Premium 2018.4 – What the ITC Decision Means for the Industry

The Boeing-Bombardier trade dispute that was completed by the International Trade Commission last week found that Bombardier was illegally dumping into the US market, but that there were no damages to the US industry and Boeing in particular. As a result, no punitive tariffs will be applied, and Bombardier’s plans to open a Mobile, Alabama assembly line and deliver aircraft to Delta Air Lines remains in place. Let’s examine the impact of the decision on the four major industry participants: Bombardier Bombardier is breathing a sigh of relief that tariffs won’t be imposed in the US market and will go to work aggressively on campaigns at JetBlue and Spirit, each of whom provided supporting briefs to the ITC and appear interested in the program. JetBlue, which operates a fleet of 100 Embraer E190s primarily from its Boston hub, has found the aircraft to be the “right size” but experienced maintenance difficulties as Embraer’s launch customer in the US. Embraer appears to be “out of favor” at JetBlue, who are looking to replace those aircraft over the longer term, despite the fact that the aircraft are quite young. Boeing’s trade action, if nothing else, placed a cloud of uncertainty around the Bombardier program in recent months, diverting management’s attention from needed sales campaigns to deal with attorneys rather than customers. With the trade action now moot, Bombardier can refocus its efforts on selling additional C Series aircraft in the near term. The impact for Bombardier is that the US market remains open, a critical factor for the C Series program and that plans to assemble aircraft in the US have effectively eliminated any regulatory threats from a trade perspective. Airbus Airbus, which has agreed to complete a transaction to acquire 50.1% of the C Series program later this year, celebrates its “deal of the century” in gaining an efficient and modern addition to its product line, essentially for free. The freedom to sell the aircraft in the US and manufacture it adjacent to its A321 line in Mobile will provide Airbus the ability to effectively serve Delta and several other potential US customers for the aircraft effectively. Having the two final assembly lines adjacent to each other will be efficient from a management and logistics perspective. Airbus has indicated that the C Series will supplant the A319neo in the marketplace. The question now is whether Airbus would consider a growth version of the C Series into the 150-160 seat class provide a new offering against the 737 MAX8. While the current A320neo remains the best selling model in its class, Airbus could put additional pressure on Boeing with a larger model of the C Series family while focusing on an "A322neo" to put further pressure on the forthcoming 797/NMA from Boeing. There are some interesting possibilities that the C Series acquisition offers to enhance Airbus already industry-leading narrow-body product line. However, were Airbus to push ahead with the putative CS500, we expect Boeing will be back with a complaint to the government. This time they will have solid evidence of a threat to their 737 MAX program. The Airbus-Bombardier Transaction Clearly, this win is a big plus to both parties, and will likely ensure that the transaction goes through and that the Alabama assembly facility is completed. Boeing Boeing was perhaps a bit aggressive in its Goliath versus David campaign against Bombardier, which represented only a potential threat to the 737 MAX. But that threat is real because the MAX is the fourth redesign of a 1967 aircraft designed when engines were “cigar tubes.” The 737 is unable to take engines as large as the A320 family without a complete redesign of its landing gear and pressing the credibility of utilizing the same type certificate for the aircraft, grandfathering the current certification requirements for the new model. While Boeing has done an outstanding job of updating a 50-year-old design, the 737 remains just that, a 50-year-old design going up against new technology competition. Without a viable competitor in the sub 150 seat market, the acquisition of Embraer and the E2 jets program now becomes more of an imperative for Boeing, since Airbus can now offer full solutions from 100 seats and up in the narrow-body range. Boeing viably starts with the 162 seat 737-8, as the 737-7, despite an increase in seating, remains economically uncompetitive and has only sold a handful of airplanes. Boeing essentially forced Bombardier to join with Airbus through this action, and must now make an expensive acquisition to essentially correct a mistake from overzealous attorneys at corporate headquarters to fill a product line gap. Boeing is also suffering the consequences of ill will in several countries, including Canada and the UK, that has resulted in cancellation or exclusion of Boeing in several defense competitions. The cost of the decision to take a trade action is continuing to grow at Boeing. Embraer With Airbus acquiring the C Series program that competes with the E190-E2 and E195-E2 models, Embraer will be facing a much more sophisticated marketing team once the program is integrated with Airbus marketing, service and support. Airbus has stronger marketing resources than Embraer, along with a larger customer base, and opportunities to conclude deals that include multiple aircraft models across a broader product line. Essentially, Embraer’s job will soon become much more difficult, despite a 1,400 plus aircraft installed base for EJet models. Nonetheless, Embraer remains a capable organization, producing aircraft on-time and on-budget during an era in which that doesn’t happen very often (if ever), and has unique resources, including its own IT university for that critical resource as IT becomes more prevalent in aircraft design and control systems. The Brazilian government is a key shareholder at Embraer and holds the “golden share” that enables it to veto any acquisition or take-over with those rights. As a result, a merger becomes a three-party rather than two-party discussion, with the Brazilian government in a position to keep the company independent if the right guarantees for investment, employment, and local decision-making are not provided. The E2 program faces a US market scope clause issue for the E175-E2, which will likely remain too large for the scope clause when it is reconsidered in 2019 and could result in that model being out of the US market for five years if, as expected the union contract clauses remain at today’s gross weight and seating restrictions. This would be a blow to both Embraer and Mitsubishi, as each of their regional models is a bit too heavy for existing requirements. Boeing-Embraer The proposed acquisition of Embraer by Boeing is needed by both organizations. Embraer will need access to Boeing’s sophisticated and extensive marketing resources to better compete with Airbus-Bombardier, and Boeing needs Embraer to fill out its product line. In terms of who needs each other more, it appears that Boeing needs Embraer more than Embraer needs Boeing; for now. Embraer has been successful with its EJets and business jet markets and is gaining momentum every year. Boeing will soon be overtaken by Airbus as the largest producer of aircraft as planned production rate increases through 2022 indicate. Airbus is gathering momentum, and with a stronger position in the key narrow-body market, will soon become number one in the marketplace. The C Series acquisition by Airbus strengthens its position, and Boeing feels it is necessary to react. The acquisition of Embraer by Boeing would land Boeing into two new markets, the regional jet market, and the business jet market, with which it has only peripherally been involved at the high end with the BBJ. Embraer has the stronger expertise in the regional and business jet markets and would need to take the lead in those two critical areas. The decision that enables C Series sales in the US without tariffs now ups the pressure on Boeing and Embraer to make a deal beneficial to all three parties involved. The Bottom Line With the decision of no harm now in, our conclusions are as follows: Airbus made the deal of the century The C Series program will now be a success A side note - both the E2 and C Series are powered by Pratt & Whitney's GTF, making it another (unreported) winner from this action Boeing's decision to pursue the ITC case was expensive, fruitless, and a future B-school case study Boeing now needs Embraer more than ever The Brazilian government is in the catbird seat By moving back into a duopoly the industry will come back to rational behavior This is crucial as China is going to menace the duopoly, most likely within the next decade

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