Thursday, October 8, 2009

China’s Aviation Corp. Makes Global Splash

Defense News


China’s Aviation Corp. Makes Global Splash

By Wendell Minnick

TAIPEI — No more evidence was needed of China’s defense-industrial rise than the July 8 announcement that China’s Aviation Industry Corporation (AVIC) had made it to Fortune’s Global 500 list for the first time at 426.

The commercial and defense aviation corporation posted sales revenue of $21.7 billion with profits of $568 million. Just how much of that was defense sales was not given.

AVIC’s leap onto the list was abetted by the November merger of AVIC 1 and AVIC 2, rejoining two spun-off companies into a single state-owned aviation behemoth with 120 operating units, including manufacturers of military aircraft.

“China seems to be finally reap­ing some dividends from all its defense industrial base reforms,” said Richard Bitzinger, senior fellow, S. Rajaratnam School of International Studies (RSIS), Nanyang Technological University, Singapore.

Bitzinger attributed much of it to the relentless increase in defense spending since the late 1990s.

“But we cannot discount the impact of a decades-long dual-use R&T [research and technology] strategy, which has pumped considerable commercially originated high technology into the defense industry and even some modest structural reforms,” Bitzinger said.

However, it appears to be too early to say how the merger will improve the performance and capabilities of the defense industry, said Tai Ming Cheung, author of the new book “Fortifying China: The Struggle to Build a Modern Defense Economy.”

“AVIC has been one of the top corporate recipients in financial stimulus money from the Chinese government and has strong military and civilian orders,” said Tai. “At least two-thirds of its revenue comes from civilian output.” The key issue is whether it can continue to grow as rapidly as it has done over the past six to seven years, especially overseas.

Tai said the aviation merger marks a strategic defense-industrial shift. When AVIC was split into AVIC 1 and AVIC 2 in 1998, the aviation industry was focused on domestic markets. Now, the Chinese are beginning to look at the lucrative foreign aviation market, and the re-establishment of a domestic aviation monopoly allows AVIC to become a bigger international player. 

Bitzinger called the 1998 separation a mistake.

“It did not stimulate competition, and basically, it created one strong company and one weak one,” he said. “Putting all the aviation companies back together under one roof allows the Chinese to spread out the work from its growing commercial aircraft business pool technological expertise, and gain potential economies of scale in R&D [research and development] and production.”

Tai said that from 1999 to 2008, Beijing focused on encouraging market competition by doing away with “monopoly structures and having two or more companies compete for work in each of the defense industry’s five key sec­tors”: nuclear, aviation, space, ordnance and shipbuilding.

However, the competition was artificial and there was “little or no real competition” because AVIC 1 specialized in military aircraft and AVIC 2 focused on civilian aircraft and helicopters.

“The merger is a clear signal that the defense-industrial authorities have embarked on a major course change and are emphasizing that consolidation and economies of scale are more important in their future growth,” said Tai, now a senior fellow with the University of California Institute on Global Conflict and Cooperation.

“Having a single player allows AVIC to begin to challenge their far larger foreign players, especially as they build new generation military and civilian jets they want to sell,” he said.

China’s first domestically developed ARJ21-700 regional passenger jet made its first trial flight on July 15. AVIC-owned Shanghai Aircraft Manufacturing developed the jet and on July 10 signed a contract with four Chinese factories to begin mass production in 2010.

According to AVIC officials, there have been 208 domestic and foreign orders for the ARJ21, including an order for 25 from U.S.-based GE Commercial Aviation Services. One unanswered question is how AVIC will manage relationships with its specialized subordinate units, which are now being reorganized into “clear functional entities that are significantly different from the way that AVIC 1 and 2 was originally organized,” Tai said.

“The new AVIC is now modeled on their Western counterparts, especially EADS, Boeing, etc., and this is an important corporate reform that will likely improve discipline, efficiency and autonomy.” AVIC’s corporate management model has changed.

“A key part of the new initiative is to promote functional decentralization, as well as some geographical decentralization,” he said. “It will take some time before we see if this experiment works as many of these functional subsidiaries are still in their infancy, but the lessons from Western counterparts that have implemented this organizational model are positive.”

If AVIC’s efforts demonstrate an improved performance, “we can see broader adoption of this functional, decentralized model throughout the rest of the defense sector,” Tai said.

China has also tinkered with its dual-use policy creating opportu­nities for both commercial and defense industries. In 2003, during the Third Plenum of the 16th Party Congress in Beijing, a decision was made to build a new civilian technological and industrial base with “embedded military capabilities.”

“China is going along with what is taking place in the rest of the global defense industry, where dual-use civil-military integration is an important and expanding trend,” Tai said.

However, this has caused some problems for the United States and Europe, which have been “very cautious about this dual-use phenomenon because of the very tight export-control regulations imposed by their home governments.”

Europe and the United States imposed arms embargoes against China after the 1989 Tiananmen Square uprising. However, numerous companies, including Boeing, EADS, Honeywell and Sikorsky, have participated in joint development, assembly and co-production of a variety of “civilian” products with Chinese companies that have dual-use potential.