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.
