Thursday, May 05, 2005

Does the battle go to the biggest or the quickest?

On April 27th, thousands gathered in France to see the Airbus A380 take its maiden test flight. Three months earlier, over 10,000 people; including the heads of state of Spain, Germany, the United Kingdom, and France; all converged on Toulouse to see the unveiling of the A380. Airbus has spent nearly a decade and over $13 billion to bring the Airbus A380 to market; similarly, Boeing has made comparable investments on its next-generation aircraft, the 787 Dreamliner. An earlier blog (“Boeing Making a Comeback? We Don’t Think So…”) looked at the profitability prospects for each company while another blog (“Boeing’s 787 is Shooting-down Airbus’ A350, recent events in the jetliner rules”) very briefly touched the future industry characteristics which might emerge. Our blog will address how these new planes represent distinctly different views on the future of commercial aviation and which of those views will prevail.

Different views of the world
The A380 is the world’s first full double-decker, superjumbo airplane. It can seat over 555 passengers (as compared to the 747, currently the world’s largest jet which has a 416 passenger capacity) with similar speed and range capabilities as current jumbo jets. The Dreamliner will be the world’s first jet to combine the faster speed and intercontinental range of a jumbo jet with a mid-sized fuselage; it will seat 241 passengers.
The most striking differences between the two planes is size: the A380 is very large while the Dreamliner is a modestly-sized, medium-body jet. This primarily reflects Airbus’s bet that the current hub-and-spoke routing system will continue to dictate air travel, while Boeing is betting air carriers will adopt point-to-point routing systems going forward. To see this, let’s look at a hypothetical traveler, Joe. Joe lives in Phoenix and needs to fly to Nanjing, China.
In today’s hub-and-spoke world, Joe will fly from his home airport, a spoke; to a hub; then to another hub; and finally to his destination, another spoke. Joe would fly from Phoenix to Los Angeles, then Los Angeles to Tokyo, and finally Tokyo to Nanjing. Traditionally, only jumbo jets have had the range to make intercontinental flights (the LA to Tokyo segment in Joe’s case). Since jumbo jets require many passengers to fly profitability, hubs are necessary; an airline must consolidate all its intercontinential passengers into its hubs and onto a single, large flight. Airbus’s bet is that hub-to-hub flights will need to have increased capacity, hence the A380 will allow airlines to fly the same number of flights but increase their seating capacity by 33%.
In a point-to-point world, one or more of those hub flights will be eliminated. Ideally, Joe would fly direct from Phoenix to Nanjing; however, a route from Phoenix to LA to Nanjing or from Phoenix to Tokyo to Nanjing would certainly be an improvement in Joe’s eyes. Traditionally, no airline would offer a Phoenix to Tokyo flight since it would have to use a jumbo jet because of the distance, but there isn’t the demand in a city like Phoenix to support a 400+ seat plane. The Dreamliner will allow airlines to support intercontinental city-pairs which do not have the passenger demand to support a jumbo jet, but which could support a medium-sized plane.

Who will win?
The fundamental question is which airplane manufacturers’ version of the future will take hold. A typical traveler like Joe would clearly prefer a point-to-point flight, however, this has historically not been an option. Today, there are 12 U.S. airports that have direct flights into Tokyo, all of which are hubs. Any travelers not residing in one of those hub cities will need to make transfers in one of these hubs to reach Asia. While most of the non-hub cities will not have any demand to support a 400+ passenger route, many could probably support a 200-300 passenger route thanks to the technological advances embodied in the Dreamliner.
Southwest Airlines, far-and-away the most profitable major US airline, has proven that a point-to-point strategy works. As the world continues to experience economic growth, something especially true in Asia, there will be an increased demand for point-to-point routes. Today, there is no direct flight from Mumbai (the largest city in India) to Shanghai (the largest city in China). The Dreamliner will directly connect these and many other city-pairs which in the past have not been able to support a jumbo jet. It will now be possible to implement Southwest’s point-to-point strategy on an international scale now that there exists a mid-sized, long-range plane (Southwest’s fleet until recently was composed entirely of mid-sized 737s).
Industry analysts are divided on which view will prevail. An earlier blog (“Boeing’s 787 is Shooting-down Airbus’ A350, recent events in the jetliner rules”) pointed out that A380 orders have been high with 154 so far, which could lead one to believe that the jumbo jet and the current state of hub-and-spoke will win out. At a list price of $285 million, that would imply potential future revenue of $44 billion. Airbus, however, is well known for price discounting, which could imply that to garner an attractive return on investment it will need more than the 250, stated number of planes needed to breakeven.
Some of the airlines are taking a “wait-and-see” attitude, according an airline industry consultant. This could hurt the A380 demand, especially if Airbus suffers delay in production as it recently announced. Another concern is many airports is the need to incur significant costs to accommodate the new A380. Atlanta’s Hartsfield International Airport, the busiest in the world, has publicly stated that it will not upgrade its airport, and only few airports in countries in Asia can be quickly upgraded. As of today, Boeing has gained traction in the mid-sized jet market with 237 orders for its Dreamliner. Maybe it is too soon to herald the demise of the hub system. However, the market for direct flights and the potential uncertainty surrounding the future performance of a new jumbo jet, A380, leads us to believe that the future of air travel will be based on a point-to-point routing system dominated by long-range, mid-sized planes.
Andrew van Fossen and Jim Wu

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