How Boeing and Airbus Should React as Airlines Restructure
The Boeing regional headquarters is seen amid the coronavirus pandemic on April 29, 2020, in … [+]
AFP via Getty Images
The 737Max has taken its first new test flights and it seems there is a path to that plane coming back over the next half year or so. Airbus has announced a 40% cut in production and plans to layoff 15,000 people. Yet a high priority for both companies is talking to every airline in the world about their order book, plans for recovery, and need for airplanes.
Even in good economic times, aircraft makers mange their order book, sometimes called the backlog, very carefully. Every order has a probability distribution around it. Will all the planes in the order be delivered in the time the contract says? At the price the contract says? By the airline that signed the contract? For some airlines these distributions will be very tight, meaning the contract is quite firm and its expected production needs and revenue potential almost assured. Others, though, may have more variability because of the underlying airlines’ credit, competitive position, or access to capital. And these are just the airline customers, yet aircraft lessors are also big customers of the aircraft manufactures.
The lessors take prospective positions in airplanes that can determine the early success or failure of the model. For example, the Bombardier C‑series plane had a hard time selling in part because lessors were worried about the “second lease”. This means that while they may have felt comfortable buying the plane as part of a sale-leaseback from an airline they respected, they were uncertain about where the plane would go when that lease ended. Once Airbus took over this model and renamed it the A220, sales took off in part because airlines became more comfortable they would get the support they need, but also because lessors saw the Airbus backing as confidence that the plane would be successful.
Every airline in the world is re-thinking its fleet plan in light of reduced demand and uncertainty about the return of traffic, especially long-haul traffic. This means that every one of those probability distributions has widened, and by extension for the lessors as well, making the manufactures realize that their production is too high in the short term and pricing for their products is uncertain. So what should Boeing BA and Airbus do given this?
The Airbus logo outside the company headquarters in Blagnac, southern France, on June 30, 2020. … [+]
AFP via Getty Images
The goal should be to firm up their probability distributions again! That means that if an airline has 100 planes on order, the most important thing is to reconfirm those 100 planes even though the structure of the delivery may have to change. Perhaps originally all the planes would have been delivered by 2025, but now the order will be stretched to 2030. That’s better than canceling the order or shrinking it significantly. Norwegian’s announcement of canceling 97 airplanes and suing Boeing in the process is exactly what Airbus and Boeing do not want to happen. So how can Boeing and Airbus, even facing short term massive drops in demand, mange their business for the longer term?
The answer is to forget about long-held beliefs in aircraft pricing and delivery flexibility. Just as airlines need to restore confidence in their passengers, Boeing and Airbus need to do the same to their customers. This means giving airlines and lessors confidence that as they confirm orders, and maybe even make new ones, they do so with enough pricing certainty and order flexibility that they believe the risk becomes reasonable again. Boeing has the unique problem with the 737Max, and to bring that plane back into the strong sales position it had prior to the crashes is going to mean significant price and order creativity. Yet as airlines are uncertain about demand and know they will be smaller for some time, most think it is better to be more efficient during this time and that means demand for the 737Max will be strong once the plane is certified again. But Boeing can’t assume that pre-Covid market values will hold, especially for new buyers, and for airlines to not do what Norwegian did they likely will have to restructure deals previously cut.
KANSAS CITY, MISSOURI — APRIL 03: Planes belonging to Delta Air Lines sit idle at Kansas City … [+]
Airlines take huge risk when buying airplanes. Most things an airline does has a four week to half year effect. Pricing decisions affect the next 60 – 90 days, scheduling moves change by season and typically are not firmed until a few months out. But aircraft start being paid for years before they even arrive, and then stay around for a decade or longer. Changes in energy prices, global economic cycles, and more can change what looks like a great deal into a marginal one quickly. Boeing and Airbus can better reflect this reality in contracts with airlines by creating flexibility in ways that allow them to manage their own production but let the airlines adjust to swings in economic cycles. This reality is magnified with wide body equipment. Wide-bodies, or dual-aisle airplanes as some call them, fly the longest routes and are needed when the flight is over five or six hours. Yet their cost to acquire and operate are a multiple of the narrow-body aircraft being made, meaning that airlines take on even more risk when they buy the big jets. WOW Air went out of business before coronavirus largely because they bought wide-bodies and couldn’t support their incremental cost and operational complexity. Airlines like Emirates, whose business is based exclusively on long haul travel, will take the longest to recover as this traffic is going to take the longest to get comfortable flying again. They buy big planes from both Boeing and Airbus, so what can the manufactures do to help ensure this customer can not only survive, but live to buy even more airlines?
This is not an easy time for airlines, aircraft lessors, or commercial aircraft manufactures. Airlines are doing what they can, building cash and adding capacity as demand slowly returns, while making the changes needed to bring confidence back to the flying consumer. Boeing and Airbus need to think about their customers, both airlines and lessors, and how they can not only reconfirm orders that once seemed firm, but also to be sure that there will be enough airlines and lessors left to buy their aircraft when coronavirus is long gone.