The Boeing-Embraer deal: a partnership that may transform the aircraft industry

embraer

Anatomy of a deal:

Brazil´s Embraer, the third-largest aircraft maker, received an offer from Boeing, the world’s largest aerospace company, to combine their assets. The options are open and range from the total acquisition of the Brazilian company (less likely scenario) to the creation of a Joint Venture (JV) focused on the development and commercialization of a specific family of products, the medium-sized jets. Anyway, an agreement between the two companies will create a global aviation giant with arms in commercial and military businesses.

Many uncertainties hang over the deal. The first involves the Brazilian state, which has the right of veto due to the possession of golden shares, a special type of stocks that allows Brazil to veto any strategic decision involving Embraer. The second concerns the importance of the company in foreign trade, since Embraer is Brazil’s third largest exporter, behind only Vale and Petrobras. The third reason comes from the importance of the company in the technological development and in the leadership of the aerospace cluster located in São José dos Campos. This fact explains why the federal government will most likely relinquish strategic control of the company, especially the business unit that involves military technology. Fourth, there is the nationalist bias, still very present in the Brazilian economy. As the company is a Brazilian national champion, the “national pride” component regarding Embraer´s role as a leading emerging market multinational may prevent a commercial agreement, especially in an industry where the federal government has a strong influence. Thus, a form of trade association between companies or even a JV may be preferable to a total acquisition of the Brazilian company by the North American giant.

boeing

Does the deal make sense from a strategic point of view?

The question that should be asked is not why Boeing proposed association with Embraer, but why it took so long for this proposal to be implemented. This questioning makes sense because of just a few months ago, Airbus, Boeing´s main competitor, bought the program of regional jets from Bombardier, a Canadian manufacturer of medium-range aircraft (such as the C-series), capable of transporting approximately 120 passengers. It is important to remember that Bombardier is a direct competitor of Embraer in the manufacturing of mid-sized jets, such as the E-jets family. For more than 30 years, Embraer and Bombardier have led in the last 30 years the market for the manufacture of specific jets for regional transportation, a segment dominated by smaller operators that employ pilots, mechanics and staff with significantly lower salaries.

After the Airbus-Bombardier agreement, the Boeing-Embraer proposal would be a classic strategic response to replicate the same rationale employed by Europeans and Canadians. The Boeings´ largest competitor, the European consortium Airbus began operating in the mid-range aircraft segment by purchasing the Bombardier regional jet program. In the case of large aircraft, Airbus and Boeing are the leading commercial aircraft manufacturers for long-haul flights, a similar duopoly seen with Embraer and Bombardier.

embraer bombardier

Why the deal makes sense for Boeing?

First, a partnership with Embraer would expand Boeing’s product portfolio, especially in the segment of mid-sized jets. Second, a potential partnership with Embraer would give the US company access to low-cost and highly-qualified manufacturing capacity because most of Embraer´s production capability is based in Brazil. Third, Boeing would hamper existing cooperation between Embraer and Comac, Boeing´s incoming Chinese competitor. Fourth, a Boeing-Embraer agreement would create entry barriers for potential new entrants, such as Russia’s Sukhoi. This is because both Boeing and Airbus have strong financial arms, which supports sales of their expensive equipment small carriers from emerging countries. It is unclear how Sukhoi could develop equivalent financial muscles. Finally, there will be increased efficiency in the supply chain of the American company (see link here), given that projects, parts, and services could be developed jointly.

Why does business make sense to Embraer?

The list of benefits for Embraer depends on the type of agreement to be developed by the companies involved in the deal. Generally speaking, the Brazilian company could benefit from spillover effects, such as the of transfer of technology and access to the greater commercial musculature of Boeing. Economies of scale and scope are fundamental in a capital intensive and technology business such as the aerospace industry. Regardless of pro-market and nationalist biases, does not seem to make sense to prevent an external investment, such as that from Boeing, that could transfer technology to Brazil.

What can go wrong?

As with any partnership, merger or acquisition, incompatibility of organizational cultures may cause unsuccessful outcomes. Despite current cooperation agreements between Boeing and Embraer such as the development of KC-130 (medium-sized freighter that will replace and compete with the C-130 military aircraft), both companies are exposed to the high failure rates that are common in transnational mergers.

Conclusion

Given the context of the industry, the technological and geopolitical implications of the aerospace sector, expectations are that both companies will be able to create an agreement, especially in relation to Embraer’s business unit of mid-sized jet business. This way, executives would minimize the Brazilian government’s aversion to a deal that could lead to a loss of “national sovereignty”. Another alternative would be a copy of the Airbus-Bombardier deal, which created a JV focused on commercial jets and excluded Bombardier´s portion that develops military technology.

References

  1. https://www.ft.com/content/6b17f6b4-e733-11e7-97e2-916d4fbac0da, extracted on Dec 23rd, 2017.
  2. https://www.wsj.com/articles/boeing-aims-to-bulk-up-with-embraers-small-jets-1513938601, extracted on Dec 26th, 2017.
  3. https://www.bloomberg.com/news/articles/2017-12-22/boeing-explores-embraer-tie-up-to-match-airbus-s-small-jet-foray, extracted on Dec 22nd, 2017.
  4. https://www.bloomberg.com/news/audio/2017-12-22/embraer-gives-boeing-similar-product-lineup-to-airbus-ferguson, extracted in Dec 22nd, 2017.
  5. http://www.mdic.gov.br/comercio-exterior/estatisticas-de-comercio-exterior/empresas-brasileiras-exportadoras-e-importadoras, extracted in Dec 26th, 2017.

 

2 Thoughts

  1. Olá Evodio, tudo bem ?

    Eu creio que a matéria abaixo poderia ser um complemento para esse seu artigo (excelente, inclusive):

    http://www1.folha.uol.com.br/mercado/2018/01/1947359-boeing-mira-jovens-engenheiros-brasileiros-da-embraer.shtml

    De acordo com a matéria, um dos interesses da Boeing é o corpo técnico e corpo de vendas da Embraer, compostos por uma geração de técnicos mais jovens, mas igualmente capacitados.

    Acho que vale a pena a leitura !

    Abs,
    André Nogueira

    1. Olá André, obrigado pelo comentário e pela matéria. Você está correto, o sucesso do negócio passa necessariamente pelo nivel de qualidade dos corpos técnicos. Abs, EK

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