Group A6 – Strategic Audit

Rachelle Topacio

Erik Bronger

Julien St Girons

Uday Mudholkar

Dimitri Koufos

Patrick Wiebusch

IntroductionSo...what do Ronaldo and the “Cristo” of Rio de Janeiro have in common?

Short Profile Empresa Brasileira de Aeronáutica - EmbraerEmbraer is active in aircraft manufacturing and related services

Revenue Share(2003)

Customer Services

8%

Executive Aviation

11%

Commercial Aviation

69%

Defence Aviation

12%

Source: Embraer

> 19901981-19901971-1980

•1971 – First flight of ground attack aircraft – Xavante

•1972 – Delivery of first EMB110 to Brazilian Air Force

•1976 – First flight of EMB121

•1979 – Foundation of Embraer Aircraft Corporation (EAC)

•1983 – First flight of EMB120

•1985 – First flight of AMX

•1990 – First flight of CBA123

•1995 – First flight of ERJ145

•1997 – Foundation of Embraer Australia

•1998 – First flight of ERJ135

•2000 – Opening of Beijing Office, First flight of ERJ140

•2001 – 400th ERJ145 delivered, First flight of Legacy

• 2002 – 600th ERJ145, First flight of ERJ170

Overview Embraer (Timeline) The introduction of the ERJ145 was the single most important event in the history of the company

• Founded in 1969

• Maiden flight of Ipanema in 1970

Source: Embraer

Cliché

Why Strategic Audit of Embraer?Although originating form a developing country, Embraer is able to compete successfully in a high-tech market

Developing country

High tech market

Contradiction?

-123

145

235

321

-33

32857

54

45

35

3126

-200

-100

0

100

200

300

400

1996 1997 1998 1999 2000 2001

0

10

20

30

40

50

60

Pro

fit

in M

$

years

Market Share and Profit development Embraer

Ma

rke

t S

ha

re i

n %

Comments

•High-tech company coming from a developing country

•Major contributor to Brazilian economy - 2nd largest exporter

•High market share growth – 30% increase in 5 years

•High profit growth – CAGR 240%

Source: Embraer

Airline Market(Number of airplanes 2001)

Embraer’s Relevant Market Segment Embraer competes with only one other competitor Bombardier in the regional jets market

Regional Aircraft Market

• Categories of airplanes

– 100 to 120 seats

– 80 to 99 seats (jet)

– 60 to 79 seats (jet)

– 40 to 59 seats (jet)

– 20 to 39 seats (turbo prop)

• Competitors regional market1

– Embraer

– Bombardier

18%

65%

10%

7%

Twin-Aisle

Single-Aisle

747 or bigger

Regional

Source: Embraer; Harvard Business School Case 9-703-0221 Only competitors in regional jet market, not included competitors of turbo prop market

• Aircraft: “Dual Use”

• Boeing – Airbus

• Pressure for Political Intervention – Aftermath of 9/11

• Brazil and Canada accuse each other of unfair trade practices

Market PeculiaritySubsidies are a pervasive problem for international trade and economic development

Free Trade Area of the Americas - FTAA

PROEX CANADA ACCOUNT

Precarious position of airline industry will necessitate public

financing

Source: The Bombardier-Embraer Dispute and its Implications for Western Hemisphere Integration, CSIS, 2003

53 53 52

34

43

26

31

35

5457

43

45

0

10

20

30

40

50

60

1996 1997 1998 1999 2000 2001

Embraer

Bombardier

Market Share in %

Years

Market Share (Embraer vs. Bombardier)

Market Share Comparison Bombardier and EmbraerIn the late 1990s Embraer overtook Bombardier in terms of market share; since than it is the biggest regional jet manufacturer in the world

Source: Embraer; Bombardier; Harvard Business School Case 9-703-022; SoZ - Sozialistische Zeitung Nr.05 vom 01.03.2001, Seite 9 “Kampf um Privatjets- Kanada: Mit der WTO gegen Konkurrenten“

-265-241

-258

-116

-310

-253

-123

-33

145

235

321 328

136

223

-400

-300

-200

-100

0

100

200

300

400

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Profit in M$

Profit Growth(Embraer)

Embraer’s Profit EvolutionEmbraer took off after the new CEO Mauricio Botelho took over in 1995 and shortly afterwards introduced the new ERJ-series of regional jets

years

September 11

Afghanistan invasion

Iraq war

Significant reduction on new aircraft deliveries:• Reduction of 35% since 2001 peak• Recovery expected for 2005

Privatization Embraer and appointment new CEO (M. Botelho)

Implementation of Real plan. Brazilian currency unit pegged to USD within predetermined band

Introduction ERJ-145

Introduction ERJ-135

Introduction of ERJ-series 37,000% increase in inflation over this period

Source: Embraer

High Technology

Qualified People

Global Presence

Cash Intensiveness

FlexibilityAirline

Industry Fundamentals

FrameworkThe airline industry is characterized by five industry fundamentals

Source: Embraer

Example: ERJ-170/190– Developing time reduced from 60 to 38 months– Cost savings in manufacturing between 5% and 10%

Industry Fundamentals – High TechThrough the deployment of high-tech applications Embraer was able to reduce its development time and manufacturing costs significantly

Concurrent Engineering

Electronic Mock-up

Flight Simulators

Virtual reality Center

CADCAMCAECFD

• 50% reduction of allocated personnel• Savings of $3M

Source: Embraer

Industry Fundamentals – Qualified PeopleEmbraer’s success is fundamentally linked to its highly educated workforce

1% PhD or Masters

4% Graduates

30% College Undergraduates

65% High School Graduates

25% of employees are engineers

2-year in-house MBA program

focused on international

aviation

$96 million investment in last 5 years in

training and development of all

personnel

Embraer’s Continuous Employee Development System

18 months course in aeronautical

engineering for all hired engineers

1

2

3

Source: Embraer

Industry Fundamentals – Global PresenceGrowing foreign markets and an increasing need to seamlessly serve customers necessitate a global presence

Market Forecast 2023 for 30–120 Seaters: 8,450 jets

USA, Canada

6%

8% China

Asia Pacific

23% Europe, Middle East & Africa56%

Latin America & Caribbean

7%

Embraer has operations in Brazil, USA, Europe, Asia and AustraliaNumber of employees per region:

12,086 482 189 165 10 09

Source: Embraer

• Five sources of funding

Industry Fundamentals – Cash IntensivenessAirline industry is in a weak financial position

Straight loan

Operating Lease

Financing Lease

Leveraged Lease

Capital Markets

0

2

4

6

8

10

12

US T-Bills Airline Market Rate Proex Buy-Down Net Rate to Airline

Brazilian Government buy down of 3.8%

• WTO: Subsidies and Countervailing Measures

• PROEX: Government interest equalization financing program

Source: Bombardier “Canada versus Brazil at the WTO, Harvard Business School Case 9-703-022, 2003

Industry Fundamentals – Flexibility Embraer created a flexible production process that allowed faster delivery times

P1 P2

Worker

P3 P4

Worker

Product

New processOld process

Line Assembly Dock Assembly

8

3,4

0

1

2

3

4

5

6

7

8

9

1996 1997 1998 1999 2000 2001 2002 2003

Lead time

Number of

months

- 4.6 months

Source: Embraer

CUST-OMER

COMPANYCOMPE-TITOR

Val

ue/ S

peed

Cost/ Speed

Value/ Speed

Value, Cost and SpeedBy excelling in all of the five industry fundamentals Embraer is able to beat the competition in terms of value, cost and speed

Deltas

Δ Value: • High technology

Δ Cost:• Flexible production process• Low labor cost (developing country)• Strategic partners (risk sharing)

Δ Speed:• Flexible production process• High technology

Source: Prof. Dr. Horst Bender, Rotterdam School of Management, 2004; Embraer

Value, Cost and SpeedEmbraer’s superiority in value, cost and speed is underlined by the following three case examples

3,4

5,0

17,6

21,0

1,9

2,1Bombardier

Embraer

Bombardier

Embraer

Bombardier

Embraer

Value: Operating Costs1 ($M)

Cost: Reference Price2 ($M)

Speed: Lead time (months)

Source: Embraer1 Operating costs equal to total trip costs for a distance of 500 nautical miles2 In the nature of a list price; most planes are sold at discounts to this price3 EstimationNote: The operating costs and the reference price refer to Embraer’s ERJ145 and Bombardier’s CRJ-200

$M 0,2

$M 3,4

1,6 months

3

Industry OutlookMajor factors affecting the regional airplane market

Regional AirplaneMarket

Strong growth

Others

Boeing&Airbus

entering market

Geo-political world tensions

Liquidity problem

Right size aircraft capacity

Source: Boeing Commercial Airplanes Current Market Outlook, 2003; Federal Administration of Aviation (FAA) “Regional jets reshape a dynamic industry”, 2001

Industry OutlookThe regional jet market is the strongest growing segment – until 2021 it is expected to grow from 1,500 to 5,500 aircraft

Regional Jet Network – USA

2001 2021F

1995: 76 Routes2004: 2,224 Routes

Market share aircraft segments – Worldwide

Market share regional jet market: +7%

Regional

Single-Aisle

Twin-Aisle

747+

10%

65%

18%

17%

57%

22%

15,271

32,495

Num

ber

of a

ircra

ft

-8%

+7%

+4%

Source: Embraer

SWOT-AnalysisIn summary…

Strengths

• System integrator

• Know-how in design and service

• Outsourcing/ risk sharing partners

• Low labor costs

• Flexible/ innovative production process

• Synergies through product families

• Market intelligence

• Located in Brazilian “Aeronautical Brain Park”

• “National icon”

• Extensive investment in HR

Weaknesses

• High dependence on the US market

• Weak financial strength

- depends on partners to fund projects

• Single core business

• Reliance on Brazilian government

• Follower

- Bringing new products to market

Opportunities

• Growth of regional jet market

- Growth of low cost airlines

• Overall aircraft market growth– Growing aircraft replacement market

• Brazilian defense contract for fighter jets

• Transfer of intelligent defense systems to naval and ground-based applications

Threats

• Boeing and Airbus entering regional jet market

• New entrants from emerging markets in commercial and military aircraft market

• WTO politics - Embittering of subsidy conflict

• Unstable economic environment

• Terrorism

• Global Diseases (e.g. SARS)

• Substitutes

- High speed trains

- IT

SWOT

Strengths

•System integrator

•Know-how in design and service

•Outsourcing/ risk sharing partners

•Low labor costs

•Flexible/ innovative production process

•Synergies through product families

•Market intelligence

•Located in Brazilian “Aeronautical Brain Park”

•“National icon”

•Extensive investment in HR

Weaknesses

•High dependence on the US market

•Weak financial strength –depends on partners to fund projects

•Single core business

•Reliance on Brazilian government

•Follower–bringing new products to market

Opportunities

•Growth of regional jet market–growth of low cost airlines

•Overall aircraft market growth–growing aircraft replacement market

•Brazilian defense contract for fighter jets

•Transfer of intelligent defense systems to naval and ground-based applications

Threats

•Boeing and Airbus entering regional jet market

•New entrants from emerging markets in commercial and military aircraft market

•WTO politics - Embittering of subsidy conflict

•Unstable economic environment

•Terrorism

•Global Diseases (e.g. SARS)

•Substitutes –High speed trains–IT

• Maintain competitive advantage in the face of Boeing and Airbus entering the regional jet market

– Rely on core competencies (innovative technology, extensive training of employees, flexible production process)

– Aggressively improve time to market by applying more efficient management practices

• Decrease dependency on US market through aggressively developing and creating new European and Asian markets

• Improve financial position in terms of funding their development programs since competitors have huge financial advantage

– Gain access to additional capital markets (e.g. LSE)

• Reduce dependence on aircraft business through diversification in related activities– Supplying parts and systems to space programs (NASA, ESA) – Logistics consulting– Software development

Implications for EmbraerThere are four major implications which should be addressed by Embraer