Executive Summary In fierce competition with Boeing, venture into VLA segment – as a rather neglected segment by Boeing – could pose as a strategic opportunity for Airbus which it could utilize to build a competitive advantage combined with its technological resources and capabilities. However, its assumptions of a drastic increase in VLAs demanded in next 20 years along with its ability to satisfy most of this are too optimistic. Provided that these assumptions (inc. reakeven points, initial order requirements) are normalized, A3XX is a project worthy to pursue for Airbus in order to exploit a neglected spot on the perceptional map – long-haul + big capacity. When we hold the market itself continues to grow as proposed in the case, this can be win-win case for Boeing as well, which can concentrate on its existing operations. When we look at the category, Airbus’s venture of A3XX into the existing market of commercial jet aircrafts is an example of product development.
As of end of 1999, when we say commercial jet aircraft manufacturing and sales market, we’re talking of an oligopolistic $56. 5 billion market, which is expected to double by 2019. It is evident from the case that this is a highly regulated market, both by national and international institutions, where states are among the major stakeholders (direct investments by states, employment creation, military affiliations, launch aid restrictions, etc. ). However, due to investment intensive (R&D, capital) nature of the market, projections – esp. nes concerning launches – need to be comprised of accurate net present value calculations (as opposed to undiscounted cash flows) which in turn are based on realistic demand forecasts. Given the admonitory cases of Boeing 747’s initial launch disappointment (yet later reversal of fortune) and the “faithfully departed” due to failing launches, to predict in this market is particularly hard. We can also bear in mind the market’s linkage to tourism, an industry with demand highly vulnerable to external effects, if we want to reinforce this assumption.
What we know though, both the players see a sustainable annual growth of approx. 5% in passenger traffic over the next 20 years. An important point to note is that aircraft support services constitute a bigger portion of the commercial jet aircrafts market, so Airbus, like its counterpart, could consider the possibility of vertical integration (backward: manufacturing of engines, parts, training, maintenance, etc. ; forward: used airplane remarketing) as a more secure means of cost efficiency & increased profits.
In terms of issues related to the company, it can be said that, with A3xx, Airbus is on the verge of adding a new product line to the existing category of commercial jet aircrafts, VLA. In the VLA market, Boeing almost had a monopoly with 747s. Airbus wanted to shake it with a product, more advanced in capacity and technology, suited well to its already established image of being innovative in design and technology (thanks to “fly-by-wire”, CCQ technologies). The initial problem could be seen with the product’s positioning; as a result of conflicting strategies presumed to be followed by Airbus.
A3xx is a differentiated product more technologically advanced (e. g. four engines as opposed to two), has superior design (e. g. triple-decker, more space per seat) option for augmented services (lounge, showers, etc. ). With this feature it tries to appeal to serving long-haul travelers and particularly “high yield” travelers. The price is proportionately more expensive. Airbus, on the other hand, stresses on the cost efficiency paradigm (lower breakeven point with 323/550=59% load factor as opposed to Boeing’s 290/420=69%) due to increased capacity.
However, increased capacity is only meaningful with increased occupancy after breakeven point and if the demand doesn’t guarantee a proportional increase in load factor, paying almost 50% more for a VLA (747 at $150mil vs. A3XX at $216mil-$225mil) does not necessarily mean increased efficiency for customers. The internal rate of return of 15% to 20% (plus a possible 1. 5%) seems well above the discount rate that is the opportunity cost based on the formula real risk free rate of return (based on bond rates and inflation) + Beta * Risk Premium (Market Risk premium – Risk Free Rate).
We don’t have a market risk premium value at hand for aviation sector but even if it is 15% – the rate of return Airbus presumes – then 3. 9% + 0. 84X(15-3. 9) = 13. 2. So the project seems feasible. However, when we apply the operating margin of 15%-20% as the source of cash flow per plane, we see that from 288 to 385 planes would be needed for a breakeven to compensate investment costs. If we also take into consideration of the fact that these payments will not be made all in the first year, each cash flow will need to be discounted based on real interest rate (3. 9%) and the year in question.
We can easily say, if the plane price is not appropriated accordingly each year, the breakeven point will go even farther away from what Airbus imagined. As for competition, Boeing had built approximately 85% of the industry’s current fleet, which indicates the high experience and brand awareness of Boeing in the industry, which is a competitive advantage in terms of strong service level. 747-400 is the only model that can be seen as an alternative to the new Airbus VLA models. Boeing’s 747 launch case indicates that this kind of decision to make for Airbus should based on long term projections.
It can be seen as unnecessary for the industry in the short-run but when the growth figures are considered, it can be easily said that in the future it would be a must for airlines in order to get cost advantage. The main competitive advantages of airlines are its unique technological capabilities such as “fly-by-wire” technology and “cross crew qualification” (CCQ). Despite the gains in market share, if Airbus do not develop a model in VLA segment, they would lose a big competitive advantage since they are also behind Boeing in small and medium sized aircraft segments.
The 747 family constitutes a monopoly in the large aircraft segment, in which Airbus doesn’t exist. The Boeing 747 can currently provide non-stop service in the same routes that A3XX can do, therefore Boeing saw VLA market as unnecessary. The lack of attention by the main competitor is an opportunity for Airbus, since it can gain the first mover advantage without any stress of being second in this strategic move. The capability of accommodating baggage, cargo, and/or passenger amenities is an important advantage for A3XX compared to B747’s since better passenger satisfaction can be managed with this kind of comfort attributes in long routes.
As for Boeing possible retaliation, Boeing would likely respond in one of four ways: it could develop a stretch version of the 747 (the 747X), cut prices on the 747, develop a competing super jumbo jet, or ignore the potential threat. Boeing could respond Airbus’s attempts with introducing a stretch version of the 747 (the 747X, that has over 500 seats) that has similar properties with A3XX. This launch would provide Boeing not to lose competitor advantage, because if they do not do this, they would be out of this segment in the future.
Cutting the cost of current 747’s is not a feasible response since this response is an indicator of accepting the threat and so the supremacy of A3XX. Besides that, it is estimated that Asian airlines would shift to VLA segment because of high fixed costs. Therefore in order not to be deprived from Asian market, Boeing should response with an incremental solution (not a new-from scratch one, not to have financial risks). The main customers of aircraft companies are airlines, which have a highly competitive industry that is both capital and labor intensive.
The recent emergence of low cost budget carriers (EasyJEt, Northwest etc. ) have put high pressure on traditional long haul carriers, who are the biggest customers for large capacity aircrafts, manufactured mainly by Boeing and Airbus. Therefore cost has become the main concern of airlines. Therefore, most possibly airlines would buy the A3XX for its operating advantages and passenger appeal. In addition, Airbus felt confident in its analysis that capacity increases would eventually prevail.
Due to the huge growth of air traffic over the years, the congestion problem along many routes and especially at major hubs will worsen indirectly supporting the need for the A3XX. While the customers of the A3XX airplane are the major airlines, the actual consumers are airline travelers. In this respect Airbus provides options to segment the consumers into 2 or 3 classes based on services and different comfort levels. The plane can be configured to seat up to 853 passengers in single economy class configuration or 525 passengers in a three first, business and economy class configuration.
The extensive amount of space inside the plane means extra amenities for travelers such as duty-free shops, restaurants and bars. Such comforts have never existed in traditional narrow or wide-body planes before. When we look at the culture, air travel can be generally regarded as a sector in which little innovation is made in terms of the traveler. For decades airplane designs, seating and in flight services have not significantly changed. In fact, the only two areas of innovation in the aircraft industry seem to be speed and capacity.
The Concorde can be an example of the former and the Boeing 747 is an example of the latter. Consequently the consumer’s expectations and therefore bargaining powers are limited since many competing airlines operating different planes offer very similar services. Alternatives & Recommendations One alternative is to launch the project with 50 orders secured as one fifth of the sales needed to breakeven. Other alternative is simply to abandon the project in the face of high demand related risks, bad examples and regulatory concerns.
Investment in vertical integration to capitalize on the larger segment of the commercial jet aircraft market (that is aircraft support services) could be pursued instead The data presented in the case allows us to see that many expectations of Airbus in relation to the growth of the airplane market are similar to that of Boeing. The only difference is that Airbus assumes the importance of large airport hubs will remain strong while Boeing assumes smaller and secondary airports will rise in importance together with direct flights rather than connecting flights. Boeing does not have a lot of viable options against the A3XX.
Being more economical in the long term, operators using the 747 for both its economy and long range will most likely completely abandon the 747 in favor of the A3XX. A stretch or a re-engineered version will likely not be popular since the plane has already been in service for over 40 years. It would be best for Boeing to take no action and instead focus on its other smaller planes, making them more efficient and comfortable. As for Airbus, we believe that the launch should be done but on a different level of secured orders. Increase in VLAs can be a profitable form of absorbing the increasing passenger traffic.
However, they have overestimated the market of the A3XX. According to our estimations, on average, Airbus might need 40% more sales to break even than what it presumes now. Consecutively, a 40% increase in minimum orders (that is 70 orders) should be required prior to launch. Today in 2009, they have sold 200 planes and have revised their breakeven estimate from 250 to 420 planes due to cost overruns, delays and problems with the extensive amount of wiring. However, there is a possibility that this plane will become a cash cow in 20 or so years just like the 747 was for Boeing.