Premium #330 – a review of Boeing’s ITC testimony

The full transcript is 289 pages. The focus of our story here is only on Boeing's testimony. There is more than enough in this to keep anyone interested in this issue riveted. The impression one has of the all-mighty Boeing Company starts to change going through this. This post consists The Antidumping and Countervailing Duty Investigations by the US International Trade Administration (ITC) has begun. Use these terms in your online search to get all the public information being posted: 701-TA-578 and 731-TA-1368. You can track the process from this link. The names of the investigators and their phone numbers are listed. A preliminary transcript (Ace-Federal Reports, Inc.) is available and is being reviewed by the parties for corrections. Meanwhile, the claim Boeing made centers around Bombardier offering its C Series for less than $20m, while they cost more than $33m to produce. Boeing has not, to our knowledge, provided any information how these numbers were derived. The hearing last week must have been testy. The stakes for both sides are high. But there is no doubt the faceoff here is a Goliath in Boeing and a tiny David in Bombardier. We know how the original story ended. Is the same outcome in this latest version going to go the same way? Very few people bet against Boeing. The stakes are high for other parties too. Delta Air Lines for one, which may have to pay the duties if they are imposed. Such an outcome would almost certainly force Delta to cancel the deal it has. Does Delta have any public opinion on the claim by Boeing? Why yes it does. Here are snippets from the transcript: Greg May, Senior Vice President, Supply Chain Management & Fleet Strategy, Delta Air Lines Inc. “I want to be clear that Boeing is not competing for new orders when we were negotiating with Bombardier. Boeing had no viable competitive alternatives to the CS100. We were not even considering any new Boeing product as an alternative when we made the purchase that Boeing challenges in the petition. ” “The 737-700 is particularly well suited for certain unique mission profile, such as takeoff and landing at airports with shorter runways or at high elevations. However, it’s not economical on the vast majority of our routes. That is why we only have 10 of these aircraft in our fleet. I can’t emphasize enough it is not -- the 737-700 is not a 100 to 110-seat aircraft.” “At no time did Boeing even try to convince us to consider the 737-700. It would be wrong to suggest that Boeing lost sales to Delta because we purchased the CS100. Boeing simply was not in the mix. They did not have a plane that satisfied our mission profile and needs.” “The key difference, though, between Bombardier and Boeing was that Boeing could not offer us a new airplane in the 100 to 110-seat space that met our needs in the timeframe that we needed to execute. Boeing was aware of what we were looking for and simply could not offer a new Boeing alternative.” “We’d already determined that there were not sufficient used 717s available. It was only about 17 airplanes potentially available in the distant future to meet our long-term needs and Boeing had ceased production of the 717, as you’ve heard earlier, in 2006. The 717 was, in fact, the last model that did fit the 100 to 110-seat space that Boeing had to offer. While we were negotiating with Boeing for used E190s, they never offered us any new Boeing-produced planes as alternative to our needs. They couldn’t because they do not produce a plane in the 100 to 110-seat gauge.” “Frankly, you simply cannot put a lot of weight on what you read in industry papers or in the rumor mill about pricing. We don’t rely on abstract and opaque market intelligence. We rely on our own actual data. Lastly, to briefly rebut an early comment about list prices because of the magnitude in variation and discounts from so-called “list prices,” we find them, frankly, to be completely meaningless and Delta’s so-called “commercial momentum” does not drive our purchasing decisions. In fact, it’s not even a term we use at Delta or that I think others generally use in the airline industry.” “Everyone in the industry understands that the first marquee or single customer is being rewarded for being the first for fully evaluating the aircraft. While speculation abounds in the press and various analyst reports, there also is no pricing transparency here.” Joe Esposito, Vice President, Network Planning, Americas, Delta Air Lines Inc. “In that sense, it is very important to be aware that a 100-seat plane and 150-seat plane are not interchangeable for Delta’s purpose. We cannot profitably fly a 150-seat aircraft on a flight with demand for only 100 passengers. At Delta, in this hearing we’re talking a lot about the variation of 100 to 150 seats, which in my world is a big difference. It’s a 50 percent increase in capacity on any given route, so we are very specific in having a 100-seat airplane.” Yohai Baisburd, Partner, Dentons (Delta Air Lines counsel) “We started the morning with a statement we are here today because immediate economic harm. To whom? Boeing, the largest exporter in the United States? Not of aircraft, of anything, with billions, hundreds of billions of dollars of revenue. How are they subject to immediate economic harm because of depressed prices and lost sales to Delta? You have to be in it to win it. They didn't have a plane to offer Delta that they manufactured.” Boeing’s counsel Bob Novick was articulate and started off noting that,”…Bombardier failed for over a decade to gain real traction offering the C series in the U.S. market at real market prices. But after receiving $2.5 billion in equity infusions from Quebec to augment the one-half billion dollars in risk free launch it had already received, Bombardier began to dump its product into the U.S. market, which we saw in with particularly in its sale to Delta.” Mr. Novick focused on Boeing’s claim using Delta as the example to prove “the loss of a single sale can cause immediate economic harm and where it may be impossible to offer meaningful relief if the investigation is not initiated until after importation takes place." He then went to mention United as well: “Beyond that, it (ITC) has compelling information in the record regarding United's sales campaign, where direct competition between the CS-100 and the 737-700 caused Boeing to have to drop prices significantly below any prior levels.” Mr. Novick went out to explain that Boeing was caused economic harm because the CS100 sale to Delta depressed prices that will affect future transactions. He also noted that Delta may buy up to 90 CS300s which compete directly with the 737-700 and MAX 7. Mr. Novick then went to note that “If Boeing cannot secure additional orders for the MAX 7, or is forced to sell at depressed prices, the program will not succeed and Boeing will be eliminated from the 100 to 150 seat market.” What does the 737-700 fleet look like? As the chart shows market demand for this aircraft started to slow after it peaked in 2013. The market seemed to move on from the 737-700. As further proof of this, look at 737 deliveries. Airlines and lessors quickly moved to the 737-800, which now dominates deliveries (regardless of which model was ordered). In 2015 and 2016, 737-700 deliveries were in single digits. This data suggests that concern about the C Series impacting the sales of the 737-700 might not be the whole picture. Bombardier’s counsel was Mr. Peter Lichtenbaum. As is obvious, Mr. Lichtenbaum focused on the fact that Boeing does not offer an aircraft that competes with the C Series. This is a bit of dancing, as he did not specify the CS100, which he should have. Delta and United were both looking at the CS100 and if that is the only focus by Boeing, their case would be much flimsier. However, Mr. Lichterbaum was correct when he pointed out later that the CS100 seats fewer than the MAX 7. He was correct when he noted “Larger aircraft are heavier and more expensive to operate. Thus an airline does not want to operate a larger aircraft than it needs for a particular route.” He was also correct when he stated “Boeing and Airbus both adopted deliberate strategies years ago to make larger single aisle aircraft that are more profitable for them. Boeing presses its customers to up-gauge their orders from the 737-700 and MAX 7 to the MAX 8 and 9, effectively cannibalizing demand for its smaller aircraft. Airbus does much the same. And they've been able to follow this strategy because there was no alternative for airline customers. But in doing so, they left a hole in the market that created the business case for the C Series. Boeing had decades of head start and plenty of opportunity to produce aircraft in the seat range as it did until 2006, but chose instead to exit the 100 seat market space.” Bombardier’s counsel then made a very strong point when he pointed out that United’s order for 737-700s was priced “aggressively” which he followed with noting that Boeing then persuaded United to switch this order to the larger MAX 8. In this point, counsel demonstrated that indeed Boeing did not offer United what it wanted, a 100-seat aircraft. Boeing’s counsel then provided more information, noting that “Bombardier has reportedly already had discussions with U.S. carriers, JetBlue and Spirit.” He did not mention that neither of these airlines deploys a Boeing product. Boeing would have to buy its way in if they were sent an RFP because these airlines would have to switch OEMs with the consequent costs this requires. Boeing’s Vice Chairman Ray Conner spoke about the threat Bombardier represents “A single campaign loss immediately harms our commercial momentum with only a handful of make or break orders from market customers to go around, every major order that Bombardier wins helps convince the remaining customers that Bombardier will be the best, long term solution and partner in this market.” Mr. Conner went on the explain how a low priced CS100 pulls down all competing pricing. This is a smart approach because in doing this he can move the conversation beyond the 100-seat market where Delta and United were focused. Mr. Conner also noted “The Max 7 only has 63 orders from 5 customers, has not received a significant customer order since 2013 and received its only U.S. orders in 2011. Sixty-three total orders is far from a healthy backlog.” Boeing has not previously enumerated the MAX order breakdown by model, so this is news. It also confirms what analysts have expected - the MAX 7 is not getting market traction. Next Professor Jerry Nickelsburg from UCLA spoke. He noted, “The 100 to 150 seat LCA are optimal for U.S. airlines for a very large number of routes that they want to operate.” This is an accurate statement. He then noted that airline consolidation has shrunk the number of target customers. Also true. Professor Nickelsburg then went to explain that the fleet of these aircraft are aging. How old is the US-based fleet of these aircraft? As of the end of 2016, the next table shows the number of aircraft in active service and their average age. To provide some perspective on this fleet, look at the following chart. Among the US-based majors, the 737-700 is only significant at one airline. If we take a detailed look at the Southwest Airlines fleet we note this as of the end of 2016. The number of 737-700s being added to the fleet are not bringing down the average age. That is because they are second hand. The only new models the airline is taking delivery of is the 737-800. Using data from Boeing’s O&D data we can see that Southwest has not taken delivery of a new 737-700 since 2011. The Professor’s testimony about the damage the CS100 might be causing Boeing 737-700 sales seems to ignore the fact that US-based airlines have shown little interest in the aircraft. Even the biggest customer for this model worldwide has not taken delivery of a new model in five years. The Professor noted “The Boeing 737 Max 7 appears to be perilously close to, or maybe even already be, locked into such a negative commercial momentum cycle. It has not had any major U.S. orders since 2011, and has not had any major orders of any kind since 2013.” He may be correct but that does not seem to be C Series driven as he alludes. Boeing 737-700 sales peaked some while ago, and the MAX 7 does not appear attractive as a replacement to operators of the 737-700, or orders would have shown this. Certainly, a reasonable expectation is that Southwest would have started to plan replacing 737-700s, many of which are a decade old. Southwest placed an order for 30 MAX 7s in 2011. This order represents 55% of all MAX 7 orders. Southwest’s interest seems low and the rest of the market appears in sync. The Professor closes with a crucial comment: “In closing, let me note that historically, the market has not supported more than two suppliers for any appreciable length of time.” This is a telling statement and fits closely with Porter’s Five Forces theory. Oligopolies remain stable and even rational when there are two competitors. Add a third and chaos ensues. Bombardier is a third player entering what has been an oligopoly, and Boeing’s aircraft is the most vulnerable because it is based on the oldest design. Here we see the true fear for Boeing articulated, even if inadvertently. Bottom Line The testimony, in this case, is intriguing to read. Once again, as was the case when Boeing lost the tanker contract, they are relying on the government to change the playing field, as they cannot compete as effectively as they would like in a free market and don’t want a new competitor to upset their profitable balance. Boeing is currently protesting yet another USAF project. Boeing has a pattern of protesting when it loses. The C Series development resulted in Airbus countering with the A320neo, which took Boeing completely by surprise and upset the new aircraft timetables for the big two players. Boeing, which was late to react, is now a 40% rather than a 50% player in narrow-bodies because they underestimated and failed to react to the C Series in a timely basis. Now that it is too late, they want government protection.

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