Premium #215 – The Boeing MAX challenge

It is pretty obvious that Boeing is having a tough time selling its 737 MAX7 and MAX9 models. With 3,090 orders, the MAX program is clearly not in difficulty. But of those 3,090 only 60 are for MAX 7 and 217 for MAX 9. The Airbus A320neo family has generated 4,510 orders, giving Airbus a substantial lead in market share. Of those orders, 1,108 are for the A321neo, which is leading the MAX9 by a 5:1 margin. While Boeing is offering a 200-seat high-density version of the MAX8, it is essentially the base aircraft with a few tweaks and essentially a Ryanair product. As a result, while Boeing is offering a four aircraft MAX family, the market indicates that only one of those aircraft appears viable. The MAX program was born out of a decision to offer something to American Airlines in July 2011 in reaction to Airbus A320neo family. The airline ended up ordering 460 single aisle aircraft, with half from Airbus and half from Boeing. Boeing was shocked that Airbus might win the entire order at a traditional Boeing customer and, seemingly overnight, offered a new version of 737 - the MAX. This rapid move by Boeing demonstrates two things: first, the company can move quickly if it has to and second, it is often dangerous to bet against Boeing. The MAX program recently added a third aircraft to its flight test program, which is centered about the 162-seat MAX 8, the best selling model. All indications are that Boeing’s flight tests are going according to plan. There are hints the aircraft might enter service earlier than planned. The key item to look for in that regard is to find a customer that could be ready for early deliveries. Our thinking is that Southwest Airlines can be ready ASAP. The Product Line Gap Meanwhile the other side of the MAX story is less positive. MAX is being beaten soundly in the market by its nemesis, the Airbus neo. The quandary for Boeing is that every competitive campaign pits its 162-seater against Airbus’ 150-seater. This is, in Boeing’s view, not exactly a fair fight. And they are correct. Boeing ends up discounting its 162-seater to match the 150-seat Airbus. This applies both in NG vs. ceo or MAX vs. neo campaigns. The challenge is further complicated by a lack of market interest in the 130-seat A319 and 737-700 models on the low end and the radically greater market interest in the A321neo than the MAX9 at the upper end. It may be true that some customers with MAX7 orders are playing the pre-delivery payment game and convert to the MAX8 when production starts. Anyway one looks at it, the 737 family isn’t an effective family. The -800NG and MAX8 are by far the best sellers. Airbus has a much more balanced demand between the A320neo and A321neo. Boeing has seen this before when they moved from the 737 Classic to the 737NG; they had done well selling the 737-500 but there was very little interest in the 737-600NG. So the 737-700NG and MAX7 story is one seen before. Boeing has to take the lesson to heart and, we understand, this is happening. The Solution Boeing has to develop an “anti-neo” product. This would be a 150-seater to compete directly with the A320neo, allowing the larger and more capable MAX8 to be better (and more fairly) priced. An aircraft is being offered to customers (“located from the farthest western US to the most eastern US” we were told) and would essentially be based on the MAX8. Rather than build the MAX7 currently described Boeing’s website, a derivative of the MAX8 could become the new MAX7. Cheekily described as a MAX7.5 by industry people we spoke with, the aircraft could consist of the basic MAX8 minus a plug and with two less rows of seats. Crucially this aircraft will be like the MAX8 in other ways – notably the same wing. The current MAX7 has a different wing, and the decision to cancel the current MAX7 for the MAX7.5 would save Boeing development costs. Besides the wing, the MAX7.5 could also require fewer exits which would also save cost and weight. While no name has been given to this aircraft, we would not be surprised to see MAX7 get sidelined, and the new aircraft be called the MAX8-150, following the similarly named MAX8-200. This MAX7.5 would, on paper, have impressive range and performance. Boeing could in fact use such an aircraft as a solution to not only compete (and perhaps beat) the A320neo, it could also use this solution to stall Bombardier’s CSeries progress. While such an aircraft may be too late for winning a deal at Delta, it almost certainly could forestall progress by Airbus or Bombardier at American Airlines. American has a lot of MD80s it is replacing and has been doing this mainly with 737-800s. But these -800s are significantly larger aircraft than the MD80. As airlines are discovering, the “up-sizing” mantra has proven to be a siren song – those extra seats have to be sold and often this requires a discount which disturbs yields in ways revenue management departments don’t like. “Right Sizing” is making a comeback - which Embraer told us would happen. Boeing’s decision to offer a MAX7.5 can be seen as playing a weak hand. After all, what other options does Boeing have? But rather than dwell on the negative, we see this in the same light as the original American Airlines derived MAX creation. Boeing can develop an idea quickly that optimizes its options and provide a credible solution. In coming up with this idea, Boeing potentially disrupts Airbus and Bombardier. It drives down its own production costs by deepening economies of scale around the MAX8. It is likely that Boeing will also revisit its “Partnership for Success”. This has been a deeply unpopular strategy with vendors, but Boeing probably will do it anyway, as it now appears that Airbus builds aircraft at lower cost, even as it opens production lines in the US. The challenges for Boeing’s managers in our view will include: Explaining why Boeing is leaving the 130-seat market and discontinuing the MAX7, ceding this territory to the A319neo and Bombardier CS300. Defining why a smaller seat count differences between the MAX models make sense. (i.e. MAX 7.5, MAX8, MAX8-200 and MAX9). No doubt Boeing will conjure a great story about right-sizing aircraft and 150-200 seats being the heart of the market. Explaining how its MAX9 is a better competitor to the A321neo. The MAX9 simply isn’t competitive with A321neo in the market, as the 5:1 order rations shows. Does Boeing need a MAX9.5 to effectively compete, or is there an adequate market for a Middle of the Market airplane? It may already be too late to stop the A321neo from effectively becoming the replacement for the 757-200. The Bottom Line The current MAX offerings from Boeing were generated quickly in response to Airbus, and two of those models are not selling well. Boeing can tweak the MAX7 to even the seat-game with Airbus in competitive campaigns for A320neo, and eliminate the original poorly selling MAX7. This should help them more effectively compete on certain campaigns. But the top end of the product line appears still problematic. The MAX9 has a performance disadvantage vis-à-vis the A321neo, and Boeing currently has no answer. That is the more difficult problem to solve if the MAX is to truly become an effective three-model product line. Given the WSJ article above, is Boeing leaving this market to CSeries and neo? The cost of the MAX7.5 could be higher than the current MAX7, despite economies of scale, making the MAX7.5 possibly less competitive (i.e. requiring deep discounts in campaigns to win deals such as United Airlines). Which may mean the Airbus approach to compete against CSeries is that you can only win if you have a 150-seater (supporting seat-mile cost arguments) and heavily discount prices.

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