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:: November 2010 Letter ::

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Dear Fellow Single Aisle Game Players,

People perceive value in very different ways. A young Albert Brooks put it best. As a precocious valedictorian in the movie Broadcast News, he gets the tar beaten out of him by three toughs. As they walk away leaving him in a heap, he chides them that “You'll never make more than nineteen thousand dollars a year!” The brutes look at each other and nod agreeably. “Nineteen thousand dollars,” one says. “Not bad.”

A difference in value perception could be stifling change in the jetliner market. The single aisle (SA) segment is ripe for change, with new engines as the primary catalysts. Pratt & Whitney’s Geared Turbofan (GTF, or PurePower, in marketingspeak) has led the way, with GE/Safran’s Leap-X also promising notable improvements. The lessors, of course, are the party of no, eager to stop anything that threatens residual values for their current generation jets. Yet Boeing has also grown dismissive of the idea of adapting the new engines for its 737 family, saying that the net gain was just 3-4% when everything was taken into account. The airlines, of course, regard 2% margins as a miraculously great, so anything that lowers their aircraft direct operating costs (DOCs) by 4% is equally miraculous.

The one non-airline player that seems amenable to re-engining is Airbus. For most of this year, the company has been poised to offer a New Engine Option (NEO) for some or all of its A319/320/321 family. There are elements within the company that are eager to sell an A320 NEO, but the launch decision keeps being delayed. There are also elements in the company that are concerned about resources and about anything that could affect revenue in 2013-2015, when current A320 customers might be inclined to defer their deliveries in favor of a NEO after 2015. What’s astonishing about the anti-NEO element is that it doesn’t deny anything about the NEO’s virtues. Rather, they merely cite a possible shortage of engineers. Yet there are five arguments in favor of an Airbus NEO launch that are pretty strong.

The first argument is the current SA jets themselves. The 737 has a fuel burn advantage over the A320, and the 737-800 enjoys a slightly higher rating as a financial asset. The A320 is a superb aircraft that competes on comfort, performance and other factors. It’s fine to offer a premium product when you’re in a two-way race, but if the CSeries and any other new market entrants start offering reduced fuel burn, you look like a high-cost laggard. Fortunately for Airbus, the larger ground clearance of its A320 family lets it take full advantage of the new, larger engines. An A320NEO should offer cost savings well above 4%.

Boeing, by contrast, can coast for a few years, selling 737NGs at a discount, tweaking the product to offer minor savings when possible. In 4-7 years they can create a 737 replacement. I can’t identify any enabling technologies that would allow Boeing to design an A320 NEO killer, but after 45 years they could use a new airframe. They may wait to see if Leap-X turns out to be as promising as GTF, in order to keep their alliance with GE intact. And they may want a bigger and more capable SA design. Or, they may want to prioritize a 777-X.

The second argument is that the two primes are in very different places in the product development cycle. The 787, Boeing’s poorly executed and disastrously delayed composite mid-market twinjet, will wind down in 2011/2012, freeing up resources for whatever Boeing wants to do next. The A350XWB, which, based on recent Airbus and Rolls-Royce program performance will likely be a poorly executed and disastrously delayed composite mid-market twinjet, by contrast won’t wind down until 2016 at the earliest. Boeing could have a 4-5 year head start on its next-gen SA. Re-engining now would be a cost-effective way for Airbus to hedge against that.

The third argument is that the A321 NEO is a great opportunity. An A321 with new engines and winglets (“sharklets,” in even more dismal marketingspeak) would offer near-757 performance with great economics. There are still about 1,000 757s in service, and the replacement cycle will begin soon. Even if just half are replaced by similarly-sized machines, that’s a great submarket. More importantly, much of it is a US market. The two big US airline mergers have seen pro-Airbus SA customers (United, Northwest) vanquished by pro-Boeing ones (Continental, Delta). Republic has gone with the CSeries. That leaves USAirways as the last notable Airbus customer in the US, and it’s destined for a marginal industry share. If Airbus wants to keep any kind of US market presence, the A321 NEO is their best chance. It may even offer a key advantage.

The fourth argument in favor of an NEO launch is simplest: Don’t annoy and confuse customers. Again, Airbus isn’t denigrating the GTF’s capabilities. It’s just saying it might not have the cash. It’s one thing for a jetmaker to say, “We looked at re-engining, and it just isn’t worth it.” It’s quite another thing to say, “We looked at it, we like it, we were going to beat the competition and give you what you want, but, whoops, it turns out we’re completely under-resourced, so you can’t have what you want. We screwed up. Our bad. Please regard our current SA product line as fully competitive, and around for the long haul.”

It’s easy to blame Airbus itself for their predicament. When you blow $25 billion on the A380 (~5% of orders by value over the past decade) you run the risk of short-changing the SA segment (~50% of orders by value over the past decade). They’ve taken some dumb risks. But, in a sign of overreaction to this experience, some executives at the company might be too timid to take smart risks.

Still, I’m reasonably confident that they’ll do the right thing, and that sometime soon NEO will happen. My biggest reason for thinking this is that Airbus is the most exposed to the emerging competitor threat (this is argument five). So far, all CSeries customers (both actual and mooted) have been Airbus SA customers, not Boeing ones. Similarly, the C919 is aimed directly at Airbus’s carefully cultivated China SA position (it even looks like an A320, but with new engines). If Airbus does nothing, these new guys, particularly the CSeries, will benefit.

For years, I’ve maintained that the new market entrants had little hope because the two big guys could easily adapt any new technology and use it to crush them. If Airbus screws up, I’ll be wrong. I still don’t see how the C919 or MS-21 can go anywhere on export markets, but the C919 would look better to Chinese airlines. And despite its myriad problems, the CSeries might get some traction.

And I, for one, welcome our new Canadian overlords. Until then, Teal Aircraft Binder updates this month include the MRJ, ARJ21, Lynx/Wildcat, KT-1/T-50, King Air, TBM850, A.129, and the NH90. A very happy holiday season to all.

Yours, ‘Til Southwest Launches The 737-XWB,
Richard Aboulafia

 

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