Airbus A3XX - Developing the World\'s Largest Commercial Jet (A) PDF

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9- 201- 028 REV: APRIL 26, 2004

BENJAMIN EST Y

Airbus A3XX: Developing the World's Largest Commercial Jet (A) Aviation is a great business to be in, provided you have limitless money at your disposal, limitless confidence in your ability to get everything right the 1 first time, and limitless resolve and iron nerve. EADS (Airbus) is betting the company on this aircraft.

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On June 23, 2000, Airbus Industrie’s Supervisory Board approved an Authorization to Offer (ATO) the A3XX, a proposed super jumbo jet that would seat from 550 to 990 passengers, have a list price of $216 million, and cost $13 billion to develop. Before the Board would commit to industrial launch, the point at which significant expenditures would begin, it hoped to secure orders for 50 jets from as many as five major airlines. While Airbus had been courting potential customers for many years—in fact, development had been underway since 1990—the ATO gave the sales force permission to begin taking firm orders for the plane with delivery starting in 2006. Airbus management announced the first orders for the A3XX at the bi-annual Air Show in Farnborough, England, in July 2000. Noël Forgeard, Airbus’ CEO, reported that Air France, Emirates Airlines, and International Lease Finance Corporation had agreed to order ten, seven, and five jets, 3 respectively, and that there were another 30 orders lined up. The initial orders were a positive, though not unexpected, sign. The real question, however, was whether there was sufficient long-term demand to justify industrial launch. Management believed they would break even on an undiscounted cash flow basis with sales of 250 planes, and could sell as many as 750 over the next 20 4 years. At the time, Airbus was predicting that there would be demand for more than 1,500 super 5 jumbos over the next 20 years that would generate sales in excess of $350 billion. Given the fact that Airbus had booked more than half of the orders for new passenger aircraft for the first time in 1999, capturing more than half the very large aircraft (VLA) market with the A3XX would constitute an enormous financial success and would position Airbus as the commercial aviation industry leader.

________________________________________________________________________________________________________________ Dean’s Research Fellow Michael Kane and Professor Benjamin Esty, with assistance from Research Associate Fuaad A. Qureshi, prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2000 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

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Airbus A3XX: Developing the World's Largest Commercial Jet (A)

The Commercial Jet Aircraft Market At year-end 1999, the world commercial jet fleet consisted of 12,000 passenger and 1,600 cargo 6 planes operated by more than 400 scheduled passenger and cargo airlines. In the passenger category, large aircraft (those with 70 or more seats) accounted for 90% of annual deliveries, while smaller, regional jets accounted for the rest. The largest aircraft, those seating more than 400 passengers or carrying more than 80 tons of freight, were known as very large aircraft (VLA). With revenues of $56.5 billion in 1999, the manufacture and sale of jet aircraft was the biggest single segment of the $143 billion commercial aviation industry (see Exhibit 1). Two firms, Boeing Company and Airbus Industrie, dominated the manufacture of large aircraft. Although Boeing had recently announced a desire to expand into the $86.7 billion support services segment, both companies had historically focused on manufacturing and left support services to the airlines, component manufacturers, and other vendors. Airbus and Boeing were less active in this segment because the components that required the most maintenance and repair work, such as engines, landing gear, and electrical systems, were installed but not manufactured by them. Combined, the two firms delivered 889 aircraft in 1999, ranging from single-aisle jets seating 100200 passengers to the twin-aisle Boeing 747-400 seating more than 400 passengers. Exhibit 2 shows a market map of the Boeing and Airbus fleets. Boeing had built approximately 85% of the industry’s current fleet and had regularly captured between 60% and 70% of orders and deliveries until recently when Airbus had gained share. Exhibit 3 shows the delivery history and order status for select passenger aircraft.

The Boeing Company Boeing had been at the forefront of civil aviation for over half a century. From the B17s and B29s of World War II through the B52s of the Cold War, Boeing had leveraged its manufacturing and defense experience to become the world’s leading producer of commercial aircraft. Sales of commercial aircraft accounted for two-thirds of revenues; sales of military aircraft, missiles, and space systems accounted for the rest. Strong demand and improved operations led to a doubling of net income in 1999 compared to 1998. Exhibit 4A presents Boeing’s recent financial statements. Boeing’s unique importance for the U.S. economy as a whole, underscored by its role as the supplier of Air Force One, F-15s fighter aircraft, and the Space Shuttle, provided a basis for its political strength. In addition to being the federal government’s second largest defense contractor, Boeing was the largest single contributor to the United States balance of payments in terms of exports. In addition, it had 190,000 employees in the United States and indirectly accounted for at least as many jobs at its extensive network of vendors. Boeing’s fleet consisted of 14 models spread across 5 aircraft families, each with somewhat different technologies. The flagship of the Boeing fleet, the 747-400, held 420 passengers in the standard three-class configuration. There were, however, more than 30 so-called “high density” models operating in Asia that could hold as many as 550 passengers. Boeing’s decision to develop the 747 in 1965 was widely viewed as a daring, bet-the-company gamble on an untested product. The 747 was more than twice as big as the 707, the largest plane then operating, and Boeing had only 25 orders when it commit to build the plane. Yet when Boeing announced the initial 25-plane order, its 7 stock price jumped 5.1%. At the time, it predicted the launch would cost $1.5 billion and would 8 generate sales of more than 700 planes by 1980. Despite this optimism, the launch turned out to be very difficult and almost caused Boeing to fail:

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Boeing’s problems with the 747 sounds like a litany of the damned . . . (and almost) threatened the company’s survival . . . Boeing not only had to pay penalty fees for late deliveries, but, far worse, didn’t receive the large last installments until the deliveries were made. Deprived of an adequate . . . cash flow, Boeing found itself 9 seriously short of funds yet obliged to finance a huge inventory of partly built 747s. More than three decades later, demand for the 747 was running strong. Boeing delivered 47 planes in 1999, at an average price of $150 million per plane, and had an order backlog for 74 more.

Airbus Industrie Airbus was founded in 1970 as a consortium of the principal aerospace companies of Germany (Deutsche Aerospace, now a Daimler-Chrysler subsidiary known as DASA), France (Aerospatiale Matra), England (Britain’s Hawker Siddeley, later BAE Systems), and Spain (Construcciones Aeronauticas, CASA), and had its headquarters in Toulouse, France. Through the consortium, the partners combined their resources and technologies to produce a more competitive line of commercial aircraft. While Airbus functioned as a marketing organization, the partners developed and manufactured aircraft components individually. For example, BAE made the wings in Great Britain and DASA did final assembly in Hamburg. The host governments had significant interests in the consortium because it employed approximately 37,000 workers and provided military aircraft and space systems to them. In addition, the French and Spanish governments had direct financial interests in their member companies. As a partnership, Airbus did not publish detailed financial statements, but analysts estimated it had sales of $16.7 billion and earnings before interest and taxes (EBIT) of $0.9 billion in 1999 (see Exhibit 4A). Over time, the partnership structure had become increasingly cumbersome, and limited the consortium’s ability to reduce costs and finance growth. To address these problems, the three continental European partners merged into a new company known as European Aeronautic Defense and Space Company (EADS). The new company was launched in July 2000, with a 1.6 billion initial public equity offering (IPO). Exhibit 4B presents consolidated pro forma financial statements for EADS. The partners also planned to create a new French corporation called Airbus Integrated Company (AIC) which would assume all of the Airbus-related activities. When formed in January 2001, EADS and BAE Systems would own 80% and 20% of AIC, respectively. From the beginning, Airbus had a reputation for innovative design and technology. Its first plane, the A300, served as the platform for several derivative models with varying range and capacity combinations. By 1999, it had a fleet of nine basic models (see Exhibit 2), a customer base of 171 10 operators, and an order backlog for 1,445 planes. All Airbus planes employed “fly-by-wire” technology that substituted computerized control for mechanical linkages between the pilot and the aircraft’s control surfaces. This technology combined with a common cockpit design permitted “cross crew qualification” (CCQ) whereby pilots were certified to fly similar aircraft. For example, pilots could fly and maintain certification in several planes including the A3XX, A340, and A330. The ability to schedule flight crews interchangeably on various models led to better pilot utilization and lower training costs. These features helped explain why Airbus had received over half of the total large aircraft orders for the first time in 1999, and why a leading industry journal had recently 11 declared: “Airbus has won and will become the world’s leading producer of commercial jets.” Despite the gains in market share, Airbus still did not have a product to compete with Boeing’s 747 in the VLA market. A senior executive at Aerospatiale complained: “The problem is the 12 monopoly of the 747, which is a fantastic advantage. They have a product. We have none.”

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Airbus A3XX: Developing the World's Largest Commercial Jet (A)

The Airbus A3XX Airbus began exploring the possibility of creating a jumbo jet in 1990. Initially, Boeing and Airbus collaborated on a feasibility study for the plane, but Boeing withdrew in 1995 because the project was 13 too expensive and too risky given the uncertainty in demand. Airbus forged ahead with development and finalized the basic design in 1999. It proposed to offer a family of aircraft consisting of both passenger and cargo models. The first model would seat 550 passengers in the standard three-class configuration and could provide non-stop service from Sydney to Los Angeles, Singapore to London, or New York to Tokyo, the same routes currently served by the 747. A later, extended-range model could operate from the East Coast of the United States to either Sydney or Singapore. Both versions would have two full passenger decks and a third deck capable of accommodating baggage, cargo, and/or passenger amenities such as a cocktail lounge, an exercise room, or showers. Exhibit 5 presents an artist’s rendition of the A3XX. Compared to the 747, the A3XX would have more space per seat and wider aisles. Airbus believed these features would attract passengers especially on the longer routes. Other passengers, particularly on transpacific flights, would appreciate the safety of a four-engine plane compared to two-engine planes like the Boeing 777. From the airlines’ perspective, the plane would have the same fly-by-wire technology, flight deck design, and performance characteristics that were common across the Airbus family. Although the A3XX would have a higher list price than the 747-400, Airbus claimed the combination of increased capacity and reduced costs would provide superior economics. The operating cost per flight would be 12% more than the 747’s cost, but given the plane’s 35% 14 greater capacity, it would provide almost 25% more volume for free. According to Airbus, the 15 A3XX would need only 323 passengers to break even compared to 290 for the 747. Despite these advantages, the plane’s size posed several problems. Yet based on continuing dialogue with its customers, airport authorities, and others, Airbus believed it had solved all of them, and had begun the necessary procedures for regulatory approvals in the United States and elsewhere. The major issues were noise, emissions, turnaround time, taxiway movements, and evacuation. Airbus claimed that the noise levels would be below those of the 747 and emissions would be at the low end of the 747 range. Turnaround times would be held within the 747 envelope by using dual 16 boarding bridges and taking advantage of the A3XX’s wider aisles and double interior staircase. Airbus claimed that the A3XX would operate within existing runways and airports because it had been designed to fit within an 80 square meter box as specified by the United States Federal Aviation Administration (FAA). In fact, the FAA had recently published an “Issues Document” identifying 102 technical, physical, and safety issues in connection with the operation of new large aircraft in the United States. One key hurdle, though again one Airbus believed that it had solved, was the requirement that the plane could be evacuated within 90 seconds even if half the exits were blocked.

Forecasting Demand Because large jet aircraft took years to design and develop, required enormous up-front investment, and had useful lives of over thirty years (some thought the 747 would have a useful life of 50 years or more), Airbus and Boeing had to generate long-term demand projections. Each year they prepared 20-year forecasts for large commercial jet aircraft: Airbus published the Global Market Forecast (GMF) while Boeing published the Current Market Outlook (CMO). Exhibit 6 presents a comparison of the forecasts over the past six years. The 2000 editions agreed that there would be significant growth in the air transportation industry. Worldwide passenger traffic would almost triple in volume by 2019—Airbus forecast an average annual growth rate of 4.9% while Boeing forecast growth of 4.8% per year. Although Boeing had, at 4

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one point, cut its growth forecasts for Asia because of the regional financial crisis in 1998, both manufacturers believed that Asia would register the world’s highest growth rates over the next 20 17 years. To produce the GMF, Airbus predicted annual demand for new aircraft on each of 10,000 passenger routes linking almost 2,000 airports. The model assumed that cargo and passenger demand would track GDP growth as they had for the past 50 years. For each airline, on each route pair, the model estimated the need for specific aircraft, and compared that number against the then existing supply of aircraft. The model calculated maximum feasible frequency limits for each route based on assumptions about airport capacity, airplane speed, distance, and other factors. It assumed that all airlines would attempt to maintain market share by adding capacity as demand increased, and by increasing aircraft size when it was no longer feasible to increase flight frequencies. Exhibit 7 presents forecast growth rates for the 15 largest air travel sub-markets. Exhibit 8 illustrates a highly simplified example of this kind of analysis focused on the VLA segment. It shows how assumptions about growth, fleet retirement, and conversions to alternative planes (e.g., from the 747 to the larger A3XX) could be used to estimate the total demand for super jumbos. Airbus forecast demand for 14,661 new passenger aircraft and 703 new air freighters over the 20year period through 2019. It forecast demand for 727 new aircraft seating from 400 to 500 passengers—the mainstay of the 747 market—and 1,550 new aircraft seating 500 or more passengers. a Of this number, 1,235 would be passenger planes and 315 would be cargo planes. The GMF predicted that, by 2019, Asia-Pacific airlines would hold almost half the VLA passenger fleet, and that 18 six of the top ten airports served by VLA aircraft would be in Asia. In contrast, Boeing forecast economic growth in 12 regions in its CMO. It then used these growth assumptions to forecast regional traffic flows in 51 intra- and inter-regional markets. For example, travel within China would grow at an average annual rate of 9.0% compared to 2.8% within North America. The CMO concluded there would be demand for 22,315 new aircraft through 2019. One reason for the difference between the two forecasts was that the CMO included demand for more than 4,000 regional jets. Despite general agreement on overall growth, Boeing forecast a much smaller VLA market. The 19 CMO stated bluntly: “The demand for very large airplanes is small.” It forecast total demand for only 1,010 new aircraft seating 400 passengers or more, 40% of which would be 747-400’s (410 aircraft). Of the remaining 600 planes, 270 would be cargo planes, leaving demand for only 330 aircraft seating 500 passengers or more. More importantly, most of the demand for the larger planes 20 would not materialize for at least ten years. The disparity between the two forecasts could be traced to conflicting assumptions regarding the relative importance of flight frequency, new route development, and aircraft size. Airbus believed that increased frequencies and new routes would provide only short-term solutions to the problem of growing demand. Airport curfews, gate and runway capacity, and passenger arrival preferences would limit the ability to increase frequencies at many airports including some of the world’s busiest airports like London Heathrow, Tokyo Narita, Singapore, and Los Angeles International. As Airbus Senior Vice President John Leahy said, “The trouble is that on these long-distance flights, nobody wants to arrive at 3:00 a.m. and nobody wants to drive out to the airport for a 2:30 a.m. departure so 21 that they can have more flights.”

a The Airbus GMF defined the VLA market as consisting of passenger aircraft with 500 or more seats and cargo aircraft capable

of handling more than 80 tonnes of freight (the size of the 747 or larger).

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At the same time, Airbus did not believe that the development of new routes would provide a feasible long-term solution. Adam Brown, Vice President for Strategic Planning and Forecasting noted: “The pace of new route development has slowed sharply . . . between 1990 and 1995, the total 22 number of routes grew by less than 700, an average increase of just 1.7% per year.” Part of the problem was the difficulty of opening new airports. In fact, only 10 major new airports were 23 scheduled to open within the next 10 years and only 18 airports had approved plans for growth. An even bigger concern was the fact that new routes would not solve the problem of growth at the l...