Case: Airbus A3XX BA 389 Strategic Management

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Case Airbus A3XXBA 389Strategic Management
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Airbus A3XX Agenda

• Economics of the super jumbo project
• Potential NPV
• Demand for Very Large Aircraft (VLA)
• Boeings Response
• Boeings choices
• Role of government
• Committing to the Project
• Real Options
• Update

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The A3XX Project

• Airbus has no product in VLA market
• Boeing monopolizes segment with 747
• Development
• 13 billion 5 years to develop
• June 2000 22 orders with 34 more likely
• The plane
• 550 seat
• Sell for 216-225 million
• Eventual capacity of about 50 per year

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Economics of the Super Jumbo Project
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How many planes does Airbus need to sell to break
even?

• How much will Airbus need to invest in present
  terms?
• At what sales level will Airbus break even?

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How much will Airbus need to invest in present
terms?
2001 2002 2003 2004 2005 2006 2007 2008 Total
Total Invested -1100 -2600 -2850 -2850 -1570 -930 -660 -440 -13,000
Tax Shield 418 846 859 872 540 272 189 105
FCF -682 -1755 -1991 -1978 -1030 -658 -471 -335
PV (Yr. 2000) -614 -1424 -1456 -1303 -611 -352 -227 -145 -6133

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What is the breakeven point for Airbus?

• Treat future sales as a stable income stream
• Value of an income stream in perpetuity

of planes per year after 2007 44
Price per Plane 225
Annual Revenue 9,900
Margin (18) 1,782
Depreciation 100
Adjusted Margin 1,882
Taxes (38) -715
Cash Flow 1,167
2007 PV 12,965
2000 PV 6,245
PV CF/(d g)
PV Present Value CF Cash Flow d discount
rate g growth rate
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How many planes can Airbus expect to sell?

• Airbus Boeing VLA forecasts for the next 20
  years diverge dramatically.
• Airbus 1,550 VLA planes (550 seat)
• Boeing 1,010 planes 747 or bigger (400 seat)
• Sees only 330 passenger planes gt 500 seats
• The companies have nearly identical forecasts for
  overall growth in passenger traffic (4.9 vs.
  4.8)
• What is the source of the different views of the
  VLA segment?

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Airbus view of the world
United States
Europe
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Boeings view of the world
United States
Europe
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Why does Boeing see a world of fragmented
connections?

• Success of Southwest in US
• Point to point travel popular profitable
• Experiencing weak demand for 747s
• 747s are a declining portion of the fleet for 13
  of the worlds top 15 airlines
• 1997-2001 data, Exhibit 9
• Is this because the 747 is an older model, or
  because customers are shifting to smaller
  long-range planes?
• Boeing has substantially lowered its VLA
  forecast.
• Total market of 330 is well below Airbus
  breakeven
• Is the lower forecast a strategic move?

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Why does Airbus see a future of hub to hub travel?

• Capacity constraints at major hubs will limit a
  profusion of new connections.
• New routes grew only 1.7 annually from 90 to
  95
• Few new airports opening
• Fewer secondary destinations in Asia, where
  traffic growth is strongest
• No matter what, more capacity will be needed
  between major, congested hubs
• Airlines themselves arent sure.
• United a lot depends on cost
• British Air Im not inclined to go ahead unless
  it really can be demonstrated that this equipment
  can produce the kind of savings we need to
  justify it.

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How reasonable are Airbus forecast assumptions?

• Key assumptions growth conversion from 747

Conversion Rate
45 55 65 75 85 95
5 531 595 659 723 787 851
6 658 741 824 908 991 1,075
7 809 916 1,022 1,129 1,235 1,342
8 90 1,124 1,258 1,392 1,527 1,661
9 1,206 1,373 1,540 1,707 1,874 2,041
10 1,436 1,669 1,876 2,082 2,288 2,494
Growth Rate
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Boeings Response
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How can Boeing respond?

• The 747 is probably the core of Boeings
  profitability
• 1999 Sales 47 150m 7 billion
• 20 margin 1.4 billion
• 42 of Boeings 1999 EBIT!
• Boeing is in an operational and earnings crisis
• 1997 first operating loss in 50 years
• Our manufacturing is broken
• Renewed emphasis on shareholder value

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Boeings Potential Responses (1)

• Collaborate
• Could Boeing revive the alliance to develop a
  super jumbo?
• Anti-trust problems
• Could cannibalize 777 demand
• Boeings mid-size, long-range jet for fragmented
  market
• Probably too late to revive an already tricky
  relationship

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Boeings Potential Responses (2)

• Develop a competing super jumbo
• Cant dominate VLA market with a 1960s plane
• Has debt capacity to pull off such a huge project
• Could use a WTO complaint over Launch Aid to slow
  Airbus.
• But
• Most expensive option
• Profitable?
• Already lost first mover advantages of reputation
  relationships
• Stock fell when it announced a stretch 747, how
  would shareholders react to a 13 billion VLA
  investment?

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Boeings Potential Responses (3)

• Build a Stretch 747
• Cheaper (4 billion) and quicker than a new VLA
• Close to A3XX in seat capacity (520 vs. 550)
• At least Airbus wont have a complete lock on
  this segment
• But
• Revamped 747 still based on older technology
• Probably accepting 2nd place in a high status
  market
• Draws investment away from the 737, which is
  losing ground to Airbus A320
• Shareholder value? Stock falls every time they
  announce this.

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Boeings Potential Responses (4)

• Cut Prices on 747
• Would move Airbus breakeven to more than 50
  planes (greater than planned capacity).
• 15-20 margin on 747 gives some room to cut.
• But

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Should Boeing get into a price war with Airbus?

• Why might Airbus be a formidable opponent in a
  price war?
• Deep pockets
• 4 partners
• 4 government backers
• Government support

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What is governments role in Airbus?

• Ownership
• EADS partners Aerospatiale Matra CASA are owned
  by the French and Spanish governments,
  respectively. (Exhibit 4B)
• Demand
• Many European governments control national
  carriers, which are key customers for Airbus
  Boeing.
• Both firms also compete for defense business.
• Subsidy
• Launch fees are advantageous financing for
  industry.

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What would happen if Boeing or Airbus were close
to bankruptcy?

• Strategic importance
• Economic Jobs Production
• A3XX project estimated to protect 28,000 jobs in
  UK alone.
• Boeing is often the largest single component of
  US exports
• Strategic
• Europe US dont want to be completely dependent
  for air transport
• Military technology
• Home governments probably would not let these
  companies fail.
• Bottom Line a price war with a government-backed
  company with deep pockets is not profit
  maximizing.

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Committing to the Project
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What Real Options can Airbus Consider?

• Option to Stage No
• The demand uncertainty that Airbus faces cannot
  be resolved until the firm is actually building
  and selling planes.
• Staging is unlikely to create much value.
• Option to Wait No
• The demand uncertainty that Airbus faces cannot
  be resolved until the firm is actually building
  and selling planes.
• Waiting is unlikely to create much value.

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What Real Options can Airbus Consider?

• Option to Abandon No
• Most of the development costs will be specialized
  to the VLA market segment.
• Assets are unlikely to have much transfer value
  if the project is abandoned.
• Option to Grow Yes, somewhat
• Production capacity is constrained to 50.
• If demand is higher than expected, additional
  models could be developed to capture it.
• 650 seat version, 750 seat version

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Airbus Wrap-Up

• A3XX Risk Return
• Present cost is reduced by staging and tax
  shield.
• Demand depends on scenario for industry
  evolution.
• Airbus needs to sell close to capacity to break
  even
• Prestige efficiency of super jumbo could help
  Airbus supplant the 747
• Success depends on Boeings response
• Competing pressures of shareholder demands and
  aging product base.
• In large industries, strategic actions
  interactions are influenced by governments
• Project setting offers few real options most
  information revealed after completion

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Airbus A3XX Update
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Developments since 2000

• A380 launched in 2000 with roll-out in 2006.
• Budgeted 10.2 billion for development
• Total orders up to 95 by October 2002
• FedEx is first US customer for A380
• Successfully ended Boeings monopoly many
  carriers splitting large scale orders between
  A380 747
• Airbus is eating Boeings lunch
• Order backlog of 1,700 compared to Boeings 1,200
• Deliveries should surpass Boeing in 2003
• Leaner more flexible than Boeing 75 of
  employees more subcontractors
• Boeing charges sales are won with steep discounts
• Easy Jet (Euro low-cost) switched to Airbus for
  30 discount

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Developments since 2000

• Boeing struggling with operations, aging
  products.
• Boeing gone from 80 market share in 92 to less
  than 50 in 2001-2002.
• Boeing deliveries down 28 in 2002 (527 to 380),
  2003 will be under 300
• Cut production by nearly ½ laid off 30,000 (1/3
  of commercial aircraft workforce)
• 2001 operating margin down to 10.5 vs. Airbus
  16.5

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Still, the two fly in tandem