Last November, BAE Systems decided to cancel the RJX program.

A failed gamble
In the late 1980s, numerous manufacturers began design studies for regional aircraft powered by turbofans. Interestingly, of the myriad proposals, the only ones to reach the market were low-cost derivatives of existing aircraft designs. Bombardier’s CRJ-100/200 and Embraer’s ERJ-135/140/145 families soon became wildly successful, with about 2,000 orders split between them by early this year.

This success was only partly due to turboprop replacement efforts. The bigger cause was route passdowns from major carriers to their regional subsidiaries. Like manufacturing outsourcing, passdowns soon became a necessary part of any major airline’s operating philosophy.

And as with outsourcing, the key limiting factor in route passdowns was union activism. Airline pilots’ unions have negotiated scope clauses governing how many planes, and what types, can be operated by these regional subsidiaries, preventing the extension of route passdowns to larger (60+ seat) RJs. Pilots were understandably concerned that a 100-seat DC-9, flown by a major airline pilot earning $110,000 a year, could be replaced by a 90-seat regional jet flown by a regional airline pilot earning less than half that figure.

	Bombardier’s regional jet family includes the CRJ-700.

Bombardier was able to grow its CRJ family to include 70- and 90-seat derivative versions, the CRJ-700 and 900. But when Fairchild and Embraer began doing battle with their all-new regional jet families (the 528/728/928 and ERJ-170/190), the first battlegrounds were Lufthansa and Crossair (now Swiss). These are among Europe’s most important regional airlines. But the European regional aircraft market is much smaller than the North American market, which historically has accounted for 60-70% of regional aircraft demand.

In short, Fairchild and Embraer pursued the European regional market because today it is the only truly open market for large regional jets. Both manufacturers bet that it is just a matter of time before the North American RJ market opens up, and both have relied on a European launch order to put them in position to attack this market.

Unfortunately, the gamble does not appear to be paying off. Three years after the two new RJ families were launched, they had zero North American market penetration, except for some speculative orders from General Electric Capital Aviation Services’ (GECAS) leasing unit. While Bombardier has received some North American orders for its CRJ-700 and -900, these have been somewhat constrained. The recent AMR Eagle union compromise deal threatens anything larger than that airline’s modest 25 CRJ-700 orders.

Meanwhile, the RJ market also stalled at 70 seats. Aside from a token number of 928s and ERJ-190s, there has been no breakthrough in either the U.S. or Europe in the 90/100-seat segment. This left Fairchild Dornier with the costs of developing a family of planes, only one model of which had any kind of immediate sales prospects.

There are few doubts that one day the large RJ market will indeed mature, and that large block orders will be placed by North American carriers (majors or regionals). The Teal Group forecast calls for RJs of 60+ seats to go from 15% of the total regional aircraft market this year to 50% of the market in 2011. But the recent BAE and Fairchild Dornier experiences are eloquent comments on the likely timing of this market’s growth.

	528

The Fairchild Dornier story
In May 1998 Fairchild Dornier announced its long-rumored plans for creating a new family of regional jets. The concepts are loosely based on late-1980s designs from DASA (an EADS precursor) for an MPC 75 regional jet. There were three proposed new models—the 55-seat 528, the 70-75-seat 728, and the 90-95-seat 928. Development of the 728 was to cost $800 million, with an additional $150 million for each of the two other variants.

In late April 1999 Lufthansa City Line placed the 728 launch order. The carrier signed for 60 firm and 60 option planes, worth up to $1.6 billion. Deliveries were to begin in July 2003. Even more promising, in December 1999 Fairchild was purchased by Allianz Capital Partners, a German insurer, and Clayton, Dubilier & Rice, a New York buyout firm.

Yet from the start, the odds were long. Since 1960, just one all-new company, Embraer, has come into being and succeeded in delivering more than one jet per month. Of course, Fairchild Dornier is not an all-new company—its two names are among the proudest in aviation. But its purpose in life as a new entity was to create a new family of large regional jets, the 528/728/928. This was a tremendously ambitious undertaking. It made all of their previous programs, the Metro turboprop and the 328 and 328JET regional aircraft, look insignificant.

	728

This has, in short, been a high-cost venture. Fairchild Dornier bet that passenger comfort would sell the plane, which is never a good bet in this industry. Unlike Embraer and Bombardier, the 728 series uses a fuselage with 3-2 seating, one seat wider than the typical 2-2 arrangement. This is roomier, but it costs more to fly through the air than the narrower configuration. It also rendered the 50-seat 528 version a nonstarter (it would have resembled a winged beer can). The death of the 43-seat 428JET in August 2000 meant that the company had abandoned the entire 40/60-seat market to its competitors. And again, given negligible progress between airline labor and management on scope clauses, the action in the regional market looked set to stay in that 40/60-seat zone for years to come. This meant that Fairchild Dornier’s income depended on the niche 328JET and some Airbus subcontracting work. The latter also was hit by the post-September 11 commercial jetliner downturn.

Nothing else about the company was low cost, either. Fairchild Dornier decided to keep a lot of production work in Germany, never known as a country with low manufacturing costs. It quickly acquired lots of talent, presumably at considerable expense.

While the schedule has slipped by some months, and development costs predictably have grown, the company has made tangible progress. On March 21, the first 728 prototype was rolled out, with a maiden flight imminent.

But until insolvency was declared, the company was burning cash at the rate of $50 million a month. Clayton, Dubilier & Rice and Allianz have provided over $400 million. About $90 million in additional bridge financing may be provided by a consortium of German banks. By some accounts this will go a long way toward fully certifying the 728, clearing the way for deliveries (and revenues). However, new aircraft program costs typically increase quickly in the certification and first production phases, and the real costs might be considerably higher.

Yet neither Clayton, Dubilier & Rice nor Allianz is known for its shallow pockets. Perhaps the most disconcerting aspect of Fairchild Dornier’s move to seek bankruptcy protection is that it implies hopelessness. It suggests that the two investors greatly underestimated the cost of developing the new jets, and greatly overestimated the likelihood of finding a buyer. Indeed, it suggests that they have been searching unsuccessfully for a strategic investor for quite some time, and while they have the cash to continue funding Fairchild Dornier on their own, they simply do not want to throw good money after bad.

	In large measure, Fairchild Dornier’s income depended on the niche 328JET.

Salvation?
Fairchild Dornier is currently protected from creditors. In theory, it can still be saved. Unfortunately, the signs are not promising. Many people are being fired, particularly in the U.S. (500 of 700 U.S.-based workers have been laid off so far). About 3,600 German workers are protected by local law for the next three months (the government pays their salaries during that time), but many German contract engineers are also being let go. This saps customer confidence and strips the company of critical capabilities for the certification process.

Meanwhile, production of wings for the 33-seat 328JET is being halted in the company’s San Antonio plant (declining 328JET revenues, partly due to a capricious Chinese decision to deny Hainan Airlines an import license, have been another source of trouble). On the positive side, the new jets remain potentially attractive products. Lufthansa has emphasized its commitment to acquiring them, and in March ordered two 728 full-flight simulators from CAE. The current bankruptcy process would lower the cost of acquiring the company. Yet if Allianz and CDR will not fund Fairchild Dornier without a strategic partner, then who will be the white knight?

For a time, Boeing was mentioned as Fairchild Dornier’s likely rescuer. After all, if and when airlines begin shifting passengers from 100-seat DC-9s and 737s to large RJs, Boeing would lose business if it did not have a large RJ product. That company’s sole potential presence in the large RJ market, the 717, has not been accepted by regional or major carriers.

Yet Boeing’s experience with regional aircraft has been consistently negative. In addition to its 717-100 proposal, Boeing’s ownership of De Havilland Canada (DHC) in the 1980s was disastrous. Even with a full order book, DHC was consistently unable to turn a profit. By some accounts, Boeing has completely ruled out a Fairchild Dornier acquisition.

Bombardier officials also have hinted that they might be interested. After all, Fairchild Dornier’s 928 could be stretched into a perfect replacement for Bombardier’s shelved 90/110-seat BRJ-X proposal. In addition, Bombardier has a history of acquiring troubled aircraft companies at fire-sale prices (DHC, Learjet, Short Brothers). But this interest has not resulted in any concrete action. Bombardier would need to terminate the CRJ-700/900 programs, and the company has always had a low-cost RJ market position. Both of these current non-suitors, and others, might change their minds as Fairchild Dornier’s price drops. But as of this writing, it sounds as though its administrators are more interested in liquidating the company.

	Large RJS: A delayed phenomenon (Value of deliveries in 2002 $billions)

Survivors’ benefits
If Fairchild Dornier is indeed dissolved, the big beneficiaries will be Embraer and Bombardier. Even if the large RJ market has proven disappointing, there are few doubts that there is enough left for two players. And the speculative large RJ orders placed by GECAS will now be split between them.

Also, Bombardier will have had its low-cost derivative RJ philosophy heartily endorsed. They may even get Lufthansa back as a client (the German carrier had already taken a number of CRJ-200s and 700s, and may switch from 728s to additional CRJ-700s for reasons of commonality).

As for the Brazilian company, it would have the only all-new large RJ family in the business. Ironically, its customer base revolves around Crossair/Swiss, which is certainly weaker than Lufthansa. But in the long run, the market would be split: Embraer would offer a completely new solution, while Bombardier would offer something less expensive.

Again, as of this writing, this must be regarded as the likeliest scenario. Fairchild Dornier looks set to pass into history. Clearly, it is a case of phoenix into ashes.