ISI04 Case Embraer Turn Around

7/31/2019 ISI04 Case Embraer Turn Around

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EMBRAER: TURN AROUND?11

1 This case was prepared by Prof. Dong Bian, EM-Lyon Business School. It is intendedfor class discussion rather than illustrate either effective or ineffective in business

administration.

Copyright 2011 by EM-Lyon Business School. No part of this publication may be

reproduced, stored in a retrieval system, or transmitted in any form or by any

means-electronic, mechanical, photocopying, recording or otherwise-without the

permission of EM-Lyon Business School.
http://www.em-lyon.com/france/corporate/index.aspx


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EMBRAER: TURN AROUND?

The international press often refers to Brazil with the perception that we burn our forests, we kill our

children, we do notpay back our debts, we steal their patents. I dont deny some of those things happen,

but they are not the fundamental Brazil. We feel we represent another side of Brazil that is not very well

perceived.2

-- Botelho, Former CEO of Embraer

Embraer is one of the main aircraft manufacturers in the world. Though, compared

with other industrial players like Boeing, Airbus and Bombardier, it is still young,Embraer aggressiveness in business development and airplane research in the last 40

years proves that it will be a strong competitor in the global aviation industry. Its jets

now almost cover all the worlds most important markets: US, France, Portugal,

Singapore, China and its home country Brazil (see Exhibit 1).

With around 17,149 hard-working employees (shown in Exhibit 2), Embraer recently

experienced ups and downs due to changes of the macro economy and the

ever-increasing airplane industrial competition. Its performance seemed good in

2007 and 2008: net revenues amounted to 5,245 million US dollars in 2007 and 6,335

million US dollars in 2008 with net incomes of 489 million US dollars and 389 million

US dollars respectively (see Exhibits 3 and 4). However, sales drops in 2009 and 2010,

macro factors that constrain the world business to recover and challenges from

Russian and Chinese aircraft manufacturers may signal that Embraer probably has a

long way to go if it wants to achieve an absolute leading position in the global

aviation market. Experts are wondering whether Embraer has entered another

recession cycle and whether it is able to overcome those internal and external

difficulties and turn around its current situations.

In fact, the concept ofturnaround is not new for Embraer. In 1980s, the companywas almost bankrupt. Privatization, a series of management measures and right

timing of implementing a new strategy saved Embraer. Nevertheless, how exactly

Embrear recovered from the very bad circumstances and became competitive in

1990s, although a lot of stories about it, is still a kind of myth. Can Embraer borrow

its past experiences to sustain Embraers future development? In addition, what

challenges Embrear may meet in the coming yearsWhat would be its new strategic

direction, as the growth rates of American and European economies keep low in the

next decade?

2http://money.cnn.com/magazines/fortune/fortune_archive/2005/11/14/8360683/index.htm


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EMBRAER BEFORE 1980s

CTA (Centro Tcnico Aeroespacial) and ITA (Instituto Tecnolgico de Aeronutica)

were two state-owned aviation and aerospace engineering organizations in Brazil.

Established in 1946, CTA was designed to coordinate and develop advanced

aerospace technologies to serve Brazilian Air Force. ITA, although located in CTA

campus, was functionally different from CTA. It was an engineering institute. Its job

was to disseminate basic engineering knowledge and educate talent engineers for

Brazilian space industry. Obviously, the cooperation of these two was to help the

Brazilian government achieve competitive edges in the military field.

Since its establishment, CTA had taken various aircraft projects for the Brazilian Air

Force. One of them was IPD-6504. The objective of IPD-6504 was to develop and

produce mid-range turboprop biplanes, named Bandeirante, to replace old fighters.

In 1969, the Brazilian government found that this plane might have commercialpotential too and decided to introduce the Bandeirante into civil markets. At that

time, few companies or institutes could manage such a big and complicated project.

Though CTA and ITA could do so, their involvement in military programs made them

sensitive to contribute to commercial market development. To avoid technology leak,

a hybrid organization Embraer was created on July 29, 1969: Embraer was to not

only develop and manufacture military planes but also involve in civil aerospace

engineering and market competition. Based in Sao Jose dos Campos, Sao Paulo state,

Embraer built up a team of around 500 employees. It could be easily predicated that

most of them were from CTA and ITA.

In 1975, after delivering some Bandeirantes to the Brazilian Air Force, Embraer

realized its first commercial sales to TransBrasil13 (an air company). Cheaper price,

relatively mature technologies and friendly design quickly exposed Bandeirante as a

competitive commercial plane in the global aviation market. Many countries bought

it. Bandeirante was proved to be so successful that, before Embraer stopped

production of this model in 1990s, over 500 were sold. The performance of

Bandeirante was encouraging. The Embraer top management believed that they had

found the success recipe and decided to invest more engineers and capital in some

other projects: Xingu and Tucano (a combat aircraft) then succeeded the story. Theformer was the first pressurized aircraft of Embraer, while the later was a combat

aircraft. These two became stars among Embraer s military products. 14 countries

eventually used Tucano as advanced military training aircraft; in late 1970s, Embraer

developed a new regional plane with 30-40 seats, Brasilia, for commercial purpose.

When it was officially certified and delivered to Airline companies, its high speed,

light weight and cheaper price immediately won the market recognition.

Except for military and commercial markets, Embraer also eyed on agricultural planes.

That made its product portfolio quickly enlarged to meet various kinds of demands

based on similar technologies. To acquire new knowledge, Embraer relied on not


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only its own research institutes but also external collaboration. In 1980s, Aeritalia

and Aermacchi agreed to cooperate with Embraer in developing a subsonic fighter.

This allowed Embraer to access European technologies.

THE FAILURE OF VECTOR AND PROBLEMS IN PRIVATIZATION

In late 1980s, Embraer signed an agreement with FMA (Fabrica Militar de Aviones: a

key Argentinean military aircraft manufactuer) on designing and manufacturing a

new product CBA 123 Vector plane (known as Vector). Since they used the best

turboprop technologies at that time, both parties believed that Vector could strongly

establish their leading market positions if things were going on the right track. They

spent several years on research and development and 300 million US dollars of

investment. When launched in the market, the price of Vector was so high that no

single plane was actually sold to any interested client. The project finally was

cancelled. The failure of Vector seriously trapped Embraer in a very difficult financialsituation.

Even worse, in the early 1990s, Brazil transformed from a government-controlled

economy to a market economy. It required that the Brazilian government had to

withdraw its visible hand on businesses. That was why Plano Real was introduced.

The new Constitution regulated that the Brazilian government should reduce its

investment and financial support to the aviation industry. It meant that, even though

Embraer was a state-owned enterprise, it could not directly get money from the

Brazilian government as it usually did but had to work as an independent business

organization to finance its projects by itself. In addition, due to the end of the Cold

War, the communism camp and the capitalism camp were not fighting that hard

in the military field. The falling down of former Soviet Union immediately led to

low demands in the military market. Aircraft manufacturing industry consequently

became one of the industries that were greatly influenced. The situation eventually

brought about operation difficulties for Embraer.

Like many other state-owned enterprises in Brazil, except for the abrupt external

business environment changes, Embraer had its own problems. It inherited the

tradition of CTA and ITA as an organization which was supposed to take theresponsibility of developing top technologies for the country. This tradition

determined that Embraer should conduct some research, no matter whether the

research would be cost-efficient and meet the market requirements or not. Through

this mode of R&D financing, the company did cumulated a pool of advanced

aerospace technologies. However, because of the gap between Embraer s R&D

activities and market demands, a large percentage of the developed technologies

were simply not marketable and applicable in the civil aviation market. It was either

due to higher prices (caused by higher investment cost) or strict governmental

control on application of those military technologies to the civil industry (security

reasons). Even though some of the projects might fit the commercial markets, bad


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management on R&D and manufacturing cycles made Embraer miss many marketing

opportunities. 6 years after it cooperated with FMA, Embraer ran in red (330 million

US dollars loss).

In fact, Embraer was not the only case in Brazil. In the early 1990s, several big

state-owned enterprises were in similar circumstances. The Brazilian government

definitely did not want such big companies to go bankrupt. Neither did the labor

union. Since those firms could not rely on support from the government any more,

many of them counted on private investments. In December 1994, Bonazo Group

and two other government-owned pension funds, Previ and Sistel, formed a

syndicate to become investors of Embraer. Though the objective of the privatization

was to push firms into markets, the government was obviously cautious about it.

Bonazo, the state-related Previ and Sistel held a total of 60% of Embraer s assets. To

avoid foreign investors takeover and keep its influence on the company, the Brazilian

government in addition held a golden share with veto power in Embraer. Thatallowed the government to play a role in key decision makings in the company. The

new Embraer named Mauricio Botelho, the former CEO of the Bozano Group, as the

new President and CEO of Embraer.

POST PRIVATIZATION DILLEMMA

When Mr. Botelho assumed his position, he thought that he should immediately

analyze the financial situation of Embraer and issue a feasible turnaround plan as

soon as possible.

In the early 1990s, the external demands were low and Embraer found it even

difficult to market its own believed competitive aircrafts. The financial performance

of Embraer was so bad that it might even hard for the company to manage normal

operations. To recover from this situation and hope to achieve a kind of

competitiveness again in the market, Embraer had few choices at hand. As most of

the economic theories suggest, the company had to reduce cost and tried to increase

revenue. Cost cuts sounded more convenient and realistic than increasing sales.

After a tough negotiation process with the labor union, over 40 percent of the

workforce was laid off. This directly caused a serious tension between the topmanagement and the labor union. Even though the lay-off plan was successfully

implemented, the financial gap was still large and the reduced cost was difficult to

compensate for the loss. Botelho ever thought to further lay off 600 workers.

However, that would make the labor union even angry and uncooperative. Increasing

revenue? It would be tough to achieve this target, at least in the short run, based on

Embraers current product portfolio: Vector? Died. Agricultural planes? Low profit

rates and low high-tech contents. Combat aircrafts like Tucano? Low demands.

Brandeirante? Seemed a good choice but the technologies were out of dated and

Brandeirante planes were small (15-21 seats), which meant a low-end product. In

1989, Embraer launched ERJ-145, a 50-seat airplane designed to compete


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Bonbardiers CRJ-200. However, whether the technologies were mature enough,

whether ERJ-450 was competitive in terms of manufacturing costs and after-sales

and how to establish trust between air service companies and Embraer (Embraer is

from a developing country) were still problems, especially competing with a global

recognized player Bombardier.

The aviation manufacturing industry, to some extent, is different from other

traditional industries. It is both knowledge and labor intensive. In 1990s, there were

only a few players competing in the field. Interestingly, due to the complicatedness of

air planes, no single firm could produce all the parts of a plane. They relied on

professional component suppliers to manufacture key parts and their own assemble

lines to integrate the supplied and its own produced parts into a final product. In this

business, Embraer was less experienced compared with its competitors Boeing,

Airbus and Bombardier. Boeing was founded in 1916 in Chicago. Before 2000, Boeing

kept the world number one position in the global civil aviation manufacturing market.It is still the second largest defense contractor in the world after Lockheed Martin up

to now. The company had offices in over 60 countries which served clients from

around 140 countries. Its product series like Boeing 717, 737, 767 and 747 were

mostly larger aircrafts. For instance, 717-200 is a 106-seat plane; 737-600 is 110-seat;

737-700 is 126-seat; 737-800 and 737-900 are 162-seat and 177-seat respectively;

757 goes to 200-seat; later, 777 is 340-seat and 747 is 280-seat. Years of R&D and

marketing experiences helped Boeing strongly dominate the market, until it met

Airbus. In 1970, Sud-Aviation, Deutsche Airbus decided set up a consortium to jointly

develop air planes. Later, British, Spanish, Dutch aerospace firms were invited and

participated in the project. This mode of cooperation greatly moved things forward.

As A300 series were released in the market, Boeing became uneasy since these

products were competing directly against theirs: A318 is 107-seat; A319 is 120-seat;

A320 is 150-seat; A330 is around 300-seat and A340 390-seat. In 1990s, these two

companies were fighting in the130-seat market. The emergence of A380 in 2000s

signaled that the competition is going to be escalated to the superjumbo segment. To

some extent, Bombardier Aerospace (hereafter called Bombardier) was more

comparable to Embraer. As part of the Bombardier Group, Bombardier was

established to produce Learjet business aircrafts. Its CRJ series are much smaller than

the products of Boeing and Airbus: CRJ440 is 44-seat; CRJ100/200 is 50-seat; CRJ-700is 70-seat. Q series are also 50-seat (Q300) and 70-seat (Q400).

Embraer needed money and other resources to survive. It also had to develop

current or new products if the company wanted to go forward. However, the bad

performance of its product portfolio and the established positions of its competitors

put it in an awkward situation.

THE AIR SERVICE INDUSTRY AND THE COMING CHALLENGES FOR EMBRAER

Air service companies like Lufthansa, Air France, Air Swiss, Delta, Continental, United


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Airlines, and US Airways etc. are customers of air plane manufacturers. Air service

companies usually borrow money from banks and buy commercial airplanes to

provide air services to their customers air plane passengers. Since international

airways are more profitable than domestic routes, most of big air service companies

are intensively competing in offering international, cross-continental transportation.

That is why they purchase long-haul bigger airplanes. However, bigger airplanes have

drawbacks. When the number of passengers is not enough, flying bigger airplanes

would be not that cost-efficient. Some research says that more than 60% of flights in

the United States take off with around 1/3 or even 1/2 empty. In addition,

smaller/low-cost air service companies are joining in the air service competition.

They tried to cover regional or secondary-route airways, where bigger airplanes

obviously could not fit. Though bigger air service companies realized the market

potential and started deploying their airplanes to meet regional demand, cheaper

prices with limited foods and luggage services provided by small firms really

attracted many passengers from the customer pool of bigger ones. Additionally,especially in US, pilots were usually unionized. Flying bigger planes would get more

salaries than flying smaller ones. So, it would be difficult to have pilots flying small

planes with reduced salaries. In fact, it greatly prevented bigger air service

companies from doing regional businesses. Those made bigger air service companies

feel unsafe.

Ten years after Embraer released its ERJ-145 in 1989, Bombardier launched a lawsuit

against Embraer at the World Trade Organization. Embraer was complained by using

Brazilian governmental subsidies to gain price advantages in the civil aviation market.

Bonbardier won the lawsuit. It seemed that Embraer could no longer compete

against other players on low-price basis.

Although Embraer had experiences in designing and manufacturing turboprops,

Botelho decided to stop all other product development but focus on R&D and

manufacturing ERJ-145 in 1990s. It was true that turboprops were noisy and bumpy,

which was not popular at that time. Nevertheless, the resurgence of turboprops in

2003 created a new competitor ATR. ATR 42 and ATR 72, even Bombardiers Q

family, were sold well. Is it a wrong strategy for Embraer to stop manufacturing

turboprops?

After having ERJ-145 in the market, Embraer quickly developed bigger planes ERJ-170

and ERJ-190. The first delivery of ERJ-190 was in 2005. One year later, the biggest

customer of Embaer JetBlue claimed its first quarterly loss. Experts stressed that

the loss was largely due to the inappropriate use of ERJ-190 and many thereafter

occurred technical problems for Embaer s products. Some even said that Embraer

should slow down its growth to take care of product quality issues.

In 2005, Antonov ASTC, a Ukrainian aircraft manufacturer, marketed its 70-seat

An-148 in Russia. Ilyushin Finance Company and KrasAir (the fourth largest domestic


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airlines in Russia) bought it. Sukhoi, another big name in Russia, also intended to

push it new 75- and 95-seat Sukhoi SuperJet 100 into the global market. 163 units of

SuperJet 100 will be delivered by the end of 2016. Chinese-made ARJ21 will

participate in the regional jet competition soon after.

In 2005, 7.9% of Embraers revenues came from Brazil. It seemed that Embraer had

already been an international company.

CASE QUESTIONS:

1. Embraer is a Brazilian aircraft manufacturer. In the late 1980s, what were theproblems for the company?

2. Collect additional information to show the positions as well as product portfoliosof Boeing, Airbus, Bombardier and Embraer.

3. If you were Botelho, how to turn around Embraers situation?4. Do you think it was wrong to stop producing other products but ERJ-145? Why?5. In the future, there will be a lot of competition in the regional jet market. If you

were Botelho, how do you deal with this market?

6. Review on the above questions and your answers and discuss what would beyour strategy to turn around a firm from a developing country.


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Exhibit 1: Business Landscape of Embraer

Source: Embraer website

Exhibit 2: Employees and Composition

Source: Embraer website

Exhibit 3: Annual Evolution of Net Revenues (US$ - million)


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Exhibit 4: Annual Evolution of Net Income (US$ - million)

Exhibit 5: Revenue by Segment and Region


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Documents

ISI04 Case Embraer Turn Around