Insight: Friday 4 December 2020: Can Boeing Afford Not to Leapfrog the A321neo

News:

There is speculation that Boeing is now focusing on developing a new 200-260 seat aircraft to position against the A321neo, which has been cleaning up in the marketplace vacancy once occupied by the Boeing 757 and 767, the “middle of the market.” Boeing had developed (and spoken with airlines about) a wide-body NMA (‘New Middle-market Aircraft’) design but could not overcome uncertainties about the business case when the MAX crisis hit, followed by the COVID-19 crisis for the industry.

Boeing is now speaking with airlines about a narrow-body NMA to “leapfrog” the A321neo in terms of efficiency with an all-new design, which we will call NBA for new Boeing aircraft in our nomenclature. As Boeing evaluates the business case for this aircraft, there are compelling forces on both sides of the debate whether to build or not to build this aircraft.

Analysis:

Boeing is facing a tough decision when it comes to the middle of the market. Is it already too late to recapture some of the market, or can it leapfrog its competitor and regain market share? One can present a cogent case either way.

The Case Against:
Building an all-new aircraft at Boeing will take a substantial investment of $8-10 billion dollars for an all-new program. It is quite clear, based on the 737-10, that the 1967 airframe cannot easily be stretched any further, and the performance limitations from that design cannot overcome the economic advantages of the A321neo. As a result, to compete, Boeing will need to spend a lot of money it currently doesn’t have.

The recent track record at Boeing hasn’t been pretty. The 787 was a development disaster, well over its initial budget and costing the company billions in excess costs and late delivery payments to airlines. While that program is finally cash flow positive, it may never fully break-even as demand has fallen with the pandemic for wide-body aircraft.

The 737 MAX, which was rushed to market to compete with the A320neo family, was a design failure, resulting in two fatal crashes, a 20-month grounding, and more than $20 billion in added costs.

After spending $60 billion in stock buy-backs and dividends, Boeing is now in a position of not having the financial strength to easily move forward. While the MAX crisis shows light at the end of the tunnel, the global pandemic has decimated demand for aircraft, and production rates for all of Boeing’s commercial aircraft have been reduced, negatively impacting cash flow.

Boeing is already well behind the A321neo in orders, and it appears that Airbus has cornered this segment of the market. The key question for the NBA is whether it is too late for the market to become successful. The answer to that question may be technically based, as Boeing needs a clear advantage over Airbus to convince customers to move from the A321neo to the NBA. But new technologies are high cost. A financial advantage could be gained from innovative manufacturing processes, but automated factories are also expensive, and it takes time to prove out new production systems.

All in all, the risks to Boeing from a new program are quite high, and the rewards may not merit the expense since Airbus has already captured about half of the potential market.

The Case For:
Boeing needs to effectively compete with the A321neo and hasn’t been able to do that with the MAX 10, which hasn’t generated the level of interest it needs as yet to become successful. With Airbus now commanding a 65-35 lead in narrow-body backlog, Boeing needs to close the gap to retain parity in this “cash cow” market segment.

One-upping the A321neo with the NBA would provide Boeing a new technology platform with technologies it could further utilize on the Future Small Aircraft (‘FSA’) that will replace the 737 early next decade. Establishing a new production system is a difficult task, and introducing that technology on NBA could provide a lower volume platform on which to work out any kinks, rather than waiting and rolling out a new system with a high-volume FSA.

It is a well-known adage that it costs about ten times as much to regain market share than to defend it. While Boeing erred in not having a viable replacement for the 757 and took the risk that the 737-10 could become a viable competitor, it still needs to regain market share. That will require a new airplane to leapfrog Airbus in the competitive environment.

If Boeing fails to regain market share, it runs the risk of being at a long-term disadvantage versus Airbus. The question is whether the MAX, which is a damaged brand, can weather the storm until FSA arrives, or whether innovation is needed at the high end of the narrow-body range. Clearly, the best model of the MAX series is the 737-8, which accounts for the vast majority of orders. The -7, -9, and -10 have had limited success.

Boeing needs to do something before it falls too far behind Airbus in the marketplace. With former 757 customers now buying the A321neo, the evidence is clear that Boeing needs to make a positive move to regain momentum.

Insight:

Boeing’s management and its board are facing a tough decision. In many respects, they are between a rock and a hard place. If they invest, they face increased financial risk and can’t afford another 787 or MAX screw-up. But if they don’t, they cede a portion of the market to Airbus and may not have a chance at getting it back for twenty years.

About 1/5th of the MAX order book is in China, and the US trade relationship with the PRC appears to be on shaky grounds. Restrictions on COMAC and other Chinese companies by the US might result in fewer Boeing’s to China. The current glut of good used airplanes could be used to tide them over until the C919 with a domestic engine is ready. That would provide both a loss in short-term revenues and market share for Boeing.

The bottom line is that Boeing’s management will be criticized either way they decide. If they produce the NBA and maintain a stronger competitive position with Airbus, including new production systems, Wall Street may not be happy with the capital expenditures. But if they decide not to produce the new aircraft, shareholders will be angry when they become the number two rather than the number one player in the industry and lose their mantle of leadership to a competitor that gained a competitive advantage by re-engining a more modern airplane.

Dave Calhoun has an important decision to make and needs to make that decision soon, as the clock is ticking. The outcome of that decision will shape Boeing’s competitive position for the next 30 years.

Ernest Arvai

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President AirInsight Group LLC