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Airbus Case Analysis

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Memorandum - Airbus A3XX
2011/11/2

Ruowen Du 112013196; Siqi Deng 112110741; Xingzhou Li 112042165; Ying Liu 112015299; Yue Wu 112077129

1. Reasons that Airbus interested in A3XX  A Revolution Adventure -- The first objective of this project is to fill the market gap by introducing a new type of aircraft. Airbus, with A3XX under the plan, is stepping into an area that Boeing has rarely touched, the very large aircraft (VLA) market. If Airbus well forecasts the future market, A3XX will be the flagship in a new airline revolution. Capturing more than half the VLA market with A3XX, Airbus would constitute an enormous financial success and achieve the ultimate objective-- the leader of commercial aviation industry.  Abundant Financial Resources and Developed Technologies -- Airbus possesses abundant funding resources and cutting-edge technologies which could substantially reduce the training cost. Airbus was prepared to receive around $4 billion development loans from the British, French, German and Spanish governments, repayable from sales revenue. Together with contributions from risk-sharing partners and its own shareholders, Airbus has no need to worry about its financial resources and thus can concentrate on the production and sale of A3XX. In addition, the well-developed aircraft technologies such as fly-by-wire technology, fight deck design, and performance characteristics that are common across the Airbus family pave the way for the A3XX’s development and potential market.  Favorable factors from Context Analysis -- Needs for travelling and cargo transportation are essential parameters which airlines have to take into consideration; hence, they are also vital determinants of demand for commercial aircrafts. According to Airbus’s Global Market Forecast (GMF), air transportation industry is expected to grow at 4.9% annually. This continuous growth demand of the flight market can offer Airbus Company a sound support to launch new types of planes. In addition, although various customers have different preferences, new type of aircraft could still draw market attention by satisfying traveler’s specific needs. For instance, first-class travelers and businessmen may be more likely to take new aircraft after new launch in order to pursue fresh flight feelings and to treat it as new fashion. Such trend may further lead more people to join in, which can positively affect the market needs as well. Hence, A3XX aircraft could be launched. 2. Break-even Analysis In order to break even, Airbus must secure to deliver 43 aircraft per year (Appendix I). Airbus estimates an operating margin of around 20%. Optimistic analysts claim that 20%-30% would be appropriate, but Boeing must assume a much lower rate that justifies its withdrawal from the VLA R&D. A 15% operating margin yields break-even sales of 57 aircraft, and 25% results in 34 aircraft. According to the Table XX, break-even sales per year are insensitive to effective tax rate change, while sensitive to inflation rate. Airbus has to deliver 48 aircraft per year under 1% inflation rate and 44 aircraft per year under 3% to break even.  According to the computation, the total break-even sales in twenty years will be 645. This number is less than Airbus’ estimated total demand of 750 aircraft. However, Boeing is more pessimistic over the VLA market. We project that at least break-even sales can be achieved. That is to say Airbus can sell 680 to 700.


3. Boeing’s Response Boeing claims that the demand of very large plane will not increase in the future. The corresponding strategies are to increase frequencies and to introduce new routes. Although such approaches may lead to a decline of the average seating capacity of many airline fleets, Boeing has optimistic prediction on the continuously increase of direct transatlantic routes which will be supported by its smaller jets. What’s more, airlines will probably change the traditional hub-to-hub


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routes to point-to-point routes using Boeing’s medium-sized and long-range aircraft, which may improve their operational efficiency.  Besides, Boeing can respond in one of four ways: to update versions of the 747, to cut prices on the 747, to innovate a competing super jumbo jet, or to ignore the potential threat. Although to update versions of the 747 works theoretically and Boeing did spend a lot of money to support in practice, customers’ responds were negative in terms of passenger comfort and operating efficiency. Therefore, this method will probably let Boeing suffer from loss. Alternatively, by cutting the price of the 747, Boeing could preempt more market shares from the sales of the A3XX and even deter launch completely by the economics unattractive. Additionally, Boeing could develop its super jumbo jet to compete with the A3XX, which may involve more financial risk to the company. Besides, Boeing may choose no response to its best option, as it has a chance to increase its profits through its existing products. Whichever option Boeing selects, it should be consistent with the firm’s renewed objectives, concentrating on value added.  From legal perspective, Boeing can file a complaint with the World Trade Organization (WTO) to fight the A3XX through WTO restrictions for improper subsidies. However, such legal sanction may be vulnerable because Boeing has once withdrawn a complaint to avoid offending foreign governments who owned some of Boeing’s major customers in the past.  Relationship with what Airbus is likely to do -- Because Boeing has a negative view of future VLA market, its solutions focus on cutting the price, expanding the routes and enhancing the current services. Moreover, if two companies developed a brand new VLA, both would suffer from huge losses (a typical preemption game). Thus Airbus’ A3XX innovation will preempt Boeing from entering this segment. Even if Airbus does not start the A3XX project, Boeing is unlikely to set foot in VLA market due to the high risk of and Boeing’s negative view towards this new market. Therefore, Boeing may still adopt the solutions mentioned above under such situation. 4. Conclusion regarding to launch A3XX After thorough quantitative analysis, Airbus should adopt the strategy of launching the new aircraft. The project would bring broad prospect to Airbus, since the project has a low break-even number of aircraft per year, leading to a considerably positive NPV at full production level and a moderately-expected payback period (Appendix II).  The board of Airbus decides that the threshold of initial orders was 50 aircraft. With 22 already-placed orders and 30 orders lined-up, Airbus would probably begin to commit substantial funding to launch the project. In addition, Boeing took a bold move to begin building 747 in 1970s when obtaining only 17 orders. Now, Airbus faces a similar situation as Boeing decided to launch 747. It seems Airbus is in a better situation with more orders and higher market potential. Moreover, the early response from customers could be served as a reliable indicator of long-term demand. The initial order of over 55 (with possible options to purchase aircraft) far exceeds the break-even sales of 43.  From qualitative prospects, A3XX, being the world’s largest jetliner series, costs less gasoline and uses less runway, which illustrates that it is an innovative and airline-companyattractive aircraft. The economic growth and the government investment will boost the demand. Also, from the managerial view, A3XX is a highly competitive aircraft series against those of Boeing’s; it would contribute to Airbus’s long-term development.


Therefore, the launching of the A3XX is beneficial to Airbus. However, Airbus should be aware of the highly competitive industry as Boeing might have several different responses to the project.

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Appendix Appendix I Break-even Analysis 2001 Cash Flows Revenue Number of Planes Price per Plane Annual Sales Operating Profit R&D Depreciation EBIT Tax Net Income +Depreciation -Capital Expenditures -Increase in Working Capital Free Cash Flow FCF - growing part FCF - constant part PV of FCF up to 2008 PV of FCF after 2008 PV of the project Discount rate Growing rate 2002 2003 2004 2005 2006 2007 2008 2009

0.2 -1100 0 -1100 418 -682 0 0 0 -682 -2200 -25 -2225 845.5 -1379.5 25 -250 -150 -1754.5 -2200 -60 -2260 858.8 -1401.2 60 -350 -300 -1991.2 -2200 -95 -2295 872.1 -1422.9 95 -350 -300 -1977.9 -1320 -100 -1420 539.6 -880.4 100 -50 -200 -1030.4

0.38

0 -880 -100 -980 372.4 -607.6 100 -100 -50 -657.6

0 -660 -100 -760 288.8 -471.2 100 -100 0 -471.2

42.94614 225 9662.881 1932.576 -440 -100 1392.576 -529.179 863.3972 100 -100 0 863.3972

42.94614 229.5 9856.139 1971.228 0 -100 1871.228 -711.067 1160.161 100 -100 0 1160.161 1222.161 -62 5606.587

-614.193 -1422.97 -1454.38 -1301.03 -610.392 -350.821 -226.386 0 11.0400% 2%

373.5726

Key assumptions: 1. Profit margin = 20% 2. Growth rate = inflation rate = 2% 3. Discount rate = 6%+0.84*6% = 11.04% 4. Realized price in 2008 = $225m/plane 5. Capital Expenditure = Depreciation, and both keep constant after 2006.

Appendix II Financial analysis at full production
NPV with indefinite life Payback Period CF from first 12 years Discounted Payback Discounted DF from first 24 years IRR (with 50-year project life) 1517.733 12.31846 -330 24.73037 -95.0803 12.724%

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