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Considering Embraer’s success in commercial aviation, is its position sustainable and able to grow or do you consider it a niche market and mostly opportunistic and unpredictable, limiting its potential for long-term success?

  •  It is sustainable
  • Consider discussing this with the professor if you are having trouble
  • Jets are niche commercial is not
  • Touch on the unpredictability of the industry, but that long-term success in not limited and state how so

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________________________________________________________________________________________________________________

Professor Pankaj Ghemawat, Gustavo A. Herrero, Executive Director, HBS Latin American Research Center, and Luis Felipe Monteiro, Senior
Researcher, HBS Latin American Research Center prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are
not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

Copyright © 2000, 2009 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-
7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be
digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

P A N K A J G H E M A W A T

G U S T A V O A . H E R R E R O

L U I S F E L I P E M O N T E I R O

Embraer: The Global Leader in Regional Jets

By any standard, 1999 was a milestone year for Embraer. Our company earned a record US$230 million in
net income and celebrated our tenth consecutive quarter of rising profitability. Total revenue reached US$1.89
billion, and our year-end backlog was US$6.4 billion in confirmed orders and US$17.7 billion including
options – both all-time highs.

—Mauricio Botelho, Embraer´s CEO 1999 Annual Report

At the beginning of 2000, Embraer (Empresa Brasileira de Aeronautica S.A.) of Brazil was the
fourth largest commercial aircraft manufacturer in the world, behind Boeing (U.S.), Airbus (Europe)
and Bombardier (Canada). Although it was the smallest of the four competitors that dominated the
global aircraft market, Embraer was the most profitable in 1999 (see Exhibit 1). Founded by the
Brazilian Government in 1969, Embraer was privatized in December 1994—the same year it lost $310
million on sales of $177 million (see Exhibit 2). Since its privatization, Embraer had implemented a
successful turnaround and become a global leader in the fast-growing regional jet segment of the
market. Regional jets accounted for 83% of the company’s sales, and Embraer delivered 97, compared
to 82 by Bombardier, 23 by British Aerospace and 15 by Fairchild Dornier. Embraer posted revenues
of $1.9 billion in 1999, of which its cost of sales accounted for 65%, operating expenses for 10% (with
selling expenses representing 6%), financial and other non-operating expenses for 13%, and net
income for 12%. As of December 1999, the company had 8,300 employees. In 2000, Embraer’s ERJ-145
family of aircraft held a 29% share of regional jet deliveries worldwide and ~44% in the 20-59 seat
category. Embraer was Brazil’s largest exporter and was viewed by many as a symbol of the
country’s economic and technological advancement.

Embraer’s management had also recently made a set of decisions which they hoped would set the
company on a course to sustain and build upon its present wave of success. In July of 1999, Embraer
announced an initial set of orders for a new family of larger jets which would cost a projected $850
million to develop but had the potential to double the company’s sales. In October of 1999, Embraer
announced that a consortium of French aerospace and defense companies would acquire 20% of its
equity. This announcement came on the heels of a World Trade Organization (WTO) ruling against
both Brazil and Canada for the financial support they had given Embraer and Bombardier
respectively in regional jets. Embraer was also preparing for a foreign listing and equity offering on
the New York Stock Exchange to be completed in 2000.

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701-006 Embraer: The Global Leader in Regional Jets

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Founding and Development as Public Sector Company

Embraer’s history was intertwined with the Brazilian government’s efforts to promote
aeronautics—a priority for the country given its enormous land mass, wide rivers, and limited
surface transportation infrastructure. The Brazilian military, upon taking power in 1964, attempted to
transform the country into a ‘Great Power’ through a policy that focused on research—not only for
military needs, but also for the civilian sector. The Brazilian military adopted a development
approach that explicitly favored state intervention to support the development of industry, science,
and technology, as well as protection of national infant industries. To facilitate this, a vast research
program was set up through Brazil’s university system.

The Brazilian government believed in the philosophy of funding strategic technologies to build
knowledge for the civilian economy up to a stage that it could benefit from the knowledge. For the
aircraft industry in particular, Sao José dos Campos (SJC), a small town 55 miles from Sao Paulo,
became the Brazilian aeronautical industry’s hub. An Aeronautical Technical Center (CTA), an
Aeronautical Technology Institute (ITA), and a research and development institute (IPD) were set up
there to technically support Embraer.

Ozires Silva, a graduate of ITA and an air force officer, became Embraer’s first president. His
objective was to combine state-owned enterprise resources (the Brazilian government would control
at least 51% of its equity) with the entrepreneurial agility of a private-sector firm. It was evident,
though, that Embraer’s government relationship awarded it special privileges, for example:

o Federal agencies had to purchase from Embraer rather than competitors,
whenever possible.

o Embraer would pay no taxes or duty on imported raw materials, parts, and
equipment unavailable locally.

o Brazilian corporations could invest 1% of their federal income tax obligations
each year in Embraer’s shares. This scheme helped Embraer raise an estimated
$350 million in capital between 1970 and 1985.

Embraer entered three segments of the aviation business: regional passenger aircraft, defense
aircraft, and special purpose aircraft. The company’s first export orders were from Uruguay and
Chile; the first sales to the US were in 1978, when Embraer persuaded someone in Florida to buy 3 of
its ‘Bandeirante’ aircraft. After securing certification from the U.S. FAA (Federal Aviation
Administration), U.S. sales increased from five planes in 1979 to 39 in 1981, when Embraer set up a
wholly-owned U.S. subsidiary to focus on U.S. sales. By then, Embraer had captured 46% of the
commuter turboprop market and the Bandeirante, nicknamed the “Bandit” by competitors, had
surpassed former leader Fairchild.1

In 1982, Fairchild filed a complaint before the U.S. International Trade Commission (ITC)
requesting a 39%–44% countervailing duty on Bandeirantes to offset government subsidies Embraer
received. The ITC ultimately rejected the complaint. Soon after Bandeirante’s success, Embraer
launched the Brasilia in 1985, a 30–passenger pressurized twin turboprop, and sold 350 by 1999—a
major commercial success, although its financial viability was questioned.

Privatization

In the late 1980s and early 1990s, Embraer’s performance went into a tailspin for a number of
reasons including the Russian economic crisis, the cancellation of billions worth of military programs

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Embraer: The Global Leader in Regional Jets 701-006

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worldwide, and a global recession that hit commercial orders. In 1985, after years of military rule, the
new civilian president encouraged Embraer to develop the CBA123, a shortened, 19-seat version of
the Brasilia, in partnership with Argentina’s Fábrica Militar de Aviones (FMA). The aircraft’s name
stood for “Cooperação Brasil-Argentina” (Brazilian-Argentine Cooperation) and was reportedly
motivated at least in part by foreign policy considerations in play during the development of the
Mercosur trade pact. The CBA proved to be advanced but far too pricey and by 1990, the cumulated
losses on the CBA123 program upon its cancellation were calculated at $280 million.

This setback came during a period of serious macroeconomic difficulty in Brazil, which led the
government to run large deficits. Budgetary pressures constrained the government’s export support
programs and inflation reached an annual rate of 37,000% by the beginning of 1990! Prices were
finally brought under control under a program in which the Brazilian Real was pegged to the U.S.
dollar within a predetermined band.2 Inflation had since stayed under control, although Brazil rated
poorly on international competitiveness measures (see Exhibit 3).

These events had a devastating impact on Embraer; sales plummeted from $700 million in 1989 to
$177 million in 1994, as deliveries dropped from six planes per month to two. Even a workforce
reduction from 13,000 to 6,100 could not stop the bleeding, and average losses continued at $200
million per year. Ozires Silva, who had left the company in 1986 to serve as president of Petrobras
(Brazil’s state-owned oil company) was brought back as president. Although he was unable to restore
Embraer’s profitability, he persuaded the Brazilian government to consider privatizing the company.3

The privatization of Embraer, a symbol of Brazilian nationalism, was met with protests that
delayed the process by two years. Even when Brazilian Congress approval came, a moratorium on
layoffs was imposed that was estimated to cost the new owners’ up to $45 million. However, the
Brazilian government assumed $700 million of Embraer’s debt, recapitalized another $350 million, set
a low reserve price on the company’s shares, and allowed partial payment in bonds that traded at
approximately 50% of their face value.

A consortium consisting of Companhia Bozano, Simonsen (CBS), a Brazilian financial services
group, two large public-sector pension funds, and Wasserstein Perella, a U.S. investment bank,
acquired a 45% stake in Embraer on December 7, 1994 for $89 million. However, Embraer’s problems
continued as Brasilia turboprop sales declined faster than expected and 30% interest rates crippled
the company financially.

Turnaround

CBS director Mauricio Botelho, a 53 year-old mechanical engineer was appointed by Embraer’s
shareholders as its new CEO in mid-1995. Over the next few months, Botelho changed Embraer’s top
management structure, bringing in half the senior managers from outside and promoting the rest
from within. His turnaround plan involved 3 major changes:

Workforce Reduction/Incentives. Dealing with the demoralized and embittered workforce was a
key challenge. The day after the six-month moratorium on layoffs expired, 1800 people (30% of the
workforce) lost their jobs, although they did receive the officially mandated severance pay. In
addition, the pre-privatization habit of giving excess salaries based on tenure to get around salary
caps was brought under control. On the other hand, underpaid managers and engineers received
salary increases within one month and managerial levels were reduced from seven to five.

However the losses continued in 1996, and Embraer campaigned to secure wage and overtime
concessions through the unions. Another 400 indirect positions were eliminated in early 1997.

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701-006 Embraer: The Global Leader in Regional Jets

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Workers acquiesced partly because they feared more sweeping cuts if they resisted and also because
laid-off workers were offered compensation in excess of the statutory minimum.

As a result of these changes, total headcount dropped to 3,200 in April 1997 and average salaries
fell from $2,100 during the pre-privatization era to $1,600. The total employment cost to the company
per worker was roughly twice this base salary. By late 1997, Embraer began hiring for the first time in
nearly 10 years. Its emphasis on hiring young workers led to further reductions in the average basic
salary, to about $1,100 per month by early 2000. However, to energize the workforce, Embraer
launched an incentive program in 1999 which distributed the equivalent of 25% of the dividends paid
to shareholders to its employees (nearly 3 months salary) based on performance targets. These were
derived from a master ‘Strategic Plan of Action’ which stated Embraer’s objectives five years into the
future; the targets were supplemented by yearly action plans elaborated by each division VP,
Director, or Manager, with input from subordinates. This iterative up-and-down approach ensured
internal consistency as well as serving as a basis for incentive compensation.

Restructuring the Organization around the Customer. Botelho saw his key challenge as
transforming Embraer from a product-driven company to a customer-focused company. As he put it,
“When you’ve got only 100 customers, you have to focus entirely on what they want.” He and other
top managers consistently emphasized that traditional production functions were not as important as
line functions that ran from customers to shareholders. This message was backed up by a
reorganization project, launched in 1996, that led to a matrix organization, structured around
projects, that meant to enhance flexibility, interaction, and autonomy while reducing development
times and costs.4 See Exhibit 4 for Embraer’s organization chart.

Outsourcing Non-Core Services. In line with Embraer’s stated strategic objectives, organization
boundaries were redrawn as basic supplies such as catering and security, training, specialized
technical services, and even basic manufacturing and assembly were outsourced to Embraer’s
extensive partner-network. On the production front, Embraer emphasized coordinating supplier
relationships to improve quality and speed. As a result, the Brasilia turboprop’s production lead time
declined from 14 months in 1995 to 8 months in 1996, and finally six months in 1997. Meanwhile,
Embraer put more focus on what it considered its core businesses – in-house design & development
and the aircraft’s lifetime service provision.

As a result of these 3 initiatives, operating losses were stemmed relatively quickly, but net income
remained stuck around zero, largely as a result of a heavy debt burden (see Exhibit 5). Embraer
secured more cash from its controlling shareholders, increasing their total equity contribution to $520
million by the end of 1997, and arranged cheaper sources of financing for itself, reducing its average
interest rate from 33% in early 1995 to 8% by 1999. However, Bothello knew that sustainable
performance could only come from a hit product: the only immediate prospect was the ERJ 145, a 50-
seat twin-engine regional jet.

The ERJ 145

The ERJ 145 was conceived in 1989 as a stretched, jet-powered version of the 30-seat Brasilia
turboprop. The new plane was projected to cost $300 million to develop and meant to tap increasing
demand for short-range, regional flights, and travelers’ growing aversion to turboprops. Despite
market interest in ERJ 145, the project languished as Embraer’s finances deteriorated through the
turbulent 1990’s and by 1994, the new shareholders had to decide whether to invest another $240
million to complete the project.

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Embraer: The Global Leader in Regional Jets 701-006

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Prior to Embraer’s privatization, CBS’s consultants validated the market for 50-seat regional jets as
well as the ERJ 145’s prospects. The new plane flew for the first time in August 1995 and was certified
in 1996. The Brazilian National Development Bank, BNDES, provided a loan of $115 million and
additional financing came from Embraer’s four (non-Brazilian) risk-sharing project partners—their
contribution was worth about $100 million and the partners were paid as the aircraft were sold.
Several dozen smaller “partner suppliers” were eventually signed up as well. The high degree of
reliance on external partners was illustrated by the fact that materials and equipment purchased from
risk-sharing partners and other major suppliers came to account for 79% of production costs for the
ERJ 145 (85% for the ERJ 135, a 37-seater that was the second plane in the family).

The ERJ 145’s principal competitor was Bombardier’s CRJ-200. Bombardier had, with a three-year
head start, already delivered close to 100 CRJ-200s by the time Embraer delivered its first ERJ 145.
However, Embraer’s management was confident ERJ 145’s sales could excel through new
“campaigns” to highlight key competitive differences, which included:

1. More Passenger Space. The CRJ-200 had four-abreast seating that offered less
cabin width per passenger, compared to three-abreast for Embraer.

2. Pure Commercial Aircraft Design. The CRJ-200’s design was derived from
Bombardier’s Challenger business jet and in Embraer’s view, the CRJ-200 carried
more than a ton-and-a-half of extra weight, was more complicated, and had other
expensive systems and unnecessary operating characteristics. The ERJ 145, in
contrast, was designed from the start as a commercial aircraft for maximum
efficiency in airline operation.

3. Lower Cost. Embraer calculated the CRJ-200’s production cost as $2–3 million
more compared to the ERJ 145, based on the industry rule of thumb that each extra
ton cost $1 million. This, they believed, was reflected in the cost differential in
reference prices of $17.6 million for the ERJ 145 and $21 million for the CRJ-200.
(Note: it was not uncommon for airlines placing large orders to receive discounts of
up to 10–20% off of reference prices with higher discounts offered on more expensive
aircraft). In terms of direct operating costs, the ERJ 145 was significantly more
economical—especially on shorter flights because it had lower fixed costs per flight
than the CRJ-200 (see Exhibit 6 for Embraer’s estimates). According to the Official
Airlines Guide, about 70% of all flights by “small” passenger aircraft (with fewer than
110 seats) covered less than 300 miles and another 20% ranged 300–500 miles.

Bombardier was a much larger company than Embraer, with operating groups active in
aerospace, transportation equipment, motorized recreation equipment, and financing. Aerospace
was, however, emerging as by far the largest and most profitable business at Bombardier and
included Learjet and Challenger business jets and De Havilland Dash turboprop transports, as well
Canadair Regional Jets (CRJs). In addition to delivering 72 regional jets in 1999, Bombardier
Aerospace delivered 103 business jets, 30 turboprops, and 12 amphibious aircraft, as well as
supplying major aircraft components to Boeing and Aerospatiale, delivering other military hardware,
and providing a variety of aviation related services.

Bombardier’s aerospace division had an estimated 33,000 employees with perhaps 9000 involved
in the regional jet business. Salary levels at Bombardier were not publicly available, but one estimate
placed its fully-loaded annual labor cost per employee at roughly $55,000.

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701-006 Embraer: The Global Leader in Regional Jets

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Bombardier responded aggressively to Embraer’s ERJ 145 entry by cutting CRJ-200’s prices
significantly, circulating a detailed manual to potential customers comparing the ERJ 145 unfavorably
with its own plane, and even luring away some of Embraer’s engineers by placing help-wanted ads
in a Sao José dos Campos newspaper. It also used personal connections—Bombardier Chairman
Laurent Beaudoin was considered close to Canadian Prime Minister Jean Chretien5—to spur a
complaint by the Canadian government to the World Trade Organization about the Brazilian
development bank’s role in financing ERJ 145 orders (as described below).

Despite Bombardier’s aggressive response, ERJ 145’s sales quickly took off, helped by an order for
200 planes—25 firm and 175 options—from Continental Express in 1996. Cumulated deliveries hit 100
within two years, compared to three-and-a-half years it took CRJ-200. By 1997, the ERJ 145 accounted
for 60% of Embraer’s revenues and pushed Embraer back into black in 1998. Its success prompted
Embraer to launch two similar planes: the ERJ 135, a 37-seat jet first delivered in 1999, and the ERJ
140, a 44-seater to be delivered from the first quarter of 2001 onward. Sales of ERJ 145 and 135
combined to generate 83% of total revenues in 1999. The large orders by Continental Express and
American Eagle were particularly pivotal: as of March 2000, they accounted for 57% of firm orders for
the ERJ 145 and 135, 46% of options, and 80% of deliveries since the beginning of 1999. Relatedly, the
geographic mix of Embraer’s business shifted towards the United States. Between 1997 and 1999, the
Americas outside Brazil increased their share of Embraer’s revenues from 39% to 65%. Brazilian
revenues fell from 36% to 13% of the total, and European revenues fell from 25% to 23%. Since total
revenues increased by more than 250% over this period, the Americas outside Brazil accounted for
nearly three-quarters of the absolute growth in Embraer’s revenues.

The New Family

In 1998, Embraer conducted a survey of about 50 airlines (accounting for more than half the
market) to gain a better understanding of the larger regional jet market. The survey results made
Botelho confident about the opportunity and he floated the idea to Embraer’s board of directors and
received a green light to begin developing jets in the 70–110 seat range (see Exhibit 7). Crossair,
Europe’s largest regional airline was the first customer, ordering 160 units—60 firm and 100
options—in June 1999. Embraer’s board approved the project, and the new family was announced
with fanfare at the Paris Air Show in June 1999. The commitment to deliver the first 70-seat ERJ 170s
in December 2002 implied a 38-month target for certification that would set a new industry record,
particularly since the ERJ 170 was the first of a new family. Executive Vice-President of Planning and
Organizational Development Horacio Forjaz, who had worked at Embraer since 1974, commented:
“We would have never been able to make the decisions we made, with the speed at which we made
them, if we had still been a state-owned enterprise. Approvals are much slower when you deal with
government officials—we even had to get preapprovals for foreign trips in those days.”

The Planes. Stretching the ERJ 145’s body from 50 to 70 seats was out of the question given its
relatively narrow fuselage. Satoshi Yokota, the executive vice president of Embraer’s industrial
business summarized the advantages of the company’s new design for the ERJ 170 as follows:

The ERJ 170 has optimal fuselage width, including adequate aisle space for roll-on baggage
and service carts. Two roll-ons can be stored overhead for each row, and two underneath front
seats. The seating configuration is flexible since there are no over wing exits. Engines under the
wings allow for 4 doors, 2 in front and 2 in the back, allowing faster turnaround since the
aircraft can be serviced through rear doors. Below-wing engines are usually 5% lighter than the
tail-mounted engines used in the ERJ 145, and leave more room for passengers in the back. The
greater height associated with below-wing engines also allows more room for cargo.

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Embraer: The Global Leader in Regional Jets 701-006

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An analysis performed by a Miami-based consulting firm retained by Embraer indicated that the
ERJ 170 outperformed Bombardier’s CRJ-700 in terms of profit potential as well as “cabin
configuration/passenger appeal.” The analysis reaffirmed that the ERJ 170 offered the shortest
airfield requirements, longest range, lowest costs, lowest break-even payload, and the highest
potential net margin contribution, see Exhibit 8 for summary cost comparisons.

Market and Competitive Analysis. Embraer’s market analysis suggested that between 2000–
2009, total demand for regional jets and turboprops would be 4,800 units and of that 55% (2,360 units)
would be accounted for by market segments Embraer’s new family sought to address: jets in the 70-
to 110-passenger band. The U.S. was expected to account for 60% of unit demand, Europe for 25%
and the rest of the world for 15%. Bombardier’s forecasts were similar.6

Forecasting Embraer’s market share involved additional judgments about competitive factors: the
relative timing of entry, product positioning, and broader assessments of strengths and weaknesses.
The first delivery of Embraer’s 70-seater (ERJ 170) was scheduled for December 2002, of its 108-seater
(ERJ 190-200) for June 2004, and of its 98-seater (ERJ 190-100) for June 2005. Based on this timeline
and competitors’ public announcements, ERJ 170’s first delivery would trail Bombardier’s CRJ-700 by
one year. This sequencing coincided with backlogs of firm orders at the end of 1999: 99 CRJ-700’s and
40 ERJ-170’s. However, Embraer’s management thought that the 70-seater’s lower direct operating
costs (see Exhibit 8) would make up for this lag. In relation to Bombardier, Embraer stressed that the
CRJ-700’s narrower/longer fuselage was likely to lower passenger comfort and slow ground
turnaround (aisles would be only 15 inches wide rather than 19 inches, for example). The company
also cited its own ability to overcome a three-year first-mover advantage for Bombardier in the 50-
seat segment. It recognized, however, that Bombardier had a powerful sales force and that the CRJ-
700 would benefit from commonality with the CRJ-200.

For larger (81–110 seat) planes, competitive dynamics were expected to be quite different.
Embraer had 30 firm orders for ERJ 190-200s, compared to zero for Bombardier and Fairchild
Dornier. In early 2000, Bombardier was still considering the launch of a 90-seat derivative of it’s
already stretched 70-seater—which would presumably be extremely elongated if it materialized.

Irrespective of whether these and other entries materialized, Embraer’s larger planes were bound
to compete with the 106-passenger Boeing 717-200, and the 107-passenger Airbus 318—the smallest
planes in the two largest manufacturers’ product lines. Embraer thought that their approach of
providing shrunken versions of big planes would not offer the desired performance characteristics
and pointed to weight—the ERJ 190-200 would end up being five tons lighter than the Boeing 717 and
13 tons lighter than the Airbus 318. It also believed that small planes wouldn’t be nearly as profitable
for Boeing and Airbus as their larger ones, especially at the pricing levels at which they had won
some recent contracts for the former. Some corroboration came from Boeing’s experience with
DeHavilland, a turboprop manufacturer which it purchased in 1986 and sold to Bombardier in 1992
after losing $1 billion.

Based on competitive considerations of this sort, Embraer developed basic market share scenarios
for both the ERJ 170 and the ERJ 190. In the 61–80-seat market, the base case or middle scenario
involved a struggle for the number one position between Bombardier and Embraer: Embraer’s
market share was projected to be 35%. In the 81–110 seat market, Boeing and Airbus were expected to
play a significant role in the market and, as a result, Embraer’s base case scenario projected its market
share at 18%.

Project Economics Development of the three larger regional jets could cost $850 million in
total, compared to approximately $500 million for developing just the ERJ 170 (the first family plane).
Satoshi Yokota guessed the CRJ-700 cost Bombardier $400 million, while other estimates ranged from

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701-006 Embraer: The Global Leader in Regional Jets

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$300 million to $450 million; 7 the high end of this estimate meant limited savings for Bombardier for
stretching an existing aircraft, compared to Embraer’s new one. In addition, Yokota believed the ten
million engineering man-hours in developing the new family would have cost Embraer $100 million
more in Canada (assuming a $10/hour difference in the costs of engineers in …

9 – 7 0 1 – 0 0 6
R E V : J U N E 3 0 , 2 0 0 9

________________________________________________________________________________________________________________

Professor Pankaj Ghemawat, Gustavo A. Herrero, Executive Director, HBS Latin American Research Center, and Luis Felipe Monteiro, Senior
Researcher, HBS Latin American Research Center prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are
not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management.

Copyright © 2000, 2009 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-
7685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be
digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

P A N K A J G H E M A W A T

G U S T A V O A . H E R R E R O

L U I S F E L I P E M O N T E I R O

Embraer: The Global Leader in Regional Jets

By any standard, 1999 was a milestone year for Embraer. Our company earned a record US$230 million in
net income and celebrated our tenth consecutive quarter of rising profitability. Total revenue reached US$1.89
billion, and our year-end backlog was US$6.4 billion in confirmed orders and US$17.7 billion including
options – both all-time highs.

—Mauricio Botelho, Embraer´s CEO 1999 Annual Report

At the beginning of 2000, Embraer (Empresa Brasileira de Aeronautica S.A.) of Brazil was the
fourth largest commercial aircraft manufacturer in the world, behind Boeing (U.S.), Airbus (Europe)
and Bombardier (Canada). Although it was the smallest of the four competitors that dominated the
global aircraft market, Embraer was the most profitable in 1999 (see Exhibit 1). Founded by the
Brazilian Government in 1969, Embraer was privatized in December 1994—the same year it lost $310
million on sales of $177 million (see Exhibit 2). Since its privatization, Embraer had implemented a
successful turnaround and become a global leader in the fast-growing regional jet segment of the
market. Regional jets accounted for 83% of the company’s sales, and Embraer delivered 97, compared
to 82 by Bombardier, 23 by British Aerospace and 15 by Fairchild Dornier. Embraer posted revenues
of $1.9 billion in 1999, of which its cost of sales accounted for 65%, operating expenses for 10% (with
selling expenses representing 6%), financial and other non-operating expenses for 13%, and net
income for 12%. As of December 1999, the company had 8,300 employees. In 2000, Embraer’s ERJ-145
family of aircraft held a 29% share of regional jet deliveries worldwide and ~44% in the 20-59 seat
category. Embraer was Brazil’s largest exporter and was viewed by many as a symbol of the
country’s economic and technological advancement.

Embraer’s management had also recently made a set of decisions which they hoped would set the
company on a course to sustain and build upon its present wave of success. In July of 1999, Embraer
announced an initial set of orders for a new family of larger jets which would cost a projected $850
million to develop but had the potential to double the company’s sales. In October of 1999, Embraer
announced that a consortium of French aerospace and defense companies would acquire 20% of its
equity. This announcement came on the heels of a World Trade Organization (WTO) ruling against
both Brazil and Canada for the financial support they had given Embraer and Bombardier
respectively in regional jets. Embraer was also preparing for a foreign listing and equity offering on
the New York Stock Exchange to be completed in 2000.

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701-006 Embraer: The Global Leader in Regional Jets

2

Founding and Development as Public Sector Company

Embraer’s history was intertwined with the Brazilian government’s efforts to promote
aeronautics—a priority for the country given its enormous land mass, wide rivers, and limited
surface transportation infrastructure. The Brazilian military, upon taking power in 1964, attempted to
transform the country into a ‘Great Power’ through a policy that focused on research—not only for
military needs, but also for the civilian sector. The Brazilian military adopted a development
approach that explicitly favored state intervention to support the development of industry, science,
and technology, as well as protection of national infant industries. To facilitate this, a vast research
program was set up through Brazil’s university system.

The Brazilian government believed in the philosophy of funding strategic technologies to build
knowledge for the civilian economy up to a stage that it could benefit from the knowledge. For the
aircraft industry in particular, Sao José dos Campos (SJC), a small town 55 miles from Sao Paulo,
became the Brazilian aeronautical industry’s hub. An Aeronautical Technical Center (CTA), an
Aeronautical Technology Institute (ITA), and a research and development institute (IPD) were set up
there to technically support Embraer.

Ozires Silva, a graduate of ITA and an air force officer, became Embraer’s first president. His
objective was to combine state-owned enterprise resources (the Brazilian government would control
at least 51% of its equity) with the entrepreneurial agility of a private-sector firm. It was evident,
though, that Embraer’s government relationship awarded it special privileges, for example:

o Federal agencies had to purchase from Embraer rather than competitors,
whenever possible.

o Embraer would pay no taxes or duty on imported raw materials, parts, and
equipment unavailable locally.

o Brazilian corporations could invest 1% of their federal income tax obligations
each year in Embraer’s shares. This scheme helped Embraer raise an estimated
$350 million in capital between 1970 and 1985.

Embraer entered three segments of the aviation business: regional passenger aircraft, defense
aircraft, and special purpose aircraft. The company’s first export orders were from Uruguay and
Chile; the first sales to the US were in 1978, when Embraer persuaded someone in Florida to buy 3 of
its ‘Bandeirante’ aircraft. After securing certification from the U.S. FAA (Federal Aviation
Administration), U.S. sales increased from five planes in 1979 to 39 in 1981, when Embraer set up a
wholly-owned U.S. subsidiary to focus on U.S. sales. By then, Embraer had captured 46% of the
commuter turboprop market and the Bandeirante, nicknamed the “Bandit” by competitors, had
surpassed former leader Fairchild.1

In 1982, Fairchild filed a complaint before the U.S. International Trade Commission (ITC)
requesting a 39%–44% countervailing duty on Bandeirantes to offset government subsidies Embraer
received. The ITC ultimately rejected the complaint. Soon after Bandeirante’s success, Embraer
launched the Brasilia in 1985, a 30–passenger pressurized twin turboprop, and sold 350 by 1999—a
major commercial success, although its financial viability was questioned.

Privatization

In the late 1980s and early 1990s, Embraer’s performance went into a tailspin for a number of
reasons including the Russian economic crisis, the cancellation of billions worth of military programs

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worldwide, and a global recession that hit commercial orders. In 1985, after years of military rule, the
new civilian president encouraged Embraer to develop the CBA123, a shortened, 19-seat version of
the Brasilia, in partnership with Argentina’s Fábrica Militar de Aviones (FMA). The aircraft’s name
stood for “Cooperação Brasil-Argentina” (Brazilian-Argentine Cooperation) and was reportedly
motivated at least in part by foreign policy considerations in play during the development of the
Mercosur trade pact. The CBA proved to be advanced but far too pricey and by 1990, the cumulated
losses on the CBA123 program upon its cancellation were calculated at $280 million.

This setback came during a period of serious macroeconomic difficulty in Brazil, which led the
government to run large deficits. Budgetary pressures constrained the government’s export support
programs and inflation reached an annual rate of 37,000% by the beginning of 1990! Prices were
finally brought under control under a program in which the Brazilian Real was pegged to the U.S.
dollar within a predetermined band.2 Inflation had since stayed under control, although Brazil rated
poorly on international competitiveness measures (see Exhibit 3).

These events had a devastating impact on Embraer; sales plummeted from $700 million in 1989 to
$177 million in 1994, as deliveries dropped from six planes per month to two. Even a workforce
reduction from 13,000 to 6,100 could not stop the bleeding, and average losses continued at $200
million per year. Ozires Silva, who had left the company in 1986 to serve as president of Petrobras
(Brazil’s state-owned oil company) was brought back as president. Although he was unable to restore
Embraer’s profitability, he persuaded the Brazilian government to consider privatizing the company.3

The privatization of Embraer, a symbol of Brazilian nationalism, was met with protests that
delayed the process by two years. Even when Brazilian Congress approval came, a moratorium on
layoffs was imposed that was estimated to cost the new owners’ up to $45 million. However, the
Brazilian government assumed $700 million of Embraer’s debt, recapitalized another $350 million, set
a low reserve price on the company’s shares, and allowed partial payment in bonds that traded at
approximately 50% of their face value.

A consortium consisting of Companhia Bozano, Simonsen (CBS), a Brazilian financial services
group, two large public-sector pension funds, and Wasserstein Perella, a U.S. investment bank,
acquired a 45% stake in Embraer on December 7, 1994 for $89 million. However, Embraer’s problems
continued as Brasilia turboprop sales declined faster than expected and 30% interest rates crippled
the company financially.

Turnaround

CBS director Mauricio Botelho, a 53 year-old mechanical engineer was appointed by Embraer’s
shareholders as its new CEO in mid-1995. Over the next few months, Botelho changed Embraer’s top
management structure, bringing in half the senior managers from outside and promoting the rest
from within. His turnaround plan involved 3 major changes:

Workforce Reduction/Incentives. Dealing with the demoralized and embittered workforce was a
key challenge. The day after the six-month moratorium on layoffs expired, 1800 people (30% of the
workforce) lost their jobs, although they did receive the officially mandated severance pay. In
addition, the pre-privatization habit of giving excess salaries based on tenure to get around salary
caps was brought under control. On the other hand, underpaid managers and engineers received
salary increases within one month and managerial levels were reduced from seven to five.

However the losses continued in 1996, and Embraer campaigned to secure wage and overtime
concessions through the unions. Another 400 indirect positions were eliminated in early 1997.

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Workers acquiesced partly because they feared more sweeping cuts if they resisted and also because
laid-off workers were offered compensation in excess of the statutory minimum.

As a result of these changes, total headcount dropped to 3,200 in April 1997 and average salaries
fell from $2,100 during the pre-privatization era to $1,600. The total employment cost to the company
per worker was roughly twice this base salary. By late 1997, Embraer began hiring for the first time in
nearly 10 years. Its emphasis on hiring young workers led to further reductions in the average basic
salary, to about $1,100 per month by early 2000. However, to energize the workforce, Embraer
launched an incentive program in 1999 which distributed the equivalent of 25% of the dividends paid
to shareholders to its employees (nearly 3 months salary) based on performance targets. These were
derived from a master ‘Strategic Plan of Action’ which stated Embraer’s objectives five years into the
future; the targets were supplemented by yearly action plans elaborated by each division VP,
Director, or Manager, with input from subordinates. This iterative up-and-down approach ensured
internal consistency as well as serving as a basis for incentive compensation.

Restructuring the Organization around the Customer. Botelho saw his key challenge as
transforming Embraer from a product-driven company to a customer-focused company. As he put it,
“When you’ve got only 100 customers, you have to focus entirely on what they want.” He and other
top managers consistently emphasized that traditional production functions were not as important as
line functions that ran from customers to shareholders. This message was backed up by a
reorganization project, launched in 1996, that led to a matrix organization, structured around
projects, that meant to enhance flexibility, interaction, and autonomy while reducing development
times and costs.4 See Exhibit 4 for Embraer’s organization chart.

Outsourcing Non-Core Services. In line with Embraer’s stated strategic objectives, organization
boundaries were redrawn as basic supplies such as catering and security, training, specialized
technical services, and even basic manufacturing and assembly were outsourced to Embraer’s
extensive partner-network. On the production front, Embraer emphasized coordinating supplier
relationships to improve quality and speed. As a result, the Brasilia turboprop’s production lead time
declined from 14 months in 1995 to 8 months in 1996, and finally six months in 1997. Meanwhile,
Embraer put more focus on what it considered its core businesses – in-house design & development
and the aircraft’s lifetime service provision.

As a result of these 3 initiatives, operating losses were stemmed relatively quickly, but net income
remained stuck around zero, largely as a result of a heavy debt burden (see Exhibit 5). Embraer
secured more cash from its controlling shareholders, increasing their total equity contribution to $520
million by the end of 1997, and arranged cheaper sources of financing for itself, reducing its average
interest rate from 33% in early 1995 to 8% by 1999. However, Bothello knew that sustainable
performance could only come from a hit product: the only immediate prospect was the ERJ 145, a 50-
seat twin-engine regional jet.

The ERJ 145

The ERJ 145 was conceived in 1989 as a stretched, jet-powered version of the 30-seat Brasilia
turboprop. The new plane was projected to cost $300 million to develop and meant to tap increasing
demand for short-range, regional flights, and travelers’ growing aversion to turboprops. Despite
market interest in ERJ 145, the project languished as Embraer’s finances deteriorated through the
turbulent 1990’s and by 1994, the new shareholders had to decide whether to invest another $240
million to complete the project.

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Prior to Embraer’s privatization, CBS’s consultants validated the market for 50-seat regional jets as
well as the ERJ 145’s prospects. The new plane flew for the first time in August 1995 and was certified
in 1996. The Brazilian National Development Bank, BNDES, provided a loan of $115 million and
additional financing came from Embraer’s four (non-Brazilian) risk-sharing project partners—their
contribution was worth about $100 million and the partners were paid as the aircraft were sold.
Several dozen smaller “partner suppliers” were eventually signed up as well. The high degree of
reliance on external partners was illustrated by the fact that materials and equipment purchased from
risk-sharing partners and other major suppliers came to account for 79% of production costs for the
ERJ 145 (85% for the ERJ 135, a 37-seater that was the second plane in the family).

The ERJ 145’s principal competitor was Bombardier’s CRJ-200. Bombardier had, with a three-year
head start, already delivered close to 100 CRJ-200s by the time Embraer delivered its first ERJ 145.
However, Embraer’s management was confident ERJ 145’s sales could excel through new
“campaigns” to highlight key competitive differences, which included:

1. More Passenger Space. The CRJ-200 had four-abreast seating that offered less
cabin width per passenger, compared to three-abreast for Embraer.

2. Pure Commercial Aircraft Design. The CRJ-200’s design was derived from
Bombardier’s Challenger business jet and in Embraer’s view, the CRJ-200 carried
more than a ton-and-a-half of extra weight, was more complicated, and had other
expensive systems and unnecessary operating characteristics. The ERJ 145, in
contrast, was designed from the start as a commercial aircraft for maximum
efficiency in airline operation.

3. Lower Cost. Embraer calculated the CRJ-200’s production cost as $2–3 million
more compared to the ERJ 145, based on the industry rule of thumb that each extra
ton cost $1 million. This, they believed, was reflected in the cost differential in
reference prices of $17.6 million for the ERJ 145 and $21 million for the CRJ-200.
(Note: it was not uncommon for airlines placing large orders to receive discounts of
up to 10–20% off of reference prices with higher discounts offered on more expensive
aircraft). In terms of direct operating costs, the ERJ 145 was significantly more
economical—especially on shorter flights because it had lower fixed costs per flight
than the CRJ-200 (see Exhibit 6 for Embraer’s estimates). According to the Official
Airlines Guide, about 70% of all flights by “small” passenger aircraft (with fewer than
110 seats) covered less than 300 miles and another 20% ranged 300–500 miles.

Bombardier was a much larger company than Embraer, with operating groups active in
aerospace, transportation equipment, motorized recreation equipment, and financing. Aerospace
was, however, emerging as by far the largest and most profitable business at Bombardier and
included Learjet and Challenger business jets and De Havilland Dash turboprop transports, as well
Canadair Regional Jets (CRJs). In addition to delivering 72 regional jets in 1999, Bombardier
Aerospace delivered 103 business jets, 30 turboprops, and 12 amphibious aircraft, as well as
supplying major aircraft components to Boeing and Aerospatiale, delivering other military hardware,
and providing a variety of aviation related services.

Bombardier’s aerospace division had an estimated 33,000 employees with perhaps 9000 involved
in the regional jet business. Salary levels at Bombardier were not publicly available, but one estimate
placed its fully-loaded annual labor cost per employee at roughly $55,000.

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Bombardier responded aggressively to Embraer’s ERJ 145 entry by cutting CRJ-200’s prices
significantly, circulating a detailed manual to potential customers comparing the ERJ 145 unfavorably
with its own plane, and even luring away some of Embraer’s engineers by placing help-wanted ads
in a Sao José dos Campos newspaper. It also used personal connections—Bombardier Chairman
Laurent Beaudoin was considered close to Canadian Prime Minister Jean Chretien5—to spur a
complaint by the Canadian government to the World Trade Organization about the Brazilian
development bank’s role in financing ERJ 145 orders (as described below).

Despite Bombardier’s aggressive response, ERJ 145’s sales quickly took off, helped by an order for
200 planes—25 firm and 175 options—from Continental Express in 1996. Cumulated deliveries hit 100
within two years, compared to three-and-a-half years it took CRJ-200. By 1997, the ERJ 145 accounted
for 60% of Embraer’s revenues and pushed Embraer back into black in 1998. Its success prompted
Embraer to launch two similar planes: the ERJ 135, a 37-seat jet first delivered in 1999, and the ERJ
140, a 44-seater to be delivered from the first quarter of 2001 onward. Sales of ERJ 145 and 135
combined to generate 83% of total revenues in 1999. The large orders by Continental Express and
American Eagle were particularly pivotal: as of March 2000, they accounted for 57% of firm orders for
the ERJ 145 and 135, 46% of options, and 80% of deliveries since the beginning of 1999. Relatedly, the
geographic mix of Embraer’s business shifted towards the United States. Between 1997 and 1999, the
Americas outside Brazil increased their share of Embraer’s revenues from 39% to 65%. Brazilian
revenues fell from 36% to 13% of the total, and European revenues fell from 25% to 23%. Since total
revenues increased by more than 250% over this period, the Americas outside Brazil accounted for
nearly three-quarters of the absolute growth in Embraer’s revenues.

The New Family

In 1998, Embraer conducted a survey of about 50 airlines (accounting for more than half the
market) to gain a better understanding of the larger regional jet market. The survey results made
Botelho confident about the opportunity and he floated the idea to Embraer’s board of directors and
received a green light to begin developing jets in the 70–110 seat range (see Exhibit 7). Crossair,
Europe’s largest regional airline was the first customer, ordering 160 units—60 firm and 100
options—in June 1999. Embraer’s board approved the project, and the new family was announced
with fanfare at the Paris Air Show in June 1999. The commitment to deliver the first 70-seat ERJ 170s
in December 2002 implied a 38-month target for certification that would set a new industry record,
particularly since the ERJ 170 was the first of a new family. Executive Vice-President of Planning and
Organizational Development Horacio Forjaz, who had worked at Embraer since 1974, commented:
“We would have never been able to make the decisions we made, with the speed at which we made
them, if we had still been a state-owned enterprise. Approvals are much slower when you deal with
government officials—we even had to get preapprovals for foreign trips in those days.”

The Planes. Stretching the ERJ 145’s body from 50 to 70 seats was out of the question given its
relatively narrow fuselage. Satoshi Yokota, the executive vice president of Embraer’s industrial
business summarized the advantages of the company’s new design for the ERJ 170 as follows:

The ERJ 170 has optimal fuselage width, including adequate aisle space for roll-on baggage
and service carts. Two roll-ons can be stored overhead for each row, and two underneath front
seats. The seating configuration is flexible since there are no over wing exits. Engines under the
wings allow for 4 doors, 2 in front and 2 in the back, allowing faster turnaround since the
aircraft can be serviced through rear doors. Below-wing engines are usually 5% lighter than the
tail-mounted engines used in the ERJ 145, and leave more room for passengers in the back. The
greater height associated with below-wing engines also allows more room for cargo.

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An analysis performed by a Miami-based consulting firm retained by Embraer indicated that the
ERJ 170 outperformed Bombardier’s CRJ-700 in terms of profit potential as well as “cabin
configuration/passenger appeal.” The analysis reaffirmed that the ERJ 170 offered the shortest
airfield requirements, longest range, lowest costs, lowest break-even payload, and the highest
potential net margin contribution, see Exhibit 8 for summary cost comparisons.

Market and Competitive Analysis. Embraer’s market analysis suggested that between 2000–
2009, total demand for regional jets and turboprops would be 4,800 units and of that 55% (2,360 units)
would be accounted for by market segments Embraer’s new family sought to address: jets in the 70-
to 110-passenger band. The U.S. was expected to account for 60% of unit demand, Europe for 25%
and the rest of the world for 15%. Bombardier’s forecasts were similar.6

Forecasting Embraer’s market share involved additional judgments about competitive factors: the
relative timing of entry, product positioning, and broader assessments of strengths and weaknesses.
The first delivery of Embraer’s 70-seater (ERJ 170) was scheduled for December 2002, of its 108-seater
(ERJ 190-200) for June 2004, and of its 98-seater (ERJ 190-100) for June 2005. Based on this timeline
and competitors’ public announcements, ERJ 170’s first delivery would trail Bombardier’s CRJ-700 by
one year. This sequencing coincided with backlogs of firm orders at the end of 1999: 99 CRJ-700’s and
40 ERJ-170’s. However, Embraer’s management thought that the 70-seater’s lower direct operating
costs (see Exhibit 8) would make up for this lag. In relation to Bombardier, Embraer stressed that the
CRJ-700’s narrower/longer fuselage was likely to lower passenger comfort and slow ground
turnaround (aisles would be only 15 inches wide rather than 19 inches, for example). The company
also cited its own ability to overcome a three-year first-mover advantage for Bombardier in the 50-
seat segment. It recognized, however, that Bombardier had a powerful sales force and that the CRJ-
700 would benefit from commonality with the CRJ-200.

For larger (81–110 seat) planes, competitive dynamics were expected to be quite different.
Embraer had 30 firm orders for ERJ 190-200s, compared to zero for Bombardier and Fairchild
Dornier. In early 2000, Bombardier was still considering the launch of a 90-seat derivative of it’s
already stretched 70-seater—which would presumably be extremely elongated if it materialized.

Irrespective of whether these and other entries materialized, Embraer’s larger planes were bound
to compete with the 106-passenger Boeing 717-200, and the 107-passenger Airbus 318—the smallest
planes in the two largest manufacturers’ product lines. Embraer thought that their approach of
providing shrunken versions of big planes would not offer the desired performance characteristics
and pointed to weight—the ERJ 190-200 would end up being five tons lighter than the Boeing 717 and
13 tons lighter than the Airbus 318. It also believed that small planes wouldn’t be nearly as profitable
for Boeing and Airbus as their larger ones, especially at the pricing levels at which they had won
some recent contracts for the former. Some corroboration came from Boeing’s experience with
DeHavilland, a turboprop manufacturer which it purchased in 1986 and sold to Bombardier in 1992
after losing $1 billion.

Based on competitive considerations of this sort, Embraer developed basic market share scenarios
for both the ERJ 170 and the ERJ 190. In the 61–80-seat market, the base case or middle scenario
involved a struggle for the number one position between Bombardier and Embraer: Embraer’s
market share was projected to be 35%. In the 81–110 seat market, Boeing and Airbus were expected to
play a significant role in the market and, as a result, Embraer’s base case scenario projected its market
share at 18%.

Project Economics Development of the three larger regional jets could cost $850 million in
total, compared to approximately $500 million for developing just the ERJ 170 (the first family plane).
Satoshi Yokota guessed the CRJ-700 cost Bombardier $400 million, while other estimates ranged from

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$300 million to $450 million; 7 the high end of this estimate meant limited savings for Bombardier for
stretching an existing aircraft, compared to Embraer’s new one. In addition, Yokota believed the ten
million engineering man-hours in developing the new family would have cost Embraer $100 million
more in Canada (assuming a $10/hour difference in the costs of engineers in …