1. INSERTION OF COSTA RICA IN GLOBAL PRODUCTION CHAINS: A CASE STUDY Ricardo Monge-González and Sandro Zolezzi First workshop on “International Product Fragmentation and the Insertion of LAC in Global Production Networks” Washington DC, July, 2011

2. Costa Rica and the GPC 43% of Costa Rica’s total goods exports in 2009 were made as part of GPCs. These exports were produced by 60 firms, 80% of which operate in Export Processing Zones (EPZs). The main 5 GPCs are: electronics, medical devices, automotive, aeronautic/aerospace, and film/broadcasting devices.

4. GPC for the case study aeronautic/aerospace It is the most diversified GPC CR is participating, with a total of 13 types products or services being exported It displays the smallest concentration of exports to one single country, with the United States accounting for only one third of its exports (34%) The share of the domestic contribution to exports in the aeronautic/aerospace sector scores the largest (72%), followed by medical devices (59%) and automotive (39%).

5. Besides, the share of L and K together are larger in the aeronautic/aerospace GPC (60%) as well as services (31%)

6. Main objective The aim of the project is to contribute to our understanding of the drivers of production fragmentation in the aeronautic/aerospace industry, its effects on trade patterns and to uncover potential policy implications for Costa Rica. 6

7. Questions to be answered 1.What forces led to the initial fragmentation of the production by the outsourcing firm and what factors made it possible? (i.e. advances in production or telecommunications technologies, reductions in transport costs, reduction in tariffs, declines in trade barriers on services, reduction in informational costs, etc.) 2.Which country/regions were considered by the outsourcing company as potential providers for this stage of the production chain? 3.What factors, at the country level, were critical for the outsourcing company to finally select Costa Rica for this stage of the production chain? (i.e. good logistics infrastructure, adequate contract enforceability, large pool of skilled individuals, good financial development, etc.) 7

8. Questions to be answered (2) 4.What factors, at the firm level, were critical for the outsourcing company to select this firm as the provider of this stage of the production chain? Where there detrimental factors at the country level (i.e. poor logistic infrastructure, inadequate contract enforceability, credit constraints) that the firm had to overcome and what actions did it take to do so? 5.What role did the government play, if any, in facilitating the insertion of this country/firm in this international production chain? 6.To what extent has the insertion of this firm in the international production network benefited other firms in the same country? For instance, does this firm obtain its own inputs from local providers? If yes, did the local providers produce this input before? Had the local providers benefited in any way from this relationship? If the firm does not obtain its inputs from local providers, explain why not. 7.Had the experience of this firm helped other firms in the country become part of other international production networks, or vice-versa? 8

9. Firms selected for the case study 9 Global Production Chain: Aeronautic / Aerospace Main characteristicsCAMTRONICSAVIONYX Participation in GPCsIntermediate productIntermediate service OwnershipLocal companyForeign company Year of establishment in CR19922005 LocationZeta FTZ, CartagoAmerica FTZ, Heredia Building / office area (m 2 )2,100440 Employees9039 Cumulative investment ($m)0.80.5 Main customers Electronic components for medical, telecommunication and aerospace industries Boeing and NASA tier one - suppliers Main destinations (countries)USA and Costa RicaUSA Exportation products / services Assembly of electronic circuit cards, harnesses, subassemblies, cables, coils Software for the electronic devices (avionics). Testing and software verification

10. Both firms are serving the aeronautic / aerospace industry from Costa Rica 10 Different % of engineers in total headcount leads to a different level of sophistication Avionyx, 39 people, 92% engineers Camtronics, 90 people, 4% engineers

11. Preliminary findings Interview with Mr. Gustavo A. Cubas, Software Engineering Manager of Avionyx in Costa Rica GPC in the aeronautic/aerospace industry 11

12. What does Avionyx do? Avionyx provides engineering services to the safety critical systems’ avionics in the aeronautic industry (avionics derives from "aviation" and "electronics“) 1.Software development Requirements definition / reverse engineering Software design / reverse engineering design Programming / coding Software testing Software integration 2.Verification and validation Requirements validation Requirements-based software verification – Black box testing (manual / automated) – White box testing (manual / automated) Static analysis such as code reviews Unit testing / stress testing Structural coverage analysis Timing, memory, stack, performance analysis 12

13. How does Avionyx work? Avionyx has its headquarters in Florida, USA and only one branch in Costa Rica. 1.Headquarters in Florida It does only marketing and sales 2.Branch in Costa Rica It makes software development and verification / validation – 39 employees (36 engineers and 3 white collar) – Almost 100% employees are local – Original idea was near-shore outsourcing to US market » Two key factors for success: higher productivity and higher quality let Avionyx compete successfully with other companies from China, India and other locations around the world. 13

14. Typical Aerospace (aircraft) Value Chain The distinctive supply chain role Tier – three supplier (raw materials and piece part manufacturer) Tier – two supplier (component manufacturer) Tier – one supplier (sub-system integrator) Prime integrator Customer Prime integrators, those farthest along in value chain integration, have partners in most steps of the value chain. Tier-one contractors have partners in several steps of the value chain. Tier - two and - three contractors, those that do not have plans to partner in most steps of the value chain, tend to serve their immediate downstream tier only. 14

15. Aircraft manufacturers and Tier 1 suppliers have become large scale integrators (“super integrators”) and coordinators of airplane production. New strategies adopted by the aerospace industry to achieve this include greater dependence on Tier 1s, increased risk sharing by suppliers, adoption of low cost region suppliers, increased aero structures outsourcing, and an increased transparency in their aircraft program plans and schedules, and proposal making is more a joint process between customer and supplier. There is more focus on systems integration, less internal production capability, a desire to work with a lesser number of Tier 1 primes, and significant reduction in direct dealings with Tier 2 and Tier 3 suppliers (except when developing such suppliers in low cost regions like Costa Rica, Mexico and India). Tier – three supplier (raw materials and piece part manufacturer) Tier – two supplier (component manufacturer) Tier – one supplier (sub-system integrator) Prime integrator Customer Super integrators Typical Aerospace (aircraft) Value Chain The distinctive supply chain role 15

16. U.S. Aircraft Industry Prime Integrator and Major Suppliers Boeing Prime Integrator Large Commercial Jet Engines GE Aircraft Engines United Technologies Corporation (parent Pratt & Whitney) The Engine Alliance (JV between GE and Pratt & Whitney to produce GP7200 engine for the Airbus A380 engines) U.S. Major Suppliers The Carlyle Group (designs and manufactures major airframe structures) Eaton Corporation (hydraulic and fluid power products for aerospace) Goodrich Corporation (airframe systems, engine systems, electronic systems, landing systems) Harris Corporation (communications equipment and systems) Honeywell International (turbofan turboprop engines, flight safety systems) Parker Hannifin Corporation (designs, builds and supports systems) Rockwell Collins (aviation communications) United Technologies Corporation (parent Hamilton Sundstrand, engine, flight and environmental controls) Source: Niosi, J and Zhegu, M. (2010). “Multinational Corporations, Value Chains and Knowledge Spillovers in the Global Aircraft Industry”. International Journal of Institutions and Economies, Vol. 2, No. 2, October 2010, pp. 109-141. 16

17. European Aircraft Industry Prime Integrator and Major Suppliers Airbus Prime Integrator Large Commercial Jet Engines Rolls-Royce Group plc. Snecma Group (62% owned by government of France) International Aero Engines (multinational consortium. Partners: Pratt & Whitney, Rolls- Royce, Japanese Aero Engines and MTU Aero Engines) European Major Suppliers BAE Systems plc. (avionics and other commercial aerospace operations) Finmeccanica spa (air traffic management, avionics and fuselage components) Kohlberg Kravis Roberts & Company (parent: US-based private equity firm) Smiths Group plc. (advanced avionics and mechanical and electrical equipment) Thales (33% owned by government of France. Air traffic management, avionics, computer hardware and software) Volvo Aero (aircraft engines) Meggitt plc. (specializes in extreme environment components and smart sub-systems for aerospace) Crane (parent: Smiths Group plc. designs and manufactures seals and associated products) Source: Niosi, J and Zhegu, M. (2010). “Multinational Corporations, Value Chains and Knowledge Spillovers in the Global Aircraft Industry”. International Journal of Institutions and Economies, Vol. 2, No. 2, October 2010, pp. 109-141. 17

18. Next steps Follow the tips on researching global value chains suggested by IADB team Review literature Collect data on Avionyx and Camtronics business functions Keep contact with the two companies’ managers in Costa Rica to explore in detail the branch operations Interview Avionyx’s owner and President in the Headquarters in Florida to get better understanding of Avionyx involvement in the GPC Answer the question: Why did Camtronics owner open operation in Costa Rica to serve mostly foreign markets? Write the case study for both selected companies 18

19. Ricardo Monge-González rmonge@caatec.org Thank you! 19