Premium #157 – Selling the CSeries |

Two of aerospace industry’s perennial questions are these: at the high end – why aren’t more A380s being sold and at the other end of the spectrum, why aren’t more CSeries being sold? At the recent Airline Economics Conference in Dublin, we had the chance to speak with a number of people in the industry who are buyers of aircraft. The discussions focused on three areas where Bombardier should be focusing. Below is a composite of the interactions we had discussing the CSeries program. Pricing The aircraft list price is between $62m (CS100) and $71m (CS300). But nobody pays attention to these numbers – they aren’t even useful guidance. The same can be said for A319 and 737-700 list prices at $88.6m and $78.3m respectively. They are essentially meaningless in today’s environment. Some industry people believe the appropriate price for the CS300 is around $36m or roughly 51% of list price. At this price the aircraft would be discounted to a similar level as competing Airbus or Boeing aircraft. In terms of discounts to counter Bombardier, Airbus is the most aggressive. We’ve heard reports of low $30m prices for an A320, which lists at $97m, to counter potential CSeries replacements of A319s on more than one occasion. Airbus has a wide range of aircraft over which to spread losses from very deep (65% plus) discounts. Bombardier does not have that luxury and thus cannot win a price war. If Bombardier were to be realistic, it needs to discount more aggressively. It is deeply committed to the CSeries so its a case of “in for a penny in for a pound”. It was suggested to us that if, for example, Bombardier wanted to win a customer like American Airlines, it should go in with two strategies – either it would ask what the airline wanted to pay and work from there, or start at $26m. Then demand “give backs” based on performance, for example fuel burn and dispatch reliability. As the aircraft meets its performance guarantees, the airline would give back part of the discount and get Bombardier back to a more reasonable $36m price point. But even at $36m, Bombardier’s margins will be tighter than those of Boeing and Airbus, which are amortizing fixed costs over several thousand orders for neo and MAX. Boeing and Airbus enjoy the efficiency and scale economics of 40+ aircraft per month production rates, versus a planned 10 per month for Bombardier. Demand Bombardier claims to be aiming at replacing fleets of older aircraft such as the Bae146/Avro RJ. There are only 292 of these left in service. But there are also 255 Fokker jets left in service. In total this means there are potentially 547 “obvious” replacement opportunities. Bombardier won’t win them all – but even a 50% win gives the CSeries program an extra 274 aircraft which easily pushes current firm orders over the 300 target at EIS the company is aiming for. Another opportunity is the replacement market for 717, 737-500s, -600s and -700s, plus the A318s and A319s. The table below illustrates the extent of this market. There are 3,047 aircraft to work with here and the opportunities are rich. Assuming Bombardier gets only 25% of the replacements, which amounts to 723 aircraft, along with the 274 replacement aircraft identified above, Bombardier is potentially looking at 997 additional replacement aircraft it could sell. Of course, there is significant growth potential in an industry in which traffic is expected to double in 15 years. Growth is a factor, as well as replacement. The key question is whether growth occurs from larger aircraft (more seats per flight) or additional aircraft. We believe it will be a mix of both, and while the 100-130 seat market will not double over that period of time, it will experience significant growth from the sales levels in the last three years. The demand for aircraft between 100-130 seats is something of a niche. But the niche is really in relation to how many of these sized aircraft Airbus and Boeing have sold. Between 2000 and 2014, Airbus sold 1,296 and Boeing sold 933. For Airbus this was 13.7% of single aisle aircraft sold over the period and for Boeing this was 12.4%. Even if one believes the segment between 100-130 seats is a niche, historically it is large enough to accommodate the ambitions of Bombardier and Embraer. Airbus and Boeing appear to be withdrawing from this segment. An issue with this segment is that it is shrinking, as Boeing and Airbus push customers to larger aircraft, and at the current time this segment is “no man’s land” – too large for the US regional airlines because of scope clauses, and too small for the major airlines focused on larger aircraft and seat-mile costs. We believe that scope clauses and creative B-Scale arrangements, such as the one Delta implemented for the Boeing 717, can enable aircraft in this niche to succeed. Many markets still remain in which a 100-130 seat aircraft is the “right size” for demand, and for which a larger aircraft would either be unprofitable or require lower yields. An analysis of routes abandoned by majors using A319 and 737-700 because they were unprofitable would likely show significant potential, as CSeries lower operating costs would change the economic equation. Supply Airlines are still looking for fuel efficient aircraft, despite a sharp drop in fuel prices. Attendees at the Dublin event universally do not expect current fuel prices trends to continue at low levels for very long, they are adjusting upward to an intermediate oil price around $80/BBL. This could mean deliveries for next generation aircraft might be pushed back by a year. But not for much longer than that. In Europe, growing “green” pressure means no delaying deliveries because of carbon and noise taxes. Moreover, Airbus and Boeing are growing their production rates despite the drop in fuel prices, and will need to deliver those aircraft to customers. They also do not believe the current low oil prices will remain. Despite the potential push-back of some orders, it will remain difficult for airlines to get their hands on next generation aircraft, as the OEMs have a six to seven year backlog. The earliest likely slots, without cancellations, will be 2018 at the earliest. Supply will remain tight even as production increases. While this could provide an opportunity for Bombardier for earlier deliveries, they are also sold out for the first three years of production, albeit there might be some wiggle room for a new major customer. Plus there are the 40 CS300s for Republic probably looking for another home. In summary, the conditions Bombardier faces are a combination of pressure from the market, but there is also good news that the industry believes the aircraft will be technologically more advanced and efficient. Bombardier clearly has to become much more aggressive on pricing. Lower fuel costs mean airlines are less desperate to retire older aircraft than they were even six months ago. But in certain markets, particularly Europe, lower noise and fuel burn make next generation aircraft attractive even with lower fuel prices. Industry people we spoke to at the conference expressed confidence in the CSeries from a technical point of view. One individual described the marketing team for the CSeries as “good”. However, he did not share that opinion for the sales team, describing them as “not so much”. Recent staff changes at Bombardier have left some customers bewildered – they don’t know what is happening and they do not relish having to develop new relationships again. The critical hurdle for Bombardier at this stage, other than pricing, is delivering. The CSeries promise has been well received. The OEM must now deliver on the economic numbers. Customers have high expectations – even as they describe the disappointment with Airbus and Boeing program delays that have jaundiced them. The proof they want from Bombardier now is the data that demonstrates industry leading fuel burn, low noise and low emissions. There is high confidence in the P&W engine and use by Airbus, Embraer, Irkut, and Mitsubishi underscore this. Since the CSeries was optimized around this engine, its numbers should be the benchmark. If the numbers are as good as we have heard whispered, and program head Rob Dewar’s confidence is justified, then the CSeries should prove to be between 2-5% better than the A320neo. When this outcome is confirmed, leasing firms that have been waiting in the wings are likely to move forward to engage with Bombardier. They will want to secure delivery slots, knowing that competing programs at Airbus and Boeing are sold out for over seven years. They also know that the Embraer E2 program is also likely to run into delays and see its EIS slip from 2018 to 2019. If Bombardier can meet its 2015 EIS and produce the right economics, it is only pricing that will hold back sales. And because airlines pay for performance, Bombardier might earn a small price premium above A319neo and 737-7 pricing. To some degree, the market is waiting for performance data. When the data is announced at spec or better than expected, an order spike is possible. Potential customers need their confidence in the program to be justified. The airplane won’t fly off the shelf by itself. Momentum for this airplane needs to be ideally generated with a large order from another bellwether customer. The new sales team needs a near-term win to change industry perceptions. Airbus and Boeing will do all they can to prevent that from happening. From all indications, the CSeries could be a strong performing airplane. But to date, that promise hasn’t translated into sales. Following up to better than expected numbers from the flight test program, Bombardier needs a strong Paris Air Show to change perceptions and momentum, and the next four months will be a key referendum on the program.

US Flight Planner	Airbus vs Boeing
US Airline Schedule Performance	Daily Production & Deliveries

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