EMBRAER: TURN AROUND?

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1
This case was prepared by Prof. Dong Bian, EM-Lyon Business School. It is intended
for 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

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permission of EM-Lyon Business School.
 EMBRAER: TURN AROUND?

“The international press often refers to Brazil with the perception that we burn our forests, we kill our
children, we do not pay back our debts, we steal their patents. I don’t 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 world’s 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 of “turnaround” is not new for Embraer. In 1980s, the company
was 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 Embraer’s future development? In addition, what
challenges Embrear may meet in the coming years？What would be its new strategic
direction, as the growth rates of American and European economies keep low in the
next decade?

2
http://money.cnn.com/magazines/fortune/fortune_archive/2005/11/14/8360683/index.htm
EMBRAER BEFORE 1980s

CTA (Centro Técnico Aeroespacial) and ITA (Instituto Tecnológico de Aeronáutica)

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 commercial
potential 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. The
former 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
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 financial
situation.

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 the
responsibility 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
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. That
allowed 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 top
management 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
Embraer’s 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
Bonbardier’s 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-700
is 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
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 Bombardier’s 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
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 Embraer’s 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 the
problems for the company?
2. Collect additional information to show the positions as well as product portfolios
of Boeing, Airbus, Bombardier and Embraer.
3. If you were Botelho, how to turn around Embraer’s 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 be
your “strategy” to turn around a firm from a developing country.
 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)

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

Exhibit 5: Revenue by Segment and Region