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Business Case: Airbus

Written Report

Prepared for:
Dr. Teo Kwong Meng

Prepared by:
LOH Yao Sheng
Michelle TING Mei Chen
Remi CHOONG Ciyuan
Roger KOH Fong Jit

Question 1
 TWC Airbus Business Case Report

There are several reasons Airbus should build the A3XX. It represents the
next step of innovation in the commercial aircraft industry and the profit
potential was immense.

Despite the higher list price compared to the 747, the A3XX had 35%
greater capacity, giving the airline greater profit potential. The A3XX was
also safer in a way, as it had 4 engines, compared to 2 engines on the
777. With more space per seats and wider aisles, the A3XX would appeal
to passengers who value comfort, especially over long haul flights. These
factors would make the A3XX more attractive to airlines since premium
travel actually accounts for a large portion of an airline’s revenues.

The A3XX was not without its problems. A major concern was whether the
major airports could accommodate the A3XX, as its huge size severely
limits its available landing options. Airbus claims to have solved the
problems of noise, emissions, turnaround time, taxiway movements and
evacuation but the solutions have not been tested in reality, hence
doubts remain.

In a way, A3XX is Airbus’s answer to Boeing’s highly successful 747-400.

Airbus is facing a set of problems similar to those encountered by Boeing
in 1965 when they launched the 747-400. Despite nearly being crippled
financially, Boeing persevered and the 747-400 has become its flagship
model.

Industry dynamics play a major role in Airbus’s management to launch

the A3XX in July 2000. Significant risks include the large up-front
investment in R&D, uncertainty in demand and possibility of adverse
market conditions leading to delays in payments or cancellation of orders.
However, airlines usually don’t place orders more than 5-6 years in
advance so these were risks that Airbus had to undertake.

2
 TWC Airbus Business Case Report

A “wait-and-see” attitude would cost Airbus its early mover advantages.

Airbus could have established its dominant position and maintained its
technological edge over Boeing within the VLA niche.

Airbus can try to minimize its risk in various ways. Currently, Airbus gets
funds from its RSPs who will lose their investment if the A3XX doesn’t sell,
reducing Airbus’s financing risk. In addition, it can demand a higher level
of commitment from its customers (in terms of larger down-payments).

Question 2
Boeing could challenge the launch aid by filing a complaint with the WTO.
A recent precedent would be the ruling by WTO against regional jet
makers for improper subsidies. However, Airbus can easily point out
Boeing’s use of Foreign Sales Corporations (deemed illegal by WTO).
Airbus could also seek alternate sources of financing. Boeing would not
want to offend foreign governments that owned some of its major
customers.

Boeing could develop a stretch version of the 747 (747X) to compete with
the A3XX in terms of passenger capacity. Boeing had the advantage of
simply retrofitting an existing model and would be ahead of Airbus.
However, the 747X’s older style and technology could not compare with
the A3XX. In addition, Boeing was placing renewed emphasis on
shareholder value. Compensation for top executives was adjusted, to be
linked to stock price appreciation. All this would give management
incentive to boost share prices. It has been seen that the market dislikes
Boeing’s 747X idea, punishing the stock when the idea was revived in
1999. Hence this option is extremely unlikely.

Boeing could develop its own jumbo jet to compete head-on with Airbus.
However, this is unlikely since it involved significant financial risk for
Boeing and it went against Boeing’s forecast for passenger air travel
preferences in the years ahead.
1
 TWC Airbus Business Case Report

The fourth option was to cut prices on the 747. Boeing had the advantage
of economies of scale and the learning curve effect, having been
manufacturing the 747 for decades. This would divert sales from the
A3XX and make it less viable. However, a price war would not benefit
Boeing as well, as its own margins would be hurt.

Boeing’s last option is the most sensible. It could ignore the A3XX and
focus on developing its existing product lines. With regards to increasing
shareholder value, this option would be the most effective since Boeing
still retains nearly 67% of the commercial aircraft market share.

Question 3

Operating Profit from Sale of 1 A3XX 15% x $225 million = $34 million

Net Profit (after tax) 62% x $34 million = $21 million

Number of A3XX needed to break $15 billion / $21 million = 717

even

Number of years needed to break = 717 / (4x12) = 14.9 years

even

We emphasize that the figure is only an estimate. We have adopted a

conservative approach towards total expenditure and operating margins
($15 billion and 15% respectively). The net profit used does not take into
account the repayment of launch aid, risk sharing capital and other
interest expenses. Capital expenditure and working capital might be
subject to market conditions as well.

Boeing and Airbus came up with different estimates of total demand for
VLA over the next 20 years. Airbus forecasted 1,235 VLA passenger
planes required by 2019 whereas Boeing arrived at only 300 VLA
passenger planes for the same time period. The number of A3XX needs to
sell to breakeven, according to our estimates, seems to lie between the 2
estimates.

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 TWC Airbus Business Case Report

Both Boeing and Airbus agree air travel would continue to increase but
the varying estimates are due to their differing views on the development
of air travel.

Airbus believes increasing frequency of flights and opening new routes

are only short-term solutions to the demand problem. They cite traveler
preferences limiting frequency increase and the difficulty of opening new
airports as obstacles to any improving of the problem of over-demand.
Thus, hub-to-hub travel would still remain the industry standard.

Boeing sees the change in traveler preferences towards point-to-point

travel, from a secondary airport near where they are, to a secondary
airport near their destination. They also forecasted lower average seating
capacity in the years ahead, due to these opening of new routes and stiff
competition from the newer airlines. Hence, there was a need for
medium-sized and long-range aircraft.

Question 4
The government provided a significant portion of financing for the
development of the A3XX. The partner governments accounted for $3.6
billion, out of an estimated total of $13 billion required, and this is within
the 33% limit of development costs as laid out in the agreement between
the US and the EU.

The EU also ruled that the aid had to be repaid within 17 years and earn a
market rate of return. However, aid repayment came as a per plane fee
and non-repayment did not trigger default, making the launch aid seem
more like preferred stock as opposed to debt. (In the case of debt, a
company that defaulted on its debt would be declared bankrupt. Its
assets would be auctioned off and the proceeds would go to the
company’s creditors.)

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 TWC Airbus Business Case Report

In certain industries like aircraft production, automobile manufacturing

and financials, certain companies might grow to such a size that its
performance had a real impact on the national economy, either in terms
of the GDP or number of workers employed. It would then be in the
government’s interest to support these corporate entities in any way
possible, for the benefit of the nation. Long term aid would not be viable
but governments would not hesitate to “chip in” to help tide the
companies over the current rough patch. A pertinent example might be
government backing for financial institutions which might suffer a sudden
bank run due to investor panic.

It is hard to draw the line separating government aid from protectionism.

It can be suggested that such support be restricted by tough terms and
conditions, in the spirit of free trade. In reality, it is difficult to enforce
such standards. For example, despite the efforts of WTO, the Doha
negotiations failed to produce tangible results from participating nations.
The US, in particular, had been repeatedly condemned for its US farm
subsidies and duties on steel imports.