The Super Duopoly and transfer pricing

We have just seen the first example of this effect take place with the recent JetBlue order for the A220.

As recently as one month ago we understand the deal was in favor of the E2.  After all, it is readily clear at current production rates, the airline would be able to get an E2 delivery with some certainty in the timeframe they needed.  The A220 production rates are, frankly, anemic.  The benefits of the GTF come with either aircraft.  The economics between the two are are very close.

There is an argument to be made that the A220’s wider cabin might allow the airline to make better use of its Mint premium product.  But in truth, the staggered seating on the E2 could be tweaked to closely approximate this, too.  We were hearing that the A220 (then CS) was favored heavily by some people at the airline.

But to secure a deal required some twists – after all, Jetblue has a firm order for E190s that has yet to be delivered.  Walking away from that would not come at zero cost.  Almost certainly GE would make sure of that as the engine supplier.

When Embraer heard the deal they thought was in the bag had been pushed back for review, they knew something was up.  The dealy could only have meant that Airbus was going to use its muscle to make a “deal you can’t refuse”.  How could Airbus achieve this?  Quite simply, Jetblue is a large Airbus customer with a large outstanding order.  Using transfer pricing, Airbus could tweak its A320neo order with the airline and convert these to the more attractive A321neo at no or little charge.  This meant transferring value to Jetblue from the A320 family to the A220 family.  The value Jetblue got was the transfer cost – but because it’s all inside Airbus, the impact is zero overall on a corporate level.  The A320neo program took a “hit” but that was recovered by the A220 program.

To be sure, Jetblue had to see the A220 as attractive in the first place.  There had to be a tight gap between the E2 and A220 – and Airbus could deploy transfer pricing to win.  Embraer does not (yet) have that benefit.

For Embraer to pull off a similar deal requires not only the use of transfer pricing.  It also requires the customer to be open to Boeing products – likely the MAX.  Jetblue would not entertain the MAX as a big Airbus customer.  We alluded to this in an earlier post.  But almost certainly Boeing will deploy its critical mass in future deals once the tie-up with Embraer is complete.

A logical target for the same transfer pricing strategy by Boeing/Embraer will be at United, and perhaps at American.   United is the better target though as it is squarely in the Boeing camp.  American is more complicated, as they have big deposits on the A350 they don’t want to lose.  Having switched from the A350 to the 787, American will want to deploy those deposits on an Airbus product – either A320neo, A321neo or the A220.

Bottom Line
Going forward the super duopoly will be moving value from one program to another to ensure a win.  We can expect to see deals become a lot more complex as a result. The two big OEM combines will be creating cocktails from 100 to over 400 seats.  How do airlines deal with this?  They will struggle because they don’t generally buy from 100 to over 400 seats.  Even when they do, they don’t do it at the same time.  The market has simplified one the OEM side perhaps but becomes a lot more complex on the buyer (airline and lessor) side. Consolidation is always good for the consolidator side.