© 2006, I.P.L.

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Airbus v. Boeing
Until 2001, Airbus was a marketing consortium established under French law as
a “Groupe d’Intérêt Economique”. The four shareholders – Aerospatiale–Matra
(37.9%), British Aerospace (20%), Construcciones Aeronauticas (4.2%) and
Daimler Aerospace (37.9%) – performed dual roles as owners and industrial
contractors.
Most major decisions required unanimous approval of the shareholders. Airbus
was obliged to distribute production work among its shareholders according to
political as well as economic considerations.
Then, Airbus was re-organized into a single fully integrated limited company.
The objective was to streamline operations across national boundaries, reduce
costs, and speed production.
The re-organization coincided with a consolidation of Airbus market position. As
Figure 1 shows, from 31% in 1996, Airbus had steadily increased its share of the
market to 57% in 1999, but then dipped sharply to 47% in 2000. Following the
re-organization, Airbus recovered and maintained its share in the mid- to high
50s until 2005.
In April 2004, Boeing launched the new 7E7 Dreamliner jet with a firm order for
50 aircraft from All Nippon Airways of Japan. The deal was worth about US$6
billion at list prices, with deliveries scheduled to begin in 2008.
Eight months later, in December 2004, following considerable speculation, Airbus
announced that it would develop the A350. This would compete with the Boeing
7E7 in the market segment of twin-engine medium to long range jets with
capacity of 200-300 passengers. Airbus Chief Commercial Officer John Leahy
predicted that the A350 would attract a substantial number of Boeing customers
and “put a hole in Boeing's Christmas stocking”.1
Boeing subsequently renamed 7E7 as the 787. It is a completely new design,
with development cost estimated to be $8-10 billion. By contrast, the A350 is a
derivative of the existing A330, enhanced with a new wing, more fuel-efficient
engines, and other new technologies. The development cost would be just 4
billion Euros (equivalent to $5.3 billion).
Besides the development cost, aircraft manufacturers also incur substantial costs
to manufacture the aircraft. The manufacturing cost is driven by an “experience
curve”. As engineers and workers gain experience in production, they devise
new processes to reduce cost. As Figure 2 shows, the experience curve in
aircraft manufacturing flattens out once cumulative production reaches the
hundreds of units.
Airbus and Boeing must set prices for aircraft based on projections of unit costs.
Owing to the experience curve, these projections depend critically on forecast
sales. If the sales fall short of target, unit costs will be higher than planned, and
the manufacturer may incur a substantial loss on the plane.
By December 2004, Boeing had secured 52 firm orders for the 787 (7E7), far
below its target of 200 by that time. Richard Aboulafia of industry consultant Teal
1 “A350: Airbus's counter-attack”, Flight International, January 25, 2005.
Group remarked that Airbus had succeeded in its goal of “disrupt[ing] the
business case for the 7E7”.
Northwest Airlines is one of the world’s largest airlines. However, since 2000,
the airline has consistently incurred losses. In 2004, Northwest’s operating loss
was $505 million and net loss was $862 million. Yet in May 2005, it placed a firm
order for 18 Boeing 787s, worth approximately $2.2 billion at list prices, plus
options for 50 additional planes. The first planes would be delivered in August
2008, with 6 planes delivered in each of 2008, 2009, and 2010.
A sharp and sustained increase in oil prices has hurt Northwest and other
airlines. Yet, amidst continuing losses, Northwest is buying new planes. Why?
Investment decisions are forward-looking. Current losses are sunk costs.
Airlines believe that higher oil prices will persist, so it is important to buy more
fuel-efficient aircraft for future operations.
Table 1 shows that, while Northwest and United operate a mix of Airbus and
Boeing aircraft, American and Delta concentrate on buying Boeing planes.
Why? One reason is economies of scope in maintenance, repair, and training.
An airline can reduce these costs by concentrating its fleet with one
manufacturer, but not across manufacturers.
Airbus has emphasized that the high degree of commonality among its various
models provides airlines with substantial savings in crew training and
deployment. Chief Commercial Officer John Leahy remarked, “The A350 goes
up on the ramp in 2010, and you’ll see pilots walking over from 330s without any
training and flying it, walking over from 340s with just a very short transition
course lasting a couple of days ... It fits right into the Airbus family.”3
2 “Airbus pushes ahead with rival to 7E7”, Seattle Post-Intelligencer, December
11,2004.
3 “AF&NM interview: John Leahy, chief commercial officer, Airbus”, Airline
Fleet &
Network Management, November/December 2005, 62-65.
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Discussion Questions
1. Suppose that there is demand for 500 units of the Airbus A350-Boeing
787 type of aircraft, and that the selling price of each plane is $110 million.
Assume that if Airbus manufactures the A350 and Boeing manufactures
the B787, then each will sell 250 units, while if only one manufacturer
enters the market, it would sell 500 units. Further, assume that there is no
experience curve and that the manufacturing cost is fixed at $85 million
per aircraft. Use a game in strategic form to identify the pure-strategy
equilibrium(ia).
2. Is this a situation of first-mover advantage? Please explain your answer.
3. How does the experience curve affect the strategic situation? Please
explain in qualitative terms.