One of the big stories coming in 2021

A new year (with all the best wishes to our readers) brings fresh hopes and dreams. No Paris Air Show this year to look forward to, but a significant event is looming that will have industry observers focused. That story is Southwest Airlines and it’s pending the decision on what to do about replacing its aging 737-700s. The airline has an order for 30 MAX7s, but the betting on those being delivered doesn’t carry the same odds anymore. Moreover, orders for the MAX7 are comparatively tiny compared to the rest of the family. Other than its future role at a BBJ, the MAX7 seems to have very little airline interest. This is what Southwest Airlines’ fleet looks like. While the pandemic proved useful to park older aircraft, and then use them for spares, that tactic has limits. It buys some time at best. Southwest will almost certainly start to remove the oldest -700s from its fleet soon. Southwest built its business on keeping operations as simple as possible. As it grew, the policy had to be modified and their fleet grew more complex. When your airline gets to be over 750 aircraft how can it stay simple? Simplicity for Southwest meant commonality. It started with focusing on the 737-200, then the 737-300, and a few -500s. Then came the -700 and the older models were removed from the fleet. But growth continued and Southwest grew to become the largest domestic airline and needed more seats. The simplest solution? Move up to the -800. The switch is clear in the chart above. As we have noted before the last new delivery -700 was in 2011, any -700 acquired after that date was a used model. A significant amount of the airline’s traffic utilizes the -700 fleet as the following chart illustrates. Even as the -700 has seen its relative volume decline, it still accounts for over two out of three passengers. Another item to consider is just what the -700 fleet consists of. For an airline focused on commonality, this next data point looks odd. The following chart lists the various models among the -700 fleet. Note the average age for these models. In the pie chart we note the 737-7H4 is the “standard” Southwest version and is the plurality (71%) of the fleet. But what that means as much as 29% of the -700 fleet is out of the standard. It appears, from the outside, that the airline was looking for a way to maintain its -700 fleet numbers without buying new. The desire to remain as common as possible trumped other options. But does that logic still hold true? Here’s why we think the question is viable – if the logic was still true, Southwest would be looking at about 500 MAX7s. But they only have a token 30 on order. It would seem the MAX7 has not won over Southwest yet. The next question then, what does Boeing have to do to ensure the MAX7 wins? Now the issue becomes a multi-billion-dollar conversation. For Boeing to win this deal, it will have to discount the MAX7 deeply. Very deeply. The MAX7 now has competition in the Embraer E195-E2 and the Airbus A220. The Embraer could have been an alternative offered by Boeing, but the merger failure destroyed that option. Southwest currently requires an aircraft that can fly any route in its network. And the A220-300 can do that, from any corner in the US to any other corner, including Southwest’s Hawaii routes. If that requirement still holds true, the decision process narrows to a MAX7 vs A220-300 runoff. When it was MAX7 (or -700 vs CS300 at United) against a Bombardier CS300, Boeing would have thumbed its nose at the Canadians. It took Delta to explain the way the market works to the ITC. Bombardier’s commercial aerospace business was crippled after winning the case, giving Airbus the commercial aerospace deal of the century. Bombardier ended up losing, but its airplane won. And it won big and has kept on winning. Now Southwest gets to play off Boeing against Airbus. And Boeing is not the obvious winner. Boeing’s incumbent position has never been so tenuous. The MAX7 economics are not as good as those of the A220-300. The gap is significant, and our economic models show a 6 to 8% gap. To close that gap Boeing will need to discount the MAX7 substantially. Considering that discounting for large orders is substantial, Airbus and Boeing will each discount quite significantly, with Boeing needing to price to the point of economic indifference. Our calculations place that price between $28-$32 million given today’s market conditions. One must consider what this means for Boeing. It is between the proverbial rock and hard place. It can’t really afford such a discount on the MAX given the cost overruns for the program - but the potential loss of Southwest’s business would be catastrophic. How much is Boeing willing to lose? How significant is cockpit commonality? On the other hand, Airbus can afford a big discount. A large order would help drive its program costs down and keeps the Mobile final assembly line (“FAL”) busy for the next decade. Indeed, it might justify the FAL’s expansion. Moreover, with Airbus R&D at low levels, it can afford to bet on the Southwest deal. Knowing that winning Southwest enables the A220 program to expand, which loosely translates into developing the -500 which Air France has asked for. And a putative A220-500 could hammer the economics of the MAX8. For Boeing, the tradeoff is how much it is willing to bleed? For Airbus, the potential is all upside. For Southwest Airlines, it’s a case of almost can’t lose, as both OEMs want their business. Airlines smaller than Southwest manage to work around pilot/flight deck commonality. A large A220 order will make the fleet less common, but is it really such a hurdle? Passenger acceptance of the MAX is another issue to consider, and Southwest will soon be gaining direct experience in that regard as the MAX 8 returns to service during the first quarter. A negative passenger reaction could become a factor in the decision process. Expect industry chatter around one of the key aircraft campaigns all through the next nine months or so until Southwest reaches its final decision. Stay tuned, as this could be quite interesting.

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