Assessing the Air Canada 737 order: factors that likely played a role

How did Boeing win the Air Canada mainline 150-200 seat jet order when only a couple of weeks ago Flight Global reported the Airbus won the deal?

We, too, heard that Airbus seemed to be the favorite, but the information was soft. We’re not rapping Flight Global—undoubtedly it was confident in its sourcing, but this just shows that a situation can change dramatically and quickly.

We’ve been following the competition for months, behind the scenes, and here are factors we understood that were involved.

Embraer E-190

The future of the Embraer E-190 fleet played a bigger role in this deal than might be apparent, even from Air Canada’s press release:

Air Canada continues to evaluate the potential replacement of its Embraer E190 fleet with more cost efficient, larger narrowbody aircraft that are better suited to its current and future network strategy. Consistent with this strategy, the agreement with Boeing provides for Boeing to purchase up to 20 of the 45 Embraer E190 aircraft currently in Air Canada’s fleet. The E190 aircraft exiting the fleet will be initially replaced with larger narrowbody leased aircraft until the airline takes delivery of the Boeing 737 MAX aircraft. The company will be reviewing various options over the next six months for the remaining 25 Embraer E190 aircraft including continuing to operate them or replacing them with a yet to be determined number of aircraft in the 100 to 150 seat range.

According to Market Intelligence, Air Canada has been unhappy with the maintenance costs of the E-190, principally focused on the GE CF34 engines. JetBlue, another E-190 operator, has cited engine maintenance costs in its SEC federal filings as an area of concern. Air Canada uses the E-Jets on some routes that push the range–Toronto-Seattle, for example–and on rare occasions, a tech stop in Montana on this route is required, Air Canada gate agents told us.

Disposing of the E-Jets presented a problem, however: Current Market Values for the planes are said to be substantially below book value, presenting Air Canada with a potentially large one-time write off if the right deal wasn’t structured. But the prospect of Airbus or Boeing taking the airplanes in on trade presented a problem for the buyer, too. Appraisers and lessors we consulted told us that the market for used E-Jets is soft, with lease rates or resale values reflecting this, making it difficult for the buyer to make a financially sound deal.

Embraer did not return a call and email seeking comment.

GE Connection

The Embraer issues didn’t stop with those described above. GE is the engine supplier, and there are believed to be commercially-based engine maintenance contracts associated with the CF34s. GE and CFM are also the engine providers on all but a small number of Air Canada’s jets. Maintenance agreements are likely involved as well. GE Capital Corp. finances a number of the mainline jets.

All this GE pollinization enables GE to offer a “global” deal in connection with a Boeing 737 deal. Maintenance agreements could be altered. Financing rates could be reset.

Airbus vs Boeing

But CFM supplies engines on the A320neo, too, so couldn’t CFM have wheeled and dealed on this, too?

Of course, it could. But if Boeing wins the deal, CFM is 100% assured of getting the engine order. If Airbus wins, there is a competition with Pratt & Whitney and only a 50-50 chance of a win. Some Airbus officials bitterly complain about what they perceive is a bias by CFM to favor Boeing in competitions as a result. But some at Boeing believe CFM’s exclusivity on the 737 is a doubled-edged sword. It makes a good argument for residual values and for lessors continually faced with remarketing over the life of the airplane (one engine type vs two). At the same time these officials also believe it is harder for the Boeing sales force to muscle CFM into stepping up and contributing to financial concessions, leaving Boeing with the disproportionate burden.

Did the 787 delays play a role?

Air Canada has 37 787s on order, and it’s been negatively affected by years of delays, just as every other customer has. As we’ve written many times, compensation by Boeing could come in many forms: cash, rate breaks on maintenance, spare parts and training and discounts on 787s—or other aircraft types. If we were betting, we’d believe compensation played a role in the negotiations not only for the 737s but also prospectively for the E-190 trade-ins.

Price

Airbus says Boeing won this on price.

What of Bombardier?

Air Canada kept open consideration about the future of the remaining 25 E-190s. As noted above, AC could retain the aircraft. Or it could replace them with the Boeing 737-7, the Bombardier CSeries or presumably the Embraer E-Jet E2.

GE will undoubtedly be a factor with respect to maintenance contracts on the CF34s in any analysis to retain the airplanes. The same would be true for the prospect of acquiring the 737-7, which is powered by the CFM LEAP-1B.

The same issues outlined above relating to the prospective trade-in would face Boeing and Bombardier. AC is already widely viewed as a must-win for Bombardier because AC is figuratively across the street from Bombardier. How aggressive will BBD be, which is known for being notoriously unwilling to cut pricing or provide other steep concessions? How willing will Pratt & Whitney, the CSeries engine provider, be to step up? After all, Pratt & Whitney Canada is actually building the GTF engines for the CSeries.

Finally, how aggressive will Boeing and CFM be to prevent a sale by BBD and PW to Air Canada?

A decision is slated for the first quarter.

31 Comments on “Assessing the Air Canada 737 order: factors that likely played a role

  1. Air Canada says the MAX will have 10% better fuel efficiency then their Airbus fleet. Boeing says the NEO will be 12% better then the CEO, Airbus claims 15% better. Obviously other factors compensated the lower efficiency of the MAX.

    It seems AC made their selection involving a large number of variables and considerations, they’re broke. http://centreforaviation.com/analysis/air-canada-vows-bankruptcy-is-not-an-option-as-its-losses-continue-to-mount-73571

    ..just like at the time of the large 787 / 777 contract when they were just out of bankruptcy. http://www.flightglobal.com/news/articles/a350-too-big-for-carriers-twinjet-needs-197415/

    I wonder how financially independent Air Canada really is.

    There obviously is the 12 seat capacity advantage of the 737-8 vs the A320 , the NEO seems sold out for a long time, NEO price will no doubt is determined by steep demand / few slots, maybe Airbus/ Leahy became arrogant?

    About seat comfort on AC new 737MAX fleet;
    “We’re honored that Air Canada chose Boeing to lead its fleet renewal plan,” said Brad McMullen, vice president of North America Sales, Boeing Commercial Airplanes. “We know the 737 MAX will provide the airline and its customers with an experience that can’t be matched.” http://boeing.mediaroom.com/2013-12-11-Boeing-Statement-on-Air-Canada-737-MAX-Commitment

    I guess he means E jet, CSeries and A320 seat comfort are different.

    • AC’s financial situation today is much better than 18 months ago (when that Centre for Aviation article was published).

    • “Air Canada says the MAX will have 10% better fuel efficiency then their Airbus fleet.”

      You’re wrong, keesje. AC did not say this at all, and you know better than to compare fuel costs per seat with CASM. Fuel cost accounts for about 1/3 of the total operating cost, not 100%, and CASM includes all the costs associated with operating an aircraft, not just fuel.

      In the press release AC said “We have estimated that the projected fuel burn and maintenance cost savings on a per seat basis of greater than 20 per cent will generate an estimated CASM reduction of approximately 10 per cent as compared to our existing narrowbody fleet.”

      So, AC is claiming that the MAX gives a 20% improvement over the CEO in combined fuel and maintenance costs per seat. This is inline with Boeing’s claim that the 737 MAX 8 burns 17% less fuel per seat than the A320.
      http://leehamnews.files.wordpress.com/2012/02/max-v-neo-sfc.jpg

      When factoring in the other operating cost contributors that are independent of aircraft type, the CASM improvement turns out to be around 10%, which is pretty good in my opinion.

  2. All airlines make fleet selections on all kinds of variables all the time, not just AC.

    “Air Canada says the MAX will have 10% better fuel efficiency then their Airbus fleet. Boeing says the NEO will be 12% better then the CEO, Airbus claims 15% better. Obviously other factors compensated the lower efficiency of the MAX.”

    How can you say that when the B-737-8MAX carries more pax than the A-320NEO and both airplane designs are essentially paper airplanes at this point?

    Airbus said that Boeing won the AC order on price. That is probably true, but it is only part of the story, too.

    Airbus has claimed for years the development costs of the NEO, estimated at E1B, is paid for by the engine OEMs. If that is true, then the engine OEMs set a point when they start to receive a return on their investment. If it is not true then Airbus (meaning Airbus also shares in the development costs) must be in a position where they decided they must begin making a profit on the NEO program and most sales prior to this point were sold at costs or even a loss. I tend to believe the E1B program costs because the NEO is, more or less, just a reengine program with related wing modifications. The MAX program costs more because it involves more engineering and more systems and subsystems modifications beyond the reengine and related wing modifications. For example the new winglets, tail cone mods, extended NLG, and some FBW modifications. Both designs do have other mods to improve fuel economy but they are relatively minor.

    The MAX and NEO programs are essentially in the same position as other new or improved models like the B-787, B-747-8, A-380, A-350, etc. where the break even production airplane is still a moving target.

  3. Unthinkable to some, maybe, but perhaps Boeing undercut Airbus on price? Surely not!

  4. Boeing pulled off a tricky deal, I think. I guess they were hungrier than Airbus, who would normally be expected to win this one. The only consolation to Airbus is that if you win every deal you are pricing yourself too cheap. I think Boeing will be happy and Airbus won’t, however.

  5. I think this AC order is good for the industry. The 737MAX backlog started to look relatively weak, and not only in the numbers ordered.

    I’m almost sure Air Canada will order some A321NEO’s on top of their MAX commitment. On some routes you just can’t replace a A321 with a 737-9MAX, even on paper, in terms of capacity /cargo requirements, payload-range and airfield performance. Just like JetBlue, AA, Delta, Spirit, US. I guess its the size, traffic and temperatures of North America.

    North America remains the only 737MAX strong hold. http://www.pdxlight.com/neo1.png

    • Now you’re really making sense. If Boeing lost every deal Airbus would go broke trying to cover the cost of winning. Airbus needs to walk away from some of these deals because the overall value of a fleet of A320 becomes so low that parting out is a better deal than resale. The price of new will be so low that airlines will get in line to buy hundreds of new frames over doing anything on the reslae side. Which might be the reason why the Asian market has gotten so strong on the new side for Airbus. Also North America has become the home of the monster airlines. T

    • “The 737MAX backlog started to look relatively weak, and not only in the numbers ordered.”

      keesje, the B-737MAX has over 1700 orders now. Not bad considering the A-320NEO had a year and a half head start.

      • I thought usually when counting which plane has a head start in any programme, it’s usually date of launch that is taken into account NOT EIS. In this case, the NEO was launched in Dec 2010 and the MAX in June 2011, so not quite 1 year and half. Also the MAX isn’t quite up to 1,700 orders yet.

      • kc135topboom: Nice cite, and I wonder who the unidentified customer is with the 249.

        Bryan, blown up again, eh?

        • NOT
          Bryan was correct in his assertion for the current date.
          WP is a bit ahead of the real world. ( as of Dec. 12th Boeing hasn’t booked the Air Canada order yet. And not much from the DXB orderfest either. From “orders and options” most everybody seems to have dropped the “options” qualifier without changing the numbers reported. Thus all around a bit of an overstatement to Boeings advantage. )

  6. Scott, Air Canada is not figuratively across the street from Bombardier. It is literally across the street. Bombardier Inc. is headquartered downtown Montréal, but Bombardier Aerospace and Air Canada Headquarters are both located on the same street in Dorval, between the two main runways of Pierre Elliott Trudeau Airport, almost facing each other.

    • and strange why Leeham did not cover it; maybe it does not go with the Leeham worldview

      Just hadn’t gotten to it yet.

    • ‘Greedy little children’? Seriously? Well good to know that the altruistic adult bosses in Chicago with their USD20 million annual salaries are just in it for the good of the company. We have a saying for that in Germany – preach water, drink wine.

      • Im trying to figure out how skilled labour so lowely that they get social to make ends meet are greedy? Are you saying US wages in general are poverty level?

        • No, I am just saying that you can’t blame the machinists who make the company succeed for wanting a fair shake, especially when they see top level management being rewarded for failure. It’s rational, not childish.

  7. No interesting comments yet from the financial media here on the deal – merely straight reporting. One point not yet mentioned is the total lack (at least in public) of any political pressure on AC to buy Canadian – that is Bombardier – which is fairly unusual in national deals of this kind.

  8. Thousands of A320s and 737 have been sold and delivered. Has there ever been an airline replacing A321s with 737-900s or -9s?

  9. It had to happen but no denying for whatever reason this is the first & long awaited extensive reversal of loyalty away from Airbus & does in some small way counter Airbus’s inexorable trend of poaching of loyal Boeing customers, well done to Boeing at last.

  10. “Airbus says Boeing won on price” : yes , may be -just like Airbus has won so many orders. Which means Boeing convinced AC that this order was the best value on offer. Well done Boeing.

  11. What usage slot is AC filling when they trade in 20 from their Embraer E190 fleet for this Boeing 737 MAX purchase?

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