety of products, including automobiles, tractors, motors,motorcycles, and arms. This may have been the first major blunder in terms of industrialpolicy, in reducing resources further at a time when major technical advances were occur-ring in international aviation, including the transition from piston motors to turbopropengines, needed to create jets and the development of integrated circuits of innovation,which led to the ability to surpass previous limits on aviation performance. A formerengineer at the plant states in an anonymous interview with the author:

As military men, we thought we could do anything with the appropriate will. We did notthink of the complexity of the task as we would for something like surgery.

Ironically, the auto sector itself was soon taken over by the Kaiser company of the US andFiat of Italy.

Even more damaging was the political institutional volatility, a pattern that was todoom the possibilities for a consistent long-term strategy for the Fbrica, which remained acaptive of the Air Force rather than becoming the industrial pole as desired. As PrezEsquivel relates:

The alternation of civil and military regimes, promoted by coup-oriented coalitions thatpushed their interests through military intervention in the political arena strengthened thegrowing autonomy of the Air Force. The military intervention and the growing institutionalautonomy produced successive changes of roles and institutional objectives, following thepredominating doctrines (at the time). Each new force tended to strengthen itself indepen-dently of the others, creating numerous super-positions in arms production initiatives, theexpansion of activities and resources, and as such making the tasks of cooperation difficult(Perez Esquivel 2005: 10, translation my own).

A new government in 1955 shook up the regime as the country became increasinglypolarized around pro- and anti-Peronista factions. Meanwhile a growing macroeconomiccrisis contributed instability in that dimension.

The demise of Perns government had incalculable repercussions for the future ofthe country. The new government shook up all institutions, changing key personnel in theIAME, the Air Force and the Instituto Aerotcnico. Lalouf reports that between 1955 and1960 there were 9 different directors, with a maximum term of 23 months, and equally


volatile policies. The IAME was transformed into the Direccin Nacional de Fabricacionese Investigaciones Aeronuticas (DINFIA). They also fatefully pushed Kurt Tank out ofthe country, noting his irregular entry. The moment gave the opportunity for critics ofnational production a chance to voice their doubts within the Air Force, citing the qualityand reliability problems of the Pulqui II experience. This led to the renewal of assembly ofplanes under license, and a proliferation of additional projects. The alternative of finding adomestic private partner was discussed in theory but could not be materialized. Along withthis came enticing offers from the US to purchase military planes at low cost, accepted bythe new government seeking a re-alignment with the US during the Cold War, as it began toface a leftist guerrilla insurgency at home. Even with the transition to civilian governmentunder Frondizi, pressures from these critics remained strong within the military. In 1960,the fifth prototype of the Pulqui II was realized, the same year that 14 F-86 Sabres weredelivered from the US following a year of training Argentine pilots (Lalouf 2005: 164174,190196).

The loss of technological capacity was recognized by the late 1960s. Lalouf notes thatby 1960, the Pulqui II had only half the speed of contemporaries, could not be fueled in theair, could not carry missiles and had limited radar capacity (Lalouf 2005: 206) Changes inthe name of the enterprise reflect the ongoing volatility in management, resources, andsupport. The DINFIA became the FMA again in 1967, but in 1968, it adopted the nameArea Material Crdoba. In 1972, the Air Force pushed the Fbrica to solicit offers toassemble helicopters under license from foreign companies, but the contract was annulledin 1973 after being deemed economically unviable (Halbritter 2004: 262263). In the 1970sthe Pucar fighter and the Pampa trainer planes were designed.

Stage 3: End of the DayThough at one point (1947) Argentina was the fifth largest manufacturer of planes in theworld, a series of disastrous decisions in the 1980s, including the failure of such partnerships,helped to finally doom the enterprise, including:

The Argentine state contracted the US company LTV to provide engines, seats andemergency systems for the IA-63 Pampa plane. LTV went bankrupt and the result wasa loss of $400 million to the Argentine state.

The New Zealand and Australian Air Forces agreed to buy the IAE-63 Pampa plane butdue to a lack of credit availability, opted instead for an Italian plane.

The 1982 Condor II project to build a rocket was dismantled by the Menemgovernment under pressure from the IMF for lack of financial resources.

The aforementioned joint CBA-123 project with Brazil, created in 1987 to produce a 19passenger plane with speed greater than 600km/h was estimated to cost $300 million, ofwhich Embraer would pay $200 million and Argentinas Fbrica Argentina de MaterialAeronutico (FMA became FAMA to begin producing for commercial purpose in 1987)$100 million. Each plane would cost $ 4.5 million and 127 formal requests to examine theplane followed an air show in France. When in 1989 the FAMA was unable to delivermaterials in time and according to specification, Brazil reduced Argentine participationto 20 per cent. When Argentina again was not able to produce adequate volumes orfinance expansion, Brazil turned to foreign banks for financing. As noted above, thefailure of this plane probably deterred Brazil from any further joint efforts (Benitez,internet source).


The long-standing problems of the Fbrica were apparent and as early as 1977, alterna-tives were openly discussed. In La gran esperanza (the great hope), Peluzzi, writing foran Air Force journal, makes several key suggestions to his compatriots for finding a wayforward. First, he says that Argentina must look to the possibilities for private domestic/international cooperation, without ignoring national priorities. Second, he says while FMAmust keep up with knowledge, and the FAA has the right to demand contemporary tech-nology, this can not come at any cost. Third, the FMA should look for markets outside thecountry to reach economies of scale. Fourth, adequate consideration of the business cyclesof the industry must take place. Last, Peluzzi states that the FMA needs to considerintegrating components globally, as very few products can have 100 per cent local sourcing(Peluzzi 1977).

Unfortunately, Peluzzis and similar suggestions, which could be read almost as aplaybook for Embraers success, were never seriously considered. The defeat of the militaryin the Malvinas War in 1982 led to a strong anti-military attitude and set of policies in thecountry. In addition to ongoing economic crisis, the new democratic governments tried todistance themselves from the military projects of the past regime. Alfonsins government,for instance, vetoed the sale of the Pucar to the Dominican Republic in 1983. In 1986,similar sales to Iraq and Mauritania were vetoed by Alfonsin, who sought to promoteArgentinas image as a peacemaker. The Pampa was seriously considered for adoptionby the US, in 1994, but in good part owing to its association with LTV, it lost the bid(Halbritter 2004: 410416). In 1987, the government, upon creating FAMA, tried to createa coalition of partners to take over the enterprise. A coalition of Italian companies Aeritalia,Agusta and Argentine firm Techint had serious conversations about developing acommercial plane based on the CBA 123, but the proposal ultimately went nowhere with thegovernment, as most of the construction would have been moved to Italy.

In 1995, under the duress of financial crisis and with the new ideas of neoliberal growth,the Argentine government privatized the former Area Material Crdoba (AMC) company,including the Fbrica Militar de Aviones, selling assets to Lockheed Martin, and endingnational production which had produced over 1,300 aircraft of 30 different types. Theprivatization was one of many initiated by the Menem Government, in this case by Decree899 in 1991, as part of a larger effort to reduce fiscal expenditures. A consulting reportat that time by ING bank suggested that half the work force of the AMC was surplus torequirement, and that 24 million pesos of new investment were needed, while it estimatedthat the Air Force had only 7 million at its disposal (Perez Esquivel 2005: 122123). Theterms of the privatization of the facility to Lockheed are for 25 years with two additionalten-year options; however, Argentina has an opt-out clause every 5 years. Though the latestversion is secret, terms have been released for the previous (second) contract. Lockheedis supposed to maintain planes for the Air Force; develop support programmemes for thedevelopment and construction of new types of planes, specifically the Pampa, motors andcomponents, for sale domestically and internationally; and employ at least 2200 of the per-sonnel of the plant. Lockheed received $230 million for these services. Lockheeds purchaseof the FMA coincided with the receipt of a five year contract from the Argentine Ministry ofDefense for the maintenance, modification and modernization of the Air Force fleet in 1995,in particular refurbishing 36 used Skyhawk A-4 planes purchased from the US in 1993(Scheetz 2002). The Skyhawk purchase was roundly criticized both in terms of costs andlevel of technology available via other options. This contract was worth $279.5 million toLockheed.


The privatization, like many others in Argentina, sparked off a firestorm of protest thatassets were being given away at fire sale prices. There was no solicitation of contract, andno public discussion of what would be reasonable terms. The controversy was not helpedwhen Lockheed reduced the number of employees from 2,950 to 1,950 and then to 950. Still,this travesty did not prevent a renewal, signed in July 2000, which included maintenance ofthe existing fleet and the manufacture of 12 AT-63 attack-trainer aircraft. According toSheetz, a 2001 contract promises to increase the workforce back to 1100, in order to produceat least 12 Pampa planes under contract for the Argentine Air Force. Unfortunately, withthe previous lay-offs much of the skilled workforce has either gone into retirement oremigrated to Embraer (Scheetz 2002). Moreover, the Lockheed privatization was necessi-tated not only by the fiscal crisis, but the lack of allocated budgetary resources for the main-tenance of the newly acquired A-4 planes, a decision in which the Argentina Air Force tookno part (Scheetz 1998: 110). Another renewal took place in 2005, this time with a secretcontract. In July 2006 new protests by Lockheed workers were taking place amidstrumblings of the Argentine state possibly annulling the contract.

Conclusions: Lessons for Other Developing Countries

We can now answer the two questions of the study. First, that state support of high-techfirms is crucial to their success throughout their lifespan. Former CEO Ozires Silva statesthat the Brazilian Government has been fundamental and allowed the company to exist(Silva 2005: 426). Silva, who later went on to manage the highly successful Petrobras stateoil company, was known for being oriented towards privatist management of stateenterprises (Franko-Jones 1992: 70). Current CEO Mauricio Botelho has stated:

Reliance on Brazilian governmental support is critical. They are the ones that count. The USwont support us, even though it is our biggest market and our biggest source of imports. Wewant to keep on being the technological and industrial arm of the Brazilian government(quoted in Ghemawat et al. 2000: 15).

However, we have seen that the state can have both positive and negative effects. This bringsus to our second question, namely how statefirm relationships can optimally evolve. Ouranalysis suggests the following.

Stable and consistent but flexible state support for industry growth is necessaryBrazilian state support for Embraer was at arms length, but stable and consistent, includingserving as the most important customer. By contrast, the Argentine government, whoseinitial strong support meant a viable industry in the early years, began to vacillate aroundthe same time Embraer was forming. Argentines purchased from abroad, and werefactionalized in their support.

Brazilian statefirm relationships were also more flexible with changing global condi-tions and the evolution of the company. Embraer stumbled upon the solution to thisproblem in developing its global systems integration approach.

Both parties should expect and absorb failures along the way and possess a willingness tofinanceEmbraer has had a number of major project failures along the way, including the CBA 123joint venture project with Argentina. Embraer has also suffered through major downturns


in the market. Yet, in hindsight, each major crisis appears to have been another opportunityfor improvement. Brazil stuck with its long-term plans, and continued to try to improve onthe basis of failure. In Argentina, as a property of the Air Force, the FMA never really hada chance in the initial period to become efficient. As one interviewee described, The goalwas to produce planes [efficacy]. Efficiency was a secondary consideration. It was quitestriking to the author that there is no documentation regarding audits or financial reportsto be found regarding the Fbrica; no systematic evaluation appears to have taken place.Indeed, the Fbrica, created initially by secret decree, never had jurisdictional standing.

An autonomous centralized training and research facility with a clear mission is essentialIn Embraers case, the ITA was set up as a separate entity whose sole purpose was todevelop the aircraft industry. The politicization of the Latin American economy reinforcesthe importance of this move in more general terms (Maldifassi 1994: 116117). Since it waslinked to military budgets, it had a particularly motivated workforce and budget. The resultwas the foundation of aerospace engineering training, geared towards a concrete missionof creating a competitive aircraft industry (Botelho 1999). Moreover, almost from thebeginning Embraer embraced the idea of producing civil as well as military aircraft. Bycontrast, the FMA was conceived of purely as a means to service the Argentine Air Forcesneeds, yet even parts of the Air Force preferred to purchase planes outside the country. InArgentina, the lack of vision on civil military crossovers and the need for long-termsupport dampened the advantages of an early start. Multiple projects and spin-offs, includ-ing whole other industries meant that inadequate resources were available for maintainingtechnological capability on international levels. Heavy reliance on outside designs (andforeign teams) reduced national autonomous capacity and the reputation of the aircraft.The privatization effectively gutted the human capital built up over the 63 years ofexperience, ironically to Embraers benefit, where key Argentine experts joined.

Export or die, and recognize that underserved market niches are opportunities for learningAs noted above, Embraers orientation towards exports in the 1970s was crucial for its long-term success and particularly achieving economies of scale in production and world-classtechnology. Embraers need to export forced the state to provide increasing amounts ofpublic finance and to gear public support towards exports, including Pro-Ex subsidies andmarketing assistance. The export markets themselves disciplined the cost structure andgenerally guided the enterprise towards that central mission. As related in the CBA 123debacle, the cost structure and design of the planes had to be guided towards externalmarkets, forcing a continual learning curve approach in the company. It also forced thecompany to develop an international marketing savvy that led to relationships in the keymarkets and the licensing breakthroughs. Last but not least, the need to reach externalmarkets has helped Embraer to adopt the global modular design of production, by which itmanufactures with international partners. None of these aspects ever occurred inArgentinas FMA, essentially because of the lack of mission.

Embraer understood that it would not likely be able to compete with Boeing andAirbus in large passenger planes. It astutely focused on underserved and less competitiveniches that were more feasible as part of its learning process, beginning with agriculturalspray planes to military training planes, at each point having a focal project, beginning with


the Bandeirante. These forays allowed it to work out the kinks in the technology, savefinancial resources, and slowly build a reputation for quality and competence in smallaircraft. Only after this learning curve did it enter into the moderately competitive mid-sizeaircraft segment.

Certainly, we have to consider that timing played a role in the fact that Argentinasobjective in the heyday of its production was national self-sufficiency in the industry, in linewith the prevailing ideas at the time. To be sure, Embraer was fortunate in that its designsfor the Bandeirante and Brasilia planes meshed with the development of the new regionalcommuter market rising in the 1980s as a result of US deregulation. These market windowsrequire pro-active strategies, such as Japans auto manufacturers being ready to take off byproducing fuel-efficient vehicles in the wake of the 1970s oil crisis. Given Argentinas indus-trial base, it could have equally entered such a market had institutional and financial factorsbeen better managed.

By contrast with the consistent public support and internal management that enabledlong-term success, the Argentine government has effectively subsidized Lockheed withoutensuring the survival of its industry or human capital. With no consistent strategy on indige-nous design or foreign partnerships, and inconsistent support for either, with deals killed,and with no marketing or export strategy, it is difficult to see how Argentina could haveturned the situation around by the 1990s, in the midst of a macroeconomic crisis (notdissimilar to Brazils, however). Yet, even in the period leading up to the privatization, it isconceivable that some aspect of the Fbrica could have been preserved through the engage-ment of national and foreign capital, certainly there were several possibilities, particularlyin the Pampa trainer. As Prez Esquivel notes, from the outset, the FMA project was neverclosed to collaboration with private capital, either national or foreign (Perez Esquivel 2005:8). The contract with Lockheed Martin, without any solicitation of bids or governmentscrutiny, therefore remains inexplicable. The renewal of the contract is even more unfatho-mable given that the initial promises to maintain jobs and to sell Argentine planes have beenopenly broken, with immense social costs. It is a big leap to move down from aircraft manu-facture to a maintenance hub, and even the latter has not succeeded as a strategy. The foun-dations of the industry built up through precarious straits over the course of 80 years, havebeen wiped clean.

Acknowledgements

We gratefully acknowledge the support of the Canadian Social Sciences and HumanitiesResearch Council and Simon Fraser University for this research. We particularly would liketo thank Thomas Scheetz for his generous guidance in the Argentine portion of the research.We would like to thank Ron Hira, Tom Scheetz, David Pritchard and Brian Wixted forcomments. Anil Hira translated all materials for citation here. This article is dedicatedby Anil to his brother, Ron, for inspiring him to examine the question of technology anddevelopment more.

In addition to secondary and sector-specific sources, this research, particularly in termsof understanding the context of the issues from the point of view of complex statefirmrelations, could not have been completed without the generous support of numerous col-leagues in Brazil and Argentina, academic, military and corporate, who shared their lifeexperiences with the states and markets in open-ended interviews and creating access to


privileged archival material; we mention the most important here where possible (severalsources did not want to be identified for obvious reasons). We have rendered anonymousquotes and data from sources interviewed in order to protect them. All interviews wereconducted by Anil Hira in Brasilia, So Paulo, and Rio de Janeiro and Buenos Airesbetween MayJune 2006. I include a short description of interviewees background/exper-tise. I also acknowledge gratefully the engagement of the GUP18 users group of Argentinesinterested in aerospace.

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