China Airborne

by James Fallows

  Cirrus was in a very different position when sales collapsed again in early 2009. By then its design and manufacturing workforce was over a thousand. It had a large customer-service division to take care of the thousands of airplanes flying on every continent but Antarctica. It was investing heavily in the Klapmeier brothers’ next dream project, a small, fast, safe, relatively inexpensive “personal jet.” As new orders disappeared, it could not lay off the service staff; they were “fixed overhead,” the long-term obligation created by its previous success in selling airplanes. Alan Klapmeier did not want to delay or cancel work on the jet, which the company had publicized heavily as the key to its commercial and technological future. Also, since announcing the jet project in 2007, the company had taken deposits of $100,000 apiece from customers eager to get an early place in the delivery line a few years hence. Those deposits provided some of the working capital for R & D on the jet, and they were spent as soon as they came in. But in a confident (or extravagant) gesture during the boom times of 2007, the company had made those deposits fully refundable. If word got out that the jet was being scrapped, depositors would inevitably rush to get their cash back, and Cirrus would be in even more serious trouble trying to cover this counterpart to a run on the bank.

  At the request of the Klapmeiers, the managerial staff of Cirrus took a 10-percent pay cut in 2008 and again in 2009, but as sales continued to fall there was no alternative to laying off production staff. From its peak employment of fifteen hundred in 2007, Cirrus was down to six hundred employees by the beginning of 2009. That reflected the results of two big layoff waves, and a third was apparently in store.

  At that point, everything about Cirrus’s story changed, when Alan Klapmeier was forced out of the company. In the aviation business, this was instantly likened to what had happened at Apple twenty-five years before, when Steve Jobs was ousted from the company he had helped found. Like Jobs before him, Alan Klapmeier lost the crucial struggle between his view of what the company “should” do and the financiers’ judgment of what it “had to” do to survive.

  The majority owners from Crescent Capital, having invested in 2001 in hopes of a relatively quick payout, had started looking for purchasers during the flush times before the 2008 financial collapse. They had considered a range of private-equity offers but not nailed down a deal. They did not want to put in any more of their own money—but further investment was what Alan Klapmeier was asking for. He said it would be a costly error to postpone work on the jet. In the short term, the company had no way to cover the inevitable demand for refunded deposits, and in the longer run, without a jet it would have no way really to broaden its business whenever customers began buying again.

  Crescent Capital was looking to cut its losses rather than deepen them. It had an ally in Brent Wouters, a consulting-firm veteran who had come to Cirrus a year earlier as its CFO. The contrast between him and Alan Klapmeier was stark. Klapmeier had pictures and models of airplanes not just at his office but all over his home; inside the front door of his house was a glass display case holding hundreds of small airplane models. Wouters had no apparent passion for aviation and in presentations referred to Cirrus aircraft as “our product” rather than as airplanes. As an aviation enthusiast who had become a businessman, Klapmeier wanted to keep spending on future airplanes. Wouters, a financial-management expert who happened to work at an airplane company, wanted to hold down the payroll to let the company survive the tough times. In a family drama that became the talk of Duluth, but whose details none of the participants has fully disclosed, Dale Klapmeier—the younger, less extroverted and outspoken, operations-rather-than-vision member of the family—sided with Wouters and Crescent Capital. In February 2009 they voted Alan Klapmeier out as CEO, and Brent Wouters in.

  Wouters had two crucial objectives, only one of which was publicly discussed. The first was to lower the company’s “burn rate,” or fixed operating costs, through whatever means it took, so that it could get by on its reduced sales levels in worldwide hard times. More layoffs ensued, bringing the workforce to four hundred fifty. The aviation press was full of grumbles from Cirrus suppliers who waited months for payment; two of them sued. The company said that jet work was proceeding at full speed, but many of the crucial engineers and designers on that project had left or been laid off. Jet depositors who asked for their money back waited six months or more before they saw the cash.

  The company did survive, and long enough for Wouters to realize the other goal Crescent Capital had set: to sell the company to the only apparent source of ready cash during a crisis, the Chinese government. In the spring of 2009, soon after his ascent as CEO, Wouters began negotiations with China’s AVIC, working through an overseas middleman whose specialty was brokering this kind of deal. Despite their own problems in coping with the aftermath of the financial crisis in 2009, big Chinese corporations and state agencies recognized that their relative position in the world economy continued to improve. Businesses and governments in the rest of the world needed cash. Chinese businesses and government interests had it. So their deliberations, as I heard in many interviews with Chinese officials at the time, concerned how to manage their international expansion deftly rather than clumsily. The businesspeople laying out this strategy had typically worked or studied extensively outside China. They understood—as the little-traveled leaders of China’s political hierarchy did not—why a sudden influx of Chinese cash, Chinese control, and Chinese faces might create resistance in countries that received this influx.

  Many of the Chinese authorities also understood that the situation would be all the more delicate with an aerospace company like Cirrus. It was a prime example of American innovation and enterprise. Its takeover by the rising Chinese might be perceived as a symbol of American decline. The jobs it provided, though reduced in number, were high-paying factory jobs in the hard-pressed Midwest. Would they too be shipped to China? Even though Cirrus planes were in non-American hands all around the world, and even though Cirrus was actively bidding to sell its planes to the People’s Liberation Army Air Force as trainers (the U.S. Air Force Academy in Colorado Springs had already bought some for that purpose), a sale to “the Chinese” would require Federal clearance1 to be sure U.S. national security was not at risk.

  For these reasons and others, negotiations remained secret through 2009 and 2010. When the deal was announced, at a press conference in Duluth on February 27, 2011, all involved in the transaction did what they could to assuage both local and national concerns about what this transaction might signify. The mayor of Duluth, Don Ness, said that the Chinese officials had assured him that they would keep jobs there rather than transfer them to China. “They’ve made every indication that it is their intent not only to maintain their local operations but to grow jobs here in Duluth,” he said.

  Promises, promises—but the city signed on as a party to the deal, offering forgiveness on rent paid for city property, if and only if Cirrus employment in Duluth went up rather than down under Chinese ownership. Two months later, Mayor Ness got what he considered a more tangible commitment. After Minnesota’s two senators, Al Franken and Amy Klobuchar, sent a letter to the new Chinese parent company of Cirrus, asking for more details about its employment plans, the head of that company came to Duluth for another signing ceremony. President Meng Xiangkai, an aerospace engineer who had risen to become head of the China Aviation Industry General Aircraft group, or CAIGA, invited Ness to the Cirrus plant. Ness presented him with a carefully negotiated one-page memorandum saying that CAIGA intended to keep the manufacturing plant in Duluth, and to maintain or increase employment levels, even as it expanded sales and eventually production elsewhere. Meng, with a smile on his face, signed.

  There was an extra safeguard for jobs in Duluth that most news reports left undiscussed. If the new Chinese owners wanted to make the planes in China and have them sold in any market except their own, they would need to receive a new production certificate from the FAA and its
international counterparts. Certification is a time-consuming and extremely painstaking process, the prospect of which would presumably keep jobs in Duluth for the foreseeable future. If the Chinese owners did take this step, it would be a sign that they were serious about building up their own Chinese abilities in aerospace, rather than just buying foreign assets. The acquisition, while the most heralded, was only one in a continuing series that Meng Xiangkai had overseen. His CAIGA group, designed to produce future rivals to Cessna, Hawker Beechcroft, Gulfstream, and—if it didn’t already own it—Cirrus, was one of several subsidiaries of the catch-all Chinese aviation consortium AVIC. Before coming to CAIGA, Meng had been head of another subsidiary, the Xi’an Aircraft Industry (Group) Company (which for some reason goes by the English acronym XAC). In 2009, he signed a deal by which XAC bought an Austrian company called FACC, a component supplier to Boeing and Airbus.

  In an interview with the Chinese press after that sale, he explained why he thought it so important to look for further takeover targets: “If we remain at the low end of the aviation industry chain, it will do us no good in the international division of labour and we will never be able to find an equal partnership,” he said. “If we want to survive in the aircraft manufacturing industry, we must keep an open mind and have an international vision.”2 Toward that end, after his move to CAIGA early in 2010, Meng had arranged the purchase of Epic, a small-jet company based in Oregon, in March, 2010, and in September the purchase of Teledyne Continental, in Mobile, the main manufacturer of piston engines for small airplanes including Cirrus.

  In July, 2011, the Cirrus sale passed government security reviews in both the United States and China. On behalf of CAIGA, Meng Xiangkai issued a congratulatory statement. “We are very impressed with Cirrus’ performance in the global general aviation industry,” he said, in Chinese ceremonial hortatory style. “It has a very strong record of consistent product excellence, comprehensive safety features, an outstanding management team, and a highly skilled workforce who operate from advanced production facilities.”3 To mark the occasion and to welcome a team of engineers, trainee pilots, service representatives, and other CAIGA staff members who were coming to Duluth for familiarization and training, Cirrus officials draped a huge banner across the hangar where officials from both companies would speak. It expressed greetings and hearty welcome to the new partners arriving from CAIGA.

  Just before the ceremony, one of the CAIGA officials asked his Cirrus counterpart please to take the banner down before the speaking began. What was the problem? “The banner says ‘partners.’ But we are not partners. We are the owners.” The concept of ownership had survived the communist era intact.

  7 * China’s Own Boeing

  The Chinese airliner of the future

  The world’s established aircraft-makers have one big question about China. It is their specific version of the question the rest of the world has about China as a whole. In its simplest form: Is China more of a threat? Or an opportunity? If it’s both, is it more of one or the other? If the answer to that question is uncertain, when will outsiders know which is more likely? And is there anything they can do to bend the result in the direction they would prefer?

  In the special world of airplanes, the question takes the form of balancing the opportunities of the world’s fastest-growing market with the challenges posed by the world’s most rapidly expanding industrial base. The great promise for Boeing and Airbus, and for their smaller brethren like Embraer and Gulfstream, Cessna and Beech, is to sell more of their products in the one country likely to increase its fleet dramatically in the next ten years. The great nightmare for these same companies is that the price of entering the Chinese market will be joint ventures, technology transfers, potential theft of intellectual property, and local-content requirements that in effect force them to create and foster the Chinese competitors who will one day unseat them. Even if a resurgent China does not create competitive aerospace companies of its own, it might use its always growing financial reserves simply to buy up whatever firms have become world leaders, as it began doing in 2010 in the helicopter, engine, and small-aircraft ends of the market.

  The balance between opportunity and threat will depend on decisions being made now and in the next few years by companies, financiers, and governments in North America, Europe, South America, India, and elsewhere, of course including China. The obstacles the Chinese face are different from what is generally assumed outside the aerospace industry, and more imposing than many people inside or outside China might guess.

  The Chinese efforts in this regard are significant in their own right, because of the importance of the aerospace industry to American exports and general high-tech success. They also offer a near-perfect distillation of the strengths and limitations of China’s larger attempts to will its way up the ladder of high-tech industrial economic value. That is, they illustrate very clearly the unusual combination of traits that have characterized China’s efforts in other fields: openness to foreign efforts combined with a determined effort to increase the Chinese share; a powerful role for state ownership and government guidance combined with room for private initiative. So far, the Chinese efforts look more like an expensive way to pursue national grandeur than a real step toward economic, technological, military, or strategic power. But that could change.

  Trying to build an aircraft industry

  Through the Mao era, aviation was backward, mainly military, and strictly government-controlled. Through the first twenty-plus years of the opening under Deng Xiaoping, it remained backward, and also remained more government-controlled than most of the rest of the economy, which was gradually being liberalized. In the early 1990s, under President Jiang Zemin, the giant conglomerate called AVIC, the Aviation Industry Corporation of China, was created from the diverse aerospace factories and organizations that had been part of the military or other government ministries. In the late 1990s, AVIC was split into two groups: AVIC 1, dealing with large airplanes and military aircraft, and AVIC 2, for smaller airplanes and helicopters. And in 2008, it was all reorganized once again, this time in the reconsolidated Commercial Aircraft Group of China, or COMAC. That is the main institution now pursuing China’s airplane-building plans.

  COMAC and its subsidiary groups are theoretically independent businesses but in reality are part of the great penumbra of state-influenced organizations in China. The influence, as we have seen in the cases of Weinan and Zhuhai, comes not just from national officials but also from provincial and city officials hoping to be part of a new boom, or to somehow make it happen in their hometowns. As with so many aspects of modern China’s tech-based industries, the organizations share both corporate and governmental traits. As Tai Ming Cheung, of U.C. San Diego, pointed out in a 2010 report on Chinese aerospace prepared for the United States–China Economic and Security Review Commission, a group that keeps a watchful eye on signs of Chinese military and technical predation, the creation of AVIC and COMAC signaled several steps toward more market-minded operation of a still government-guided operation.1 This reorganization, Cheung wrote, was a necessary corrective for the legacies of the Mao era, including “the widespread duplication and balkanization of industrial and research facilities.”

  What do the resulting entities make, and do? In principle, COMAC and its allied Chinese subunits represent nearly the entire range of aerospace activity.2 At the most sophisticated end, Chinese companies are near completion of one “regional jet” competitor, known as the ARJ21, which would compete with Embraer and Bombardier models (and in U.S. terms might be used for, say, the Washington–Charlotte or Seattle–Spokane routes). It would hold about ninety passengers, it has been in development since 2008, and nearly all of the orders that have been placed are from “captive” airlines—the state-controlled Chinese domestic lines. COMAC is also beginning development of its C919, a “single-aisle” airliner comparable to—and, its developers hope, eventually competitive with—the Airbus A320 or the Boeing 737. At the
bottom end, Chinese companies have for years made a number of Soviet-style, antique-looking planes used mainly for crop-dusting and similar chores.

  COMAC and some still military-controlled companies are also planning to build almost any other flying-related product you can think of. Rockets to launch satellites. Satellites themselves, including a system to rival the existing United States–run GPS network. (And since the current GPS system is not just “United States–run” but managed by the United States Air Force, it is hard to blame the Chinese military for recommending this step. War between the United States and China is unlikely, but if it happened, the PLA would not want to have its navigation systems vulnerable to disruption by the other side.) Apart from the large-scale commercial airliners to compete with Boeing and Airbus, there will be smaller regional planes to compete with Embraer and Dassault, and private aircraft to compete with Cessna and Hawker Beechcroft. Helicopters to fill what seems to be an enormous market void. And behind all of these is the same integration in the global supply chain that has made China a low-wage, low-value power in many electronic projects, and that makes Japan and Germany high-value-component producers now.

  How Chinese manufacturers would prevail

  If you were going to write the script by which Chinese aerospace interests convert their current plans into eventual world dominance, the steps might be described as follows:

  1. Political pressure. All around the world, but even more so in China, the market for airplanes depends on political as much as commercial factors. The central government of China, when it does not directly approve or determine airlines’ purchasing plans, heavily influences them. It is in the government’s interest to play Boeing and Airbus against each other, so neither will be allowed a fully dominant share—and both will be affected by larger political relations between their home base and the Chinese government. Through the early 1990s, before Airbus had really gotten going, Boeing provided nearly all the new airliners for China, and Boeing officials were de facto liaisons between the Chinese and American aviation establishments. By 2010, Boeing’s share stood at 55 percent, and Airbus’s at 43 percent. Each of them knew that future changes would depend on their commercial improvements—but also on the government’s decisions about the right balance to set. The more heavily the balance eventually shifts in favor of China’s own emerging producers, the less will obviously remain for either Airbus or Boeing.