As it is today, the aircraft manufacturing industry is dominated by two major players.
You got the American player Boeing, and the European player Airbus.
The two companies have been duking it out for decades while fighting off new market entrants.
One of those new entrants is Commercial Aircraft Corporation of China or COMAC. It is a Chinese
state-owned company trying to challenge Boeing and Airbus in the commercial aircraft space.
It represents China’s most concerted effort for this market yet.
In this video, I want to trace China’s recent work in breaking into the super-competitive
commercial aircraft manufacturing industry and why it has been so hard for them to make ground.
China has always been interested in developing a viable commercial aircraft industry. But early
on after the country’s founding, it focused on developing military aircraft. Their most common
technique would be to acquire a Soviet aircraft and try to backwards engineer an indigenous
version. This did not yield much success. The most prominent indigenous commercial aircraft
program before the economic reform era was the Chinese Y-10, launched by Mao Zedong in 1970.
This aircraft looks like a reverse engineered Boeing 707. That is because it was. The original
plan for the plane was to model it after the H-6 bomber, a Chinese imitation of the Soviet TU-16.
But in December 1971, a Pakistani-owned Boeing 707 crashed in Xinjiang and the Chinese called it a
"gift from God". Now they had a chance to reverse engineer what was then one of the most advanced
aircraft in the world. 500 engineers were sent to the crash site to study the wreckage for the Y-10.
This turned out to be exceptionally difficult. Just because an example plane crashed in your
backyard does not magically mean you can make a plane now. The Y-10 needed 435 parts and 305
had never been manufactured in China before. For example, the aluminum alloy. Never done before in
China and when engineers tried, the resulting alloy was too heavy and so burned excess fuel.
The resulting plane was too heavy, noisy and fuel-inefficient. It could only fly for an hour
before needing to refuel. To test the plane's structural integrity you need to put it into
a wind tunnel, but no wind tunnel existed in China that was large enough to accommodate it.
Thus it could not be certified for safety and so no Chinese Party official dared to fly in it.
The Y-10 was discontinued in 1985 as China was granted a license to manufacture the MD-80
and it shifted resources to do that. Boeing would eventually
nix that partnership after its merger with MD.
A few years later in 1993, China's aviation industry was restructured to create
Aviation Industry of China or AVIC.
AVIC is the central state-owned giant of China's aviation industry. It or its joint-venture
subsidiaries have built all the components that go into China's military planes today.
The initial goal in creating AVIC was to improve the technology and sophistication
of the planes being provided to the PLA Air Force. This goal was not achieved. The PLAAF
still declined to purchase AVIC's planes and opted to import from Russia throughout the 1990s.
In 1999, government thus tried to spur new competition in the industry by splitting AVIC
into two: AVIC I and AVIC II. The former would focus on military and medium size aircraft.
The latter, transport aircraft and helicopters.
In 2002, AVIC I launched the ARJ-21 program.
ARJ stands for "Advanced Regional Jet", and it was a key part of the government's Five-Year Plan.
Regional jets like the ARJ-21 are designed for
short flights of less than three hours and sit around 100 passengers or less.
The dominant player in this part of the market is Brazilian company Embraer.
The plane was marketed as China's most comprehensive domestic product
yet - an independent design with indigenous intellectual property.
Despite this claim, all of its main technologies came from the West.
Some 19 European and American contractors provided 70% of the ARJ-21's components.
Furthermore, more than a few observers noted the plane's close similarity to the MD-80.
Regardless, the plane was heavily delayed after its 2002 announcement.
The maiden flight was scheduled for 2005 with commercial service some time in 2007.
But the first production aircraft would not fly until 2014, nearly eight years behind schedule.
As of 2020, there are 41 ARJ-21 aircraft in service, all in China.
Regional jets are a niche market in China as they directly compete with high speed rail. And without
extensive marketing muscle, the ARJ will not sell in meaningful numbers abroad. The Chinese
probably learned a lot, but the plane itself is unlikely to ever be a commercial success.
With the AVIC split failing to achieve its goals, the government re-merged the two in 2008.
COMAC was spun off from AVIC and was given charge of the ARJ-21 program.
There are a few reasons for this spinoff. First, the government felt that foreign technology
partners would feel more comfortable dealing with an exclusively commercial aircraft manufacturer.
Of course, this fooled nobody as AVIC remained a critical Tier 1 supplier
and the single largest shareholder.
Secondly, the government had noticed that China's space program saw a lot more success
after similarly being spun off onto its own. Since AVIC was currently bogged down
in delays and little progress had been made, the government felt that a new approach was needed.
Ok I want to take a brief step aside and talk a bit about the dynamics of
the commercial aircraft industry with special focus on how it works in China.
The commercial aircraft industry is big and expensive. It requires
large upfront capital investment, as the costs of developing a new
plane are high. The Boeing 777 and Airbus A380 planes cost
around $6-12 billion to develop. Without existing revenues, government backed funding is required.
Furthermore, the two large incumbents hold advantages independent of capital and prices.
Aircraft are extremely complicated. Airbus and Boeing are where they are today
due to the experiences (and mistakes) built over the span of 50+ years.
Experience beyond just documented technical knowledge, but also unspoken know-how in how
to put these systems together and integrate them at scale. System integration at the highest level.
The intense competition between these two well funded incumbents force them to constantly
innovate on their product and processes. Suppliers are constantly pushed to do better.
Each time Airbus loses a deal to Boeing and vice versa, the loser has to reflect on how they came
short and find a way to compensate. So it can be very easy for a third wheel to get left behind.
Lastly, aircraft manufacturers need to really know the legal side of the business
as well. Each plane has to be certified by their respective governments as being fit
to fly. Adhering to local regulations in both the US and Europe is harder
than it seems and remains a significant barrier to entry for potential upstarts.
In China, airliners purchase aircraft through the government. They need government approval before
such aircraft can be purchased. Western aircraft makers, before being allowed to sell in China,
need to set up some sort of technology program in which they have to train and oversee Chinese
workers. In other words, technology transfer. This has been going on for a long time. But as I
said earlier, succeeding in commercial aircraft is more than about having designs for a technology.
China's domestic aviation market is the second largest in the world after the United States.
So the goal of developing a viable champion in the commercial aircraft market is more than just
national pride. There is also potentially a lot of money in play. So COMAC marched on.
The C919 would be COMAC's second craft,
first announced in 2008. With the ARJ program successfully showing that China
can build products in line with its aviation goals, the C919 would show that it can develop
and build a viable single-aisle 150-190 seat alternative to Boeing and Airbus.
The plane's product strategy was to reduce fuel consumption by 15% over that of existing models
in the market. That would make the plane cheaper to own and run by some 10-12%. This
would be achieved through the use of composite materials - knowledge of which China acquired
after several years working with Airbus sister company Eurocopter. Furthermore, the plane would
also offer more comfortable passenger seating, more overhead storage and spacious cabins.
COMAC did not have significant revenues at the time and needed to draw on government funding and
orders from the domestic market. When launched, COMAC drew on $3 billion of paid-in capital from
shareholders and $4 billion in loans from state banks. The Shanghai municipal government provided
guarantees for additional loans. Altogether, the planned budget started out at $10 billion.
When launched, it was announced that the plane would take its maiden flight in 2016.
To meet this ambitious date, COMAC signed deals with foreign
tier-one suppliers for many of the plane's critical components.
As with the ARJ-21, the plane will be 70% foreign-made,
but those suppliers need to establish joint ventures with a Chinese domestic player. Foreign
companies have implemented certain countermeasures against the real threat of copying. For example,
they might split up the knowledge so that no one Chinese employee knows everything or manufacture
some key component like the jet turbine blades outside of China. Nothing is foolproof of course,
but most companies balance the upside with the risk of losing their intellectual property.
As of this writing, the program is four years late on delivery to its domestic customers.
The total development budget is estimated to have ballooned from the original $10 billion
to about $33 billion. And that is an estimate I dug up from 2015 so it might be higher today.
Higher budgets raise the number of planes that COMAC has to sell in order to recoup its costs,
assuming that prices remain the same. Depending on what
you assume those prices would be, that totals out to be around 500 or so planes.
COMAC has over 300 firm orders waiting on delivery for their C-919s
as well as another 700 commitments. Almost all of these are from domestic airliners,
with the sole foreign buyer GE looking to lease these for the Chinese market.
It is not clear when the plane would be ready to challenge the duopoly internationally.
The marketing, sales and customer service departments would need to bulk up and
adjust to cultural differences. Chinese banks have offered loans to foreign governments to
encourage purchases of the C-919, but with little success. Airbus and Boeing can procure loans too.
Furthermore, the C919’s long delays have consequences in the larger product market.
When announced it had advances seen by the market as being quite competitive.
But as the delays stretched into years, the plane now faces a different competitive landscape.
It now faces the Airbus 320neo and the 737 Max. Two of the best selling planes in the
world (groundings notwithstanding) with the MAX having 3,333 orders outstanding
as of November 2020 and the 320neo already selling some 7451 as of January 2021.
Those two planes are about 10-15 years ahead of the C919, with greater range
and lower overall cost of ownership. This lead grows the longer the c919 is delayed.
Delays in airplane development aren’t uncommon. This stuff is hard. The Boeing 787 was delayed
about three years as the plane went through quality control issues. And then even after
that the plane had battery problems, which forced it to be grounded for several months.
The key challenge for COMAC has been getting the management and system integration right.
Like I mentioned before, Airbus and Boeing has moved to where their job is to
integrate different systems from different suppliers together in a harmonious way.
Project management is a real skill. One that COMAC and its subsidiaries are having trouble mastering.
Lack of communication between COMAC's network of suppliers can lead to them
working on their own and producing a part that is incompatible with the aircraft.
Previously, members of the design, research, and manufacturing teams did not work closely together.
They worked in silos, doing just their individual part and nothing else.
Hierarchal attitudes in state owned companies also discouraged any questioning
of the superiors' decision, burying issues until they became more serious.
Add to that persistent, cascading quality issues and you can start to see why delays can happen.
COMAC has hired western consultants to install best practices, but doing is way different from
learning. These are young teams, most under the age of 30, taking on this fantastically
hard thing for the first time. It is going to take some effort, money and experience.
A lot of people have pointed to China's high speed rail industry as an example for COMAC to follow.
China has more high speed rail than any other country and leads the world in rail technologies.
It very rapidly developed its own indigenous capacity
after technology transfer agreements with Western companies like Bombardier.
This is a legitimate success story that Chinese should be proud of.
But the dynamics of this market are not quite the same. They might seem to be since both markets
are highly regulated, need boatloads of capital investment and are cool technology things. But
in high speed rail, the main and sole buyer is the government. The government sets the spec,
selects the winning bidders, and is the sole user. It is able to dictate the market.
In the world of commercial aircraft,
sure, the government appoints and broadly sets the direction of airliner senior management.
But the airlines also have to run a business - a really difficult one - and get passengers.
No profit-making airliner is going to be a patriot and buy local if the product
is terrible. They will lose customers to their competitors - which is going to get them fired.
And as for passengers ... well, did you see Americans jumping into a Boeing 737-MAX because
America? Passengers have too many options today not to get on a plane they don’t believe will
be safe. But it also has to be super cheap. But it also has to have amazing legroom. And so on.
So this is the greater challenge. The product has to be good enough to compete
in a competitive market. There are no blue oceans here. Even without the delays the ARJ21
and C919 aircraft lag the rest of the market - a market that is already constantly innovating. You
need to run twice as fast as the running deer in order to catch up to it, unless the deer stumbles.
With that being said, the Chinese government seems hell-bent to get there. And I think their strategy
development is on the right track. People make too much of the fact that the C919 and ARJ21's
components come from foreign-owned companies. The Chinese clearly know that and don't care.
Their goal is to master what Boeing and Airbus are good at:
The management, coordination and system integration. That is the special sauce.
As I said before, it took those two incumbents over 55 years to get there.
COMAC and AVIC has been around for around 20. More time is needed before passing judgement.