HarvardAsia Quarterly - Andrew S. Erickson

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HarvardAsia Quarterly - Andrew S. Erickson

SPRING/SUMMER 2012, Vol. XIV, No. 1 & 2Harvard Asia QuarterlyA Publication of Current Affairs Affiliated with the Harvard University Asia CenterINSIDEInterview: EZRA VOGEL · On Deng Xiaoping and the Transformation of Chinabettina gransow · Contested Urbanization in China: Exploring InformalSpaces of Migrants-in-the-Citymikiko eto · Making a Difference in Japanese Politics: Women LegislatorsActing for Gender Equalityxiaoping wang · From Feminist to Party Intellectual? Identity Politicsand Ding Ling’s “New Woman Stories”jinghong zhang · In Between “the Raw” and “the Cooked”: The CulturalSpeculation and Debate on Puer Tea in Contemporary Chinarup narayan das · The US Factor in Sino-Indian Relations: India’s FineBalancing ActMUBASHAR HASAN · The Geopolitics of Political Islam in BangladeshGUNJAN SINGH · Post-ECFA China-Taiwan Relations: Future ScenariosRohan Gunaratna · The Current and Emerging Terrorist Threat inSoutheast AsiaJohn Hemmings · East Asian Stabilization: Japanese and South KoreanInvolvement in AfghanistanAndrew Erickson & Austin Strange · “Selfish Superpower”No Longer? China’s Anti-Piracy Activities and 21 st -Century Global MaritimeGovernanceMihoko Matsubara · A Long and Winding Road for CybersecurityCooperation between Japan and the United StatesMarc Szepan · Changing the Rules of the Game: The Commercial AircraftIndustry in China


changing the rules of the game:the commercial aircraft industry in chinaCOMAC Shanghai Facility© GE Aviation. By Kind Permission.marc szepan · saÏd business school, university of oxfordAbstractThe present article explores innovation and imitationin the context of the commercial aircraft industry in Chinaas a critical case. The rise of Chinese firms has been one ofthe most fascinating stories in global business during the pastdecades. In 2012, Chinese firms have outnumbered Japanesefirms in the Fortune Global 500 ranking for the first time.Many scholars have focused on technological innovationand upgrading, or the absence thereof, as the primaryexplanatory variables for this phenomenal development.This study complements this perspective by examining nontechnologicalforms of innovation such as a firm’s businessmodel. It argues that Chinese firms are innovators as much asimitators of business models and do not necessarily convergewith global industry standards. Such business modelinnovation can occur at the “top of the pyramid” and haspotentially disruptive implications for competition in globalmarkets.INTRODUCTIONSince the beginning of the post-Mao reforms the paceof economic change in China has been extraordinarily rapid.This phenomenal development has been one of the mostfascinating stories of the global economy during the pastdecades. At the heart of this story has been the rise of Chinesefirms that has resulted in the number of Fortune Global 500firms from China overtaking those from Japan for the firsttime in 2012. 1Whereas the magnitude of the growth of corporateChina is largely uncontested, the mechanisms driving thisshift in the global corporate landscape have given rise toconsiderable debate within the scholarly, journalistic, andbusiness communities and have resulted in a rich body of1Molly Gray, “China Overtakes Japan in Fortune 500 List forFirst Time,” CNN, July 11, 2012, accessed July 11, 2012,http://business.blogs.cnn.com/2012/07/11/china-overtakesjapan-in-fortune-500-list-for-first-time/?hpt=hp_c2.The author gratefully acknowledges helpful comments by Mari Sako and Dwight H. Perkins on earlier related and unpublishedresearch projects that have informed the present study and by Eric Thun and Felix Boecking on drafts of the present article. Theauthor would also like to thank Peter Tufano for providing inspiration for the title of the present article and GE Aviation forgranting permission to use the above picture.112 HARVARD ASIA QUARTERLY | Changing the Rules of the Game


studies covering a broad range of analytical perspectives acrossdifferent industries. In the context of these efforts to explainthe rise of Chinese private and state-owned firms, manyscholars have focused on technological innovation, or theabsence thereof, by Chinese firms with particular reference totechnological upgrading in specific product markets.As empirically rich and as analytically insightful thisbody of studies has been, these studies could be grouped intotwo schools of thought: The first school argues that the riseof Chinese firms has been a story of imitation rather thaninnovation. The second school argues that the transformationof Chinese firms has been a story of true innovation ratherthan imitation.Both of these perspectives share a technology-centricand product-focused view of innovation. Whereas the presentarticle does not seek to question the relevance of either ofthese schools of thought, it does argue that an exclusively“technology-focused” perspective is likely to overlook otherinteresting loci of innovation such as a firm’s businessmodel. Hence this article seeks to complement the extanttechnology-focused literature on innovation in the contextof Chinese firms by examining China’s emerging commercialaircraft industry via an expressly “organization-focused” lens.It explores how Chinese firms seek to change the rules of thegame on the basis of business model innovation.This article seeks to make contributions in the followingways: First, as mentioned above, it seeks to add to the“technology-focused” literature on innovation in China byexploring how Chinese firms act as organizational innovatorsrather than imitators with particular reference to businessmodels. Second, a large body of scholarship has focused onthe disruptive power of technological innovation. In contrast,this article seeks to examine the potential disruptiveness oforganizational innovation and to highlight the resultingimplications for competitors of Chinese firms.The remainder of this article is organized as follows:The second section introduces the theoretical background anddevelops propositions, the third section briefly summarizesresearch methods and data, the fourth section providesbackground on the global commercial aircraft industry,the fifth section examines the commercial aircraft industryin China, the sixth section discusses research findings, theseventh section addresses limitations, and the final sectionoffers concluding remarks.BACKGROUNDGiven the richness of the literature on the developmentof the Chinese economy and Chinese firms in general andthe role of innovation therein in particular, a detailed,comprehensive literature review would be far beyond thescope and space limitation of the present short article. Forthe purposes of this article only a few, selected studies shall behighlighted below.In the interest of clarity and as the risk of doinginjustice to analytical nuance and detail, extant scholarshipon technological innovation in the context of Chinese firmscan be grouped thematically into two different schools ofthought.The first school argues that the rise of Chinese firmshas been a story of imitation rather than innovation. In thisview, China’s economic development has been primarily afunction of labor cost advantages at the level of the firm andsignificant surplus labor in the Chinese economy as a whole.Genuine, indigenous technological innovation is viewed asbeing conspicuous by its absence and competitive strategies ofChinese firms are described as predicated on cost leadershipand technological followership at best and on informaltechnology “borrowing” and quality short-cutting at worst. 2In contrast to this view of technological imitation,the second school argues that the rise of Chinese firms hasbeen a story of innovation rather than imitation. In thisview, China’s economic development has been driven bycontinuous technological upgrading across a broad rangeof different industries. And it is human capital formationrather than utilization of surplus labor that has been thedriving force behind the rise of Chinese firms. The capacityfor genuine, indigenous technological innovation is seen as acore element of competitive strategies of many Chinese firmsand as an explanatory variable for their successful entry into,or even dominance of, global markets. 3As different as the underlying assumptions of thesetwo schools might be, both perspectives share, explicitly orimplicitly, a focus on technology and products as the primaryloci of innovation. Whereas the present article has no intentionof challenging the importance of technological innovationand upgrading, or the absence thereof, as an explanatoryvariable for the performance of Chinese firms, it argues thatan exclusively “technology-focused” perspective is likely to2For a book-length, somewhat extreme version of this view, seePaul Midler, Poorly Made in China: An Insider’s Account ofthe Tactics Behind China’s Production Game (Hoboken: JohnWiley & Sons, Inc., 2009).3For recent journalistic examples that highlight technologicalinnovation in China, see Benjamin Reuter, “Verwandlung derNachmacher,” WirtschaftsWoche, June 30, 2012, accessedJuly 10, 2012, http://www.wiwo.de/technologie/forschung/globalisierung-verwandlung-der-nachmacher-/6784692.html;and WirtschaftsWoche Global, Der Aufstieg des Drachen:Von der Imitation zur Innovation – die chinesische Herausforderung,1/2012. A recent thoughtful analysis of technologicalupgrading in China in the context of global value chains is LorenBrandt and Eric Thun, “Going Mobile in China: ShiftingValue Chains and Upgrading in the Mobile Telecom Sector,”International Journal of Technological Learning, Innovationand Development 4 (2011): 148-180.Marc Szepan is a former aviation industry executive. He is currently a doctoral student at the University of Oxford Saïd BusinessSchool and a member of Green Templeton College. The views expressed in this article solely reflect his personal opinion andnot the position of his previous employer.Changing the Rules of the Game | HARVARD ASIA QUARTERLY 113


overlook other interesting loci of organizational innovationsuch as a firm’s business model. Hence this article seeks tocomplement the extant technology-focused and productcentricliterature on Chinese innovation by examining, as acritical case study, China’s commercial aircraft industry onthe basis of an expressly “organization-focused” perspectivethat explores how Chinese firms seek to change the rules ofthe game in global markets via business model innovation. 4In the larger context of scholarship on the rise ofemerging markets in general, many studies that have takenan organization-oriented perspective and that have exploredbusiness model innovation have focused on markets atthe “bottom of the pyramid.” 5 Many of these markets atthe “bottom of the pyramid” tend to be characterized byrelatively low-tech products such as fast moving consumergoods and relatively simple value chains. In contrast to thesestudies, the present article examines a distinctly high-techindustry characterized by highly complex value chains – i.e.commercial aircraft manufacturing – and thereby expresslyfocuses on business model innovation at the “top of thepyramid.”Exploratory propositions developed on the basis of this“organization-focused” perspective on innovation at the “topof the pyramid” are listed below:• Proposition 1: In the realm of organizational innovation,Chinese firms are as much innovators as imitators and donot necessarily converge with global industry “standards.”• Proposition 2: Innovative business models pursued byChinese firms have disruptive potential for changing therules of the game in global markets.• Proposition 3: Rivalry in global markets often is notonly a story of competition between efficient Westerncorporations and inefficient Chinese state-ownedenterprises but rather a contest between fundamentallydifferent business models.4Notable examples of the relatively small number of studiesthat incorporate, at least implicitly, both technology- andorganization-focused perspectives on innovation in Chinesefirms include Loren Brandt and Eric Thun, “The Fight for theMiddle: Upgrading, Competition, and Industrial Developmentin China,” World Development 38 (2010): 1555-1574; WinterNie and William Dowell, In the Shadow of the Dragon: TheGlobal Expansion of Chinese Companies – And How It WillChange Business Forever (New York: American ManagementAssociation, 2012); Yinglan Tan, Chinnovation: How ChineseInnovators Are Changing the World (Singapore: John Wiley& Sons (Asia) Pte. Ltd., 2011); and Ming Zeng and Peter J.Williamson, Dragons at Your Door: How Chinese Cost Innovationis Disrupting Global Competition (Boston: HarvardBusiness School Press, 2007).5For a seminal article that has pioneered the “bottom of thepyramid” concept, see C.K. Prahalad and Allen Hammond,“Serving the World’s Poor, Profitably,” Harvard Business Review80 (2002): 48-57. A recent book-length study that examinesentrepreneurship and new business models in India andChina is Tarun Khanna, Billions of Entrepreneurs: How Chinaand India Are Reshaping Their Futures – and Yours (Boston:Harvard Business School Press, 2007).METHODS AND DATAThe present article examines the commercial aircraftindustry in China as a single case study. Whereas the authoris cognizant of the inherent disadvantages of such researchdesign, a single case approach can be appropriate when itrepresents a critical case for determining whether a propositionis correct or whether alternative modes of explanation needto be pursued. 6The commercial aircraft industry in China representsa suitable case study for the purposes of the present articleinasmuch as the global commercial aircraft industry can becharacterized, as shown below, by a single, strongly dominantbusiness model that is shared by all leading players. Henceany empirical finding that would suggest that forms ofindustrial organization pursued by Chinese aerospace firms,even if emergent in nature, diverge from this global industry“standard” would be of a particularly revelatory nature.Despite the large volume of scholarly and practitionerorientedliterature on business models that has emerged inthe recent past, there is surprisingly little agreement on whatbusiness models really are. 7 For the purposes of the presentarticle, the term “business model” refers to the marketsegment in which the firm chooses to compete and, mostimportantly, the structure of the firm’s vertical value chainand the firm’s horizontal product range. 8Case study research is not limited to a single sourceof data. 9 In this spirit, the present article draws on and isinformed by multiple data sources including, but notlimited to, industry- and company-level documentation. Allpublications used for the purposes of the present study are ofa non-classified, public domain nature. Such public domainindustry-level data includes industry trade publications,trade association documents, and interviews given byindustry leaders. Similarly, public domain company-leveldata includes, but is not limited to, company press releases,company brochures, company presentations, and publishedinterviews with company executives. This article is alsoinformed by the extant body of literature in the Englishlanguage covering aviation in China such as related generalbusiness books and policy-oriented analyses. 106Robert K. Yin, Case Study Research: Design and Methods(4th ed) (Los Angeles: Sage Publications, Inc., 2009).7A helpful review of this literature can be found in ChristophZott, Raphael Amit, and Lorenzo Massa, “The Business Model:Recent Developments and Future Research,” Journal ofManagement 37 (2011): 1019-1042.8This definition is consistent with, but less comprehensivethan, Henry Chesbrough and Richard S. Rosenbloom, “TheRole of the Business Model in Capturing Value from Innovation:Evidence from Xerox Corporation’s Technology SpinoffCompanies,” Industrial and Corporate Change 11 (2002):529-555.9Yin, Case Study Research: Design and Methods.10For a recent, excellent example of the former that broadly addressesthe development of civil aviation in China, see JamesFallows, China Airborne (New York: Pantheon Books, 2012);of the latter, see Roger Cliff, Chad J.R. Ohlandt, and David114 HARVARD ASIA QUARTERLY | Changing the Rules of the Game


THE GLOBAL COMMERCIAL AIRCRAFT INDUSTRYThe global commercial aircraft industry can becharacterized by prospects for long-term growth, intenseyet largely duopolistic competition, and extraordinarilyhigh barriers to entry due to high capital requirements andtechnological, value chain management, and global servicedelivery challenges. For the purposes of the present articlethe focus of analysis shall be what is often referred to as the“commercial aircraft” market (i.e. regional aircraft, singleaislejets such as the Airbus A320 and Boeing B737 families,twin-aisle jets such as the Airbus A330/A340 and BoeingB777 families, and ultra-large jets such as the Airbus A380and the Boeing B747). The markets for smaller general andcorporate aviation aircraft and helicopters are not subject ofanalysis of the present article.The Global Market for Commercial Aircraft 11Over the past three decades airline traffic has grownby a cumulative average annual rate of about 5 percent. By2011, this growth had given rise to a global jet fleet of about19,890 aircraft consisting of 2,780 regional, 12,610 singleaisle,3,710 twin-aisle, and 790 ultra-large jets. Whereas inthe recent past aircraft projects such as the ultra-large AirbusA380 and the new generation twin-aisle Boeing B787 haveattracted major news attention, it is important to note thatthe current jet population for single-aisle aircraft is almostthree times as large as the combined twin-aisle and ultra-largefleet.Historic growth patterns are estimated to continuefor the next two decades resulting in a cumulative averagegrowth rate of the global aircraft fleet of 3.5 percent. Thisgrowth is forecasted to result in a combined global fleet ofabout 34,000 aircraft (after replacements) by the year 2031.Once again, single-aisle jets are forecasted to account for themajority of all aircraft deliveries.This forecast of sustained, long-term growth in aircraftdeliveries is particularly applicable to the commercial aircraftmarket in China. Boeing forecasts China to become its secondlargest national market (only second to the United States)with a demand of 5,000 new aircraft of all types for the period2011-2030 resulting in a growth of the aircraft fleet in Chinafrom 1,750 aircraft of all types in 2010 to 5,930 in 2030. Ofthis tremendous volume of 5,000 new aircraft deliveries, 71%are expected to be in the single-aisle category.In short, both the global and the domestic Chinesemarkets for commercial aircraft are attractive inasmuch asboth are expected to maintain continuous and significantgrowth rates over the next two decades. As a sub-segmentYang, Ready for Takeoff: China’s Advancing Aerospace Industry(Santa Monica: RAND Corporation, 2011).11Market data is derived from The Boeing Company, CurrentMarket Outlook 2011-2030, 2011, and The Boeing Company,Current Market Outlook 2012-2031, 2012. This data is largelyconsistent with similar forecasts by Airbus.of this market, the market for single-aisle, short-to-mediumrange aircraft appears to be most promising due to itsdisproportionately large share in expected aircraft deliveries.Industry Structure and Dominant Business ModelUntil the late 1970s and early 1980s three Americancompanies and one European company divided the marketfor commercial jet aircraft. 12 Even then Boeing was thedominant player among the three American jet makers.Lockheed Aircraft Corporation and McDonnell Douglaswere driven out of business or forced to merge with Boeingdue to the emergence of Airbus and due to their inability todevelop competitive products. By the mid-1990s, a virtualduopoly between Boeing and Airbus had emerged in themarket of single-aisle and larger jets and by the 2000s Airbuspulled equal with Boeing in terms of new aircraft orders anddeliveries. 13Similar duopolistic structures developed in the marketsfor turboprop- and jet-powered regional aircraft. After thedemise of a number of other players the turboprop market isvirtually dominated by Bombardier, a Canadian company, andATR, a joint venture between EADS and Alenia Aermacchiof Italy. Currently, the market for jet-powered regional jets isa virtual duopoly shared between Bombardier and Embraerof Brazil after other aircraft manufacturers exited or failed toenter the regional jet market. 14In addition to this duopolistic industry structure, theglobal commercial aircraft industry can probably be bestcharacterized by a single, dominant business model that hasemerged over the past decades and that is shared by the tworemaining major commercial aircraft manufacturers. Thisdominant business model is comprised of two key structuralfeatures:First, historically – especially since the rise of jet-poweredaircraft in the 1960s – the business model of major aircraftmakers has been characterized by horizontal separation ofproduct ranges between the makers of aircraft such as Airbusor Boeing on the one hand and makers of major aircraftcomponents on the other. Traditionally, aircraft makers haveneither designed nor manufactured major components inhousebut have sourced those from independent, third-partyfirms. These major component makers tend to supply differentaircraft makers on a non-exclusive basis and have becomemajor drivers of technological innovation and efficiency gainsin aviation in their own right. Such third party-sourced major12Earlier competitors such as de Havilland had already fallenby the wayside with the coming of the jet age. See Sam HoweVerhovek, Jet Age: The Comet, the 707, and the Race toShrink the World (New York: Avery, 2010).13For a good account of the rivalry between Airbus and Boeing,see John Newhouse, Boeing versus Airbus: The Inside Storyof the Greatest International Competition in Business (NewYork: Vintage Books, 2007).14Current non-Chinese regional aircraft that are in process ofdevelopment for this market include the Mitsubishi RegionalJet and the Sukhoi Superjet 100.Changing the Rules of the Game | HARVARD ASIA QUARTERLY 115


Aviation Industry Administration Commission and hasundergone multiple rounds of comprehensive organizationalrestructurings since its founding. In 1999, the China AviationIndustry Corporation, which had combined all Chinese civiland military aviation activities, was split into two entities,AVIC I and AVIC II. AVIC I was focused on militaryaircraft and larger civil aircraft whereas AVIC II was focusedon smaller civil aircraft and helicopters. In 2008, however,AVIC I and AVIC II were formally recombined due to theorganizational inefficiencies and resource redundancies ofthe previously split organization, and the merged entity wasdesignated Aviation Industry Corporation of China. 20In 2010, AVIC had over 400,000 employees andestimated total group revenues of approximately US$ 31billion. In the same year, Boeing had a workforce of just over160,000 and revenues of over US$ 64 billion and EADS,including Airbus, about 121,000 employees and revenues ofwell over EUR 45 billion. 21 AVIC ranked 311 th amongst theFortune Global 500 corporations in 2011. 22 It is headquarteredin Beijing and has major R&D and manufacturing facilitiesin Chengdu, Harbin, Nanchang, Shanghai, Shenyang,Tianjin, and Xian.A Short History of Civil Aircraft Making in China 23China’s current commercial aircraft programs can bebest understood in their historical context. China has tried tobuild up civil aircraft design and manufacturing capabilitiessince the 1950s. The history of civil aircraft manufacturing inChina is shown in stylized form in Figure 2 below:Figure 2: History of Civil Aircraft Manufacturing in ChinaPhase 1: From the 1950s until the middle of the1970s almost all aircraft produced in China were copies20For a good account of the historical background of AVIC, seeMark Dougan, A Political Economy Analysis of China’s CivilAviation Industry (New York: Routledge, 2002).21The Boeing Company, Annual Report 2011, 2011; EADS, AnnualReport 2011 – At a Glance, 2011.22http://money.cnn.com/magazines/fortune/global500/2011/snapshots/11566.html, accessed June 1, 2012.23Data is primarily derived from http://www.avic.com.cn/cn/wzsy/index.shtml, accessed June 1, 2012, and Dougan, A PoliticalEconomy Analysis of China’s Civil Aviation Industry.or technological derivations of Russian designs. The mostcommonly produced of these airplanes was the Yun-5, a copyof the Antonov An-2 propeller-powered biplane.Phase 2: The most ambitious aircraft developmentproject launched prior to the post-Mao reforms was theY-10, a passenger aircraft powered by jet engines. AfterPresident Nixon’s historic visit to China in 1972, China hadagreed to purchase Boeing B707 aircraft and the ShanghaiAircraft Research Institute was tasked to develop the first“indigenous” Chinese four-engine long-range commercialaircraft. 24 The Y-10 saw its maiden flight in 1980 but did notenter commercial operation due to insufficient performance.Phase 3: China adopted a revised Three-Step Plan in themid-1980s that was intended to de-risk China’s acquisitionof commercial aircraft design and manufacturing capabilities.After a drawn out contest between Boeing and McDonnellDouglas, the latter won a joint venture agreement in 1984 toassemble its MD-80, a DC-9 derivative, in Shanghai on thebasis of complete knock-down kits. In 1992 the cooperationbetween McDonnell Douglas and Shanghai Aviation IndustryCorporation was extended to include production of the MD-90 as well.In addition, China was able to acquire significant finalassembly best practices know-how by virtue of partnershipswith other aircraft makers throughout the 2000s: Forexample, in 2003, Embraer, one of the two dominantregional jet manufacturers, launched a joint venture withan AVIC subsidiary to assemble its ERJ-145 regional jet.Most importantly, the first Airbus final assembly line outsideEurope opened formally in Tianjin in September 2008 as ajoint venture between Airbus, AVIC, and the Tianjin FreeTrade Zone. This facility is dedicated to assembly of theAirbus A320 single-aisle family and, as it General Managerstates, “is not only as good as Airbus’ plants in Toulouse andHamburg – it is an improvement. ‘It is better … we had achance to start from a green field, the production flow isperfect.’” 25 All Airbus aircraft assembled in Tianjin are ofcomparable quality to those assembled at Airbus home basefacilities in Hamburg and in Toulouse. 26In short, AVIC has been able to acquire significantexperience running final assembly lines for modernaircraft. AVIC has also accumulated extensive experiencemanufacturing a broad range of aircraft parts, includingstructural sub-assemblies and other key components, formost of the currently active commercial aircraft programs at24There still is popular debate in the aviation community onwhether the Y-10 project was a reverse-engineering exerciseor whether this constitutes a genuine Chinese indigenous effort;see, for example, http://www.airliners.net/aviation-forums/general_aviation/read.main/3745561/,accessed July 17,2012.25Francis Leithen, “Improving the Best,” Flight International,September 1-7, 2009, 43.26Ghim-Lay Yeo, “China Special: Airbus Builds Bridges,”Flight International, November 5, 2010, accessed July 10,2012, http://www.flightglobal.com/news/articles/china-special-airbus-builds-bridges-349324/.Changing the Rules of the Game | HARVARD ASIA QUARTERLY 117


Airbus, Boeing, Bombardier, and Embraer. 27Phase 4: Aerospace has been defined as a priorityindustry in China’s current Twelfth Five-Year Plan. This pushto develop a truly indigenously designed commercial aircraftdates back to the Tenth Five-Year Plan and has resulted in thecurrent ARJ21 and C919 programs.The ARJ21 Program 28The ARJ21 is a twin-engine regional aircraft with tailmountedengines. Its baseline version, the ARJ21-700, isdesigned to have a capacity of 78 to 90 passengers, a standardrange of 2,225 kilometers and a maximum take-off weight ofjust over forty metric tons.The ARJ21 program was originally launched in 2002by the formation of a consortium comprised of several ofAVIC’s aircraft design institutes and aircraft manufacturingsubsidiaries. For example, Chengdu Aircraft Industry Groupis responsible for manufacturing of the nose, Xian AircraftCorporation for production of the wings and fuselage, andShenyang Aircraft Corporation for construction of thetail section. Although the ARJ21 is reportedly designedby use of Chinese indigenous technical know-how, itsbasic configuration – tail-mounted engines, T-tail – bearsresemblance to the MD-80 and MD-90 that, as mentionedabove, were previously assembled in Shanghai.In other ways, however, the ARJ21 is a technologicallynew aircraft. First, aerodynamic performance is likely to havebeen improved significantly by means of a new supercriticalwing with winglets. Second, the ARJ21 is powered by modernGeneral Electric CF34 engines. Other variants of this engineare used for competing regional jets such as Bombardier’sCRJ family and Embraer’s E-Jet family. Third, the flightdeck features a modern glass cockpit primarily consistingof avionics systems provided by Rockwell Collins. Also, keycomponents and systems are state-of-the-art and are sourcedfrom international component suppliers. For example,Hamilton Sundstrand supplies the auxiliary power unit,Liebherr the landing gears, and Parker the hydraulic system.AVIC has announced that it has secured more than300 orders for the ARJ21, including orders from GECAS,a General Electric subsidiary and one of the world’s largestaircraft leasing companies, and from Lao Airlines, theARJ21’s export launch customer. 29 A relatively large shareof orders seems to have been placed by smaller Chineseoperators, including Chengdu Airlines in which AVIC is a27Francis Leithen, “Modern and Ancient,” Flight International,September 1-7, 2009, 40-41.28Data for the ARJ21 program is primarily derived from http://www.comac.cc/, accessed June 1, 2012, and from http://www.airframer.com/aircraft_detail.html?model=ARJ21, accessedJuly 10, 2012.29Kate Cantle, “ARJ21 Wins 100 Orders from AVIC International,”Air Transport World Online, November 19, 2010, accessedJuly 10, 2012, http://atwonline.com/aircraft-enginescomponents/news/arj21-wins-100-orders-avic-international-1118.major indirect shareholder. 30Although the ARJ21 maiden flight was plannedoriginally for 2005, first flight only took place in November2008 due to delays caused by significant technical challenges.Regulatory certification and first delivery are unlikely tooccur prior to 2013. 31In sum, the ARJ21 program appears to be characterizedby a very steep learning curve. In effect, the ARJ21 is as mucha learning and technical and procedural proof-of-conceptopportunity as it is a commercial endeavor in its own right,and it serves as an, albeit somewhat unintended and costly,preparatory exercise for the more important C919 program.The C919 Program 32The C919 is a twin-engine, single-aisle, medium rangeaircraft. Its baseline version is designed for a capacity of 168passengers in an all-economy configuration or 156 passengersin a standard mixed configuration and a standard range of4,075 kilometers with a cruise speed around Mach 0.785.Additional variants, including stretched and shrunk passengerversions, a freighter, and a business or VIP jet version, areplanned as well.The C919 is the first clean-sheet, indigenouscommercial aircraft design in China since the aforementionedY-10 program. In contrast to the ARJ21 that is a nominalcompetitor to Bombardier and Embraer regional jets, theC919 is expressly designed to challenge the Airbus A320family and Boeing B737 family duopoly for single-aisle,medium range commercial aircraft, the largest global marketsegment by number of aircraft deliveries.Commercial Aircraft Corporation of China (henceforth“COMAC”), the Shanghai-headquartered AVIC subsidiarycharged with lead responsibility for the C919 program,was positioned from its start to achieve competitiveness ininternational markets, and the C919 has the potential tobecome a game changer not only for the Chinese market butalso for the global commercial aircraft industry.The C919 program was launched in 2007 whenChina’s State Council approved the foundation of COMACas a joint subsidiary of AVIC, a number of China’s largeststate-owned enterprises such as Baosteel, Chinalco, andSinochem, the municipal government of Shanghai, andChina’s central government. In 2008 COMAC received aninitial paid-in capital of RMB 19 billion including RMB5 billion from AVIC, RMB 1 billion from each of theaforementioned state-owned enterprises, RMB 5 billion from30Francis Leithen, “Taking on the Giants,” Flight International,September 1-7, 2009, 37-38.31“Wing Cracks, Other Flaws Delay China Jet Manufacture,”Reuters, June 8, 2012, accessed June 8, 2012, http://in.reuters.com/article/2012/06/08/uk-airlines-china-comac-idINL-NE85700Z20120608.32Data for the C919 program is primarily derived from http://www.comac.cc/, accessed June 1, 2012, and from http://www.airframer.com/aircraft_detail.html?model=C919, accessedJuly 10, 2012.118 HARVARD ASIA QUARTERLY | Changing the Rules of the Game


the Shanghai municipal government, and RMB 6 billionfrom China’s central government. In addition, China’s Bankof Communications made available a credit line of RMB 30billion. 33As mentioned above, in effect, the ARJ21 program canbe viewed as a technical and procedural proof-of-conceptfor the C919 program. Technological choices for the C919program appear to be characterized by continuity with theARJ21 program.First, experience gained from structural work onthe ARJ21 seems to feed into the C919 program: AVICsubsidiary Chengdu Aircraft Industry Corporation isresponsible for production of the C919 nose section as well,Xian Aircraft Corporation for production of the wings andthe fuselage mid-section, and Shenyang Aircraft Corporationfor production of the tail section. A new supplier of majorstructural elements appears to be AVIC subsidiary HongduAviation Industry Corporation for the production of forwardand aft sections of the main fuselage. The C919 is to beassembled at COMAC’s facility in Shanghai.Second, similar to the ARJ21, the C919 incorporatesengines and key state-of-the-art components originallydeveloped by leading international suppliers: The C919will be powered by the new generation LEAP-1C enginesupplied by CFM, the largest supplier of engines for theBoeing B737 family and Airbus A320 family. The line-up ofcomponent suppliers reads like a who-is-who of the globalaerospace industry; for example, the auxiliary power unit issourced from Honeywell, the landing gears from Liebherr,the hydraulic system from Parker, the electrical system fromHamilton Sundstrand, and key avionics components fromGeneral Electric.Recently, AVIC announced that it had reached 280orders for the C919 from twelve different customers. 34 Thesecustomers include the three major Chinese state-ownedcarriers and GECAS. And although the C919 has apparentlynot been sold to a major international airline so far, a numberof high profile carriers have expressed interest in the C919. 35Most recently, IAG, the parent company of British Airwaysand Iberia, announced that it is planning to cooperate withCOMAC on development of the C919 and that it would33Anil Gupta and Haiyan Wang, “Comac: China’s Challengeto Airbus and Boeing,” Bloomberg Businessweek, June 30,2010, accessed June 10, 2012, http://www.businessweek.com/stories/2010-06-30/comac-chinas-challenge-to-airbus-andboeingbusinessweek-business-news-stock-market-and-financial-advice.34“ABC Leasing Signs Agreement of 45 C919 Orders withCOMAC – COMAC secured a total of 280 C919 orders,”Commercial Aircraft Corporation of China, accessed July10, 2012, http://english.comac.cc/home/photo/201207/09/t20120709_564466.shtml.35See, for example, Ryanair, one of the most high-profile lowcost carriers globally, and its interest in the C919 as reportedin James T. Areddy and Andrew Galbraith, “Ryanair TrumpetsPlanes from China,” Wall Street Journal, November 30, 2011,accessed July 17, 2012, http://online.wsj.com/article/SB10001424052970204262304577067951924584354.html.carefully examine the C919. 36 Whether such support willresult in firm orders remains to be seen.Given that first flight of the C919 is expected tooccur in 2014 and entry-into-service in 2016, it is far tooearly to arrive at definitive judgments regarding the eventualoperational performance of the C919. 37 Significant technicaland non-technical challenges remain to be resolved in orderto deliver the first C919 on time and to make the C919into the game changer that it could well become. 38 In springof 2012, COMAC and Bombardier signed an agreementcovering collaboration in the areas of cockpit design,electrical systems, advanced materials, and customer service.The extension of this collaboration to encompass supportfor winning international regulatory approvals for the C919seems to be indicative of the range and magnitude of theseremaining challenges. 39AVIC Business ModelGiven the dominance of a single type of businessmodel in the global commercial aircraft industry, one mightexpect that AVIC’s effort at entering the world market forcommercial aircraft would be predicated upon imitatingthis organizational industry standard. In contrast to thisexpectation, however, the AVIC business model that hasemerged – in some ways by design and in others inadvertently– in process of executing the ARJ21 and C919 programsdiverges significantly from the aforementioned globalindustry “standard.”First, Airbus’ and Boeing’s vertically stronglydisaggregated value chain model relies heavily on sourcingengineering and manufacturing of aircraft structural partsand sub-assemblies from independent, third party suppliers.In contrast, as suggested above, the majority of structuralengineering and manufacturing work for the ARJ21 andthe C919 is performed within the boundaries of AVIC bya number of different AVIC subsidiaries. In other words,36David Kaminski-Morrow, “Farnborough: IAG to Co-operatewith Comac on C919,” Flight International, July 9, 2012,accessed July 10, 2012, http://www.flightglobal.com/news/articles/farnborough-iag-to-co-operate-with-comac-onc919-374014/.37“Comac C919 Plane Program On Schedule, Engine SupplierCfm Says,” Bloomberg News, June 13, 2012, accessed June14, 2012, http://www.bloomberg.com/news/2012-06-13/comac-c919-plane-program-on-schedule-engine-suppliercfm-says.html.38Some analysts have also pointed out the high probability ofC919 program delays analogous to or caused by the ARJ21program. See, for example, Leithen Francis and BradleyPerrett, “ARJ21 Delays Threaten C919 Schedule,” AviationWeek, September 12, 2011, accessed July 10, 2012,http://www.aviationweek.com/Article.aspx?id=/article-xml/AW_09_12_2011_p24-366882.xml.39“Bombardier to Help China’s First Jetliner Win OverseasApprovals,” Bloomberg News, June 11, 2012, accessed July17, 2012, http://www.bloomberg.com/news/2012-06-11/bombardier-to-help-china-s-first-jetliner-win-overseas-approvals.html.Changing the Rules of the Game | HARVARD ASIA QUARTERLY 119


AVIC’s value chain is vertically deeply integrated.Second, in contrast to Airbus and Boeing that purchaseaircraft components from external component makers,AVIC is leveraging its current aircraft programs to enterthe aircraft component market in its own right as well. 40Whereas both programs source state-of-the-art technologyoriginally developed by international component makers,selection as supplier for the aforementioned AVIC aircraftprograms tends to be contingent upon setting up jointventures with appropriate AVIC subsidiaries. 41 For example,the electrical system for the C919 will be developed andmanufactured by a Hamilton Sundstrand joint venture withAVIC Electromechanical Systems Company in Xian and thelanding gears for the C919 by a Liebherr joint venture withAVIC Landing Gear Advanced Manufacturing Company inChangsha. 42 While these joint ventures are initially intendedto be dedicated to the ARJ21 and the C919 programs, inthe medium- to long-run AVIC aims to become a majorcomponent supplier in its own right. This strategic intentto become a tier-one component supplier is reflected in thepotentially transformational 50/50 partnership in whichAVIC has entered with General Electric to create a newbusiness that will design and market integrated avionicssystems to other aircraft makers such as Airbus, Boeing,Bombardier, and Embraer in addition to its launch customerCOMAC. 43Among all major components, the development ofaircraft engines is often considered the most technologicallyand commercially challenging endeavor. 44 AVIC has entered40AVIC has also acquired foreign aircraft component makerssuch as FACC, an Austrian composite technology and cabinparts specialist firm.41Linday Blachly, “COMAC Says JVs will Develop, ProduceC919 Systems,” Air Transport World Online, July 13,2010, accessed June 1, 2012, http://atwonline.com/aircraftengines-components/news/comac-says-jvs-will-develop-produce-c919-systems-0712.42“Hamilton Sundstrand, AVIC EM lay cornerstone to markstart of production for C919 electric system,” Hamilton Sundstrand,July 31, 2011, accessed July 10, 2012, http://www.hamiltonsundstrand.com/vgn-ext-templating/v/index.jsp?vgnextoid=16eaaec96b991110VgnVCM1000007301000aRCRD&hsct=hs_news&ciid=43ddcc4247771310VgnVCM1000004f62529fRCRD; “Liebherr-Aerospace and COMAC SignMaster Contract for Chinese Aircraft C919,” Liebherr, March2, 2012, accessed July 10, 2012, http://www.liebherr.com/en-GB/134629.wfw/print-True.43“GE’s China Avionics Deal: A Q&A with Lorraine Bolsinger,”GE, January 19, 2011, accessed July 10, 2012, http://www.gereports.com/ges-china-avionics-deal-a-qa-with-lorrainebolsinger/.44For an interesting analysis of some of the related technologicaland commercial challenges, see Gabe Collins and AndrewErickson, “A Chinese “Heart” for Large Civilian andMilitary Aircraft: Strategic and commercial implications ofChina’s campaign to develop high-bypass turbofan jet engines,”China SignPost, September 19, 2011, accessed July8, 2012, http://www.chinasignpost.com/2011/09/a-chinese-“heart”-for-large-civilian-and-military-aircraft-strategic-andcommercial-implications-of-china’s-campaign-to-develophigh-bypass-turbofan-jet-engines/.into partnerships to develop indigenous engine technologyfor future replacement of the LEAP-1C engine that willinitially power the C919 and for potential future marketingof such engines to other aircraft manufacturers. 45In sum, AVIC is in the process of creating a businessmodel that is predicated upon a vertical value chainthat is deeply integrated and a horizontal product rangethat combines both aircraft and stand-alone componentbusinesses within the boundaries of AVIC. The resulting,emergent AVIC business model that differs significantly fromthe global industry “standard” is shown in Figure 3 below:Figure 3: AVIC versus Global Commercial Aircraft Industry “Standard”Business ModelDISCUSSIONA significant part of the literature on the developmentof the Chinese economy in general and the transformationof Chinese firms in particular has taken a technologyfocusedperspective and has tried to assess whether Chinesefirms are technological innovators or imitators. The presentarticle suggests that this predominantly technology-focusedperspective might fail to adequately capture other loci ofinnovation and thereby tend to underestimate the innovativecapacity of Chinese firms.In this context of pursuing an “organization-focused”perspective it might be worthwhile to revisit the propositionsstated at the outset of the present article.• Proposition 1: In the realm of organizational innovation,Chinese firms are as much innovators as imitators and donot necessarily converge with global industry “standards.”In the case of AVIC and commercial aircraft makingin China, long-term market success will clearly be contingentupon AVIC’s ability to design, manufacture, and support onglobal basis aircraft that are technologically and operationallyon par with Airbus and Boeing products. This will entaila significant technological step-up to achieve and then45See, for example, Michael Gubisch, “MTU to Work withAVIC on Possible Alternative Engine for C919,” Flight International,September 21, 2011, accessed July 10, 2012, http://www.flightglobal.com/news/articles/mtu-to-work-with-avicon-possible-alternative-engine-for-c919-362359/.120 HARVARD ASIA QUARTERLY | Changing the Rules of the Game


maintain technological parity with Airbus and Boeing.Successful execution of this game plan will be an impressiveachievement for AVIC in its own right. However, it is inthe realm of organizational innovation that AVIC is clearlyan innovator rather than imitator. The vertically deeplyintegrated and horizontally broadly diversified nature of itsemergent business model sets AVIC apart from incumbentplayers in the world of commercial aircraft making. Thisclearly is not a story of convergence to a global organizationalindustry “standard.” 46• Proposition 2: Innovative business models pursued byChinese firms have disruptive potential for changing therules of the game in global markets.Whether AVIC will be able to bring to market aircraftthat will be truly competitive with Airbus and Boeing productsremains to be seen. Interestingly, Boeing seems to consider theC919 program the biggest threat to the established Airbus-Boeing duopoly in the global commercial aircraft industryand believes that AVIC will most likely succeed in developingan aircraft comparable to Airbus and Boeing models. 47 Hence,AVIC’s entry into the global market for single-aisle aircrafthas potentially game-changing implications on the accountof endangering a long-standing duopoly alone. Moreover,its business model perhaps offers an alternative trajectory forchange at the industry level that, during the past decades, hasbeen characterized by consolidation among aircraft makersand within the group of component makers, but not acrossthe traditional boundaries of these two types of firms. It isin this context that AVIC’s business model innovation hasfurther potential for changing the rules of the game in theglobal commercial aircraft industry. It will be interesting totrack whether the aforementioned alliance between AVICand General Electric in the area of avionics components willremain an exceptional case or whether it will be emulated byother industry actors.• Proposition 3: Rivalry in global markets often is notonly a story of competition between efficient Westerncorporations and inefficient Chinese state-ownedenterprises but rather a contest between fundamentallydifferent business models.In the case of Chinese state-owned enterprises, manyanalysts have highlighted the fundamental lack of efficiencydue to their ownership status, governance systems, andthe protracted nature of their transformation to marketcompetitiveness. 48 Hence entry into global markets on the part46Interestingly, as part of its recent efforts to mitigate B787program delays, Boeing has brought in-house some work thatit had previously sourced externally. See, for example, StephenTrimble, “Boeing confirms deal for Vought’s 787 role,”Flightglobal, July 7, 2009, accessed July 10, 2012, http://www.flightglobal.com/news/articles/boieng-confirms-dealfor-voughts-787-role-329339/.47See Rupa Haria, “China is Biggest Emerging Threat to BoeingAnd Airbus, Says Albaugh,” Aviation Week, June 1, 2012, accessedJune 10, 2012, http://www.aviationweek.com/Article.aspx?id=/article-xml/avd_ 06_01_2012_ p01-01-463868.xml.48See, for example, Edward Steinfeld, Forging Reform inChina: The Fate of State-Owned Industry (Cambridge: Camofthese Chinese firms is often viewed as a single-dimensionalfight between efficient Western corporations and inefficientChinese state-owned enterprises that owe their ability toenter these very global markets solely to state support. Butin light of the above discussion of the case of AVIC, such apicture appears to be somewhat simplistic. At least in the caseof AVIC, any future battle between AVIC and incumbentcommercial aircraft makers for global market share is likelyto be a contest between different business models as much asa competitive rivalry between private and state-owned firms.LIMITATIONSThe Chinese commercial aircraft industry as a criticalcase has been selected deliberately for the purposes of thepresent article. After all, the global commercial aircraftindustry can be characterized by one strongly dominantbusiness model shared by all major incumbents. In thecontext of such homogeneity in terms of industry bestpractices, one might expect a newcomer such as AVICto imitate this dominant business model. Should suchdominance not result in imitation and followership, itappears likely that – in the case of other industries that arenot as strongly dominated by a common business modelas the global commercial aircraft and components industry– organizational innovation, rather than imitation, mightbe even more prevalent. Notwithstanding the merit of thisdeliberate industry selection for the purpose of the presentcritical case study, unconditional generalizability of the abovefindings would be contingent upon in-depth exploration ofbusiness model innovation, or the absence thereof, in otherindustries in China.Given that the C919 is scheduled to have its maidenflight in 2014 and given that there is a non-zero probabilityof program slippage, it is important to point out that AVICand its emergent business model for making commercialaircraft remain an aspirational case strongly driven by strategicintent rather than by proven technological and commercialsuccess and on-time delivery. However, when assessing theperformance of AVIC, one might be well advised to remaincognizant of significant program delays and technicalchallenges that have haunted the most recent major aircraftprograms of Airbus and Boeing.It is important to emphasize the emergent nature ofAVIC’s business model. As suggested above, for many decadesit has been the Chinese state’s objective to create a domesticcommercial aircraft industry. Clearly, industry entry can onlybe explained by reference to the Chinese (developmental)state. Also, the state remains highly relevant with regards tothe structure of the political economy and to many aspects ofindustrial organization in China. 49 At the same time, AVIC’sbridge University Press, 1998), and Shahid Yusuf, DwightH. Perkins, and Kaoru Nabeshima, Under New Ownership:Privatizing China’s State-Owned Enterprises (Stanford: StanfordUniversity Press, 2005).49See, for example, Huang Yasheng, Capitalism with ChineseChanging the Rules of the Game | HARVARD ASIA QUARTERLY 121


usiness model is also the outcome of managerial choicesand learning. A detailed discussion of these firm-internaldynamics is far beyond the scope of the present article. AVIC’sbusiness model is emergent to the extent that it has not beenthe result of execution of a detailed, ex ante master plan butan iterative process shaped by multiple factors external andinternal to AVIC.Also, the growth of Japanese firms has given rise to avoluminous literature on Japanese management principles,styles, and practices. 50 The above discussion of business modelinnovation in the context of the Chinese commercial aircraftindustry, however, is meant to suggest neither a generic“Chinese way of business” nor an aerospace variant of the“shanzhai phenomenon.” 51Lastly, the present article is intended to be an analyticalstudy. It is neither a normative endorsement of a particulardevelopment model nor a prediction of success or failure withregards to the ultimate performance of the ARJ21 and C919in global markets.suggests that Chinese firms can be innovators, rather thanimitators, on the basis of business model innovation, thatsuch business model innovation can occur not only at the“bottom of the pyramid” but also at the very “top of thepyramid,” and that organizational innovation on the part ofChinese firms has disruptive potential to change the rules ofthe game in global markets.CONCLUDING REMARKSThe rise of China’s economy and of Chinese firms hasbeen one of the most fascinating stories of the world economyduring the past decades. This phenomenal transformation hasresulted in an empirically rich and analytically insightful bodyof studies that has shed much light on the inner dynamics ofthe Chinese political economy at large and of Chinese firmsindividually.At the level of the firm, the presence or absence oftechnological innovation and technological upgradinghas often been a key explanatory variable for success.However, many of these studies appear to be somewhatsingle-dimensional. The present article has argued that thispredominantly technology-focused perspective on innovationis likely to overlook other interesting loci of innovation suchas a firm’s business model. Hence this article has intendedto complement the extant technology-focused literature bypursuing an expressly organization-focused perspective. Thepresent article has also proposed that a single-dimensional andoversimplified categorization of Chinese firms as “innovators”or “imitators” with reference to their technological innovativecapacity alone runs the risk of failing to capture the potentiallygame-changing impact of the entry of Chinese firms intoglobal markets.The case of the commercial aircraft industry in ChinaCharacteristics: Entrepreneurship and the State (Cambridge:Cambridge University Press, 2008).50For example, Jeffrey Liker, The Toyota Way: 14 ManagementPrinciples from the World’s Greatest Manufacturer (NewYork: McGraw-Hill, 2004).51For a recent exploration of the Shanzhai phenomenon, seeSheng Zhu and Yongjiang Shi, “Shanzhai ( 山 寨 ) Manufacturing– an Alternative Innovation Phenomenon in China – ItsValue Chain and Implications for Chinese Science and TechnologyPolicies,” Journal of Science and Technology Policy inChina 1 (2010): 29-49.122 HARVARD ASIA QUARTERLY | Changing the Rules of the Game

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