Highly Impressed With Embraer

To paraphrase Churchill, for decades I've had my own ideas about Embraer, and I didn't want them changed by any Embraerians. I'd always respected Embraer, as does much of the aerospace industry – if aerospace companies were restaurants, Embraer would be the restaurant all the other chefs visited on their days off – but until this month, I'd never visited São José dos Campos. I've just returned from a tour, and was highly impressed by everything I saw and by the many people with whom I met. Embraer is an exceptional company.

But like some exceptions, Embraer also proves a rule: the aerospace industry's entrance barriers are among the highest in the world. It's the only company in the world that successfully entered the civil aircraft industry since 1960. All the other "emerging" country producers who tried and failed sang the same chorus: "Embraer did it! So can we!" Well, they couldn't. But for the benefit of future wannabe OEMs, here's what Embraer did right:

1. Product Launch Discipline. CEO Fred Curado told me the company needs to be "convinced" by a new business case. Embraer's history clearly shows that they don't launch something until they have rigorously assessed the market for the new product; pricing in that product's segment; and competitive dynamics in that segment. In short, Embraer has never launched a "Ready, Fire, Aim" program like the Scorpion, CSeries, or A380. Company executives are proud that their CBA-123 pusher turboprop (a joint venture with Argentina's FMA) was killed 20 years ago for all the right reasons.

2. Privatization. Emerging producers face a difficult paradox: to be successful, you need to privatize; to privatize, you need to be successful. Emerging producers can get stuck in a holding pattern with this. How did Embraer escape? Simple:

3. Incredible luck. It's better to be lucky than good. Embraer is both. The EMB-110, -120, and most of all the EMB-145 airliners were all in the right place at the right time, taking advantage of airline deregulation and other market changes in the US (for more on the -145, the big enabler of Embraer's successful privatization in the 1990s, see my November 2005 letter). Then, Embraer launched a line of small and mid-sized cabin business jets just before Hawker died and Cessna axed most of its talent. Nobody could forecast these events; Embraer just got very lucky.

4. Be willing to lose money for a long time. After 20 years of greatness, it's easy to forget that for its first 25 years Brazil was an inefficient, money-losing government hobby shop. If it weren't for its amazing luck (followed by some very smart management), Embraer might have been yet another epic emerging OEM failure.

5. Global sourcing. Embraer's designers can shop anywhere for the best content at the best price. The company is one of Brazil's biggest exporters, AND it's one of its biggest importers, too. The Brazilian government attempted to impose local content restrictions on the KC-390 transport, but Embraer cleverly circumvented this nonsense. Compare Embraer's open sourcing with China's insistence on technology transfer for the entire supply chain, with no intellectual property protection. The results for COMAC have been predictably disastrous.

6. Focus on management, people, and education. Building a factory and launching new planes is hard enough, but cultivating a steady supply of qualified people is harder still. With the Instituto Tecnológico de Aeronáutica (ITA) and other affiliated academic institutions, Embraer has been doing that since its birth.

7. Open markets. Autarky – national self-sufficiency – is for losers. Closed borders breed complacency, which breeds mediocrity (example: India's HAL and Indonesia's IPTN, among many others). While Embraer is Brazil's biggest national defense prime, it has no special status in the country's civil aviation market. In fact, there are very few Embraer civil jets in Brazil, and quite a few Airbuses, Boeings, and even Bombardiers. From the start, Embraer needed to focus on competing in export markets, unlike many other aircraft wannabes that demand the illusory protection offered by closed borders.

I'm sure there are others, but these are the key factors that turned Embraer into a great, global aerospace company. But no aerospace company can rest on its laurels for long, and the challenges facing a mature OEM are different than those it faced as an emerging OEM. Consider:

1. What next? That combination of product launch discipline and sheer luck resulted in some exceptional programs, like the E-Jets, the Super Tucano, and the Legacy and Phenom business jet series. But I have no idea what they could do next. Competing directly with Airbus and Boeing is a charmless idea. Marco Tulio Pelligrini, Embraer Executive Jets CEO, makes the smart point that Dassault and Gulfstream are flooding the segments right on top of Embraer's niche with some impressive new products. After its crop of new programs kicks in, Embraer might need to live in a world where it's harder to outperform the broader market.

2. Brazil. Nice people, Brazilians. Awful government. The bureaucracy is wretched, and bad governance produces world-class scandals like the current Petrobras one. Crime is a major issue. And then there's the economy. Once the first letter in BRIC; Brazil has been flirting with recession for several years now, threatening the national budget. All of this is difficult for Embraer, which is at least somewhat dependent on home country defense spending and on general political support.

3. KC-390 orders. I visited the first prototype of this impressive new transport, first rolled out last month. Getting 28 Brazilian Air Force orders and a few dozen letters of interest from countries that were given work packages was like picking low hanging fruit. To get more than these first 50 or so orders, Embraer will need to compete directly with Lockheed Martin's C-130J on world markets. That's a big challenge.

4. E2 pricing. Of the three jetliners about to be re-engined, the E-Jets had the shortest life in its current incarnation. It also has the lowest production numbers. The E2 is a great product, and will dominate its niche. But given those circumstances, Embraer might find that pricing is a challenge relative to the larger jets. Then again, the E2's direct competitors (Mitsubishi and Bombardier) have that problem to even worse degrees.

Given the company's track record, I would bet they'll overcome these headwinds. They've faced greater challenges, and have come to dominate almost all of the segments they've chosen to attack. Besides, I can't remember the last time I visited an airframer that impressed me with so much competence and professionalism. And this month's Teal Aircraft reports include updates of the Legacy/Phenom and the KC-390, along with the MRJ, NH90, FalconJet, Lynx, King Air, A/T-50, ARJ21, AW129, AW609, Jaguar, and TBM 900. Have a great month.