Boeing’s American dilemma

  • Bloomberg has this story about the competition.

  • Wall Street Journal has this story.

  • Here is a story we did for Commercial Aviation Online on the American Airlines aircraft order situation.

Date: 18/07/2011 10:37
Source: Commercial Aviation Online
Location: Seattle
By: Scott Hamilton

Boeing has a major dilemma facing it in the hot competition with Airbus for a major order from American Airlines.

The deal could be decided as early as this week, and as of Friday, neither company was confident of the outcome. American wants to replace its fleet of more than 200 ageing Boeing MD80s and the large fleet of Boeing 757s. An order for between 200-250 aircraft is widely expected.

For Airbus, this is the chance to get back into American. In the 1980s, Airbus won an order for A300-600Rs and eventually sold 35 to the airline. These were withdrawn from service following 9/11 and the 2008 financial crisis. Winning an order for the A320 family, where the heart of the market it, has long been a goal of Airbus’ super-salesman, John Leahy.

For Boeing, it has been the exclusive supplier to American since 1996. Losing this order, or splitting it with Airbus, would be a huge psychological blow. The prospect of doing so is adding pressure on Boeing to re-engine the 737 to match the strong competition presented by the neo family, particularly now that 1,029 orders have been announced since the programme launch on 1 December.

Jim Albaugh, CEO of Boeing Commercial Airplanes, was quoted last week as saying Boeing will do what it takes to keep American’s business.

The stakes couldn’t be higher, and Boeing is in a difficult position to retain American’s business.

Airbus vs Boeing: What each can do

Airbus and Boeing have the ability to compete on roughly an equal basis on economic costs. CAO understands that both companies are offering prices in the +/- $30 million range for the A320neo/737-800 and proportionally more for the A321neo/737-900ER. Each presumably is offering a roughly similar package of support, parts and other concessions.

Airbus is reportedly offering some $6 billion in financing costs, and with the change in export credit rules, it can offer export financing into the US for the first time. The US Ex-Im Bank said in principal it will match any ECA deal Airbus offers, but it’s unclear if this is a possibility for a Boeing-American deal. Besides, pricing isn’t as favorable on either side as it once was but this remains a source of capital.

Aircraft Economics

Boeing claims the 737-800 is 8% better than A320 legacy economics and 2% better than A320neo economics. It also claims the 737-900ER is better than the A321 legacy aircraft, and presumably believes the -900ER is better than the A321neo. CAO understands American believes the A321 is better on both counts, plus the A321neo has somewhat longer range than the -900ER.

Hoisted on your own petard

Here is the root of Boeing’s American dilemma. Back in 1996, American and Boeing signed an unprecedented exclusive 20-year supplier agreement, cutting out Airbus from future business at Boeing. Continental Airlines and Delta Air Lines quickly followed suit.

The deals were considered huge corporate coups, blocking Airbus out of the two of the biggest carriers in the world (at the time) and a third that was a major if smaller player in the US.

But when in the following year Boeing agreed to merge with McDonnell Douglas, the European Union had to approve the deal because of the global trade implications and a condition in doing so, Boeing agreed it would not enforce the exclusivity agreement with any of the three airlines.

Still, all three bought nothing but Boeing and each has a “Most Favored Nation (MFN)” clause that guarantees none will pay more for the airplane than another airline. CAO understands that Boeing’s corporate headquarters provides a certification to the airlines attesting to this MFN when purchases are done.

Concessions in other areas apparently are another matter, CAO understands, and this is where Boeing has flexibility among the airlines.

If Boeing cuts prices to what some might consider to be ridiculously low levels, the MFN certainly would kick in for Delta and Continental-as well as having to deal with Southwest Airlines, which while not being party to an exclusive supplier deal has purchased nothing but 737s since its founding in 1971. With Boeing and Airbus locked into another fleet renewal contest at Delta Air Lines, pitting the -900ER against the A321neo once again, the American deal will be closely watched by Delta.

Furthermore, United Continental Holdings is beginning to consider a replacement programme for the old A319s, A320s and Boeing 757s ordered by United. Although United had no MFN or exclusive supplier agreement with Boeing, Continental does and the new company is managed by the Continental executives and fleet planners. So United Continental is also watching the American deal closely.

Aside from worrying about MFN deals, on a much larger level Boeing would also have to be concerned with moving the entire price structure down if it went to a ridiculously low price for American Airlines. This concern is why Boeing told Michael O’Leary of Ryanair it would not further lower prices on 737-800s a few years ago, says a source familiar with events then.

Airbus has a similar pricing erosion concern, on the macro level.

Thus, Boeing sorely wants to keep American’s business and equally wants to keep Airbus out of American. But there is only so much Boeing can do without affecting its entire pricing model. Thus, the MFN deals may well be an example of Boeing being hoisted on its own petard.

Mimicking Republic Holdings

There is another solution for Boeing, however, that Airbus cannot match.

Boeing could team with General Electric (GE) to mimic the deal Airbus and GE deal for financially ailing Republic Holdings. In this transaction, Airbus and GE’s GECAS and CFM International combined to cut financing rates on A319s and A320s financed through Airbus Finance, leases rates at GECAS and engine costs on the current Frontier Airlines fleet in order to win the NEO order with CFM LEAP engines, a transaction that also had significant incentives.

Here’s what Boeing could do by teaming with GE:

– Boeing Capital Corp. (BCC) leases 37 MD80s to American, most of which came from TWA when AA acquired the bankruptcy carrier. BCC could cut these lease rates;

– GE engines are on 73 aircraft and will be on the six ordered 777-300ER. On the assumption that AA has at least some maintenance contract with GE Aviation, these costs could be cut. Or, AA and GE Engines could enter a deal for MRO (providing it can pass labor contract provisions, if any) and reduce MRO costs that are currently done in-house;

– CFM engines are on 154 aircraft and 54 more 737-800 on order; see the preceding bullet point; and

– GECAS leases 61 aircraft to American, with the ability to shave lease rates.

The caution about GE, however, is that CFM is competing to power the Airbus NEO for American against Pratt & Whitney’s GTF, and GE needs to tread a dicey middle ground between Airbus and Boeing. Still, Boeing is GE’s largest engine customer.

The deep connection to American means it very likely CFM will prevail in the engine selection for the NEO if American orders the aircraft. But what GE will do for Boeing or for Airbus in the airframe selection remains to be seen.

4 Comments on “Boeing’s American dilemma

  1. So Boeing only has a slight (very slight) advantage over Airbus for getting the AA (and possibly later DL, UA and WN) order.

    Let’s see which OEM pulls the rabbit out of their hat at the last second.

  2. AA’s decision will have ripple effects throughout the whole of the United States airline industry.

  3. I think , Boieng will be deteriorated further if she lost AA order

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