Boeing Aircraft Company - Case Study Example

A Paper in Managerial Economics THE BOEING AIRCRAFT COMPANY The Jet Aircraft Manufacturing Industry The world jet aircraft manufacturing industryhas a duopolistic market structure for it has just two major players consisting of Boeing, which is headquartered in the United States, and Airbus Industrie, which main offices and major facilities are located in Europe. The industry is extremely capital intensive, technologically advanced, and operationally complex. The fixed costs are astronomical; for example, Boeing required $5 billion to develop its 777 aircraft. This year, it has pushed the technological frontier with the development of its 787 aircraft, planned to be launched in the middle of this year and commercially available in 2009. Today, in order to break even, an jet aircraft manufacturing firm needs to sell 350 units of the aircraft to recover its development and production costs and thus break even. Because of such tremendous amount of fixed capital requirements, experts believe that the world can support at most only 3 manufacturers. However, as the first entrants in the industry, both Boeing and Airbus get a lock on the economies of scale and discouraged subsequent entry of other competitors. Back in the 1990s it was estimated that the world demand would be something in the scale of 1500 aircraft of the 300-seater type over a period of 10 years from 1995 to 2005, so that if the firm had to sell 50 aircraft average per year or 500 over this period just to obtain a reasonable return on its investment. The Major Players: Boeing and Airbus At the beginning, Boeing had to step in the shoes de Havilland Comet in the 1950s, when that aircraft company had frequent accidents. Boeing took over and compiled a good safety record although it was not the first entrant in the industry. Boeing built on its advantages and obtained US government support for its research and development program. Boeing, located in Washington, U.S.A., is the worlds largest manufacturer of commercial jet aircraft, and today controls nearly two-thirds of the worlds market, down from its former positional advantage of a 2:1 dominance.. It is recalled that as part of a strategic industrial strategy, the US government provided substantial research and development grants to Boeing in its early years, specifically in the 1950s and the 1960s, to help the domestic firm compete in the emerging market for jet passenger planes in Boeings favor. After recently merging with McDonnell-Douglas the company has diversified more intensively its production of aircrafts and related products for military use. The government has no longer found it necessary to provide significant assistance when Boeing took off on its own. It did not have to counter the European subsidy of its major aircraft manufacturer to protect or advance the interests of Boeing. Prior to 2007, the firm was faced with the problem of aggressive competition from Europes heavily subsidized Airbus Industrie, as well as with a subdued global market. In the 1990s major airlines were faced with limited prospects for expansion, primarily because of financial constraints, and so they tried to lengthen the economic life of their aircrafts instead of buying new ones. At the same time, those airlines which planned to replenish or expand their fleets capabilities tried to play the companies against the other in an attempt to bargain down the prices of commercial jet aircraft. Because there was little to differentiate the product of one company from the other the economic situation demonstrated a case of substitutability whereby if one company such as Boeing raised its prices, airline companies would run to Airbus Industrie for their orders. Thus these two major aircraft manufacturers would have to compete by way of price reduction instead of product differentiation. Boeing dealt with this challenge before the turn of the century by managing down its cost structure. This involved the make-or-buy decision and the possibility of outsourcing the manufacture of some aircraft parts, whether in the United States or abroad. If it chose outsourcing it had to be certain that it would be a cost-effective alternative; at the same time it had to be cautious about which parts had to be subcontracted as it did not want to lose its long-term competitive advantages. (Hill, 2001). For example, the subcontracting of aircraft wings would be out of the question in view of possible giving away of valuable technology to potential competitors. Also Boeing had to avoid over-dependence on one supplier for critical components, which could endanger its long-term operational viability. As a market strategy, Boeing considered this alternative of outsourcing as part of a marketing strategy, whereby the production of certain components to subcontractors, say, in China, would help the company secure future orders from that country, assuming that its main competitor, Airbus Industrie, had not done it first. As a first step, Boeing subcontracted insulation blankets for 737 and 757 aircraft to Mexico. Such an outsourcing strategy would save the company hundred of millions of dollars and would enable it to reduce its price to compete more effectively without sacrificing profits. A major subcontractor that manufactured 777 engines, GE had to invest $2b to create a new engine instead of re-modeling existing ones for a third of the cost. It is estimated that the subcontracting policy saves the company about $600 per year without sacrificing quality. On the other hand, Airbus Industrie was established as a consortium of four companies arising from a strategic industrial policy involving several countries in Europe- Germany, France, and Spain - in order to compete with Boeing. When it began production in the 1970s Airbus had less than 5 per cent of the world commercial aircraft market .According to the U.S. government, these sponsoring governments provided $13.5 billion in subsidy to Airbus, without which it would not have been able to break into the world market (Krugman, 1991). Just 10 years after its official launch, Airbus Industrie had achieved 26 per cent market share in dollar value. By the late 1990s it had increased its share to about 40% and threatening Boeings dominance. In order to boost the competitiveness of Airbus, these governments have been continuously providing large amounts of subsidy to the European aircraft manufacturer. In terms of technological development and sophistication, Airbus does not appear to lag far behind Boeing. In fact, it may have profited from the technology developed for the supersonic Concorde, which had been scrapped for being commercially unviable. Although the company succeeded to produce and market commercially viable planes through its A300 wide-bodied medium range passenger jets, and has even made inroads in the North American market, its production costs have been significantly higher than those of Boeing and there seems to be no light at the end of the tunnel. Its aircrafts are able to compete with those of Boeing in terms of quality, but the firm has not been able to rationalize its bottom line. Its apparent success in the past to encroach upon part of the market share of Boeing has been accomplished at the great cost of a deplorably poor financial performance. Airbus, now a subsidiary of European Aeronautic Defense and Space Company (EADS), operates in Europe, Africa, the Middle East, Asia-Pacific, and Americas. It is headquartered in Blagnac Cedex, France. The company recorded revenues of E25,216 million during the fiscal year ended December 2007 (an increase of 0.1% over 2006), whose dollar equivalent is $37 billion at the then exchange rate of $1.47 to the euros. The company recorded operating losses of E881 million in 2007, equivalent to $1.3 billion in US value, compared to an operating losses of E572 million, equivalent to US$840 million, in 2006. Airbus Industrie can only continue operations if propped up by its sponsoring states, and indirectly by the taxpayers of those countries. Marketing Strategy Both companies use the outsourcing strategy to spread out component parts production to many parts of the world. Airbus has subcontractors through a global network of 1,500 suppliers in 30 countries. It has center for engineering design in North America and in Russia, as well as sales and customer support centers in Japan and China.(Airbus – Corporate Information) Boeing sells commercial aircraft as well as military aircraft and components under its integrated defense systems and these are sold not only in the United States but also in Australia, Italy, Japan, Turkey, India, and Korea. Its buyers come from 90 countries and it has presence in over 70 countries, a number of them having suppliers providing component parts for Boeing aircraft. Issues: Comparative Performance, Market Structure and Subsidy Policy Boeing has been quite profitable. It continues to dominate the market for passenger jet aircraft, in the process using its massive financial resources to keep ahead of its only competition through an ambitious research and development program and pioneering innovations. Boeing had revenues of $66 billion in 2007, from 61.5 billion the previous year. It had profits of $4.07 billion compared to $2.2 the previous year, an increase of 85 per cent. Comparatively speaking, with $37 billion in revenues by Airbus and 66 billion by Boeing, for the total combined volume of $103 billion, Boeing had 64% share and Airbus 36% - showing a ratio of 1.77 to 1 in favor of Boeing. The previous years ratio had been 1.65 to 1. It would be ludicrous and unnecessary to compare Airbus Industries massive $1.3 billion in losses to the remarkable profit performance of Boeing. As stated earlier, the market structure is that of a duopoly. This is not, however, a stable or permanent one. As mentioned by the chairman and CEO of Boeing, Mr. W. James McNerney Jr., ". . . Boeing and Airbus will not be alone forever. With encouragement from their governments, other companies are developing or building commercial airplanes at or near the lower end of the size range served by our airplanes. This includes companies in Japan, China, Canada, Russia and Brazil. We must be prepared for a future in which there could be more than two producers of large commercial airplanes."(The Boeing Company) Another issue pertains to continuing subsidy to a jet aircraft firm. The question of a possible U.S counter subsidy has sometimes been raised, but is a moot and academic under the present circumstances. From a theoretical perspective, if the United States responds to the European export subsidy of Airbus with a matching subsidy of its own, both American and European taxpayers would bear the burden of such subsidy, and if the there is a reprisal from the other party, then a trade war could ensue which would leave both countries worse off than before. Of course, the purchasers, the airlines, would stand to benefit from the trade war. The appropriate strategy, according to economist Paul Krugman (1991) of MIT would be a hands-off policy on the part of the United States, not retaliation. Then it could go to the World Trade Organization (WTO) in order to help establish and enforce the rules of the game to minimize trade-distorting subsidies. (Krugman, 1991) Conclusions This paper has dealt with the unique structure of the global jet aircraft manufacturing industry, which has just two major players, Boeing and Airbus. The demand for aircrafts come mainly from airlines worldwide as well as from the military. There being a near-absence of product differentiation, the products of both manufacturers are substitutes, so that both firms compete on the basis of price. Thus buyers play one against the other in efforts to drive down prices. As is typical of an oligopoly or duopoly, if one of the two players reduces its price, it will be matched by the other, but if one raises its price it will be left alone to suffer consequent sales losses. This situation has been very costly for Airbus because of its high cost structure. Its attempts to grab more market share from its competitor has been achieved amid huge operating losses and buttressed only by the financial backing of its sponsoring European governments and taxpayers. The marketing strategies of the two firms are unqualifiedly aggressive, both using diverse approaches and strategies, such as tapping quality suppliers from all over the world, and utilizing these networks as leverage for generating future sales from the host countries. In terms of consumer preferences, the preferences of airlines and other aircraft buyers, a financial constraint that can occur at any time, such as the financial crisis in 1977 or a major terrorist attack involving air transport, would operate to reduce their plans to buy new aircraft and potential buyers would tend instead to try to prolong the economic life of old aircraft, in this manner jeopardizing the safety of air passengers. The production processes are similar. Technological innovations that constitute their competitive strengths or core competences are carefully safeguarded; however, these companies are able to develop their technologies quite independently, apparently, with Airbus benefiting from the technology spillover from the phased-out Concorde, and Boeing sparing no efforts to create new technology frontiers, to the extent that they are able to compete nearly on even footing. Boeing has however outpaced Airbus in terms of depth and coverage of technological innovations because it is able to utilize its profits and net cash flows for R&D activities independently of government support. Where is this rivalry heading? While Airbus is aggressive in its efforts to sell its jets in the world market, it is doing so at a major disadvantage. It is not known for how long its sponsoring governments and citizens can further tolerate the operational losses Airbus is experiencing from year to year. For a while it was thought that Airbus would overtake Boeing, but based on recent financial performances of both companies, where Airbus was seen falling back and its dynamism held back by losses, it is not likely that Airbus would be able to overtake Boeing in the near future. REFERENCES Airbus – Corporate Information/History. Retrieved June 17, 2008, from http://www.airbus.com/en/corporate/people/company_evolution/history/part_4.html Baumol, W. J. & Blinder, A. S. (1997). Microeconomics: Principles and policy (7th ed.), Orlando, FL: The Dryden Press. The Boeing Company 2007 Annual Report. Retrieved June 18, 2008, from http://www.envisionreports.com/boeing/2008/15FE08006M/print/Boeing_2007AR_REDUCED.pdf Hill, C. W. L. (2001). Global Business Today (2nd ed.). New York: Irwin/McGraw Hill Krugman, P. R. & Obstfeld, M. (1991). International economics: Theory and policy (2nd ed.). New York, NY: HarperCollins Publishers. Truett, L.J. & Truett, D. B. (2004). Managerial economics: Analysis, problems, cases (8th ed.). Hoboken, NJ: John Wiley & Sons. --------- Read More