Premium #210 – Why Competitive Dynamics are Changing in Commercial Aviation

The delineation of the two major sectors in commercial aviation used to be quite clear. Airbus and Boeing built aircraft for the major carriers, while Bombardier and Embraer built aircraft for regional airlines. With the introduction of the CSeries, everything began to change. As we map the changes in competitive dynamics, we find that two segments that each behave as a duopoly should are morphing as Bombardier, and to a lesser extent Embraer, move upward. Duopolies operate carefully, deliberately and engage in no behavior that would upset the market. While companies may compete vigorously with each other, above all, they remain rational in playing their game of leapfrog. The regional segment, which we have called the small duopoly, is actually becoming more competitive. A market that once had multiple players including Saab, BAe, Fokker and others narrowed to mainly Bombardier against Embraer. But a number of new players have entered the market and they are all jockeying for market share. This makes the smaller commercial aerospace sector a lot more dangerous. Multiple forces impact the competitive dynamics of an industry sector, and there have been numerous frameworks developed to describe competitive behavior. One framework examines competitor versus customer-centric behavior – and competitor-centric behavior fits this industry well. Another outlines multiple forces (Porter's Five Forces) impacting the industry, and the likely competitive behavior emerging from each, as shown below.Combining the two frameworks, and analyzing the behavior of aircraft OEMs in that light yields interesting results. Let's take a look at what happened when Bombardier decided to move from the smaller sector to the larger one with its CSeries. Bombardier lacked the supplier bargaining power that Boeing and Airbus have, given their much lower volumes. For suppliers, there is no question which of the two customers would have higher priority should a shortfall occur or a decision need to be made. Purchasers of aircraft also had significant leverage, some of it provided by the superior economics of the CSeries. With a competitor-based competition system, buyers could play one manufacturer off against another to bring pricing down to the point of economic indifference. Airbus and Boeing, with deeper pockets, were able to undercut Bombardier in that regard. The threat of substitution was important to Airbus and Boeing, who did not want a new entrant to offer a substitute aircraft to their entrenched customers. As a result, they chose to block market entry to Bombardier through aggressive pricing and marketing tactics, including offering discounts for wide-body and narrow-body planes, something Bombardier couldn’t match. Competitive intensity jumped markedly. The CSeries essentially drove Airbus to the A320neo, as the CS300 was more cost-effective in both aircraft and seat-mile costs than the A320. The A320neo cut that advantage in half, providing Airbus the ability to purchase deals that would have otherwise gone to Bombardier while remaining profitable. Of course, when Airbus launched the neo, Boeing needed to counter with the MAX, resulting in the competitive position we have today. While each of the large OEMs had strategically planned a next generation narrow-body optimized around the new engine technology that is now available, the losses on A380 and 787 programs caused cash flow issues that resulted in re-engining rather than all-new aircraft. As a result, Bombardier has the only aircraft in the 130-seat category specifically designed and optimized around a new technology engine. But the deck was competitively stacked against Bombardier. It had to execute flawlessly to succeed in invading the other player’s turf. The threat was quite clear – Bombardier stretched the CRJ from 50 to 100 seats, and would likely stretch the CSeries to 150 or 170 seats, right in the heart of Airbus and Boeing markets. But Bombardier was late, failing to execute its program on-time or on-budget, and left itself a significant hole to climb out of. The Ability to Execute Bombardier’s capabilities had to be exactly right for the risk it took on. How did that work out? The chart above provides a good view of what Bombardier needed to have in place. The firm did not have enough of these items in place. Specific examples include enough people with commercial aerospace experience marketing to mainline airlines, people with the ability to manage and control a complex supply chain with Tier 1 and 2 vendors. In identifying the value chain and specific resources and capabilities required, Bombardier was not equipped for the risks associated with the project. For instance, its marketing and sales function was not communicating effectively to customers. A successful strategy must be one that provides an advantage that is sustainable. Two important items for this to occur are the ability to imitate and durability. Absent being able to have these in place means a company cannot sustain any advantage. It turns out that Airbus and Boeing could and did imitate the CSeries by re-engining. Doing so closed the gap CSeries had created. In terms of durability, Bombardier saw its timing advantage slip because it could not exploit the market gap it identified. Program delays provided Airbus and Boeing what they needed to catch up. Then circumstances also made the advantage a tougher sell, as oil process dropped. The key message of a 15%+ better fuel burn became moot as oil prices started to fall to less than half their prior values. Take a look at the next chart to demonstrate why Airbus and Boeing reacted to Bombardier's encroaching on their duopoly. It is clear why Bombardier wanted to move upmarket. Their CRJ products in the 70-100 seat size were under attack from newer models. Airbus and Boeing reacted by undertaking to up-size customers, the following chart illustrates how the two OEMs undertook a great swap. Note how the smaller models have all but disappeared from the order books. Low interest in the re-engined models is confirmed in the bubble chart. The nature of the game is leapfrog – moving ahead of your competitor with new technology. Airbus leaped ahead of Boeing when it introduced the A320 in 1989. Boeing retook the lead with the 737NG in 1997. Airbus re-took the lead with neo in 2010. And Bombardier took the lead in economics with CSeries - but was thwarted by the big OEMs in multiple sales campaigns, as they could not afford to let another player into the group. Porter's theory says that rivalry intensity decreases as the number of competitors decreases. Consequently, Bombardier's move into the duopoly space saw rivalry intensify. The market is also getting much more intense in the <110 seat market. Embraer is doing better and growing stronger. Well funded Mitsubishi is a threat. In addition, Russia will ensure than the SSJ stays in the market. Bombardier decided it was worth the risk to cross the 110 seat mark. The assumption was the Airbus and Boeing were exiting the ~130 seat market and moving to the 150+ seat segment. But as the bubble sizes show, the market was not insignificant. Besides the Airbus and Boeing models offered were part of a family of aircraft. Airbus saw the threat first. Its reaction to develop the neo was a superb game theory play. It was forced to re-engine as it did not have resources for a clean sheet design. Moreover, one of Airbus' most critical customers was pushing. Lufthansa wanted a GTF powered A320. Lufthansa encouraged Bombardier knowing this would achieve two outcomes: validating the GTF and also pushing Airbus. Airbus listened, turning a time disadvantage around and played its next move superbly. They were less threatened by Bombardier than Boeing. Airbus pitched the neo to American Airlines and very nearly won 400 orders. Boeing was forced to react and offered MAX, ensuring it got half the order. In one move, Airbus upset Boeing's strategy of not updating the 737NG and also undermining the case for the CSeries. At the same time, Airbus and Boeing started moving customers to up-size. High load factors and oil prices made this attractive. The duopoly also deployed two powerful advantages: production and pricing. Airbus and Boeing could deliver an aircraft faster and at lower cost. Airlines, being risk averse, preferred to take a bet on Airbus and Boeing and ordered about 7,000 neos and MAXs. But the story does not end there. As the chart shows Airbus and Boeing have seen interest in their re-engined models that compete with the CSeries wither. Meanwhile Embraer moved closer to the segment, but is staying below the Airbus and Boeing options. It will not compete in this segment even though the economics of their E2 aircraft allow for airlines to substitute them for larger models following the "right sizing" strategy. Bombardier took a high risk bet with CSeries. It has gone through the wringer to move down the learning curve and get the aircraft produced. Many people changes later, they seem to have the right team in place. The company ran out of money, but looks like getting support from Quebec and Canada. It is still an open question if this assistance will pass any WTO challenges. Embraer is watching this very closely and will pounce if they can. The floor on the large segment has effectively moved to 150 seats. Bombardier's bet achieved that at tremendous cost. That bet also gave cover to Embraer to move up, without catching any flak.

No results