It is interesting to compare Brazil`s automotive sector with the country`s far more successful production of aircraft, centred on the company Embraer.
According to the Embraer website (http://www.embraer.com/br/essencia), the company history started in 1946, with the strategic plans for a domestic aeronautical sector. In 1947/1950 there was the building of “Centro Tecnico Aeroespacial” (CTA) and the “Instituto Tecnológico de Aeronáutica” (ITA), in Sao Paulo, to offer aeronautical engineering degrees, previously offered only in Rio de Janeiro. Only in 1968 is that the first prototype of a twin-engine 20 passenger plane, the “Bandeirantes”
was conceived, and the company was officially founded in 1969, as a state-owned firm, when it started to produce the tion of Embraer, as a state-owned company, to produce the “Bandeirantes”, and, from 1971, the military “Xavante”, under licence of the Italian Aermacchi. In 1977: the firm presented the first plane 100% designed by Embraer, the “Xingu”. Several new planes started production after that: “Tucano”, a
84 Taking into consideration only those who innovated.
158 training military plane, in 1979, the civilian “Brasilia”, in 1980, and the military jet AMX, in partnership with the Italian Aeritalia, in 1985, with a total of 200 jets produced. In 1994 Embraer was privatized. Then, the launches of regional jets characterized the company`s strategy: between 1997 and 1999 several regional jets, ranging from 70 to 118 passengers, were produced. In the 2000`s new regional jets and executive jets (Phenon, Legacy, Lineage) were added to the company portfolio. In 2009 there as the start of the development of the KC 390, a military cargo aircraft, with first flight in 2015, and in 2016 Embraer launched a new generation of commercial jets.
Differences between Embraer and the Brazilian automotive sector
Analysing the Brazilian automotive sector and Embraer, with the aid of the literature, and specialized and institutional websites (Fonseca, 2012; Embraer web site, Ferreira and Salermo, 2011; Bastos, 2006; Mansueto`s blog; and Invest in Sao Paulo website) we can identify some differences that may partially explain why the Brazilian aircraft sector became more competitive than its vehicle sector.
First difference: focus on exports.
The company was established in 1969 as a state-owned firm and since its start it focused on the export market. In 2011 the company opened a factory in the USA, and in 2012 in Portugal. The domestic market accounts for roughly 10%-20% of Embraer`s production.
Second difference: Investments in R&D and partnerships with foreign suppliers.
To be able to export the company invested heavily in R&D, and in many cases had the support of partnerships with suppliers.
Third difference: labour costs are lesser than its main competitors
The labour costs in US dollars are smaller than those faced by Boeing, Bombardier and Airbus. However, China is a threat to this competitive advantage.
The firm was privatized in 1994 and faced a process of restructuring that contributed to large gains in competitiveness.
159 Fourth difference: Strategic advantages towards suppliers and dominance of key design capabilities
Embraer is very efficient in designing and assembling its products, but its competitiveness is due also to the vast share of partnerships with world leaders’
suppliers in their fields. The strategic advantage of Embraer in its relations with its suppliers is that Embraer have the capability to substitute suppliers, as it has the capability to alter designs, projects and to produce some parts.
Fifth difference: it does not need to incur in transportation costs
As the factory is close to its main domestic suppliers, in an aeronautical cluster in Sao Jose dos Campos/SP, Embraer`s suppliers producing domestically do not face the transportation costs faced by automakers` around Brazil. Some imports are also relatively cheap to transport, as the ones that come by ship arrive through Brazils`
main port, relatively close to its factory. But the most important aspect regarding infrastructure is that the products Embraer exports fly directly to its clients.
A sixth difference would be that Embraer is Brazilian owned. However, this is not necessarily a reason for substantial differences in terms of outcome and performance, as there are international investors owning shares of Embraer and the company is run like most private defence firms around the world: seeking efficiency but relying on public contracts. Moreover, some of the car manufactures in Brazil are in fact Brazilian firms, producing cars under licence of a multinational that owns the brand – such as, for example, CAOA group, that produces Hyundai and Cherry models.
The start of Embraer was possible given a combination of public money and resources and strategic partnerships. Later, after privatization, its success was based on access to imported goods, and more partnerships. It is not straightforward to replicate these conditions for other sectors, but the main lessons could be applied: investments in R&D as public goods to be used to a wider number of sectors and companies, and access to imported inputs could be essential.
Embraer has more than 4,000 engineers working with R&D. This emphasis in R&D was crucial for the company success. Although very high in comparison with the domestic operations of the automakers operating in Brazil, the investment in R&D is
160 not too far from the levels seen in the headquarters of the main automakers. However, the examination of the company`s financial statements allow us to see that the investment in R&D is showing a declining trend from the average between 2000 and 20008 and the average between 2008 and 2016 (figure 19). This could be the result of the conditions faced after the financial crisis of 2008, or due to the fact that R&D is increasingly made by suppliers, also in the aircraft sector. However, if we compare the latest figures with the percentage of revenues that is invested in R&D by the 10 biggest aircraft and defence manufacturers that have production plants in the UK, it is clear that Embraer is reducing its investments in R&D: These investments in 2016 ranged from 2.1% of sales for Lockheed Martin, to 9.1% for Bombardier. The average of the 10 biggest was 4.6% of sales invested in R&D (The Aerospace Technology Institute, 2018).
Figure 19 – R&D as a percentage of revenue
161 Source: Income statements: http://ri.embraer.com.br/
Suppliers can take a fundamental role in the development of new products, alongside the producers of the final goods. However, for this cooperative system to work well, the producers need to efficiently coordinate all suppliers and activities to generate innovations and improvements in products and processes. Ferreira and Salerno (2011) says that the Brazilian aeronautical industry is an example of successful partnerships.
A special type of partnership is the one where all parts share financial risks and rewards (Bastos, 2006). There are, however, variations in terms of how dependant is the assembler from the suppliers: if the assemblers can easily or not change suppliers if they do not deliver as expected. There is also variation in terms of who coordinates each process. (Ferreira and Salerno (2011))
Within Embraer, some of its suppliers are partners with technical and financial stakes in the development of the products. There are, however, “regular” suppliers, that just sell their intermediate goods. Embraer has gained bargaining power with its suppliers thanks to its dominant position in the market. In some products, Embraer opts for a verticalization process, for different reasons: in the case of the Phenon, the firm decided to produce more parts internally in order to accelerate the launch. In the case of the Legacy, the firm wanted to master some technologies and also use some of tax benefits to produce in its plant in Portugal (Ferreira and Salerno, 2011)
There is some modularity in aerospace, as in the automotive sector, but given the complexity of the sector, the assembler always needs to coordinate everything (Ferreira and Salerno, 2011)
The “custo-brazil” affects Embraer to a lesser extent than it affects other sectors, but it still has an effect. From the demand side, roughly 10-20% of Embraer`s sales are to domestic buyers. From the supply side, the potential bottlenecks for gains in competitiveness are somehow under control: labour costs; labour qualification, exchange rate and transport infrastructure. As said, these are to some extent smaller problems given the reasons explained in this chapter. Moreover, most of them have
162 been addressed: On top of the specialized and highly respected aeronautical engineering university ITA – “Instituto Tecnologico de Aeronautica”, Embraer has set up, since 2001, specific graduate programs of aeronautical engineering, having already graduated more than 1,500 engineers. Exchange rate is a crucial component for Embraer profits, but the company has natural hedge, as most of its components are imported and most of its sales are in foreign currency.
The main differences between Embraer and most of the Brazilian industrial sector is that the aeronautical company can buy the best inputs in the world, at almost no extra cost (this is due to the tariff suspensions of inputs, that are then exempted after the final good – the plane – is exported) and the lower susceptibility to part of the Brazilian business environment.
All aeronautical companies in Brazil benefit from a “suspension” of import taxes and IPI-import taxes. This means that they can import intermediate goods without paying those taxes, provided that later on the final goods are exported. If they do not export, the firm needs to pay those suspended taxes. It is a drawback regime, very common in other sectors and countries – and indeed used by the automotive sector as well.
One difference is that in the case of the aeronautical industry the system is also fully automatic since 2002: the imported goods can go directly to the manufacturing plant in Brazil, without the need to pass through customs control. As the customs process in Brazil is very slow and costly, this measure solves one of the biggest bottlenecks in Brazilian ports. This system, called “Regime Aduaneiro Especial de Entreposto Industrial sob Controle Informatizado (Recof Aeronautico)85”
Investe Sao Paulo (2009) indicate that the local content of Embraer in 2009 was very low (around 5%). In this sense, it is as if Embraer is an assembler that adds value in design, coordination of process, and labour, but that does not create a dense domestic supply chain. The firm uses a logistic center in Taubate to keep all supplies it needs, and then deliver them “just in time” to the manufacturing plant. Most (75%) of its
85 This supports mainly the biggest aeronautical Brazilian companies - Embraer and Helibras (helicopters), but there are similar systems for other sectors.
163 exports and imports, in terms of value, are done by air. In terms of weight, 70% is done by maritime transportation.
The cluster in São Paulo
According to the Survey “Relação Anual de Informações Sociais” (Rais), collected by the Brazilian Labour Ministry, in 2016 there were 83 companies manufacturing aircrafts and parts, located within Sao Paulo. Minas Gerais has the second position among the Brazilian sates, both in terms of number of firms and employment in the sector. This is due to the presence of Helibras, a helicopter manufacturer.
According to the “Invest in Sao Paulo” state agency, there is an aeronautical cluster in Sao Jose dos Campos, with Embraer as the main company. The aerospatial cluster is located in the São José dos Campos` technological park (PqTec) and comprises over 100 technology-based enterprises in 188 thousand square meters. Firms that are part of this cluster have many benefits, such as support for participation in international trade fairs and trade missions, setting up of consortia, technical certifications, training, infrastructure, partnerships and subsidies from governmental institutions like Finep, APEX, ABDI, Sebrae, SDECTI/SP and BNDES, and with other clusters in Canada, Sweden, England, Netherlands, and China.
The cluster also benefits from the proximity to the Aeronautical Technology Institute (ITA), created in 1950. In its campus, the institute offers graduate and post-graduate (masters and PhDs) degrees in engineering (in 28 different areas, related to aeronautics, aerospatial, electronics, mechanics and physics. In 2017 ITA had 2,400 students and 180 professors. Moreover, in the city there is also a facility of the National Institute for Space Research (Inpe), and agency part of the Ministry of Science and Technology.
Other research centers that contribute to the cluster are the “Laboratório de Estruturas Leves (LEL)”, part of the “Centro de pesquisas ligado ao Instituto de Pesquisas Tecnológicas (IPT)”86, from the São Paulo State government; the “Departamento de
86 Created in 1889.
164 Ciência e Tecnologia Aeroespacial (CTA), part of the Brazilian airforce; the “Instituto de Aeronáutica e Espaço (IAE)”; the “Instituto de Estudos Avançados (IEAv)”; the
“Instituto de Fomento e Coordenação Industrial (IFI)”, to supply certifications; and the
“Instituto de Pesquisas e Ensaios em Voo (Ipev)”.
Industrial policies should aim to increase productivity or innovation, the drivers of economic growth, and not to protect vested interests. A good example of good industrial policy is what was done with Embraer. But that is hard to be replicable. There are others in Brazil, as, for example, Petrobras, Vale, Embrapa, etc, with different degrees of initial difficulties, different degrees of scope and type of instruments, and different degrees of success.
Mansueto Almeida, in his blog, said, in 4/January/2012, that he received a reply from a former Embraer CEO, Ozires Silva, after he made a comment about the company.
The comment made by Mansueto was that the company survived in its early days thanks to the support of the Government. The reply, however, stated that although initially a state-owned enterprise, Embraer was always managed as if it was a private company. In this sense, and against all odds, it proved itself in the market and it can be considered a success case, for all metrics.
CONCLUSIONS
Although for most of the 20th century the automotive sector was one of the most important industries worldwide, its future importance to development and developed countries alike has been questioned, as the industry is seen as “old” and “dying” in face of new technologies and behaviour patterns, such as shared vehicles (potentially reducing demand for cars), for example. Partly because of sharper demand limitations in developed countries, and partly because of cost-issues, vehicle manufacturing has been moving to developing countries. However, among these, the bigger and more integrated Asian economies seem to receive the bulk of new investments.
165 In the past, all Brazilian automotive industrial policies since the 1950s have made use of protectionism, within the import-substitution framework. Moreover, domestic content87 ensured that the policy benefits reached not only the automakers, but also the auto parts producers. The level of import barriers erected was – and still is – quite high. Exports were used only to compensate for periods of low domestic demand, as since its conception, the industry always focused on the domestic market. All in all, although the previous policies were the drivers for the relatively successful attraction of FDI into the Brazilian automotive sector88, they generated serious shortcomings in terms of competitiveness for the sector. Because the scale of production was limited to the size of the domestic market, and fragmented among many automakers, productivity was compromised. In addition, without a more export-oriented approach, and within a very protected market, there was less competition from abroad and less incentives to produce better vehicles. Although the automakers in Brazil are multinationals, and therefore part of GVCs, their domestic production was inferior in terms of quality and has a higher price tag than what could be seen in the international markets.
Protectionism was used as a tool to attract FDI in all policies, but besides that, for the 1950s and the 1990s the intention was also to avoid trade deficits, while for Inovar the additional motivation was also to protect domestic producers from losing market-share to imports. Finally, Inovar Auto added R&D and fuel efficiency targets. None of the three policies directly promoted exports.
The automotive industry in Brazil is then facing a double risk: being uncompetitive given the highly protected domestic market and the high costs of producing domestically (“custo-Brazil”), and being an industry facing existential threats worldwide. As pointed out before, scale gains are necessary, and exports seem to be
87 The local content requirements and protection were higher in the 1950s, as the industry was in its infancy. For the “Regime” of 1995-1996 as for Inovar Auto of 2012, the local content requirements were smaller, although explicitly 60% in the 1995 Regime, and implicitly around this percentage for Inovar Auto. Furthermore, protection in the 1995 and 2012 policies were similar.
88 The literature suggests that the Target Plan of the 50s did play a decisive role in attracting investment, but the following policies of the 1990s and 2010s had a less clear impact: investment was increasing before these policies were set up and thus policy could have had only a partial role in the results.
166 the logical way forward, together with easier access to imported inputs and a better business environment.
Many studies tried to estimate the minimum efficient scale for the automotive sector.
As Natsuda, Otsuka and Thoburn (2015) summarizes, the optimal scale for some autoparts, such as engines, is larger than for producing vehicles itself. The authors also argue that, given the consolidation of the industry in large conglomerates, the minimum efficient scale per plant was probably reduced to 150 thousand vehicles per year (although, still according the studies surveyed by Natsuda, Otsuka and Thoburn (2015)89, the minimum size of production to achieve efficiency could be as low as 30 thousand vehicles, if assembled as CKD (completely knocked-down)). Nonetheless, the authors support that the minimum efficient size of firms has increased, reaching something around 5 million vehicles, in the case of mass-market models, and around 1 million in the case of luxury brands.
Moreover, the location of automaker`s plants can hide important information about investments and trade, as an increasing part of the value-added is traded between subsidiaries of those automakers worldwide and also between autopart suppliers and their automaker buyers located in different countries. These global value chains are one of the main characteristics of the global automotive industry90. Participation in GVCs as an exporter implies a need for cost-competitiveness, and this is more easily achieved in more liberalized countries, where imports of intermediates and capital goods help to boost export competitiveness, or at least in countries with sufficient trade agreements to boost export competitiveness and market access. The contrast with ISI policies pushes us to the debate between specialization versus diversification, as a development strategy.
As explained in the previous sections, domestic demand is among the key advantages of Brazilian manufactures, and it was the main attraction for multinational automakers since the 50s. However, domestic demand is not solely a function of population, as income level and distribution, economic growth, domestic integration, general
89 Nolan (2012).
90 The importance of these GVCs varies according to the type of product and its location in the value-chain, with estimates pointing to around 50% of autoparts being outsourced worldwide (Rudolf Traub-Merz, 2017).
167 business environment and trade and industrial policies all impact the potential for domestic vehicle sales and production. However, exports remain a key variable, in a world characterized by monopolistic competition among globalized automakers.
The domestic market is simply not enough anymore to guarantee the required scale
The domestic market is simply not enough anymore to guarantee the required scale