August 2012

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Boeing at a Crossroads: The Air Show Vote - Part Two

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The second in a two part Paris Air Show news analysis exploring the strategic questions facing Boeing and its decision about the future of the 737. This analysis builds on the discussion of tactical decisions facing Boeing as it develops the technology for the new conceptual jet. READ PART ONE
PARIS -- Amid the temporary chalets, noisy press conferences and overcrowded flight line, the Paris Air Show featured a traditional straw poll of sorts. Boeing's stalwart narrowbody customers quietly - and some not so quietly - cast their vote in favor of a New Small Airplane.

As the ink dried on a purchase agreement for 15 more 737-800s, Norwegian Air Shuttle CEO Bjorn Kjos told a room of journalists he was "lining up in the queue to tell Boeing to build a new aircraft" and was urging Boeing it was time to take "the next giant leap."

Steven Udvar-Hazy employed the pages of the Seattle Times to send his message: "We're ready to sit down (with Boeing) and make a deal on a new airplane, that's how strongly we feel."

Contemplating a 200 aircraft order from China's Comac, Morgan Stanley industry analyst Heidi Wood called Ryanair CEO Michael O'Leary's actions as "dual-pronged" with a loud message to Boeing's Chicago headquarters: "Notice served; Ryanair wants a new plane."

Even all-Boeing operator American Airlines pursuit of the A321neo to replace its 757s, as reported by Bloomberg News, was the carrier's way of saying the Next Generation 737 isn't enough. The story shot a bolt of panic through Seattle as its "cannot lose" customers cast their vote one by one.

The message is far from subtle, Boeing's customers want an all-new airplane, yet the decision, by "market-driven" Boeing, isn't so simple.

Paris demonstrated the A320neo accomplished one clear feat - Airbus found an effective means to lock in its customer base for another decade, despite the protests of lessors. In the first six months of 2011, Airbus has earned 668 firm orders for the A320neo, more than the total combined net orders for 2009 and 2010. 

Boeing's math may tell it today's 737 is still 2% more cost effective to operate than the A320neo, yet that 2% disadvantage still compelled Airbus customers to make big investments in the re-engined jet, which touts a 15% improvement in fuel burn over today's A320.

A clean-sheet New Small Airplane would be a complete break from today's 737, unencumbered by commonality in both parts and pilot type rating, and by its very definition would unlock Boeing's 737 customer base to disregard switching costs between types as it considered the A320neo against the NSA.

Would the relatively low cost investment by Airbus to develop the the A320neo to provide a 15% improvement in fuel burn give the European airframer the ability to use selling price to flip Boeing customers who have been unlocked from the 737NG? Is this a recipe for loss of market share?

"If we did a new small airplane," insists Nicole Piasecki, Boeing business development vice president, "We would not do a plan that has us losing market share. We would have a plan that would have us gaining market share. That means that we have to understand with confidence how to keep our exising customer base and grow it.

"And that means, again the NG is going to stay in production for a long period of time and that family is competitive as possible as well. So we will not abandon the NG at the same time we are going through the transition," emphasizing the 737+ developments for the next tranche of incremental improvements to the narrowbody, will provide a technological bridge to a New Single Aisle.

Though, Boeing Commercial Airplanes CEO Jim Albaugh is unapologetic about the price tag of its narrowbody: "Our view is the 737 should command a higher price and we charge a higher price because of the capability it provides," adding that a re-engined 737 or an all-new airplane would be no different.

Piepenbrock's Red-Blue suggests mature markets are battlefields for cost competition. Whether Boeing likes it or not Airbus is playing a cost game while Boeing is playing a value game, prompting price sensitive airlines and lessors to invariably weigh the value of efficiency and fuel burn if its delivered up front as as price cut.
  Boeing 787 Dreamliner N787BA ZA001

The Dreamliner Constraint

Though inextricably, the path to the New Small Airplane runs through Everett, Charleston, Wichita, Nagoya, Grottaglie, Foggia, Frederickson and Salt Lake City. To pay for a massive new development program - its design and its industrialization - Boeing must make its current clean sheet 787 profitable, before it sets out on the next.

Both UBS Investment Research and Bernstein Research have recently published a reports raising questions about the pace of achieving profitability on 787, recognizing the contractually established supplier costs coupled with the low locked-in aircraft sale price over more than 800 aircraft.

UBS's David Strauss predicts "flat to progressively worse 787 cash flow over the next several years" as the production system comes down the learning curve, coupled with prices that make 787, says Berstein's Doug Harned a "victim of its own success. With 787 production sold out until 2019, pricing is largely fixed at prices we believe were set too low in the beginning."

This page's own reporting reflects this trend, with an average airframe sale price of $76 million, locked in on at least the first 300 aircraft, a conservative estimate that has not taken into account return buying by the early tranche of customers.

"At this point in time our product development investment decision we are assuming success and progress and momentum on all of that so we're not constraining our thinking around that," says Piasecki.

"But as you and I can imagine, if we're a board member and the company isn't executing on what it needs to, there are going to be some questions around it. We have to be accountable for getting to profitability on the 87 and the 47-8, no question about it, top priority."

As Boeing brings into focus the considerations around the cost of making another big leap, the benefits of incrementally improving the 737, weighed against the development requirements for the 787-9 and -10X, as well as crafting a more comprehensive competitive response to the A350 in the 777-8X and -9X, the constrained path forward may point to re-engining the 737.

"There are tradeoffs, I think the re-engine is a very, very attractive option," says Piasecki. "From a perspective, if you're looking for minimal disruption to the industry, maximum flexibility to make a move on the 777, and those are all the sorts of things that we're thinking about as we move through this decision."

Boeing last deliberation about replacing the 737 Classic with an all-new jet came in the early 90s, in the midst of a constrained environment that focused the organization's attention toward the development of the clean sheet 777. Out of those constraints the Next Generation 737 was born.

The result, an incremental development strategy that considerably grew the capability of the 737 family, has yielded 3,700 deliveries, a 6% improvement in efficiency since 1997's first delivery and has brought the company great riches, high production rates and arguably the leanest, most productive supply chain in all of aerospace, that seamlessly joins together a quarter million parts 31.5 times every month.

As it looks down the road to an all-new narrowbody and its all-new production system, then back at its stalwart best-selling product, Boeing is again a company at a crossroads.

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