China’s dream to build a domestic commercial aerospace industry is beginning to take flight. The ARJ21-700, short for Advanced Regional Jet for the 21st Century, took its longest flight in July, a two-hour journey from its development center to a testing facility where it will undergo further evaluation to earn certification to fly domestically. In June, China unveiled the first Airbus A320 to be assembled completely outside Europe. Airbus said its China plant, which is 49% owned by Airbus and 51% owned by a Chinese consortium, is capable of producing four A320 jets per month. These short- to medium-range, narrow-bodied commercial jets will be used for travel in China alone.


Aerospace analysts note, however, that China is unlikely to be satisfied with having a domestic industry that builds regional and narrow-bodied jets for domestic travel only. Its long-term plan is to export these jets as well as wide-bodied jets to the international market by 2020. “China is not ready to design its own commercial aircraft for export yet, and to do it at the jumbo-jet level is obviously very ambitious,” says Morris A. Cohen, a professor of operations and information management at Wharton. However, he adds, “I do see this as a natural progression.”


Indeed, China has most of the necessary infrastructure in place through partnerships and joint ventures with major aerospace players and original equipment manufacturers (OEMs). Many components used by Canada’s Bombardier, Brazil’s Embraer, Boeing, General Electric and Pratt & Whitney are already built in China. And China’s aviation industry already has more than 200 enterprises — both state-owned and private — busy building parts and employing nearly half-a-million workers, according to a 2008 report to Congress by the U.S.-China Economic and Security Review Commission.


“The purpose is to bring manufacturing within the country so they can do it themselves,” says Nathan K. Smith, an aerospace and defense analyst at the research and consulting firm Frost & Sullivan. “However, China does not have the expertise and is heavily dependent on Western technology.”


Many critics, including labor organizations, worry that China is absorbing aerospace technologies and production techniques gleaned from partnerships formed between its domestic companies and foreign companies in the aerospace sector. As far back as 2001, Robert Thayer, then the general vice president of the International Association of Machinists and Aerospace Workers, gave testimony before the U.S.-China Commission, saying that as a cost of doing business in the country, China aggressively requires the transfer of technology and production. While it is common practice for Boeing and Airbus to manufacture parts in the countries to which it is selling jets — known as “offset requirements”– China is clear about its ambitions to build a domestic industry that could churn out jumbo jets by 2020.


Concerns about China’s ambitions in the industry are not completely misplaced. The ARJ21 is a variant of the McDonnell Douglas design, notes Cohen, derived most likely from the MD-82 and MD-90 models the Boeing subsidiary built in China 30 years ago. “But it’s an old design,” says Cohen. “When it comes to the latest technology, Boeing and Airbus are very careful to outsource only certain parts of the manufacturing.”


Boeing, for example, keeps the design and production of avionics — the electronic systems that control navigation, communications and wing design — in-house because it is an area of competitive advantage for them, according to industry followers. Other tightly held industrial advantages include the latest innovations in composite materials, and the powerful software to control and monitor the entire system.


“I think it’s a bit of an over-statement to suggest that companies give away the crown jewels and completely outsource their production,” says Remy Nathan, the assistant vice president of international affairs at the Aerospace Industries Association, a trade group based in Washington, D.C.


China may also find it difficult to establish a domestic commercial aerospace industry that manufactures everything from the ground up because this sector truly is a global industry, say analysts, with parts brought in from various countries and assembled into a final product. “Boeing is not just a U.S. aircraft,” says Nathan. “The parts all come from a globalized supply-chain that involves all kinds of foreign companies’ content and domestic content.” While some countries manufacture the nuts and bolts, others like Japan produce more high-end components.


Many of the parts that went into the Airbus A320 built in China were shipped in — like the engines, avionics and software — because the country does not have the technical expertise to make all these components. “But they do want to learn as much as possible,” says Smith.


Shaking up the Boeing/Airbus Competition


Boeing estimated last year that China will order 3,400 new planes over the next 20 years to accommodate the country’s growing business and middle class. That’s 12% of the total 28,600 planes Boeing expects to sell worldwide. Boeing currently buys local content but assembles the aircraft in the United States, flying the final product to China. Building a joint-venture final assembly line in Tianjin’s Free Trade Zone gives Airbus a leg-up, say analysts, allowing it to promote itself and to separate itself from Boeing.


“Assembling the entire plane within China assures Airbus that China is more likely to buy their own crafts than consider the 737,” Smith said. “Being able to build four airplanes a month when the factory is at full capacity is a huge advantage for Airbus over Boeing.”


Labor costs — a significant part of the overall cost of an aircraft — will also be far lower in China for Airbus than what Boeing pays its American workforce. This might place even greater pressure on Boeing, says Cohen, to establish a similar partnership to overcome the cost and capacity disadvantage.


Product Quality


Airbus has set up a rigorous inspection program for its fleet of A320s that will come off the assembly line in China. “No company wants to be associated with a product that is going to fail,” says Nathan. “A failure in the context of civil aviation is a catastrophic failure.”


Once China establishes an aerospace industry that can crank out low-cost regional and narrow-body jets for domestic use, it will face a tougher challenge in translating that success to the international market. In order for a newly designed model aircraft to fly over U.S. airspace, for example, it must first secure certification by the U.S. Federal Aviation Administration, an arduous process that requires around a thousand hours of flight time and can take years. The European Aviation Safety Agency plays a similar role and must approve new models before they fly over European skies, and there are counterparts to these agencies all over the world.


Even if China wins worldwide certification, analysts note that a perception of shoddy quality will linger with both foreign airliners and passengers because of China’s recent scandals of tainted consumer products, like baby formula and pet foods. And after the Sichuan earthquake in 2008, in which several buildings, including a school, easily crumbled, investigators found that construction companies had skimped by using diluted cement. These problems all stemmed from Chinese companies trying to reduce costs. In buying an airplane, however, cost is not the main consideration. Safety comes first.


“If they are going to be competitive, they must overcome any perception that they are somehow lax in the enforcement of quality,” says Cohen. “The tainted milk case was a terrible blow but a problem with a flying plane is going to be far more dramatic with more repercussions if the planes have sold internationally.” Cohen added that China will have to invest heavily in setting up a strong inspection infrastructure and to make sure the international airliner market and the international traveler is fully aware of this protective mechanism.


As if to underscore that it is prepared to go great lengths to establish a trusted aerospace industry that could one day sell aircraft internationally, China recently launched a national fund dedicated to investing in its aerospace sector to take on the global titans. It hopes to attract investors and raise almost $6 billion, the Xinhua news agency reported recently. The fund will likely play a role in helping China towards its goal of one day building a jumbo jet to take on the Airbus-Boeing duopoly.


While that threat may still appear to be far off, analysts warn not to take it too lightly. “After Airbus was officially created in 1970, Boeing basically ignored it for the first 20 years,” says Smith, adding that it wasn’t until the 1990s that Boeing began to feel Airbus’s competitive presence. “And now Airbus is outselling Boeing. That’s the same plan China has, but they have a ways to go.”

Note: This story originally appeared in the Wharton Aerospace & Defense Report.