After the September 11 terrorist attacks, the aviation industry witnessed a severe decline in air travel, which translated into cancelled contracts for airplanes and sharp reductions in purchases planned for the future. Aircraft producers like Embraer had already committed significant resources to building planes – aircraft that they could no longer sell. Between August 31st and December 31st, 2001, Embraer’s inventories grew from $600 million to $1.1 billion, absorbing $500 million in cash in four months.
CEO Mauricio Botelho later remarked: “If we did not have cash at hand and weren’t flexible, we would probably be dead right now”. But by building a cash cushion during the relative lull in the airline industry in the late 1990s, Embraer was able to survive 9/11. Embraer also shifted production to military aircraft to capitalize on rising demand from the defense sector after the terrorist attacks. Embraer’s operational improvements also conferred the flexibility to respond to the September 11 slowdown. Botelho described the situation:
We were increasing our production from 14 to 20 aircraft per month from January to December 2001. On August of that year, we had delivered 18 aircraft. Then, September 11th came and we immediately, by the end of September, announced our actions to face the new scenario. We visited all our customers, studied the impact on their operations, and then studied the impact on us. And we reacted very promptly, adjusting our man power, our course and everything to a new delivery scheme of 10 aircraft per month. We adjusted from 18 to 10 aircraft per month overnight. Flexibility is mandatory, and the downturn forced us to lay off 1,800 employees (14% of total) and reschedule our production line.
One might be tempted to attribute Embraer’s resilience to luck. After all, Embraer was at the right place to capitalize on the boom in demand for regional jets. However, a comparison with competitor Fairchild Dornier suggests that the steps Embraer took while actively waiting rather than good fortune, explain Embraer’s success. While Embraer emerged as a strong competitor in the wake of the terrorist attacks, Fairchild Dornier filed for bankruptcy in April 2002.
The contrast to Embraer is striking. Both companies focused on the regional aircraft segment just as it was booming and both benefited from an experienced financial investor at the helm. In 1990, Carl Albert took over bankrupt Fairchild Aerospace. Like Embraer, Fairchild had historically relied exclusively on commuter turboprop aircraft for the bulk of its revenue, and also like Embraer (prior to privatization), Fairchild was bleeding money. After a year of severe restructuring, Fairchild was back in the black by implementing what Albert called “common sense cost-cutting.”
In 1996, Fairchild acquired Dornier, which manufactured a popular 30-passenger turboprop. With the acquisition, Fairchild obtained a first-rate plant outside Munich in which former-owner Daimler-Benz had invested over $600 million. Additionally, Daimler provided up to $230 million to cover operating losses (and restructuring costs) in the year of the sale, while the German federal and Bavarian state governments chipped in an additional $240 million in loan guarantees.
After acquiring Dornier, Albert cut 500 middle-management jobs. By 1997, in its first year in Fairchild’s hands, Dornier made money. The Dornier engineers had already developed a jet version of their 30-seat turboprop, and the merged entity sold 200 of these planes between 1997 and 1999. Fairchild Dornier also launched a new program to develop a 70-seat commuter jet. In 1999 Forbes declared Fairchild-Dornier’s transformation a success. That same year Fairchild Dornier won a $1.6 billion order from Lufthansa for 60 new jets.
In 2000, Carl Albert and his partners sold a 96% stake in Fairchild for $1.2 billion to a U.S. leveraged buyout firm and German insurance giant Allianz. The sale left the highly-leveraged company with little cash on the balance sheet. The buyers assumed they could fund development of Fairchild Dornier’s planned new passenger plane with the proceeds of an initial public offering (IPO) planned for late 2001 as well as funds from the German government.
However, the September 11th disaster ruled out an IPO, which in turn caused the German government to back away from their earlier promises. Lacking slack resources, Fairchild Dornier could not withstand the sudden-death threat. Nor were they alone. September 11th also caught Canadian competitor Bombardier completely off-guard.
I am not, of course, arguing that Embraer’s CEO Botelho (or anyone) could have predicted the terrorist attacks of September 11th or their impact on the airline industry. But that is exactly the point. In an unpredictable environment, organizational absorption–through low-fixed costs or a war chest of cash–provide a valuable cushion against unforeseen crises. Fairchild Dornier was headquartered in Western Europe and Bombardier in Canada, and neither one was exposed to Brazil’s country risk. Embraer’s experience in Brazil, however, had inured its executives to the risk of sudden-death threats.