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Imagine aircraft parts manufactured in China... considering you can't buy a safe Chinese manufactured toy
10/23/2007 7:39:22 PM

Despite the growing production of regional airliners, with China as a favored site, skeptics remain doubtful about long-term prospects for manufacturing in China, citing past experiences. Airlines worldwide, surviving on slim margins, will find cheaper prices of quality regional aircraft hard to resist. Consequently more and more aircraft parts and even larger aircraft will be built in China over the coming decade, dramatically reshaping aerospace. Still, doubters cite the need for improved quality control and say that the manufacture of entire aircraft and sophisticated assemblies for foreign companies, especially if they seek US and international certification, is still in the future. McDonnell Douglas's troubled assembly programs in the 1980s and 1990s left a lingering, bitter taste.For many it remains proof that anything beyond making small parts in China will deliver losses. Yet McDonnell, seduced by the China dream like many in the past and many to come, was probably pushing China to run before it could walk. Nevertheless, foreign manufacturers have continually expanded, quietly, building a wider range of more complex parts in China. Boeing has sourced parts worth US$500 million from China between 1980 and 2004, forecast to hit $1.3 billion by 2010.

Cheap labor and big sales prospects - the China dream - outweigh the troubles. In late 2002, two decades after McDonnell's program started, arch rivals Canada's and Brazil's Bombardier and Embraer announced they would begin manufacturing their small regional jets in China. Meanwhile, with 41 orders in hand, China is forging ahead with its 75-to-105-seater ARJ21. Embraer seeks to send more work China's way. "The company is currently evaluating possibilities for sourcing certain parts from its Chinese partner Hafei Aviation Industry Co Ltd [HAFEI], in substitution of some imports," says Guan Dongyuan, Embraer China's managing director. "At this moment we strongly believe that our focus should be to consolidate the industrial operations of Harbin Embraer and to satisfy the Chinese domestic market. Nevertheless, future exports are a possibility." Exports of Chinese-made ARJ21s, Bombardiers and Embraers will surely come as China's cheaper labor eventually delivers lower prices, turning heads at airlines overseas. "The first batch will likely be used in China. But it will probably be another two or three years before the quality stamp is up to international export standards," says Ravindran Devagunam, leader of the consultancy Deloitte Deloitte & Touche LLP's aviation and transport practice in Singapore. "I think price will definitely win out. I don't think airlines can afford not to" [pay attention to China's lower production prices]. China sees aerospace as strategic industry Access is one aspect of the complex China equation.

Building in China creates jobs and upgrades skills. That goes down well in Beijing, which sees aerospace - the business of designing and manufacturing aircraft - as a strategic industry, with China's air transport market second only to the US market by 2020. "We believe that the local manufacture of the ERJ145 family aircraft provides Embraer with a competitive edge by providing a well-proven product and by being closer to the customers. According to Embraer's forecast, there will be some 200 aircraft within the 30-to-60 seat category delivered to Chinese airlines in the next 20 years," says Guan.

Orders, sluggish so far, in part due to aviation reform pausing this year, will surely come though, for were these ventures to fail some investors in aerospace and other industries might lose heart, causing headaches for the government, which needs foreign investment to create sorely needed jobs and introduce new technology. Short-term, local production avoids import duties of 24% on small regional jets. However, these are being cut by World Trade Organization (WTO) agreements come 2006. "These taxes are being reduced, and WTO promises to reduce them further still. Unlike Russia, for example, China is an export-driven economy and must carefully adhere to its WTO promises," says Richard Aboulafia, Teal Group's senior airlines analyst.

Manufacturing's migration from West to East will not happen without much kicking and screaming. Tens of thousands of Western jobs will be lost. While that may concern shareholders, ultimately they want greater returns, which moving to China promises. It is a delicate subject manufacturers, judging by Airbus, Boeing and Bombardier declining to comment despite repeated requests, would rather avoid. Down on the shop floor finding a suitable collaborator, politically and technically, in the right place needs careful homework. "The main challenge for the implementation of local manufacturing activity is the selection of the right partner," says Guan, Embraer China's managing director. "Location and infrastructure are other important considerations, especially in light of this summer's power shortage," says Devagunam. Government involvement a plus - or minus Government involvement, although gradually shifting to a more hands-off Western approach, remains significant. "There is still a great deal of government intervention at all levels, which can be supportive, but can also hurt if you are on the wrong team," says Peter Harbison, managing director of the Center for Asia-Pacific Aviation. If all this were not enough, there is another ball in the air for aerospace bosses to juggle: quality.

Improving it is driven in no small measure by China's fast-growing airliner maintenance, repair and overhaul (MRO) industry, which has seen significant foreign investment and is winning ever-larger shares of business on cost, quality and turn-around times. "Quality control is an issue, but it's not as big an issue as it was," says Devagunam. "If you look at other manufacturing, such as autos, it has improved. But there's a long way to go." Ensuring quality can weigh heavily when it comes to foreign companies producing aircraft in China. "It is, in fact, not always a good economic move to offshore some of that production because quality control can be very expensive. However, progressively these problems will diminish," Harbison says. Balancing these sometimes fiendish challenges are low wages. Just how much can be saved on labor is hard to ascertain, but with salaries accounting for 20-40% of an aircraft's cost, it is not insignificant. Given that aircraft, unlike cars, are still largely hand-built, labor costs will remain an important consideration for years to come. China's fast growing maintenance, repair and overhaul business, along with increasing amounts of high-tech equipment such as mobile phones, computer chips and medical products, all attest to China's manufacturing advantages. "Competitive pricing will pressure manufacturers to move parts production to China. Given China's large skilled workforce, it will be a long time before wage inflation takes hold. This pressure will also force wages down in the West," says Richard Aboulafia, an analyst with The Teal Group in Fairfax, Virginia.

Notably, China will soon nudge Japan and Korea from the top spots in labor-intensive shipbuilding and highly automated automobile production is rising fast in China, largely to satisfy local demand. "When you get down to making parts, aircraft production is not that different to auto production," says Devagunam. China's cheap labor a sensitive topic Embraer's Guan, however, plays down the impact of cheap labor, not altogether surprising given the subject's sensitivity. "Although labor costs are obviously an important element, airplanes do not have a very significant portion of production costs a