Comac: China's Challenge to Airbus and Boeing

Countries that hope to build national aviation industries can learn from Beijing's fast-moving program to develop a made-in-China jet

China is fast learning the ABCs of aircraft manufacturing: A as in Airbus (EAD:FP), B as in Boeing (BA), and C as in the Commercial Aircraft Corp. of China, or Comac. Approved in February 2007 by the State Council—China's cabinet—Comac's mission is to produce homegrown jumbo jets and by 2020 to become the third major player in the worldwide commercial aircraft industry.

If all goes according to plan, Comac's first product, the C919 (a single-aisle plane with over 150 seats) could start competing with the A320 and B737 by the second half of the current decade. These types of planes constitute the single largest-selling category of commercial aircraft. Over the next 20 years, China is expected to buy about 100 such planes every year. Not coincidentally, Comac has indicated that after the initial ramp-up period, it expects to produce about 100 C919s annually and help China end its reliance on imported airplanes.

Comac represents the epitome of China's ambition to create national champions that will go on to become major global competitors. Large commercial planes constitute not only a sizable market (Boeing's revenues in 2009 were $69 billion) but also one with very high entry barriers. Chinese companies trying to enter other tech industries such as biotech, telecommunications equipment, supercomputers, software, and semiconductors face a highly contested terrain with multiple competitors and an ongoing stream of new entrants. In contrast, the jumbo jet industry has not seen a single new entrant other than Airbus over the last 40 years. In fact, given the exit of such players as McDonnell Douglas and Lockheed Martin, the field has gotten smaller. Large commercial aircraft are not merely technologically complex on multiple fronts, they also present extreme complexity in manufacturing and are sold to a very conservative set of customers—passenger airlines. Unlike a supercomputer or a telecom switch, the failure of a jumbo jet can literally kill hundreds of people and bring an airline to its knees.

Any success by Comac in realizing its mission would be a landmark development in China's rise as a technological superpower. Commercial aircraft constitute the single largest category of exports from the U.S. Over the next 20 years, China is destined to be the single largest market for such planes. Since Comac appears well on its way to a flying start, these principles could also serve as lessons for other countries with long-term ambitions to develop commercial aircraft industries.

Comac Stakes for key institutions

First, ensure that the new venture has adequate capital. Comac started out in 2008 with 19 billion yuan ($2.8 billion) in paid-up capital. A year later, it received a credit line of 30 billion yuan ($4.4 billion) from China's Bank of Communications. Combined, this adds up to over $7 billion in start-up funding for Comac alone, not including the capital base of subsystem suppliers such as AVIC (Aviation Industry Corp. of China), a big, state-owned enterprise involved in the production of military aircraft and smaller commercial planes. To put these numbers into perspective, Boeing spent an average of $3.9 billion annually on research and development during the last five years.

Second, co-opt key institutions by giving them a stake in the new venture. The 19 billion yuan paid-up capital in Comac included 6 billion from the central government; 5 billion from the Shanghai government; 5 billion from AVIC; and 1 billion each from Baosteel (600019:CH), China's leading steel producer; Chinalco (ACH), China's leading aluminum producer; and Sinochem (600500:CH), China's leading chemicals producer. Even though all of these entities are arms of the government, giving each a direct equity stake dramatically increases its incentives to collaborate enthusiastically and proactively, rather than reluctantly.

Third, accumulate technological capabilities through alliances with global technology leaders. Wu Guanghui, Comac's chief designer and deputy general manager, has been on record noting that, while Comac would source parts and components globally, the company would give priority to suppliers that set up joint ventures with Chinese partners. AVIC, the primary supplier of subsystems to Comac, has played a major role here. In June 2007, AVIC established a Tianjin-based joint venture with Airbus to undertake the final assembly of the European company's A320 planes. Last year, AVIC and Airbus formed a further joint venture to produce composite material parts for the A350; two with Goodrich (GR), one for landing gear and the other for nacelle (engine compartment) components; one with Nexcelle—itself a joint venture between GE (GE) and France's Safram—to manufacture engine nacelles and components; and one with GE to develop and bid on avionics for C919. Other corporations that have set up joint ventures in China to win agreements to supply Comac include Honeywell (HON), for auxiliary power units, and Parker Hannifin (PH), for fuel and hydraulic systems.

India should watch Comac develop

Fourth, if a joint venture with a key supplier appears impossible, go for direct sourcing from the world's technology leader. This has clearly been the case with C919's engines, the plane's most complex technological subsystem. Although AVIC has set up an aircraft engine subsidiary in Shanghai, it is a long way from developing the necessary technological capabilities. There also is no indication that any of the major suppliers of big aircraft engines—GE, Rolls Royce (RR/:LN), or Pratt & Whitney (UTX)—is willing to set up an engine joint venture in China. Faced with this reality, Comac has signed a direct-sourcing agreement with France's CFM International (a joint venture between GE and Safram) to provide LEAP-X turbofan engines for the C919. Comac and AVIC executives have noted, however, that they remain committed to building engine design and manufacturing capabilities in-house.

Fifth, leverage the state's control of domestic airlines to reduce market entry barriers, dramatically reducing commercial risk. Comac executives appear optimistic that by the end of 2010, they will have signed the first order to supply Chinese airlines with 100 airplanes.

It is clear that Comac represents a sophisticated and well-considered mix of state capitalism and market logic. While smaller countries would find it nearly impossible to match China's scale, financial muscle, and technological capabilities, a handful of the larger economies—such as India—may have the potential to do so. They should benefit from keeping track of how China did it.

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