Plane diplomacy

As a second delegation of Chinese business leaders landed in Europe last month for a spending spree that took in Germany, Switzerland, Spain and the UK, France may be wondering why it has been left out in the cold.

The first trade delegation, which followed in the footsteps of diplomatic visits by Premier Wen Jiabao, signed deals worth more than US$12 billion across a range of industries. So when news broke that China had cancelled orders with Airbus for 150 aircraft, analysts speculated that the Toulouse-based company was paying an economic price for French President Nicholas Sarkozy’s meeting with the Dalai Lama.

Fortunately for Airbus, the report was erroneous. According to a statement given to CHINA ECONOMIC REVIEW, Airbus and China Aviation Supplies Import and Export Group Corporation (CASGC) are continuing talks based on an agreement signed in November 2007 for 160 aircraft. Airbus says 140 orders are already on the books, with negotiations for the remaining 20 planes "proceeding well." 

The French company has left no stone unturned in its battle in China with US rival Boeing. Late last year, Airbus unveiled its first assembly plant outside Europe, in the coastal city of Tianjin. The facility is slated to produce four Airbus A320 aircraft per month by 2011, with the first scheduled for delivery to Sichuan Airlines later this year. The company has a backlog of more than 400 orders in China, mostly for the A320 family.

However, the misunderstanding over the cancelled orders highlights a risk to the firm’s extensive commitment to China. Analysts have questioned the wisdom of setting up what is essentially a parallel production facility so far from home – at what is likely to be a considerable cost.

When plans for the Tianjin plant were announced, no details were given as to the amount of money involved. However, Marc Bertiaux, Airbus vice-president for cooperation and partnership with China, did admit that training Chinese workers from scratch and relocating expatriates from Europe was likely to push up initial costs. This is in contrast to Airbus’s other outsourcing ventures, which were set up primarily to save money.

A step into the unknown

In this sense, setting up a full assembly line may be something of a gamble. The recurrent irony of civil aviation joint ventures in China is that CASGC has rarely sought to compel domestic airlines to purchase domestically produced planes.

McDonnell Douglas (MD) made this painful discovery in the mid-1990s. The company’s assembly plant in Shanghai closed down – having produced only 30-odd aircraft – when the Civil Aviation Administration of China (CAAC) refused to purchase enough planes to make the program profitable. More recently, Brazilian manufacturer Embraer established a commuter jet production facility in Harbin in 2002, only to close it after producing just six aircraft.

Richard Aboulafia, vice-president of analysis at the Teal Group, is skeptical that Airbus’s gambit will yield better results.

"It’s the same delusion MD had – that you can improve your market share by building in-country," he said. "The Asian model that has worked so well for auto parts won’t work for aerospace because you can’t build in bulk that fast. The learning curve takes years. You are not going to be paid back for at least a decade."

According to Aboulafia, any market leverage Airbus hopes to gain by moving production to Tianjin should be offset by China’s WTO commitments, under which it is forbidden to give preference to goods manufactured in-country.

Point, counterpoint

Bradley Perrett, Asia-Pacific bureau chief for Aviation Week & Space Technology, however, disagrees on both points. He notes that the WTO rules regarding support for domestic aviation industries have yet to be implemented by Europe or Japan, both of which currently subsidize their domestic aviation sectors. Assuming that China will not be able to do the same is a stretch. Perrett also believes that the disproportional share of narrow-body jet orders Airbus recently won is evidence that its Tianjin ploy is working.

Aboulafia’s counterargument is that the narrow-body A320, which sells for US$40-45 million, only delivers single-digit profits margins compared to the double-digit returns on Boeing’s US$200 million wide-bodied craft. Airbus may have sold more units, but Boeing has made more money.

Regardless, Airbus shows no sign of overturning Boeing’s dominance of the Chinese market. As of the first quarter of 2008, Boeing had a 57% share to Airbus’s 33%, although the latter figure has almost certainly risen after more Airbus planes came into service later in the year.

It appears China prefers to keep its options open by sharing orders between at least two primary suppliers. Last summer, Air China approved orders for 20 wide-body Airbus A330 aircraft, but at the same time ordered 15 of Boeing’s similar 777 model and 30 Boeing 737s. As it stands, China has ordered 40 of Airbus’ wide-body A330/340 model, and 60 of its rival, Boeing’s forthcoming 787.

There may be other benefits to Airbus’s strategy, though. Yan Derocles, aerospace and airline analyst for Oddo Securities in Paris, suggests that reducing exposure to the US dollar and increasing supplier diversification offer their own advantages, as does potential future access to the Chinese defense market. He also believes Airbus has little to lose. "The risk is quite limited for Airbus, as the group is only putting in place a final assembly line. Products are still built in Europe or in the US, for the most part," Derocles said.

Bottom of the ladder

Indeed, while Chinese firms may be supplying doors and other airframe parts, the majority of the value of an aircraft lies in avionics, engines and software, all of which are still brought in from overseas. China has, for the large part, failed to become a significant competitor for sophisticated component outsourcing.

Aviation Week’s Perrett concurred that Airbus is negating the threat of domestic competition by limiting Chinese exposure to its intellectual property. "Consider the assembly line at Tianjin," he said. "Airbus is teaching the Chinese how to assemble a metal aircraft. Airbus will not build another metal aircraft. Wing fabrication is the same. Metal airframes are the past."

Furthermore, although Chinese engineers will be designing advanced composite components for Airbus, they will learn the how but not the why. "The design center is run by Airbus managers, who don’t need to explain why a part is being designed the way it is," Perrett added. "[The Chinese] are not learning as much as it seems."

Nevertheless, domestic competition is looming on the horizon in the form of Commercial Aircraft Corp of China (CACC). In March it said it would bring the delivery date for its narrow-body Comac919 airliner forward by four years to 2016. This target, if met, would put the plane in the skies before either Boeing or Airbus develops replacement models.

Whether or not Airbus regards CACC as a serious competitor, it has not excluded the possibility of cooperating with China on the development of its new aircraft. Airbus expects the total value of its industrial cooperation with China to reach US$200 million next year, rising to US$450 million by 2015. The company is also actively engaged in technology and training partnerships, having invested US$80 million in a training and support center in Beijing.