Embraer: The Global Leader in Regional Jets
1. Embraer’s success as a global competitor can be separated into two distinct periods – pre-privatisation and post-privatisation. Pre-privatisation, Embraer was founded on the back of the Brazilian government’s push for developing aeronautics and as such it was given special treatment due to its position as a symbol of Brazilian nationalism. As such, it was able to achieve success initially due to many initiatives set up to promote aeronautic research by the government. Of particular importance is the subsidies received by Embraer, which helped it to achieve the majority market share in the commuter turboprop market with its ‘Bandeirante’ aircraft. The subsidies were believed to be in the region of 39-44% as claimed by their competitor Fairchild, which undoubtedly played a huge role in their early success. However, Embraer began to falter when a series of negative events began to hurt its profits when budgetary pressures as a result of macroeconomic difficulty in Brazil meant that they could no longer depend on subsidies to help boost sales. In addition, their political ties led to the development of CBA 123, which ultimately turned out to be a huge failure.
To help examine Embraer’s post-privatisation success, we can use an adapted version of ‘The Four-Tiered Structure of Markets’ found in Khanna & Palepu (2006). In this adapted version of the regional aircraft manufacturing industry (Apendix 1), there are only three tiers namely Global, Glocal and Local. In the early stages of Embraer’s operations, they were arguably operating in the Local tier of the industry. As a state-owned initiative, their primary purpose was to serve the local Brazilian market. Around 1981, Embraer began moving up into the Glocal Tier as it set up a subsidiary to focus on its exports to the U.S. as Embraer became the market leader in the commuter turboprop market.
Brazil’s geographic landscapes led to challenges in developing surface transport infrastructure, and Embraer’s focus on the smaller regional passenger aircraft is likely a result of the need for domestic transport needs. Over time, Embraer developed expertise on the needs of its customers – with the ties developed with the regional airlines from its operations pre-privatisation, Embraer was able to develop a sense of what they looked for in a regional passenger aircraft. As a result, they were able to develop the ERJ 145 which had key competitive differences such as increased passenger space for increased comfort, increased airline operation efficiency due to its pure commercial design as well as lower costs of operation (the lower wage bills in Brazil compared to more developed countries also helped contribute to this). These key features developed as a result of product understanding, and was a key factor for the success of Embraer on the global level. The ERJ 145 helped to solidify Embraer’s presence outside of Brazil, with the export market growing from 35% in 1996 to 84% in 1997 in terms of revenue. This also marked the turnaround of the company as it recorded its first full-year profit in financial year 1998 after a long spell of unprofitability.
2. All things considered, the success of Embraer can be said to largely stem from the efforts and aid it received from the Brazilian government. With the military government favouring state intervention and protection of national infant industries, Embraer benefited through a multitude of ways. As a new player in the aircraft manufacturing industry, Embraer did not have the means to attract talent with the necessary skills and knowledge from abroad. Hence, the solution was to look internally, and the government laid the foundations for this by setting up a research program in Brazil’s universities to develop the right talent. In addition, an aeronautical industry hub was set up to drive research initiatives to further enhance Embraer’s technical capabilities.
Furthermore, Embraer’s financial performances were boosted from its close relationship with the government. It benefited from a steady stream of revenue from fiscal spending as federal agencies were mandated to buy Embraer products only. In addition, the government effectively subsidised Embraer by giving them a tax-exempt status on imported raw materials and parts.
Embraer also benefited in terms of financing from associating with the Brazilian government throughout its lifespan. Initially, it was involved in an income tax scheme which helped raise $350 million in capital between 1970 and 1985. For an industry with such high capital requirements, the importance of finding easy and cheap financing is even more paramount. In addition, Embraer was saved from bankruptcy when the government assumed $700 million of debt and injected $350 million in capital to help the company privatise.
Government support was still present post-privatisation in the form of concessional financing rates, which was provided through the PROEX program. However, even after Bombardier’s price cuts, Embraer’s ERJ 145 was hugely successful, and hence its success should be attributed to more than the 1.8-3.5% financing cost savings for their customers.
3. Botelho’s decision to re-emphasise the military business was based on the higher margins that can be obtained as well as the intention to maintain close relationships with the government amongst other considerations. However, a move to grow its military arm of the business holds huge amounts of risks as well. Based on the Porter’s Five Forces analysis of the defense industry (Appendix 2), the defense industry looks relatively unattractive to compete in. Although the threat of new entrants and substitutes is low, high supplier power coupled with intense competitive rivalry makes the defense industry a difficult one to compete in.
In addition, research & development is extremely costly for defense sales – about one third of Embraer’s product development spending is on their military products and this represents a substantial amount that can saved if Embraer decides to narrow their focus onto commercial craft only. After all, the defense sales were a mere 7% of total revenues by 1999 – Embraer could possibly divest their defense division without significant loss of income.
Post-privatisation, Embraer was not as dependent on the government as it was prior. With Brazil’s entry into the WTO, the government will be unable to subsidise Embraer’s core regional jet business for long. This reduces the importance of maintaining close ties with the government as Embraer was a well-functioning and profitable business on its own. Furthermore, the government’s stake in the company was greatly diminished after privatising and this also meant that Brazil’s defense contracts no longer automatically went to Embraer. This made the French alliance even more risky, as the company could no longer depend on Brazil’s fiscal spending in the defense sector.
4. What can Embraer do to become more internationally competitive?
With the undertaking of the new class of 70+ seater aircraft, Embraer could look towards this as their new engine of growth. With the high development costs involved in that project, Embraer should try to increase its competitiveness by increasing the scale of this new family.
Regional airlines in Asia and Africa could be new drivers of growth, and Embraer can look to increase its global presence by implementing more sales offices overseas. The company could look to further enhance its competitive advantage in terms of understanding its customers if it can operate closer to its clients both geographically as well as culturally. Regional airlines operating in different regions may have their own preferences when it comes to customising the aircraft, and Embraer could possibly look to service any requests to improve their value proposition. With feedback from their international customers, Embraer can continually innovate and design products that will capture the changing patterns of the airline industry.