Friday, April 15, 2005

Boeing Cries Foul at Airbus’ Practices in the Price War

A couple of weeks ago, in reading “Economics of Strategy” (Besanko, et al. 2004), we encountered an interesting “five-forces” analysis of the intense competition in the commercial airplane (a.k.a. airframe) manufacturing industry between Boeing and Airbus. Shortly after, our interest on this subject was further amplified, as a spate of articles on this topic came out within the span of a few days. In a representative article, titled “New Boeing Chief Vows Not to Lose Money,” Boeing’s head of commercial airplane sales, Scott Carson, was first and foremost quoted as proclaiming: “Our intention is not to do silly business.” Very well. That is probably a good motto for everyone to abide by…but what exactly does it mean in this situation?

Let’s start with a brief recap of recent events in this ongoing battle between two industry giants. The Boeing Company, founded in 1917 and currently headquartered in Chicago, had been dominating the commercial airplane manufacturing industry for decades. Boeing’s venerable winning streak came to an abrupt halt when the relatively new kid on the block, Airbus Industries, established in 1970 and based in Toulouse, France, took over the lead in both revenue and number of commercial planes delivered for 2003 and continued the trend in 2004. Currently, Boeing has a goal of delivering 320 commercial planes in 2005, while Airbus is slated to deliver around 365 planes. Boeing claims that Airbus gained this advantage by receiving tens of billions of euros in governmental subsidies from Great Britain, France, Germany, and Spain throughout the years, allowing Airbus to drastically undercut any competition in price by oftentimes taking losses simply to gain market share. This action, Boeing argued, is not only unfair but also “illegal.”

Aside from taking Airbus to court, a la the World Trade Organization, what is Boeing doing to compete? According to one analyst at Bloomberg News, an interesting strategy may be for Boeing to reduce its manufacturing costs further, so as to double its profit margins from 5.5% to 10% in order to provide even more room for price discounts. This, in effect, would be an open declaration of intent to prolong the current price war. Even if Boeing could actually go on with this plan, we think it would be a bad idea.

Airbus has not only proven that it has both the gumption and the resources to carry on a price war, but it has also proven that it could win decisively as demonstrated by its records in the last two years. Because the eventual outcome of the current trade dispute between the US and the EU on behave of these two companies is still uncertain, Airbus may continue to enjoy large amounts of governmental subsidies in the long run, while it is almost definite that it will continue to have access to them in the short term.

Although Boeing also receives various grants, tax breaks, and low-interest loans, they simply do not match up well with Airbus in this regard, no matter how much additional cost cutting is attempted. Additionally, the devaluation of the dollar against the euro in the past two years that had helped Boeing maintain its low prices against Airbus cannot be counted on to continue indefinitely. Therefore, any decision on Boeing’s part to further escalate the ongoing price war would be irrational. Furthermore, let’s assume that Boeing is indeed strong enough to continue competing with Airbus on price alone. In any situation where rivals of similar strengths successively try to undercut each other’s price without being able to drive each other out of business, there can be no winners (except for the lucky customers) because every competitor suffers from the decreased profits and even increased losses.

To put an end to the price war, Boeing needs to send a clear signal to Airbus of such intentions. A good start would be to avoid undercutting its rival in the next iteration of contract bids. Instead, Boeing should aim for a similar price level as Airbus and seek out more innovative ways to positively distinguish itself. These companies must now maneuver to outdo each other in terms of perceived quality in their products.

Airbus has already sprint slightly ahead in this regard. In an industry where lack of product differentiation is the status quo, Airbus is on the verge of commercially rolling out its latest technological advancement: the A380, a giant, bi-level commercial airliner capable of seating 555 to 800 passengers (in comparison, Boeing’s largest plane, the 777, is capable of seating 368 to 550 passengers) while being “more fuel-efficient than your car.” However, Boeing has not lost the ultra-jumbo jet segment to Airbus yet, because the A380 currently has limited potential due to the incompatibility to all but the largest airports in the world due to its sheer external size and wingspan. Boeing could capitalize on this mishap by designing its own jumbo-capacity plane that is compatible with more airports.

Additionally, resources could be invested in various other areas of product innovation, such as: flight range, top speed and ease of maintenance, just to name a few. Boeing must first re-evaluate its long-term competitive strategy and decide on the corresponding direction for future product development. Regardless of the technical direction Boeing chooses, leveraging its well-known strength in R&D will be essential to its future success.

With a history of such heated competition between these two able rivals, it is not yet known who will hold the advantage for the long run. Even though Airbus currently has the upper hand, Boeing can very well reverse its fortunes by stepping away from the current price war and thinking creatively to set itself apart from Airbus. Not to do so…would just be silly business.

By Chia-Hao Han, Sachin Gupta, and David Kim


Blogger Maranello said...

I like the strategy of avoiding overt attempts at undercutting Airbus. I think Boeing can also take advantage of their presence with every major customer by commonizing future cockpits across their various airframes. This could also be utilized as a cost reduction effort (both for Boeing as well as for their customers) by reducing the level of customization that each airframe requires.

This will allow their customers that use fewer different components for maintenance, reduce the level of training for the maintenance crews, and also allow pilots to be more efficiently utilized across their airframes. The pilots will also require less additional training for certification on a different airframe if all cockpits are the same.

As for the Airbus 380, it is going to be very expensive for airports to develop the infrastructure that can handle that passenger load, and many may not want to undertake that expense. Who knows, maybe Airbus is planning on using those subsidies to help the various airports around the world upgrade so that their airframe can be put into service?

8:54 PM  
Blogger Terence Lee said...

Good points. A price war is certainly not the most attractive way to compete in this market, but unfortunately, this has been the norm more often than not. Rumor has it that Boeing cut prices very aggressively on the new 787 orders it recently won.

I have a couple of things to add. From all apperances, Airbus does have a noticeably lower cost structure. All airplanes are priced in dollars but a large part of Airbus' costs are in Euros; yet, Airbus is still able to report higher pre-R&D EBIT margins than Boeing. While it is true that Airbus is largely currency-hedged through 2006, most forecasts point to Airbus' superior margins continuing. Margins and cost cutting should be a definite focus for Boeing, but it is not clear how much benefit Boeing can derive on this front.

Politics play a huge role as well. For example, Boeing leads in terms of market share in Japan and China and is likely to continue to hold this lead going forward. Airbus, on the other hand, has greater market share in Europe and the Middle East - no surprise there.

Government subsidies (so-called "launch aid") might have been a big deal in the past, when Airbus was was developing its product portfolio from scratch, but at this point, are a relatively minor point. A380 R&D is ramping down quickly and the only major program on the horizon is the A350, which Airbus should be able to fund quite capably without outside help.

In the end, both companies make good planes that fulfill the requirements of the airlines and passengers, and the planes are very difficult to truly differentiate. Boeing's 737 is on par with Airbus' A320 family. Boeing's 777 is on par with Airbus' A340. Boeing is launching the 787, and Airbus is likely to follow up with the very similar A350. In the final analysis, a lot of decisions end up being made on price or politics, or both.

One last thing - a small correction. Boeing's largest plane is the 747, not the 777. While it ruled the jumbo category for much of the past 40 years, recent orders have been very sparse and Boeing has essentially ceded the category to Airbus' A380. The superjumbo category, while profitable for one OEM, is probably not large enough to support product offerings from both Airbus and Boeing.

Terence Lee

6:13 PM  
Blogger jcg said...

While I agree with the strategy commentary in the post, I can't help but to correct some of the details contained therein. First off, the A380 fits in an airport standard 200'x200' box, meaning that the new, huge aircraft can park at any gate that is currently suitable for a B747 (at full load, however, the A380 does need a lot of runway, which could perhaps limit the airports where it could land). Secondly, Airbus and Boeing have in the last 4-5 years taken steps to differentiate themselves. Boeing hss focused on ergonomics, efficiency, and speed (my words, not theirs) with their 777 and 787 aircraft...Airbus, on the other hand, has clearly chosen a "high-capacity" strategy. These different tacks will resonate differently in different markets; for example, airlines in SE Asia often shuttle passengers in all-coach configurations from city to city (much like United might use a 737 in the US). The A380 has special appeal here. For long-range, transpac routes, a more efficient, faster aircraft has additional appeal, though US carriers (many of whom have recently overhauled their fleets) have been slow to order the new Boeing.

10:42 PM  

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