Competition, collaboration, & “offsets” in aircraft

1. Competition, collaboration, & “offsets” in aircraft • Industry characteristics contrast with those of the IT, biomedical sectors: • Exit, rather than entry, has dominated industry development since 1945 in US, Europe. • User-innovation is much less common in commercial aircraft. • “Vertical specialization” has very different characteristics. • Asian markets and international production networks are important, similarly to IT. • Governments are important actors in military & civil segments of the industry. • State-owned airlines, regulatory & other nontariff barriers to market access. • Gov’t actions in military affect civil industry.

2. Other industry characteristics • High development costs (new Airbus: $11B). • Development requires complex “integration” of numerous different technologies. • “Primes” work with huge # of suppliers. • Relatively few stable, well-defined “interfaces.” • Designs stay in production for decades. • Markets are global, product support is critical. • Wide swings in demand for commercial aircraft. • Links between civil and military aerospace remain important, but have changed since 1945. • Reduced “spillovers” from military to civil aircraft . • Military demand is more stable and supports R&D. • Interfirm “alliances” are used for development, production of new commercial aircraft & engines.

4. Evolution of industry structure & markets • 1970: 3 US airframe firms, 2 European. • 2003: 1 US, 1 European. • Japanese firms have failed to enter as “primes,” instead are risk-sharing partners. • Small domestic “launch market” contrasts with semiconductors, computers. • US accounts for declining share of global aircraft demand. • Asia, esp. PRC, is projected to grow rapidly. • PRC has very large domestic “launch market.” • In US, overall aerospace industry has shrunk since end of the Cold War. • Employment losses driven by military cutbacks.

7. 1981: 75 firms 2001: 5 firms

8. 1999-2019 projected growth in fleet capacity: Airbus Industrie

9. N. American share of fleet declines from 43% in 1999 to 36% in 2019

10. >300-seat aircraft share of fleet projected to grow from 15.5% to 26%

12. “Offsets”: What are they? • Promises of “workshare” (purchases of components, subassemblies) for firms in nation ordering aircraft. • In some cases, offsets involve seller firm taking other goods in “countertrade” (e.g., Polish hams for McDonnell Douglas aircraft). • Offsets are a response to nontariff barriers to market access erected by gov’ts. • Offsets are more pronounced and explicit in military aircraft procurement. • Similar “offset-like” provisions are common in sales of telecom equipment, other expensive capital goods sold to state-owned or state-influenced firms.

13. Offsets originated in postwar US policy • US gov’t encouraged “coproduction” (licensed production) of U.S. military aircraft in purchasing nations during the 1950s and 1960s. • Reconstruction of military allies’ economies an important goal in the Cold War. • Encouragement for standardization. • 28 missile/aircraft coproduction agreements during 1950-80 • Coproduction agreements aided revival of aircraft industries in Japan, Germany, other allied economies, creating demand for offsets. • Offsets remain important in foreign sales of US military aircraft. • December 2002: Polish purchase of $3.5 billion in F-16s includes indirect offsets calculated at >$9 billion.

14. Evaluating military offsets • US gov’t data on share of offsets in military exports reveal little evidence of strong trend. • Most military-aircraft offsets have transferred employment & economic activity. Transfers of advanced technology have been relatively modest. • US gov’t (witness Polish sale) has been ambivalent about offsets, criticizing them in general and supporting them in specific deals. • US industry retains primary responsibility for offsets negotiation, but gov’t retains right to review agreements. • US purchases of foreign military aircraft, other systems also include offset demands (domestic production). • Presidential Commission established in 1999.

16. Employment effects of military offsets: Presidential Commission calculations • Survey of managers in 8 firms responsible for >90% of defense offset transactions during 1993-98. • Each firm asked to calculate job losses/gains for 8 transactions. • Jobs lost through transfer of work or procurement must be compared with jobs preserved through successful export. • Results rest critically on the “counterfactual”: What would have happened without offsets? • Job losses: roughly 3700 aerospace jobs. • Jobs preserved, assuming that offsets were necessary for export sales: nearly 86,000. • For aerospace overall, exports continue to grow.

18. Alternative policy solutions to the offsets “problem” • Pursue a multilateral “standstill” agreement. • Enforceable? WTO disciplines can be waived on “national security” grounds. • US firms argue that a multilateral agreement would reduce US military exports; gov’ts would “buy domestic” without the benefits offered through offsets.. • Encourage offsets that can be fulfilled through other “workshare” agreements with less significant effects on US employment • Encourage collaboration with foreign firms “upstream,” in the R&D phase. • Huge controversy over outflows of US technology. • R&D collaboration may not reduce pressure for offsets downstream.

19. Military offsets affected postwar commercial aircraft markets • US coproduction & offset deals contribute to growth in production capacity (often state-owned) in other industrial economies, increasing political pressure on gov’ts to influence commercial aircraft purchases. • State-controlled airlines, state-controlled regulators, state-controlled loan guarantees all provide leverage & can limit foreign firms’ access to markets. • Result is formal, informal pressure for “offset-like” arrangements in large commercial sales. • But international collaboration in commercial aircraft reflects other factors as well.

20. International collaboration in large (>100 seats) commercial aircraft • Very common since the 1970s. • Boeing: collaboration with Japanese, British, Italian firms in 747, 767, 777. • McDonnell Douglas: licensed production of MD-82 in PRC, proposed collaboration with Taiwanese group. • Airbus: intra-European, little extra-European collaboration. • Collaboration also is common in large engines. • 3 broad motives: • Market access (“offset-like” arrangements). • Access to capital (from partner firms and/or partner-firm gov’ts). • Access to technology (components, process technologies).

21. Managing collaboration • Management of technology transfer is crucial and requires a balanced approach. • Partners typically share in development, as well as production, for a given design. • “Senior partners” need to adopt a strategic view. • Blocking technology transfer creates problems. • Decisionmaking can be problematic. • Need to avoid pushing decisions upward within partner organizations. • JVs with a “dominant partner” appear to operate more smoothly. • Especially in “partnerships of equals,” competition in other product lines may undercut collaboration. • Cost management: Partner workshares based on transfer prices, rather than costs.

22. Evaluating the effects of collaboration in commercial aircraft • As in the case of military-aircraft offsets, what is the counterfactual? • Would a given sale have occurred without collaboration? • McDonnell Douglas: limited collaboration=>dwindling product line and eventual exit through acquisition. • Boeing: more extensive collaboration=> broader product line. No “prime” has entered yet. • Primes’ engineering, production workers (Boeing labor strikes) and US supplier firms likely to feel greatest employment losses from collaboration. • “Prime contractor” firms are globalizing their production network, supply sources. • But US aircraft-component trade balance has improved.

24. Trade policy and collaboration • Market access barriers affect motives for collaboration. • WTO “procurement code” limits scope for gov’ts to use public procurement strategically. • PRC not yet a full signatory to procurement code, and its huge market gives it enormous leverage. • US and EU have negotiated for decades over subsidies for Airbus, DoD R&D support for US aircraft firms. • EU: US firms benefit from NASA and DoD R&D. • US: EU firms benefit from “soft” loans for product launch. • US firms remain reluctant to invoke trade sanctions. • Boeing remains largest single customer for US Export-Import Bank, supplier of subsidized credit for exports.

25. Airbus v. Boeing • Airbus: founded in 1967 as a collaboration among “national champions,” has become much stronger with the gradual removal of direct state control. • New assembly techniques enabled more widely distributed worksharing among European partners. • Arguably has been more aggressive in incorporating new technologies. • The A380 “super-jumbo” aircraft targets trans-Pacific, Europe-Asian routes. • Boeing shelved the “Sonic Cruiser,” now is reconsidering another upgrade of a 35-year-old design, the 747. • Airbus has gained market share since the 1980s.

27. Asia and the commercial aircraft industry • A major source of future demand growth (especially PRC). • Airbus 380 targeted on Asian long-haul routes. • Japan, Korea, Taiwan, PRC all have considered or participated in collaborative commercial aircraft ventures. • Japan in particular has largely given up on independent entry. • Small domestic market. • Despite long experience as a risk-sharing partner in commercial ventures, co-production agreements, leading Japanese aircraft firms lack the design & systems integration skills for “prime contractor” entry. • Domestic defense market is much more profitable.

28. The outlook • Asian markets (esp. PRC) will dominate US, European firms’ strategies for the next decade. • Gov’ts matter, but their interests don’t always coincide with those of firms. • Airbus will maintain and/or intensify pressure on Boeing, which is reducing dependence on commercial aircraft. • US defense market may grow more rapidly; military export market more uncertain. • Continued growth of international production networks and alliances (offsets and “offset-like”), many of which will focus on PRC. • Continued erosion of employment in US aircraft industry (military and civilian) is likely.

31. The politics of offsets: Japan, US, & the “FSX” • 1985: Japanese aerospace firms lobby Japanese Ministry of Defense for independent development of next-generation fighter aircraft. • 1987: US & Japan negotiate a “co-development” agreement for the FSX. • Huge controversy over transfer of military-aircraft technologies with (alleged) civil applications from US to Japanese aerospace firms. • 1988: Co-development agreement renegotiated, providing US firms greater access to Japanese aerospace firms’ technologies. • 1997: “F-2” project is over budget ($4B vs $1.1B), and US firms have expressed little interest in technology “flowbacks.”