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.

A Critical Evaluation of
Global Strategies and
Structure

© 2007, Jesse Kedy International Business Strategy


www.jessekedy.net University of Richmond
Introduction

In a paper on developing multinational enterprises (DMNE’s) in 2006 I wrote:


“Brazil’s Embraer, now the world’s third largest aircraft maker, is
revolutionizing the industry by creating cost-efficient, mid-sized jets with the
leg room and overhead capacity of larger aircraft.”
At the time, Embraer seemed like a fine example of a DMNE doing its best to
compete in a global economy dominated by developed multinationals (MNE’s). That is no
longer the case. Today, Embraer cannot be referred to as a DMNE; nothing about it
(besides its home country) resembles a developing firm.
Technologically, Embraer is at the cutting edge of aviation design; with about
19,500 employees, the company has a complex network of worldwide operations (Figure
1); over 96 percent of its revenues come from outside Brazil (Figure 2); it is a global player
in commercial, defense, and executive aviation (Figure 3); demand for its product far
outpace supply1 (Figure 4); finally, its 2004 – 2006 sales and net income were at an all-time
high (Figures 5 and 6).
This analysis explores how this national champion has evolved from a 500-employee
government founded organization to a global player that is nipping at the market share of
Boeing and Airbus, and has surpassed Bombardier in the commercial aircraft business. The
analysis reviews the following issues: the aircraft manufacturing industry, Embraer’s
competencies, home country factors, Embraer’s global strategy, and Embraer’s
organizational structure.

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With an order backlog of $14.8 billion (as of 31 December, 2006), orders continue to pour in.
© 2007, Jesse Kedy International Business Strategy
www.jessekedy.net University of Richmond
Reasons Not to Compete in the Global Aircraft Manufacturing Industry

The aircraft manufacturing industry is one of the few that is truly global; aircraft
makers that do not employ an exceptional global strategy are doomed to failure. To
emphasize this point, let us describe a few of the industry’s technical, technological,
regulatory, strategic, and competitive challenges.
Technically, the industry faces severe environmental variations as firms strive to
meet global demand. Also, aircraft are subject to strict weight and volume restrictions,
accounted for in the complicated development process. Technologically, aircraft makers
must balance the simultaneous application of various state-of-the-art technologies and the
need for highly qualified workers with cost restrictions; this creates complicated operational
requirements. Regulatory challenges are based on the requirement for certification by each
country to which an aircraft maker wishes to import its products.
Strategically, to compete, aircraft manufacturers must have flawless planning and
implementation systems in place, due to the extremely long time-to-market period (or
developmental and testing lifecycles) of aircrafts. If we know it takes years and billions of
dollars to design and produce a new car model, let us imagine what it takes to design and
produce a new aircraft model, according to the specifications of multiple countries; specific
airlines also demand specific customizations and modifications. Also, forming a successful
strategy in this industry depends on factors such as the airline (not aircraft) industry,
commodity prices, foreign currency rates, and so on. Thus, the biggest strategic challenge is
building into the firm’s operations the global flexibility that is so critical to success.
There are also significant competitive hurdles in the industry. First, since the
strongest aircraft manufacturing competitors are usually national champions (or in the case
of Airbus, regional champions), they receive significant financial backing from home-
country governments. These nationally-backed firms provide employment for thousands,
both directly and indirectly. They are also usually involved, not only in commercial
manufacturing, but in the defense industry as well. Hence, governments place strategic
importance on these industries and will tend to support them, even when they are no
longer profitable. This has created an industry characterized by very large and influential
competitors, some of which have long-term, exclusive contracts with airlines worldwide –
another barrier to penetrating this market. Finally, due to heavy government subsidies, large
aircraft makers – regardless of their efficiency – are able to compete on price.
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© 2007, Jesse Kedy International Business Strategy


www.jessekedy.net University of Richmond
In short, to compete successfully in this industry, firms must be truly global, truly
efficient, truly innovative, and truly tenacious. More than any other aircraft manufacturer,
Embraer embodies these qualities. See Table 1 for a comparison to the rest of the industry.

Embraer’s Unique Competencies

Embraer has certain strategic resources than enable this it to deal with the above-
mentioned challenges. To help understand the true value of these firm-specific capabilities,
it is helpful to think of them in terms of added value (whether the firm can exploit the
resource), rarity (how common the resource is among industry competitors, if at all),
imitability (the possibility, costs, and difficulty of imitating the resource), and organization
(whether the firm’s organizational structure is conducive to utilizing the specific resource).
Truly Global
Embraer has proven itself truly global in several ways. First, with over 1,000 aircraft
operating globally, 93 percent of its sales in 2006 were outside Brazil; its $390 million in
profits (on sales of $3.8 billion) came almost exclusively from the global marketplace.
Second, Embraer’s operations are strategically located worldwide (Figure 1). With large
operations in the Americas, Europe, and Asia, Embraer has found the best way to reach its
global customers while leveraging the research capabilities of talent from multiple areas.
Third, Embraer has learned that, to appease global investors, it must trade in a hard
currency; it sells 95 percent of its aircraft in U.S. dollars, so its stock does not have the
currency risks that Brazilian investments are notorious for. It is safe to assume that the Euro
will comprise an increasing share of its revenues in the future.
Truly Efficient

Embraer has also proved to be very efficient. First, its average wages are less than one
third of rival Boeing. This is not to say that Embraer underpays its employees, or that this is
merely due to its home country wage levels. In addition to Brazil’s low wages, Embraer
employs many aeronautical engineers and technicians in its new assembly center in Harbin,
China. Embraer recognizes that China has more to offer than cheap labor; China’s
increasingly educated and ambitious talent pool make it a prime location for locating a
capital- and technology-intensive manufacturing center. Also, Embraer has longstanding
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and deep ties to the Brazilian government. With these ties come the advanced engineering
© 2007, Jesse Kedy International Business Strategy
www.jessekedy.net University of Richmond
capabilities of Brazil’s air force aerospace program. Finally, and perhaps the best example of
Embraer’s efficiency, is Embraer’s aircraft design (mentioned below). Embraer has been
able to design common platforms for its aircraft.2 Without getting into detail, this means
that these aircraft have up to 95 percent commonality, including spacious cabins, large
cargo compartments, and superior performance capabilities.
Truly Innovative

“Embraer is one of the hottest manufacturers in the industry today… They're


willing to push into areas that others haven't explored.” (Donald Burr,
founder People Express).
Several factors make Embraer highly innovative. First was its decision, in the late
1990’s, to invest $1 billion in designing a larger plane that seats 70 to 118 passengers for
rapidly growing low-cost airlines.3 This insight has been invaluable to Embraer’s success.
Another sign of Embraer’s innovative mindset is its commitment to “judiciously introduce
new technology” when it creates value by lowering price, reducing direct operating costs, or
delivering more reliability, comfort, and safety.
Embraer has pursued this commitment by investing 6 percent of revenues into
research and development for the past six years; that is over $1.1 billion invested in R&D
since 2001. A result of this focus is its new fuselage, the “double bubble”, which has
increased head space, legroom, and luggage space, and has eliminated the infamous middle
seat. What is truly innovative about this design is that it resulted from the accumulated
insight of over 40 airlines, which Embraer surveyed during the design phase. Also, this new
design helped Embraer surpass its Canadian rival, Bombardier.
Beyond its products, several other factors complement its innovativeness. First,
Embraer trains its engineers, not only in aeronautics, but also in market research and
finance, allowing a broader understanding of the industry.
Another unique quality is Embraer’s customer-centric strategy. While it may sound
like a common quality of successful MNE’s, this is not so in an industry characterized by
few leading firms. This strategy has afforded Embraer a high degree of goodwill among low-
cost carriers in the U.S. and European markets. Its customers describe Embraer jets as well-
designed, reliable, and cheaper to operate. Embraer now outperforms Boeing and
Bombardier in fuel-efficient, midsize jets. Also, customers appreciate the ability to
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This is one of the keys to Embraer’s high degree of global integration.
3
61 percent of flights in the U.S. have passenger headcounts in that range.
© 2007, Jesse Kedy International Business Strategy
www.jessekedy.net University of Richmond
customize their aircraft with an easily changeable interior design. Further, Embraer has
established relationships and CSR initiatives with some airlines. For example, each time
JetBlue receives a new Embraer aircraft it donates $10,000 to an Embraer program that
sends poor students to college. JetBlue has ordered 101 planes, worth $3 billion.
Truly Tenacious
Finally, Embraer has what I call “underdog tenacity”. This is a quality, usually
unique to small firms, perhaps from less-developed economies, who are not expected to
succeed, and who, hence, are underestimated. These firms tend to be less risk-averse and
will seek and implement truly unusual strategies. Embraer's executive vice-president for
engineering and development says it well: “Years ago our competitors said, ‘How dare those
ugly ducklings from South America try to sell a jet in the Northern Hemisphere.’
Fortunately, they underestimated us.”

Country Factors

Being a truly global firm, most do not place much importance on Brazil’s economy
when judging Embraer (remember that 95 percent of its revenues are in U.S. dollars). Still,
a mention of Brazil’s trade agreements and its involvement with Embraer are merited.
Brazil’s main trade agreement is Mercosur (the Southern Common Market), in
which it is highly influential. Mercosur’s members include Brazil, Argentina, Uruguay,
Venezuela, and Paraguay. Initially, Mercosur was expected to enable regional economic
growth and development, stabilizing regional political relations in the process. The
agreement has succeeded on the political front, becoming a credible voice in the WTO and
the FTAA. However, in terms of economic integration, its success is not impressive.
Mercosur was designed to evolve into a customs union with a common external tariff, and
eventually into a common market. Still, Mercosur remains an incomplete customs union
with several exceptions to the common tariff.
The Free Trade Area of the Americas (FTAA) is a proposed free trade area that
would include the 34 nations of the Western Hemisphere (all but Cuba). The FTAA has
been under consideration for years, but talks have been stalled since 2003. Differences in
opinion between Brazil and the U.S., are the co-chairs of the Trade Negotiations
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Committee, are to blame. The U.S. is most concerned with an agreement that includes
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© 2007, Jesse Kedy International Business Strategy


www.jessekedy.net University of Richmond
negotiating investment, services, intellectual property rights, and other issues. Brazil wishes
to influence market access, and U.S. agricultural subsidies.
Brazil is also involved in the World Trade Organization (WTO) as a vocal leader of
the G-20, representing developing-country interests. Brazil insists on addressing reduction
of barriers to agricultural trade, especially export and production subsidies. It is also
concerned with enabling the production of certain proprietary drugs by generic makers, to
enable access to those who need it most in developing countries.
The Brazilian government has had a strong affect on Embraer. As mentioned, the
company was founded by the government in 1969. Before its privatization in 1994,
Embraer had established several partnerships abroad and was very focused on exporting its
aircraft to new markets. Naturally, Embraer was not run like a multinational. It had
international operations, but was far from being truly global until 1999, the first year of
major activity after its privatization.
Embraer began 1999 by launching a new family of aircraft and four midsized
models: EMBRAER 170, 175, 190, and 195. This was done through a partnership
agreement with large aerospace contractors worldwide (some 16 risk-sharing partners and
22 suppliers); its budget was $850 million. Also, Embraer established partnerships with a
group of European aerospace and defense firms (EADS, Dassault, Thales, and Snecma),
which acquired 20 percent of its common stock (7.7 percent of the firm). Finally, in a joint
venture with Liebherr Group (Switzerland), Embraer established Embraer Liebherr
Equipamentos do Brasil S.A. (ELEB), an engineering and manufacturing unit in Europe.
Since 2000, Embraer has undergone many more global activities, many of which
have been through strategic partnerships. The point is that the Brazilian government’s
leadership was in no way decisive to Embraer’s global success. The government lacks the all-
important entrepreneurial buzz that currently characterizes Embraer. Note, however, that
the Brazilian government does have some strategic power over the company. Though it is
not a majority stakeholder, it has the ability to veto certain decisions (see Embraer’s New
Capital Structure below).
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© 2007, Jesse Kedy International Business Strategy


www.jessekedy.net University of Richmond
Global Strategy

Embraer does not differentiate between global and home-country strategies; it is all
global. Still, Embraer’s global strategy does have several locally adaptable components. The
company’s overall strategy is based on two dimensions: its business drivers, which
encompass its tangible operations, and its corporate culture, which includes the values and
attitudes it wishes to espouse within the company, and throughout its environment.
Embraer’s business strategy dimension includes four drivers. First, Embraer wishes
to achieve continuance of growth. In 2005, the firm adopted a dispersed share ownership
capital restructuring. This has enabled using its shares in acquisition and international
expansion while maintaining the government’s strategic rights. Second is an emphasis on
globalizing operations. Embraer recognizes that new markets are essential to its growth, and
that it must establish a physical presence in these markets, such as manufacturing, after-sale
support, and customer service. Embraer has had international operations since the 1970’s;
this goal however goes beyond internationalization. For example, in 2003 Embraer formed
a joint venture with the Aviation Industry of China – a separate entity, based in China,
called Harbin Embraer Aircraft Industry (HEAI). Also, in 2005 the company acquired
OGMA (“Indústria Aeronáutica de Portugal”) and began constructing aircraft maintenance
facilities in Nashville, TN. The third business driver for Embraer is increasing its presence
in strategic markets. Embraer claims that it does not enter a new market without “thorough
analyses of market opportunities and return on investment.” For example, the company has
identified executive aviation as a strategic market and its next main focus.4 Finally, Embraer
considers its strategic partnerships as a key business driver. Embraer continually seeks new
companies who are leaders in their business segments. When entering a partnership,
Embraer focuses on flexibility, risk-sharing, and anticipated results.
Embraer’s softer strategy includes six drivers, the first two of which are arguable the
most important. First, Embraer emphasizes ethics and compliance with the requirements of
the countries in which it operates and to which it exports. Broadly, this goal also applies to
relations with customers, shareholders, suppliers, competitors, and employees. Second is
customer satisfaction, which Embraer considers demanding and the driving force behind its
development, production, and support. This customer-centric approach has led Embraer to
develop some highly successful models. The remaining cultural drivers are fairly standard
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The executive aviation market is expected to reach $144 billion in the next ten years.
© 2007, Jesse Kedy International Business Strategy
www.jessekedy.net University of Richmond
and are not unique (or uniquely stated); they include transparent shareholder relations,
recognizing employees, negotiation, and sharing of results, and social responsibility.

Organizational Structure

An issue of major significance within any multinational firm is its organizational


structure; namely, how that structure relates to its overall strategy. One would expect this
issue to be of importance for Embraer because of its complex operations. Embraer does not
merely produce aircraft in Brazil and export the finish product. Doing so would be
extremely expensive and, as mentioned, Embraer puts a lot of effort into reducing costs and
increasing efficiency. Instead, Embraer has set up facilities throughout the world (Figure 1)
in which value-chain activities are completed. This includes design and assembly. It is less
clear, however, how much manufacturing is done abroad, though we know that Embraer
does source materials globally.
For these reasons, it is surprising that there is little mention of Embraer’s operational
structure. One possibility is that a restructuring is currently underway, but not finalized.
Indeed, the restructuring proposal was only approved in 2006. What is mentioned is that
Embraer will turn into “the first large Brazilian Company with dispersed corporate
control,” implying a strong reliance on subsidiaries.
Embraer’s website gives a list of executives which makes it possible to deduce the new
structure. At the top is its board of directors, followed by the President and CEO. Next
comes a list of nine executives: Executive VP, Airline Market; VP, Executive Aviation
Market; Executive VP, Defense & Government; Executive VP, Engineering &
Development; Executive VP, Industrial Operations; Executive VP, Corporate & CFO;
Executive VP, Corporate Communications; VP, Organizational Development & Personnel;
and VP, External Relations.
The first three positions pertain to Embraer’s core product lines, while the others
refer to horizontal functions. Based on this, it seems that Embraer is adopting a matrix
structure, based on product and function. While these are important, a strong case would
have to be made against having regional divisions as well. Embraer’s global operations are
very dispersed; they are also very important to its strategy. It is arguable that the most
appropriate form would be a matrix structure, centered on product and regional divisions.
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© 2007, Jesse Kedy International Business Strategy


www.jessekedy.net University of Richmond
Embraer’s New Capital Structure

At a Shareholders’ meeting in March, 2006 shareholders approved Embraer’s


restructuring proposal, turning it into “the first large Brazilian Company with dispersed
corporate control.” The new structure should provide improved access to capital markets,
making it easier to finance and develop new programs. This fits into Embraer’s strategic
goal of achieving “sustainability, growth and continuity of [its] businesses and activities.”
Also, the restructuring is expected to improve management’s ability to adopt optimal
corporate governance practices while maintaining the government’s rights.5 As part of the
restructuring, Embraer will offer only common shares, enabling all shareholders to vote, as
well as allowing it to become a member of the São Paulo Stock Exchange’s New Market
(Mercado Novo).
The government’s strategic rights are through its ownership of “the Golden Share”, a
special class of share which gives it veto powers over specific issues relating to Embraer’s
business decisions. The restructuring will not affect the government’s strategic control.

Other Issues

There are three additional threats that Embraer must cope with if it wishes to
maintain its growth. First, it must find a way to increase its European sales. The biggest
market for the 1999 Embraer 170/190 project was meant to be Europe, where routes are
short and frequent. However, there has been a general decline in demand from the EU
since the events of September 11th. Second, Embraer must find a way to deal with U.S.
union resistance from pilots, air, and ground crews, who are paid more for operating larger
jets (another reason for the inefficiency of large planes). Finally, Embraer’s competition in
the 170/190 class will increase, as Bombardier launches a commercial aircraft program to
rival to these aircraft. Embraer must capture as much of the market while it is the only real
competitor in this category.
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It is not hard to imagine the conflict between optimizing corporate governance while the government has a degree
of strategic control over the company.
© 2007, Jesse Kedy International Business Strategy
www.jessekedy.net University of Richmond
Conclusion

Throughout its recent history, Embraer has been faced with some major competitive
challenges. Nonetheless, it has continued to thrive through constant innovation, rapid
learning and adaptation, and swift implementation of its new programs.
By recognizing its need to be entrepreneurial (after its 1994 privatization), Embraer
has exposed itself to many new opportunities, which it would have otherwise been blind to.
Still, Embraer’s dominance of the small to midsized regional jet market will no longer go
unchallenged.
As large commercial airlines continue to struggle with fuel costs and other
inefficiencies, aircraft makers will increasingly realize that they must meet the growing
demand for smaller, more cost-effective jets. Embraer will attempt to remain competitive
through its focus on airline input, such as the need for aircraft customization and comfort.
It will also increase its R&D efforts and continue exploring new frontiers, such as its recent
focus on the executive jet market. Embraer’s ability to continually and successfully forecast
future global demand and its ability to meet that demand in unique and innovative ways
will be the keys to its future success.

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© 2007, Jesse Kedy International Business Strategy


www.jessekedy.net University of Richmond
Figure 1: Global Operations

Figure 2: Revenue per region

Figure 3: Revenue per segment

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© 2007, Jesse Kedy International Business Strategy


www.jessekedy.net University of Richmond
Figure 4: Firm order backlog

Figure 5: Net Sales

Figure 6: Net Income

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© 2007, Jesse Kedy International Business Strategy


www.jessekedy.net University of Richmond
Table 1: Selected Financial Information for Embraer and Key Competitors6

Gulfstream
Key Numbers Embraer Airbus1 Bombardier
Aerospace
Annual Sales ($ mil.) 3,440.5 26,409.9 14,726.0 2,538.0

Employees 19,300 55,000 55,922 6,750

Market Cap ($ mil.) -- -- -- --

Gulfstream Industry Market


Profitability Embraer Airbus Bombardier
Aerospace Median Median
Gross Profit Margin 34.10% -- -- -- 18.50% 51.60%

Pre-Tax Profit Margin 14.30% -- -- -- 3.60% 6.50%

Net Profit Margin 11.10% -- -- -- 2.90% 5.10%

Return on Equity 30.1% -- -- -- 12.4% 9.6%

Return on Assets 6.3% -- -- -- 3.0% 1.5%

Return on Invested Capital 8.4% -- -- -- 5.7% 4.2%

Effective Tax Rate 22.7% -- -- -- 30.0% 29.6%

Interest Coverage 3.99 -- -- -- 6.44 5.36

Dividends Per Share 0.75 -- -- -- 0.48 0.64

Working Capital Per Share 8.43 -- -- -- 2.85 0.58

Book Value Per Share 7.32 -- -- -- 5.19 5.05

Total Assets Per Share 32.88 -- -- -- 14.33 10.46

Gulfstream Industry Market


Growth Embraer Airbus Bombardier
Aerospace Median Median
12-Month Revenue Growth 60.5% -- -- -- 8.5% 12.4%

12-Month Net Income Growth 179.5% -- -- -- 11.0% 15.3%

12-Month Dividend Growth 4.5% -- -- -- 0.0% 0.0%

Source: Hoovers (http://premium.hoovers.com/) 13


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Only sales and employee data are provided for competitors; most of the data compares Embraer to the overall
industry.
© 2007, Jesse Kedy International Business Strategy
www.jessekedy.net University of Richmond