Group A 6 Strategic Audit Rachelle Topacio

Group A 6 – Strategic Audit Rachelle Topacio Erik Bronger Julien St Girons Uday Mudholkar Dimitri Koufos Patrick Wiebusch

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

Short Profile Empresa Brasileira de Aeronáutica - Embraer is active in aircraft manufacturing and related services Revenue Share (2003) Source: Embraer

Overview Embraer (Timeline) The introduction of the ERJ 145 was the single most important event in the history of the company • Founded in 1969 • Maiden flight of Ipanema in 1970 1971 -1980 • 1971 – First flight of ground attack aircraft – Xavante • 1972 – Delivery of first EMB 110 to Brazilian Air Force • 1976 – First flight of EMB 121 • 1979 – Foundation of Embraer Aircraft Corporation (EAC) 1981 -1990 > 1990 • 1983 – First flight of EMB 120 • 1995 – First flight of ERJ 145 • 1985 – First flight of AMX • 1997 – Foundation of Embraer Australia • 1990 – First flight of CBA 123 • 1998 – First flight of ERJ 135 • 2000 – Opening of Beijing Office, First flight of ERJ 140 • 2001 – 400 th ERJ 145 delivered, First flight of Legacy • 2002 – 600 th ERJ 145, First flight of ERJ 170 Source: Embraer

Why Strategic Audit of Embraer? Although originating form a developing country, Embraer is able to compete successfully in a high-tech market Contradiction? Comments Developing country Cliché • High-tech company coming High tech market from a developing country • Major contributor to Brazilian economy - 2 nd largest exporter Market Share and Profit development Embraer Profit in M$ Market Share in % • High market share growth – years Source: Embraer 30% increase in 5 years • High profit growth – CAGR 240%

Embraer’s Relevant Market Segment Embraer competes with only one other competitor Bombardier in the regional jets market Airline Market Regional Aircraft Market (Number of airplanes 2001) • Categories of airplanes Twin-Aisle Regional – – – 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 market 1 Single-Aisle 747 or bigger Source: Embraer; Harvard Business School Case 9 -703 -022 1 Only competitors in regional jet market, not included competitors of turbo prop market – Embraer – Bombardier

Market Peculiarity Subsidies are a pervasive problem for international trade and economic development • • Aircraft: “Dual Use” Boeing – Airbus Pressure for Political Intervention – Aftermath of 9/11 Brazil and Canada accuse each other of unfair trade practices Free Trade Precarious Area of the position of Americas airline industry will. FTAA necessitate public financing PROEX Source: The Bombardier-Embraer Dispute and its Implications for Western Hemisphere Integration, CSIS, 2003 CANADA ACCOUNT

Market Share Comparison Bombardier and Embraer In the late 1990 s Embraer overtook Bombardier in terms of market share; since than it is the biggest regional jet manufacturer in the world Market Share (Embraer vs. Bombardier) Embraer Bombardier Market Share in % Years Source: Embraer; Bombardier; Harvard Business School Case 9 -703 -022; So. Z - Sozialistische Zeitung Nr. 05 vom 01. 03. 2001, Seite 9 “Kampf um Privatjets- Kanada: Mit der WTO gegen Konkurrenten“

Embraer’s Profit Evolution Embraer took off after the new CEO Mauricio Botelho took over in 1995 and shortly afterwards introduced the new ERJ-series of regional jets Profit Growth (Embraer) September 11 Privatization Embraer and appointment new CEO (M. Botelho) Introduction ERJ-135 Afghanistan invasion Iraq war Implementation of Real plan. Brazilian currency unit pegged to USD within predetermined band Profit in M$ years Introduction ERJ-145 37, 000% increase in inflation over this period Source: Embraer Introduction of ERJ-series Significant reduction on new aircraft deliveries: • Reduction of 35% since 2001 peak • Recovery expected for 2005

Framework The airline industry is characterized by five industry fundamentals High Technology Qualified People Flexibility Airline Industry Fundamentals Cash Intensiveness Source: Embraer Global Presence

Industry Fundamentals – High Tech Through 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 CAD CAM CAE CFD • 50% reduction of allocated personnel • Savings of $3 M Example: ERJ-170/190 – Developing time reduced from 60 to 38 months – Cost savings in manufacturing between 5% and 10% Source: Embraer Virtual reality Center

Industry Fundamentals – Qualified People Embraer’s success is fundamentally linked to its highly educated workforce Embraer’s Continuous Employee Development System $96 million investment in last 5 years in training and development of all personnel 3 1 2 -year in-house MBA program focused on international aviation 4% Graduates 30% College Undergraduates 2 18 months course in aeronautical engineering for all hired engineers Source: Embraer 1% Ph. D or Masters 65% High School Graduates 25% of employees are engineers

Industry Fundamentals – Global Presence Growing 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 Europe, Middle East & Africa 56% 23% 8% China Latin America & Caribbean 7% 6% Asia Pacific Embraer has operations in Brazil, USA, Europe, Asia and Australia Number of employees per region: 12, 086 Source: Embraer 482 189 165 10 09

Industry Fundamentals – Cash Intensiveness Airline industry is in a weak financial position • • • Five sources of funding WTO: Subsidies and Countervailing Measures PROEX: Government interest equalization financing program Straight loan Operating Lease Brazilian Government buy down of 3. 8% Capital Markets Leveraged Lease Financing Lease 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 Old process P 1 P 2 New process P 3 Product P 4 Worker Line Assembly Dock Assembly Lead time - 4. 6 months Number of months Source: Embraer

Value, Cost and Speed By excelling in all of the five industry fundamentals Embraer is able to beat the competition in terms of value, cost and speed Deltas COMPANY d V a e pe lu e/ S S e/ lu pe e Δ Value: • High technology Va d CUSTOMER Cost/ Speed COMPETITOR Source: Prof. Dr. Horst Bender, Rotterdam School of Management, 2004; Embraer Δ Cost: • Flexible production process • Low labor cost (developing country) • Strategic partners (risk sharing) Δ Speed: • Flexible production process • High technology

Value, Cost and Speed Embraer’s superiority in value, cost and speed is underlined by the following three case examples Value: Operating Costs 1 ($M) Bombardier $M 0, 2 Embraer Cost: Reference Price 2 ($M) Bombardier $M 3, 4 Embraer Speed: Lead time (months) Bombardier 3 1, 6 months Embraer Source: Embraer 1 Operating costs equal to total trip costs for a distance of 500 nautical miles 2 In the nature of a list price; most planes are sold at discounts to this price 3 Estimation Note: The operating costs and the reference price refer to Embraer’s ERJ 145 and Bombardier’s CRJ-200

Industry Outlook Major factors affecting the regional airplane market Strong growth Boeing& Airbus entering market Right size aircraft capacity Regional Airplane Market Liquidity problem Others Geo-political world tensions Source: Boeing Commercial Airplanes Current Market Outlook, 2003; Federal Administration of Aviation (FAA) “Regional jets reshape a dynamic industry”, 2001

Industry Outlook The 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 Market share aircraft segments – Worldwide 32, 495 Number of aircraft 17% 57% Source: Embraer 76 Routes 2, 224 Routes Single-Aisle 22% Twin-Aisle +7% 15, 271 10% -8% 65% 18% 1995: 2004: Regional +4% Market share regional jet market: +7% 747+

SWOT-Analysis In summary… Strengths Opportunities Strengths Weaknesses Threats Weaknesses • System integrator • High dependence on the US market • Know-how in design and service Growth of regional jet market • Weak financial strength High dependence on the US market Boeing and Airbus entering regional jet market • System integrator Outsourcing/ risk sharing partners - depends on partners to fund projects • Low labor costs Know-how in design and service –growth of low cost airlines • Single core business Weak financial strength New entrants from emerging markets in commercial and • Flexible/ innovative production process • Reliance on Brazilian government • Synergies through product families military aircraft market Overall aircraft market growth • Follower –depends on partners to fund projects • Outsourcing/ risk sharing partners Market intelligence - Bringing new products to market • Located in Brazilian “Aeronautical Brain Park” WTO politics - Embittering of subsidy conflict Low labor costs –growing aircraft replacement market • Single core business “National icon” • Extensive investment in HR Unstable economic environment • • • Reliance on Brazilian government Brazilian defense contract for fighter jets Flexible/ innovative production process SWOT • Opportunities Terrorism Threats Transfer of intelligent defense systems to naval and Synergies through product families Follower ground-based applications • • Global Diseases (e. g. SARS) • • Market intelligence –bringing new products to market • • Substitutes Located in Brazilian “Aeronautical Brain Park” • • –High speed trains • • • “National icon” • –IT • Extensive investment in HR • • 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 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

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