Battle for the skies

When did you first look at China as a market?

We started talking to the Chinese about technology transfer in 1979. We were the second ones into China. Boeing got in first when Nixon visited China, so they were in the market about ten years ahead of us.

With Boeing the Chinese were simply buying aircraft built in Seattle, and they wanted to develop their own aircraft industry. They were fairly sophisticated in manufacturing military aircraft, but they had not had much experience in building commercial transport and wanted to get into that business. They made a couple of attempts to build their own aircraft but realised that they really didn't have enough advanced technology to do it on their own. So they were seeking a partner.

We agreed in principle, in the mid 70s, to work with them on a co-production arrangement. We began by selling CAAC five MD-80s built at Long Beach in the 70s and early 80s. Concurrently, we started off giving them components to build in China. We started out with fairly simple components to be built at the Shanghai Aviation Industrial Corporation (SAIL): We sent people into China and trained them to manufacture products to our specifications, which would be certified by the FAA.

We then entered into a co-production agreement with them whereby they would assemble 25 MD-82s in China. These would be delivered to Chinese airlines for domestic use. We sold them kits, and then they would assemble the aircraft from those kits. Some of the components in the aircraft had originated in China, and had been sent to the US to be incorporated in the kits. Those 25 aircraft were successfully built and returned to the airlines in China.

Subsequently, they placed an order for an additional ten aircraft. The difference with the second order was that we agreed to repurchase five of the aircraft for export. That would start earning them some hard currency. Those five aircraft, incidentally, have recently been leased by us to TWA in the US. To my knowledge they are the first Chinese-built aircraft to be operated in the US.

The aircraft are certified in China by the FAA, under our production certificate at Long Beach and are therefore able to be used anywhere in the world where that certification is recognised.

The other five aircraft were for use by Chinese carriers.

That arrangement, of course, provides you with cheap labour as well.

I wouldn't call it cheap. Labour is certainly less expensive in China and one of the attractions was to keep the unit costs down and the other was to get a foothold in the Chinese market. So it was definitely advantageous – it gives us a second production-line in Shanghai in addition to Long Beach. We saw it as a win-win situation.

Those first two contracts cover 35 aircraft. 34 of those have been built and there is one more remaining to be assembled.

The Chinese then made it known that they were interested in building aircraft in China – they called this the Trunkliner programme. The reason they called it that is because they wanted it to serve what they call their trunk routes, which are the primary domestic routes between the major cities in China as well as some significant regional routes – from China to Japan, or to Korea. They called for a bid from ourselves and Boeing. Boeing submitted the 737 and we submitted the MD-90. We won the competition.

This was done through CATIC, which controls the manufacturing of aviation products in China.

Reports have pointed out that you made contacts at CATIC when Boeing made ones at CAAC, which have subsequently proved very profitable. How important is it to strike up relationships with the right people?

Generally speaking, relationships are very important in any transaction and this is true all over Asia. Certainly our relationship has been stronger on the manufacturing side, and Boeing's has been stronger on the airlines side. We are working very hard to change that. We are focusing on marketing the product ourselves rather than leaving it up to the Chinese. We are going to concentrate on selling both the products built in China and those built outside to the carriers themselves.

Are you seeing the effects of the regional airlines gaining increasing autonomy?

Certainly, but that is not to say that CAAC has faded from the picture because it hasn't. But there is certainly a great deal more autonomy than there was earlier. It is still important if you want to sell aircraft to China to do so through the dual route of the CAAC and the individual airlines. You can't go around CAAC nor should you.

CAAC has been reining in the airline industry recently – it has put a freeze on the formation of any new airlines, and it is going to exercise more control than it has in the past year or so, primarily on the grounds of safety.

How much of a problem does the infrastructure pose for the aviation industry?

They are building airports like crazy, but the tremendous growth in China is causing everything to strain at the seams. A few years ago the population was not free to travel, and all of a sudden the most populous country in the world is enabling its citizens to travel and at very low prices. I think they are doing a pretty good job of keeping up with the demand, but no country in the world could grow at that rate and still maintain a very high level of service.

How important does this growth make China for McDonnell Douglas?

It is not only the biggest market in the world but also the fastest growing market. Plus we've invested a lot of effort and money in building our business in China. We're very enthusiastic – especially with Trunkliner. In the first contract we worked primarily with Shanghai and then later included Chengdu in the Trunkliner contract. The Chinese want to extend the package to include Xian and Shenyang as well – so there will be four factories for the programme.

A lot of reports have taken the tack that the original Trunkliner talked about 150 aircraft and it was seen as a big disappointment and a big failure when 40 aeroplanes were mentioned – this is totally wrong. The reason the figure of 40 aircraft came up is that this is the number of aircraft that they believe that they are capable of producing between now and the year 2001. In the contract, there is an agreement that we will sit down again in 1995 and discuss another 130 aircraft. The reason it wasn't included in the contract this time is that there is no way you can price an aircraft to be built that far ahead.

Are you confident that an agreement on those 130 aircraft will go ahead smoothly?

If you think about it logically, China is making a large commitment in setting up this manufacturing in the Trunkliner. Four factories are going to tool up. By the end of the 40 plane contract, it is their desire to manufacture up to 90 per cent of the aircraft in China. Now they wouldn't do that for a mere 40 aircraft. Nobody is going to make that huge investment for a relatively small number of aircraft. If you only want a few aircraft you are going to buy them off the shelf from Boeing or McDonnell Douglas. *