The broken and unbalanced single-aisle market duopoly

For some time the single-aisle market has been commoditized. It's all about the lowest production costs and the fastest deliveries. Airbus and Boeing have managed this process so well, to date, nobody has been able to break the duopoly. The Chinese and Russian aircraft under development don't look like they could do this either. Airbus and Boeing have created economies of scale that act as a big wall keeping out everyone else. Where a threat appeared, like Bombardier's C Series, part of the duopoly (Boeing) tried to kill it and the other part of the duopoly, after aggressive pricing against it, finally absorbed it (Airbus). The duopoly has been effective. The following chart lists in-service aircraft in the single-aisle (737 and A320 families) fleet by age category. The data is through September 2020. What the chart clearly illustrates is that from ten years through 25, there was a reasonably close balance. Twenty-five years ago, Boeing was way ahead. It was only a decade ago that Airbus started to pull ahead, but even so, there was a reasonable balance. That reasonable balance remained even five years ago. But over the most recent history, the balance has gone out of whack. This is a problem for Airbus and Boeing. Once the duopoly is out of balance, market behaviors are forced into the system that may end up hurting both parties. These two firms do not collude on price but do end up colluding on output. The greater their output, the easier it is to squeeze out any other player trying to break in. A duopoly is a market structure dominated by two firms. In reality, most duopolies are markets where the two biggest firms control over 70% of the market share. Duopolies have high barriers to entry and the two key firms have significant economies of scale. Airbus and Boeing are classic examples of this. Perhaps the most important factor in the Airbus/Boeing duopoly is economies of scale. China and Russia, for example, can overcome some of the barriers to entry by state support for their domestic aerospace firms. These countries even prime their aerospace industry with local airline orders. But even state support cannot ensure these firms produce at the rates Airbus and Boeing do. The entire aerospace supply chain is focused on Airbus and Boeing for that reason. Duopoly & Commodity The thesis here is that Airbus and Boeing have been a duopoly for some time. But, the current situation may no longer be a duopoly. The only commodities in the single-aisle segment is really A320neo vs. MAX 8. The other aircraft are in a different situation. Airbus has the optimal large long-haul narrowbody in the A321 variants. Boeing’s MAX 9 and 10 are less uncompetitive. Airbus achieved a DIFFERENTIATION in what should be a COMMODITY market, which means the A220 and A321 are not commodities. Boeing's use of a 53 year-old design for the MAX created limits and, in addition, Boeing simply didn’t think replacing the 757 was a good idea when Airbus did. Boeing's tradeoff choice in creating the MAX turned out to be a cul de sac. Without a commodity product, we are back to competition, and Boeing offers limited competition to the A220 or A321neo. This results in a default win for Airbus, which shows in the market. You can price a MAX10 as low as you want, but if it cannot fly Dusseldorf-New York non-stop with a full load, an airline isn’t going to buy it – period. Boeing is viable in one segment and marginal in the other two. Airbus is viable in all three, and leading heavily in two of the three. The duopoly is two-thirds broken. What should be a duopoly is now market scenario no longer in reasonable balance. Airbus is "too far ahead" and Boeing is "too far behind". What might happen? Airlines Airlines do not want this imbalance. The primary reason is that it causes pricing to become less aggressive. With a reasonable duopoly balance, every deal gets chased. Airbus and Boeing sharpen their pencils to come up with the most creative ways to win the order. But with Airbus significantly ahead, guess who's under pricing pressure? Not Airbus. It does not feel pricing pressure on the A220 from Boeing (maybe some from Embraer). Airbus also does not feel much pricing pressure on the A321. Were it not for the MAX debacle the duopoly might still be out of balance, but probably less so. If there was no MAX grounding, Boeing would respond to these gaps with pricing - discounting the Airbus advantages away. But there was the 20-month grounding. This exacerbates the financial pressure on Boeing. Not only was there no program cash inflow, Boeing has seen program costs spiral. Airbus Like the airlines, Airbus does not benefit from being so far ahead. This sounds counter-intuitive, but in game theory it makes sense. Consider this, Boeing has to offer even deeper discounts to win orders. That drives Airbus pricing down, too. In a duopoly it's never the case of only one player bleeding - any cut makes both bleed. Boeing is behind the curve and they want to restore "balance" by clawing back market share to something closer to 50-50. In doing this, Boeing has to play a weak hand. Its MAX family only has one attractive model out of four. This would be the MAX 8 and Airbus will discount its equivalent, the A320neo, appropriately. But how does Airbus vs Boeing go in a MAX 7 vs A220? Or the 737 MAX 9/10 vs A321LR/XLR? The answer is clear, and a major advantage to Airbus. Imbalance is dangerous Were Boeing not under additional pressure from the MAX grounding, and the need to rebuild cashflow, one might expect rational pricing by Boeing. It turns out there are signs that Boeing is not offering rational pricing. The pressure on bringing in orders to signal a MAX recovery means buying orders. We know of a deal where the MAX 8 was offered for ~$40m and the MAX 7 for slightly less. The price margin between the MAX 8 and MAX 7 was slight, making the MAX 7 relatively unattractive. Boeing wants to push the MAX 8 and benefit from economies of scale from focusing on that model. Of the cards it has, the MAX 8 is the best one to play. The A220 and A321 are differentiated products that are powering Airbus' lead. Boeing needs to counter, but has been unable to develop a workable business case for either Embraer's E2 or the NMA. That leads to a serious imbalance until the next generation of aircraft are developed, and a significant market lead for Airbus during the rest of this decade. Moreover, deals comes with a 25-year sale, and critically important in shaping cash flows over the longer term. There is a large tail of aftermarket and service offerings that generate revenues well beyond the initial sale, and neither company wants to fall behind in that process. You can’t afford to lose market share to your competitor, as it hurts financially for a long time. That cashflow is what funds R&D and the next generation. Remember, a duopoly forces two players to act and react to each other. It's not like several players where market behavior is foggy - in a duopoly every deal is clear. And each deal sends a message. Boeing needs to send a message. It must deliver wins. The stock market demands this. During a pandemic every single potential order, no matter how small, will be chased hard. The outcome is an unbalanced market, where the stress Boeing is under becomes industry stress. As Boeing bleeds, so does Airbus. Maybe Airbus bleeds less, since airlines and lessors want the A321neo family. But Boeing can still act as a spoiler, cutting prices even if it won't win the deal just to hurt Airbus. That is the nature of the street fight going on. The single-aisle duopoly is broken and unstable. Since the single-aisle market is the bread and butter for Airbus and Boeing, the imbalance can have far reaching and damaging effects.

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