Airbus and Boeing slug it out with rampant price-cutting June 1998

Avicious market share war is hitting profitability at Airbus and Boeing. Here Richard Aboulafia from the Teal Group completes his analysis of the jet manufacturing industry (also see Aviation Strategy, May 1998) by looking at the fierce battle in the 100+ seat market. With well over 2,500 jet aircraft on backlog and almost 800 scheduled for delivery in 1998, all the signs indicate that the industry has passed the high point of the classic boom/bust order cycle.

Yet this has been a very unusual boom, as it happened all of a sudden. 1996 was expected to be a recovery year, not a peak year, but with well over 1,000 orders (898 net orders after cancellations) it turned into a near peak year (although 1997 matched it with just over 1,000 orders, or 940 orders after cancellations).

This recovery looks different. Airlines are not really queuing up to place orders. Rather, Boeing and Airbus are aggressively selling aircraft at a discount. Jet pricing has been extremely soft, which is unusual for an upturn. Boeing’s 1996 list prices were frozen, and remained in place through 1997 — the first time this has occurred in a decade. Airbus list prices have also remained the same.

Anecdotal evidence suggests rampant discount pricing, with rumours of $18m 737s and similar prices that usually indicate a buyer’s market.

Idiotically, the 737–300/400/500 is being forced off the market sooner than expected; in an example of intra–company predatory pricing, new 737–600/700/800s offer a superior enticement. Boeing’s endless production problems are yet another sign that this jet market upturn is unique.

While some logistical problems are inevitable in an upturn, part of the problem could be the pricing pressure Boeing has applied to suppliers. Some suppliers have been unresponsive to calls for additional production capacity.

Boeing, perhaps, is re–learning the basic laws of supply and demand. Primes can pressure suppliers to cut prices in downturns, but passing discount pricing down to suppliers while asking them to ramp up production in an upturn does not work.

This largely premature and unprofitable upturn will result in future pain, and the battle for market share may result in a massive oversupply of aircraft.

This market share war badly affects narrowbodies, but the Asia crisis — blithely ignored by the manufacturers — will hurt widebody demand too. Even with minimal up–front cancellations, follow on buys and options will be slashed. And depressed prices for used aircraft, dumped by Asian carriers, will hurt everyone’s balance sheet.

There are some grim times coming, with a serious downturn after 2000 a major possibility It didn’t have to be like this When Teal looked at this market in early 1996, we concluded that things had changed. Airline orders were increasingly small, incremental and placed on a take–as–needed basis, rather than in the enormous blocks of the past. Also, production cycle times had been slashed, allowing manufacturers to respond to these orders (and deferrals) with new flexibility. In short, if people behaved rationally, deliveries could have been timed to everyone’s satisfaction, preventing a capacity glut and allowing the market’s cycles to even out.

Sad to say, people have not changed. Both manufacturers and operators want to build and receive aircraft now. Both are frightened of losing market share. On the producer side in particular, Airbus is being aggressive because it wants to take MDC’s market share; Boeing is being aggressive because it is trying to prevent Airbus from getting it and because it wants to shut Airbus out of some key customer markets. In 1997 Boeing won a key victory when Delta, the only major US MD–90 customer, signed for 737s. But given Airbus’s fierce efforts to contest this order with A320s, we will probably never know what discounted price the airline eventually paid.

Of course, some of the current jet demand is the result of profitable airlines resuming aircraft purchases after a long hiatus. But much is the result of a vicious and unsustainable narrowbody share market war between Airbus and Boeing.

This war has seen soft pricing and excessive, speculative, lessor orders — some 25% of 737–600/700/800 orders have come from lessors. In all, Boeing’s numerous write–offs — ostensibly related to production difficulties and closure of the Douglas production lines — probably hide myriad other sins. Another interesting feature of the market today is the tendency of airlines to sign exclusivity agreements, committing themselves to one manufacturer in exchange for ‘most favoured airline’ jetliner prices — American’s 1996 and Delta and Continental’s 1997 agreements with Boeing, and US Airways' 1996/1997 agreement with Airbus are examples of this trend.

The ability to offer a complete family of aircraft, able to cover the entire 100–450 seat range, provides Boeing with a unique advantage. Airbus has little hope of creating a family of products with this breadth anytime soon. This is the main reason that Boeing will continue to be the foremost jet manufacturer, with a now–institutionalised 60- 70% market share.

Boeing - a permanent first

In 1994, Airbus made headlines when it equalled Boeing in terms of aircraft orders. However, 1995 was disastrous for Airbus and saw a return to Boeing dominance. And if that year is averaged with 1994, the combined numbers indicate the usual 65%-35% split in terms of dollar value. This ratio, again in terms of dollar value, continued in 1996 and 1997.

We expect that Boeing will be number one for the foreseeable future. Boeing has the largest sales base and product line, and the only unchallenged aircraft in the world — the 747. And thanks to the 1995 777–300 and 737–600 launches, 1996’s 757–300 launch and 1997’s 767–400ER and 737–900 launch, most of the company’s currently planned aircraft programmes are underway.

Of course, being number one is tough work. In addition to the usual quality control, foreign relations, labour, sales and production line issues, Boeing must work on keeping its enormous product line current. The 737, 757, and 767 situation is solved, but the 747 needs stretching and updating. The 777 family badly needs the -200X and — 300X very long–range variants to counter the A340–500/600. And any A3XX move must be co–opted or countered. A lot of work for one firm, but a lot of opportunities for subcontractors.

Now the bad news. The market share war hurt. Boeing kept its dominance over some key customers, but instead of filling its financial coffers during this upturn, it is being drained. The company may find itself facing a particularly painful down–cycle without the cash reserves needed for new product development. And as Boeing heads into the downturn, it has been hit by a power struggle, pitting Harry Stonecipher against the Boeing establishment.

Airbus - a permanent second

The Airbus consortium has risen from a one–product niche player to become the second greatest transport builder in the world. And in replacing MDC as the world’s number two manufacturer, Airbus was the real victor in the battle for MDC’s market share, even if Boeing bought the company.

But ultimately, Airbus is going to stay where it is. The A300/310 series will end by the early years of the next century, leaving the consortium with one narrowbody and one widebody family. Becoming a single corporate entity (SCE) will make Airbus more flexible and efficient, but it will not help it to expand its relatively limited product line.

Being an SCE could actually hurt. As the consortium’s finances become more transparent, the two partners that care about return on equity (BAe and DASA) will demand just that. DASA chief Manfred Bischoff has already stated that discount pricing is seriously hurting DASA’s profitability, and that 1998’s results would be inferior to 1997’s.

For Airbus this will mean a greater emphasis on profitability, at the expense of market share and new product development — a major change. MDC never really had a chance of survival. In an industry that increasingly favours consolidation, a niche player with inadequate new aircraft development plans was doomed for some time.

The merger gives Boeing a better shot at controlling the aftermarket for the thousands of MDC aircraft still flying, but the new–build MDC jetliner business is on its way out.

In November 1997, Boeing officially killed the MD–80 and -90 narrowbodies, with production scheduled to end in 1999. The MD–11 widebody stayed alive, primarily as a freighter, and will last as long as the programme can garner enough orders to justify the cost of keeping the production line. This means two years at most.

Intriguingly, Boeing said it would pursue a dual–track approach with the MD–95, now graced with the 717 moniker. On one hand, it will study smaller versions for the 80–100 seat market, which would not compete with the 108–seat 737- 600. On the other hand, it said it would build the current 122–seat 717 model for its sole customer, AirTran. Probably, Boeing does not want the financial responsibility for killing the programme and is counting on the Airline Formerly Known As Valujet to default on its purchase. A second order, from Bavaria International Aircraft Leasing, is equally meaningless. The 80–100 seat versions will not go anywhere either.

As for the once–enormous Russian jet industry, only Ilyushin and Tupolev have products that can survive in a semi–open market. They should be able to make the Tu–204 and IL–96 projects semi–successful, at least at home. Production rates will stay relatively low.

Narrowbodies

The 100–120 seat market now consists of the A319, 717, 737–500/600, and countless paper aircraft. These products have been fighting it out, making the most of a rather limited market. In 1995 and 1996 Airbus and Boeing got into 100/120- seater predatory pricing in a big way. Boeing sold SAS 737–600s for less than $20m each, and Airbus offered its A319 to Valujet for similar prices. They are losing money, and they could not stop MDC from launching its MD95/717.

Concerning the post–Fokker 100–seat market there are two schools of thought. One is that Fokker’s collapse is great news for BAe/Avro, Boeing and Airbus for the simple reason that they get to consume Fokker’s market share. But the other school holds that Fokker operated according to the rules of the regional aircraft market, not the large jetliner market. In the former, producers artificially inflate demand by selling their products at a loss. Many regional aircraft (and Fokker) operators, if denied aircraft at marked–down prices, would opt for used aircraft — or not exist at all. So, unless BAe and the rest agree to sell their 70–100 seaters at loss–making prices, much of Fokker’s market will simply evaporate. However, enough demand (about half) will still be left to benefit the other products (the A319 and 737–600).

With regard to new narrowbody proposals, everyone has plans to develop products in this segment. Unfortunately, competition is especially fierce when the stakes are small. Aviation Industries of China (AVIC) wants to work with Airbus on its A316/317, and Airbus is willing if China agrees to pay for it. IPTN, having learned nothing from the N- 250 debacle, has its N–2130. These projects are driven by techno–nationalist fantasies, not market realities. The A316/7 has the most chance of the lot — about 10%. Other Asia products stand no chance.

The narrowbody market segment is dominated by 130–160 seat trunk–liners — the soon–to–be dead MD80/90 series, the 737–300/400 and -700/800/900 series, and the A320. The A320 has sold well, partially with the aid of financial sweeteners. Airbus aimed for market penetration first, and acquired an order book initially composed largely of leasing companies and financially strained airlines. Still, Airbus succeeded in displacing MDC in the trunk–liner market and in establishing a viable competitor to Boeing.

Despite the A320, the 737 continues to sell better than anything else in its class. The newly–launched 737 Third Generation is competing successfully with the new–technology A320, thanks in part to a decision to emulate Airbus’s sales tactics. At the top end of the narrowbody market is the 757, now challenged by the A321. Both models have a choice of engines, which is good from the customer’s point of view (financial incentives and offsets). The 757 has more service experience, range and capacity, and is 767–compatible. The A321 is cheaper to buy and operate and fits in with A320 and A340 fleets.

Fortunately, there is room for both programmes in this market, but the days of the 757’s supremacy are over. It is also threatened by the growth of the 737–800, which can carry up to 189 passengers, and the new, even bigger 737–900. Boeing is stretching the 757, moving its market niche upward. The new 757–300 will replace the 767–200, which is dead anyway. For its size, the 757–300 stretch will offer excellent operating economics.

A third competitor in this class is Tupolev’s Tu- 204. Offered with Rolls–Royce engines and western avionics (and financing), the Tu–204 could take away some A321/757 market share in places like the Middle East.

Widebodies

At the lower end are 220–260 seat widebodies such as the 767, A330–200, A300 and A310. Most of them will be overshadowed by their larger cousins, but it is still a viable segment.

Yet Airbus is partially abandoning this segment, even though this was Airbus’s original market. The consortium’s failure to update the A300 and A310 means it is counting on the A330–200 to do too much. The A330–200 is too expensive for many A300/310 routes, and the 767 looks set to inherit much of this segment. To keep the 767 relevant, and to help fight the A330–200, Boeing is developing its -400ER stretch, launched by Delta.

The 767 will also benefit from military applications. While the narrowbody competition is a source of ongoing carnage, the battle of the mini–jumbos has largely been decided. It has ended in a relatively even match — the 777 order book is slightly smaller than the combined A330 and A340 order books, but the average 777 customer is healthier, larger and more likely to place follow–on orders.

The 777 also has the advantage of commonality — 15 airlines with 777 orders also operate 747–400s, and the two aircraft share a similar cockpit. Despite the 777’s success, Airbus has stolen a lead in the long–range mini–jumbo niche. In 1997 Airbus announced the A340–500 and -600.

The ultra–long–range -500 will carry 313 passengers up to 8,300 miles. The -600, Europe’s biggest aircraft yet, will carry 375 passengers up to 7,300 miles. The two new variants have been launched by orders from Air Canada and Virgin Atlantic and are efficient designs for Pacific routes that are too thin for a 747–400. Boeing’s contender for the ultra–long segment, the 777- 200X, remains unlaunched, with American the best hope for a launch order.

While Boeing has received more than 50 orders for the 777–300, which also seats 375–400 passengers, this design is currently limited to 5,700 miles. A proposed longer–ranged 777–300X has not been defined nor launched. There are few signs of progress, and it is possible that Boeing may abandon this niche market to Airbus. The passenger MD–11 is dying, but Ilyushin’s IL–96, which is available with western engines and avionics, has entered the market.

The really large aircraft

Beyond the mini–jumbos, there is only one real jumbo jet — the 747. Production rates are quickly rebounding from their two–per–month trough. However, Boeing has cancelled its proposed 747–500/600 growth models, leaving the 747–400 in a tight range/payload spot, chased by the 777–300 (and maybe A340–600). It is just a matter of time before the 747–X concept is revived. All–new aircraft are too expensive, and the 747 needs to grow.

Airbus continues to talk about the A3XX, but funding is a problem. Airbus is unlikely to be able to raise the money with bonds and member governments will be unwilling to kick in most of the $8–12bn needed. Even if it goes ahead, the A3XX is beyond the 2007 limit of our forecast, shown on the left.