Thursday, April 21, 2005

Boeing Making a Comeback? We Don’t Think So…

In the ultra-competitive large airplane business, it appears that recent publicity is favoring a comeback for embattled American OEM Boeing. Articles from Businessweek, The New York Times, and our own classmates suggest that recent successes are an indication that Boeing’s strategy is working, and that the company is poised to reclaim its historical lead. As might be expected, Boeing has always painted a rosy picture of the competitive situation, but this time around, the company does in fact have some concrete arguments. Boeing’s forthcoming fuel-efficient jetliner, the 787 Dreamliner, has just seen a spate of orders, possibly giving it the fastest start to any major new plane. The company has been protesting European subsidies for Airbus aircraft and has threatened to take it to the World Trade Organization if the subsidies continue. And concerns over a possible delay in the launch of Airbus’ A380 have given some credibility to Boeing’s talk of an upgraded 747-400 superjumbo – the 747 Advanced.

These recent developments are interesting because Airbus does indeed have quite a lead on Boeing in terms of backlog (1,562 open orders vs. 1,354 at last count) and has won more orders than Boeing has in each of the last five years. After delivering more planes than Boeing did for the first time in history in 2003, Airbus has since maintained a comfortable lead.

In contrast with popular sentiment, we believe that Boeing’s recent performance is likely to be short-lived and not enough to reverse Airbus’ dominance.

First, a decomposition of the backlog numbers. Airbus has a clear lead in single aisle planes, with 1,111 open orders compared to Boeing’s 907. At this point in time, Boeing’s 737 is considered competitive with Airbus’ A320 family, so major shifts in order patterns are unlikely. In the twin aisle category, Boeing leads with 419 open orders to Airbus’ 297. Again, Boeing’s 777 is relatively comparable to Airbus’ A340, so neither company is going to outsell the other by a large margin in this segment. Remember though, that Boeing’s numbers include 221 orders for the 787, which has seen a sudden surge in popularity. Airbus’ A330 is viewed as a competitor that is not quite up to par, and it has not yet formally launched its true competitive offering, the A350. The A350 is expected to get the go-ahead in June and hit the market in 2010 (2 years after the 787), and the two OEMs are widely expected to split the market evenly. In fact, talk of the A350 was probably at least partially responsible for Boeing falling substantially short of its goal to obtain 200 787 orders by the end of 2004. So, while Boeing currently has the lead in this segment, the market shares will more or less even out going forward. In the large widebody segment, Airbus has 154 orders for its A380 and Boeing has 28 orders for its 747. Boeing is currently contemplating launching the 747 Advanced – but has essentially ceded the superjumbo market to Airbus (Boeing has openly acknowledged that the market for superjumbos is not large enough to support more than one plane offering). Besides, Boeing had previously investigated market demand for the 747-X (which looked suspiciously like the 747 Advanced does) and in 2001 decided against going ahead, for lack of interest.

So, the chances of Boeing regaining the lead in backlog are not high, and because backlog translates into deliveries in a fairly predictable fashion, it looks likely that Boeing will continue to trail Airbus in deliveries going forward.

Perhaps a more important point is the fact that Airbus’ dominant position allows it to comfortably maintain its market share without having to pursue overly risky or aggressive strategies. What does this mean? In this industry, it takes huge amounts of resources and risk taking to get ahead. Just look at the gamble Airbus took with the A380 – it spent billions of dollars in R&D and capital outlays to go after a segment of the market it had never played in. Airbus could do this because it went all-or-nothing and had government subsidies (so-called “launch aid”) on its side.

When Boeing announced its intention to develop the 787 (or the 7E7, as it was initially dubbed), Airbus sat back and let Boeing have a head start. After all, Airbus had the A330-200 – a viable alternative for the middle-of-the-market segment. Launching a new plane is always a mammoth undertaking because it involves understanding airlines’ needs, projecting market demand, making sunk investments, and actually getting orders for the plane. A couple of years later, after Boeing had done all the legwork to prove that the market was interested in the 787, Airbus decided to introduce its A350 in short order. The A350 will build on and offer commonality with existing A330 technology and will draw on lessons learned from the A380. And the A350 will use fuel efficient next generation General Electric engines originally developed for use on the 787. While being the second mover does ensure that Boeing will get an early advantage in booking orders, a two year wait for a possibly superior plane is not a deal breaker for many airlines.

In this high fixed cost business, volume is key, and Airbus is currently highly profitable. If anything, Airbus is going to get a boost in profitability once the A380 starts delivering in 2006. While the company has asked for up to $1.6 billion in launch aid to develop the A350, it is capable of covering the entire estimated project cost of 4 billion euros without external financing.

With both the market share numbers and the competitive dynamics favoring Airbus going forward, it seems quite possible that Boeing, recent breakthroughs notwithstanding, may be permanently relegated to second place.

From the other blogs on Boeing and Airbus, we realize this is a popular topic. We welcome any questions, comments, or debate. Brian Home and Terence Lee (former aerospace & defense analyst).

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