The growing role of emerging markets in aerospace _ McKinsey _ Company

Yes. Welcome to McKinsey on high tech. Featuring original research from McKinsey on high tech
and telecom issues. This is David Chase practice manager of Mackenzie's North American high tech
and telecom practice. I'm talking today with next and then Cowen bird Max and associates principle
and of Montreal office of the candy. As a leader of a Kansas aerospace and defense practice. Today
will be talking about globalization aerospace. Mack has been leading research on the spread of
aerospace manufacturing. From the more developed countries. To the developing world. Back
thoughts talk about your research. And a high level. What is your research. Say about globalization.
In aerospace at a high level. What we say. Is that within the next fifteen twenty years which is the
time frame these things who. In that industry. We see new players coming into the game. Of
designing and producing fuel AK raft. Commercial aircraft. That is you know China and Russia. And
also in the case of Russia. We see Russia is a very credible player. Technical large component such
as. Engine or even if unique. And so these players are going to change the game. In the next fifteen
twenty years where you currently in most of the markets you have a very discrete and limited
number of players you know in larger craft you have. Boeing and Airbus. In regional jets you have.
And by air and even major components such as engine where you have three players. Differently
going to change the game more competition. Different value proposition. And so we see. The first set
of opportunities for. Current players. For Attention new entrants. But also. Game changing at an
industry level. Can Change even why has it taken so long. If I work at a country like China. Authority
a long time since manufacturing. Has moved to low cost countries. Why is. Aerospace. Different from
other manufacturing industries. And that only now. Are we having the discussion. And even then.
We're only looking at a couple of markets versus. A vast array of developing countries. The reason
why it actually took a lot more time and I'm currently still in infancy already. Basically you're looking
at less than five percent of the total value chain that is coming out of. You know quoting quote. Low
cost country or emerging countries. Purses. T.V. or OTOH electronics like T.V.. More than eighty
percent east on there. Roughly thirty percent. And the reason why is first. It's an industry that is
very sensitive. So a lot of the. Innovation in this industry is actually adaptation from the military.
Area that is transplanted into the commercial area. So. Countries like the Europe and the U.S. are
not very eager to see that. Know how good china. Go to Russia. Between the second reason is that
it's really complex a tree. Very high investment. And it is very high level of government support in
these countries a priority has not been to develop Aerospace in more. Around developing the basic
industry. To satisfy local needs. And now these countries. Start having the capital. To look into.
Beyond the space. Because there's going to be more money and more and more support to the
industry and. The last point is that. Also being an industry where it's just been a lot of art. In the
way. The products are manufacture you're speaking of very low rates of production. Maybe you want
to craft to extract three aircraft a week ago out of a plant that work is not very well standardized.
Most of the plants that we know. And. It's a typical actually transfer. Production from existing plans
to new plant. Around the world just because there is a lot of. Know how that is in people's head and
it is not pretty could he find. So all these. Make it more difficult. Industry. To move production
around. When we talk about this new development and. Many of the things. Coming to fruition at the
same time in terms of the available capital. The increase in. Capabilities and know how. When we
talk about the spread of aerospace and factoring are we talking about manufacturing. Of specific
components. Are we actually talking about whole. Airplane assembly. And also are we talking about
large. Marge commercial airliner. Type airplanes are we talking about different classes of airplane.
The focus of the research has been to figure out all these countries going to be able to produce AK
raft commercial though. Not from the components of it but really being able to manage a program.
In the final assembly of a full laptop in different classes of across from larger craft down to regional
jets. Even so we are really speaking about things that can fly out of the plant. So if we work at these
different countries developing aerospace industry. Whatever you have to get right. In order to be
successful. That's a good question actually because that's where the first question of the research
where does it take to actually build such a company or such an industry. And understand and to
really you know identify what are the building blocks if you wish of these industry we have to look
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The growing role of emerging markets in aerospace _ McKinsey _ Company

into the past and look to countries in the past forty fifty years have been a bow or not been able to
actually build an industry that is able to create. Design and build back up. And so we look into the
story of our best so Europe. We do tend to the story of M.R.I. or in Brazil. If you two to the story in
Canada. And we've looked into the story of. Japan. Aerospace which. Interesting enough. Has
actually not been able to get to that. Ultimate point of developing a for that craft. And has quite an
equal stop at the major component level. Today. Japan is. Number three or four. In term aerospace
industry. But they are just doing major components for the Boeing. For the album. For the body and.
There are actually five building blocks that a given country needs to put in place. The first one is. We
actually need a government that is supporting this initiative. So it has to be very high on the
government agenda and. This government needs to trigger. Somehow the consolidation. Awestruck
or of the aerospace industry. All these players be speaking about. Have actually created. One
company. That is coordinating all the aerospace activity that. Created me in Europe. In Canada and
rare in Brazil. And interesting enough Japan. Has not done that for us to have the various players. In
Japan. Doing aerospace work over the first thing you need government permission and industry
alignment. Second thing is you need money. You need a capital access to capital. They do keep to
develop. Kind of a single take north of six billion dollars So as you begin. Real money. Even in terms
of what you would need to invest in manufacturing capacity to produce. That one jet of each. It's just
a development. So it's just not even speaking of the capacity not even speaking of producing the
first. Having teams of engineers. Being able to just put Yeah crapping on the plans and. Testing
meeting the pilots at the trot to try to take care of many right. So the capital can come from different
sources can be. Government support. Various forms. Does need to be cash can be just engineering
reality or. Research centers that kind of sound you know is just direct private investment to support
you need to have a design capability. And. Interesting enough when we looked into more details of
what that means. It actually means that you need to have. What we call secondary. Engineering
capability. For the ability to develop two drawings three D. drawings. Two flight test operated touch
one that actually can actually get outside of the country. But then you need to have also primary.
Design so core engineering capability. The more technical if you wish more advanced engineering.
Kind of fundamental research and. The one area where we see. You know that is really making a
difference between the countries that. Managed to actually get to that level of a craft and a country
that do not manage to have to scale program management skill. But it also includes. Being able to
coordinate between suppliers. Being able to manage across appropriately being able to find a
market in the aerospace. World. What are the features that the airlines are going to actually value
etc etc and that. Program management skill is actually him the differentiating factor. The most
difficult to get that sort of building block. The Forbidden back is obviously manufacturing capability
and again. You need to have a manufacturing base. Just having plant our capability to assemble
aircraft. Which is tricky but it's not impossible even to build from scratch. I mean at the end of the
day. Assembling an aircraft is about making whole screen screws in a lot of them obviously and have
to be in the right place and done appropriately that. This is not at the stage rocket science. The
other part of manufacturing capability that is trickier is being able to integrate. A large set of
suppliers. To the final assembly appropriately. But it's a compartment action capability. And the fifty
billion block is. You need to have a product that is reaching its market. And you need to be able to
obviously support that product. So all the aftermarket capabilities having a hangar are having to be
able to ship the parts. In due time it's a truck striving global network of a distribution centers. Key
and. Being able. To leverage. A local demand that is definitely help. So in the case of an Airbus.
Having your best fly around in Europe. First unable to cover. You know a lot of the cost to develop
and cost. But also give a lot of credibility to a program and give us the wheel to buy the Acra. So
without using the word. Exactly captive market it's the basics and. You have enough of a basic
demand. To serve as the basis to build upon in establishing a global market. Exactly and. What was
interesting in the study is that. I'm only five building blocks. Three ones where the trickiest want to
get that really made a difference are. The compelling product. Being able to develop an aircraft that
actually bring something different in the market. But that's filling a vacuum in the market and. It will
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in a sweet spot. In terms of operating cost for the airline that the. Eighty twenty. That will a different
cost position. Different very proposition for the. Longer how flight. That he ember I or a one forty
five. And later a one seventy that was lower cost. Better of Kevin come forward to try to do a second
one is. He said it like being able to integrate. Will set of suppliers. In the design. And in the
manufacturing is tricky. And we see that we see later be Akram. Even more tricky for new ones. And
the last one is program management skills. So being able to manage the program from the green
fields to the first act are getting out of the of the plant. So which countries are prime press excess
and developing a domestic aerospace. Capability referred to China. Referred to Russia where other
countries. Do you think are the up and comers. Well. So if you use that creed that we just talked
about these five pillars and apply it to where Russia and China actually happen today. And try to.
Their project. What we think they can become in in fifteen years or so. They all have different data to
actually have and different. Gaps to feel different challenges. If you think about China first. China
has the government and industry alignment. As a government ambition an industry alignment. Right.
Clearly part of their last five year plan and. They are serious about it being Street is extremely.
Structured. Speaking of basically two different companies actually running. All the aerospace and
defense activity of China. That I became one in Arabic. To. So it is stock trades are actually two
capital. Is there. There are a lot of signs that China is it actually really investing in capacity. In that
industry in investing in generating. Hours. Into the industry. To try to try some. You know
investment partners are popping up right now. That when we get into the a design capabilities
actually China has lots of engineers. To China have thirty four are in centers. Eighty thousand or
eighty eighty thousand people. Engineers working in the county centers. And the number of
engineering students. Getting out of the university every year is five hundred thousand per year.
That's astounding. So in the engineering talent. You can argue that yeah you know maybe they're
not the same level as the Western ones maybe they are not specialized in aerospace but. Among five
hundred thousand you probably find a few thousands of would be good enough for the industry in
the design the real question mark about China is the track record actually of China in developing
programs. Who's got a program from the ground up. Is not great. We looked into. What China had
done in the past and the act that have been fully assembled in China have been done so either with
heavy support from Western players. B M D eighty to ninety. Who are heavily supported by the US.
And the result was so-so. You know the envy. Ninety. They assemble Truax. Persis twenty planned.
And he in the eighty two which became north of thirty accept him or in total this is not exactly a
great track record in the one aircraft. That the Chinese have done from scratch was stop. The ability
to manage a program. So far is not their manufacturing to the beach actually yet China is already
producing. Most of the components of the aircraft. Doing small components to or writers that control
that kind of stuff. But also a lot of components now. For a bomb. About prop. They are participating
in large component of the three fifty. So many touching base. Differently there. And they are doing
the final assembly for the A three twenty. As we speak. And so getting that know us manufacturing
capability is not that much of an issue. The fifty block now you know China yet have to take control
purchasing especially M.. Read ahead. They can really evil lot of good boost to their programs. With
the local demand that they control. Now the big question is will they be able to develop a compelling
product. That will be able to go out of the boundaries of China. And so far. The programs that they
have the A R J. Twenty one which is a regional jet are ninety feature. Seventy nine hundred regional
jet. Is an old design. So question is you know will they be able to go beyond the current design. And
really bring something to the market. Which is not guaranteed. Her main challenge. One question
that just comes to mind. Is there a vocal stopper Tanny. For a Chinese aircraft. Since the labor is
significantly lower. Is it possible for them to develop an aircraft which is similar enough to existing
aircraft. And then come out at a lower price point no other words follow a similar strategy. To other
manufacturing industries. Or is that really not relevant. In the aerospace industry. Well. That's a
very good question and actually trial event. To some extent. First it's relevant. Only. And that. The
share of the cost of the bill is going to be coming from China. You don't your share of it. So it's only a
structure. Really. So all the engines. If you only. The landing gear the interiors. There are a lot of
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things that are still going to come from Western players or exactly the same components as an
empire automatic. For the copper vintage at Chennai. On the total lack routes going to be. And
fifteen maybe twenty percent maximum. It had nothing to sneeze at when we're talking about a
million a lobbyist play it there are many considerations here. Right. That's the first thing. Personally
meet the second limit is that China is actually competing in the field with Empire which is. To a large
extent also an emerging market. And yes you know. Brazilian labor is a bit more expensive than
Chinese labor. For sure but it's quite a quite a low cost labor. Country. So the Chinese would have
an advantage over. The Bobby. For example which is high cost of course intra labor. But not so much
against an environment. And the serpent is actually. When you look at the total cost of ownership of
an aircraft from the airlines. Then point there yes. The price you purchase the aircraft is one of the
components for sure. Of the cost of ownership. But your ability to feel your craft that your
consumption performance of the aircraft is far more important actually in the equation. And the
purchase price so it's about aerodynamics. About the weight of the aircraft. About the fit between
the engine in the end the aircraft all the things that we call our very good engineering. Plus just the
comfort of the cab in two wheel people to get into that Aqua is more important than the ten to
twenty percent ticket prices. That you might get with the Chinese Aqua. Great love of Chinese and
Indians A that the Chinese have. Is the recent partnership that they struck with some of it. We see
that as a big help for them to cope with the challenges of problem management and eroding
compelling product. The partnership is actually. Exactly focusing on the area. For money will
support. The Chinese we. Engineering hours really. So we see that as a way for the Chinese to get
that program going for protecting China. Fifteen to twenty years. We really think China will make it.
We think that China will be a player. At least in the original red space for sure. And China has plans
to develop a large aircraft. And if the regional jet works well. We see no reason why. In twenty
twenty. China would not have the first. Crap. Coming out of Chinese spend. And China will. In
twenty twenty. We'll really become a manufacturing hub for more components for the rest of the
industry. Part. We copied there the cop advantageous. Really very obvious though. For an Airbus for
Boeing for Obama being there. Is going to be a master to stay competitive in the field to find a player
in the industry and. A first year supplier for most of the industry. Let's talk about Russia. And now
one question I have. I was surprised reading your research that Russia is even a question. Not to get
any hotter in the N.S.A. I was always under the impression that Russia had a long history of.
Airplane manufacturing and had its own L.S.D. for the story. Right. But you have to bear in mind
that in the late eighty's early ninety's Russia has not been producing that me across and the State of
the industry in Russia is that you have people that have all paradigms in mind and need to really
take their own incur that. Western countries have taken a long time ago. So Russia needs to catch
up pretty dramatically. If you want to become a credible player in the space. And specific areas
where Russia needs to focus is on uniting IT industry. So I'm struck showing the industry. Today you
have major players. From the former Soviet Union. We have counted more than four key U.S.
programs that these guys are trying to push forward. And obviously. Russia doesn't have the money
to fund all these programs. They need to focus on one or two programs and make them success and
from there. So the first time Lynch and Russia is tackling it. So is creating the U.A.E. he is supposed
to be an umbrella to the. Many players. Kind of an ambassador for Russia. But he's been struggling
in the past few years to get the right Peter she dare to really take the tough decisions to structure
this industry. So that the first. So it sounds like. It is one of the last industries. That is evolving from
the communist era. And so really the modern era of Russia. And I reckon you have. The Chinese that.
There were many companies. Many many companies which became more than three hundred
aerospace companies. And among the ten companies with more than five thousand people a lot of
companies are going in the first order. So going in very very different directions in that it cannot
work like that you really need that. Overarching truck sure to get going to focus the efforts on the
most promising areas. That's the first thing. The second thing is Russia has not been developing.
Craft it was still program management and integration capabilities are not there anymore. The latter
been developed and the launch of the in the late eighty's and obviously the know how to be vivid. To
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The growing role of emerging markets in aerospace _ McKinsey _ Company

be there. So that search challenges. Production quality and passion performance the Soviet Union
was not exactly a benchmark. Produce product. Performing passion. This know how it can be built
for sure. But we don't see that. For the moment. And the last one is. Russia Today doesn't have.
State controlled. Purchasing anymore. The might be a preference for a local player but it's really an
open market. Now so it doesn't have this asset anymore. Between interesting things about One is
their regional jet program. Superjet one hundred. Where basically. Russia has managed to assemble
a network of talkers. Around this project. That is leading the charge. On the Russian side. Yack up to
seventy to ninety. Feature. Crap so it. Because regional jets. In on paper. Have good things to offer
in terms of comfort can come from fuel consumption. That could be compelling product in the
market and could be the first step for Russia. Rebirth in a field. That's one thing and second thing is
the. Two engine. Such an engine. Russia is probably the only new countries that have. Engine.
Enduring tradition. Which China doesn't have that doesn't have it all. And so. Russia could become a
credible player in that field. That's Russia in twenty twenty. Where we hear Russia I. If they manage
to a structure is and history. If they manage to focus the efforts. On a few program. We could see the
rebirth of the industry and have. Russia become. Credible parents original in that field. And
potentially starting to develop a lot X. raft. In twenty years and. We hear Russia. And the potential.
Player in the engine. Manufacturing side. And we see Russia. Sourcing base for a lot of busy
components. There is capacity there is a low cost capacity. Interesting enough. Russia is also a
potential hub for engineering. Lots of engineering capabilities. Aerospace specific. Long tradition.
We already he kept the centers. From Boeing. From Pratt from G.E. over there. And in Russia really
have a low cost. Talented engineering bays at the Western O.E.M. can tap into. We also see Russia
as a potential or. Offloading engineering even core engineering staff. There. And then a third
country that you mentioned with India. The third corny country of the Union at the beginning we
thought India was actually fighting at the same level as China and Russia. What we found out is that
when we apply our great about the five pillars. And look at what is there really in India that will
enable to build up an industry. We didn't see much actually. So we didn't see clear government
ambition or aerospace is one of the many sectors that the government wants to go. Yes there is one
company a chair. Coordinating the aerospace security. Over there. But it's a small company. To
compare. If you take every one to India where you're speaking of companies is it something like five
times smaller. Small companies and we don't see the right in this realignment. Not a lot of funding.
Direct or indirect. From government or private Popper's. Capabilities are there for the secondary.
Engineering but not that much for a corn jittering apart from areas where. Injection. To from good
things but not kind of the food engineering supply chain. No program management skills.
Manufacturing they actually have quite limited capacity here. And there is no program. On paper or
you know in Thousand Year paper. In the country so we see China in twenty twenty having a great
engineering talent base for secondary engineering to offer to the industry. To you could actually
offload some players like for Boeing already doing that to be drawing pretty drawing to India and
that's pretty much it the other thing that India could do is become a niche player so choose. Few
products. Where edge. Could become. Globally distinctive and offer that the market but we don't see
in your becoming a fully integrated O.E.M. for across the next fifteen twenty years. Right now going
back to the territory is terribly out in our discussion. Your stent is highly unlikely that any it will be a
place where the planes will actually before I got of the. Manufacturing facility. I've got rather if
anything it'll be components. Exactly yeah. This is all. Really interesting and I think. Exciting and
particularly exciting. For those countries and for those who are investing in a country to work in
those countries. How should the existing aerospace. Players aerospace leaders. Respond to that in
part you've alluded to various partnerships that we think players have established. What are other
things that. That's a big player it's by the. And I would include a large commercial jetliner
manufacturer. How should they be thinking about this as both a challenge and an opportunity. Yeah.
So the short term answer is. These countries are offering. Low cost production capacity and B. are
both supplying the comedy Mbai are already started to open facilities or source. Some components
from these countries. We think that this should continue doing that. That's a trend to ease or you
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The growing role of emerging markets in aerospace _ McKinsey _ Company

know. Make more money in order to stay competitive versus competition. They should aggressively
pursue that if the supercommittee deputy. Longer term aerospace is probably one of the few
industries where in country dating. Is going to see you care center in the game and. I was invited
change steps. Are going to shift from. The big conglomerated. To more players. As you can in the
industry. What it means for the large player is that they have an opportunity to actually. Offload the
most basic task. That they are selling today. And that is you know. In manufacturing but also in
engineering we spoke about in Russia. As places where you can actually find engineering talent pool.
To offload the more basic activities and. Focus their talent. Their capacity. In developing higher tech
products that you know new material. New electronic. Leader in the industry. And so you know kind
of. Focus on higher value added task. And focus also on. Integrating better players. Because of the
future have more remote suppliers and what you have today. Just requires. Even better integration
capabilities than what you have today. And the last opportunity is actually. You've got to have a
bunch of new programs new players that are going to take chunks of the value chain. And so you can
become an investment copper. Can actually invest in these players off tomorrow and. Write the
salute change shift and capture a share of it by being investment Parker. That somehow. What
nobody's doing we Chinese partnership that they have. They are betting in the age of twenty one
which is going to be come. A competitor. And instead of looking at the trend they they are actively
participating to it and. Operating to Chinese what they have that can help the Chinese build the
engineering capability to ration. Program Management. And in exchange get a share of the pie. The
opportunity. Come out from a cost to right so there are basically two prerequisites for the incoming
players to tap into this opportunity. The first one is being able to reinvent themselves. That means.
Concretely you know shutting down plants that means having a workforce in the workforce and
manufacturing workforce that is more flexible which industries. Is tricky. That means being able to
shift. Talent from. Basic engineering to fundamental. Invention. So to speak so. That is a first
challenge. To bring that clicks ability. And second challenge is being able to integrate. Suppliers in a
real global scale. Not only having suppliers that are. You know in North America Europe and Japan.
But also in Russia. Burst in China better so in India. But also in. We didn't speak about. Other
emerging countries are more niche but being able to involve the. These new partners in the
development of a craft. To involve them seamlessly in the funnel some your family going to be.
Become even more important in the future. And the people that manage to have the two elements in
place. Flexibility and global integration. All the ones that are going to be able to take the most out of
this trend. Has really really fascinating. Particularly for those of us who spend most of our time
looking at the other areas of the high tech industry and it's really interesting to see how this plays
out in this very unique industry that is very high tech but also has these other dynamics including
the global dynamics. How should people reach out to for more information on your research.
Question. You can also contact. Who are in turn in these out of the. Hamburg office. Germany. Did
you in the prior service and market Meichi. From the Seattle office. Four of us physically and they
got the bulk of the knowledge. We in the first. Hundred thirty two priors from China India and
Russia. That we think you know was useful for the research is also useful obviously for someone who
would like to start looking into this opportunity for sourcing. Great and you are of course next and.
When Cowan Bergen you're based in the Montreal. Office and people can reach you in the Montreal
office. If you have any questions or comments about this podcast or other high tech and telecom
practice related issues place in an e-mail to. High tech. Pod cast at McKinsey dot com or I
underscore tech underscore podcast. McKinsey dot com. Thank you for listening.