Reinventing Airbus

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Copyright © 1999 INSEAD, Fontainebleau, France.

In early 1997, Jean Pierson, the irascible managing director of the Airbus Industrie and so-

called “Bear of the Pyrenees,” was frustrated and worried by the bickering between theconsortium’s partners. Endless negotiations and discussions, it seemed, were undermining his

plans to launch Airbus’ A3XX, the superjumbo jet that he hoped would challenge Boeing’smost profitable line of passenger aircraft. Instead of inserting themselves immediately intothe competition for this enormous potential market - projected by some to surpass $160 billionduring the first two decades of the next century - Airbus partners were mired in political

maneuvering regarding the future structure of the consortium. At issue were such fundamentalquestions as ownership, equity distributions, and, perhaps most important of all, work shareand the employment that Airbus contracts brought.

After years of fruitless discussion, Pierson feared that Boeing would steal a march on theA3XX with a redesigned (and stretched) 747. The A3XX, which would expand theconsortium into a complete family of passenger jets, was crucial to Airbus’ future. With price

tags over $140 million, the 747s represented a monopoly lock that Boeing used to subsidize

its other investments and aircraft production.1 Already, Singapore Airlines, a major Airbuscustomer, had hinted that further delays would force the cash-rich airline to buy its jumbos

from Boeing. According to Choong Kong Cheong, managing director of Singapore Airlines:“There are many factors in the decision [as to what superjumbo to buy]. It wouldn’t be honest

of me to say timing isn’t one of them.”2

The 1992 Airbus Accord

Back in 1988, even though the market for commercial aircraft appeared to be entering a period

of unprecedented growth, the prospects of a transatlantic entente in the aircraft sector haddarkened. To facilitate Daimler-Benz’s acquisition of a 30% share of the stumbling aerospacegiant (and Airbus partner), Messerschmitt-Boelkow-Blohm, the West German government

approved subsidies of 4.3 billion deutsche marks ($2.4 billion); up to $1.6 billion of the fundswere earmarked to protect Daimler-Benz from fluctuations in the dollar-deutsche mark exchange rate, which would prevent the company from absorbing the losses frequently

associated with dollar-denominated Airbus sales. The West German subsidy outraged thecombative US Trade Representative, Clayton Yeutter, who called it “incongruous andindefensible,” an unfair advantage supplied by the government; a Boeing official called the

action “an ominous development.”3 Yeutter’s trade “strike force” threatened to send thedispute to GATT as well as initiate action under Super 301, the tough new US trade law. Afew months later, an EC report counter-attacked the Americans for their unilateral approach,

labeling any retaliatory sanctions from the US as “illegal” under GATT rules.4

1 Ellis Juan, “Aviation: the Politics and Economics of a Boom,” Foreign Policy, 22 Dec., 1997, pp. 147-8.

2 As cited in Thor Vladmanis, “Airbust?” Financial World, 8 July 1996, p 38-9.

3 Keith Mordoff et al., “German $2.4 Billion Subsidy for Airbus Draws US Protests,” Aviation Week and

Space Technology, 14 Nov., 1988, p. 38.4 Keith Rockwell, “EC Charges Violations in US Trade Act,” Journal of Commerce, 4 May, 1989, p. 1A.

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Half a year later, however, the new US Trade Representative, Carla Hills, decided to drop the

threat of Super 301 sanctions against the Airbus Industrie consortium (AI) in exchange forEuropean promises to seek a negotiated solution to the “subsidies question.” Her decision

revived the Airbus negotiations, which had stalled in recrimination and charges of hypocrisyregarding the role of government support in national aircraft industries. The Airbus questionhad been framed in the US as one of pure economics: Boeing and, to a lesser extent,McDonnell Douglas were portrayed as free-enterprise corporations who faced a state-

supported Euro/national champion with virtually unlimited (hence “unfair”) financialresources in the form of cheap loans, the repayment of which was contingent on AI’s

profitability.5 On the other side of the Atlantic, the Europeans argued that Americanmanufacturers received indirect government subsidies - from the Department of Defense andNASA - of comparable (if not greater) magnitude and for the same reasons as did the Airbus

partners of the EC. The playing field, in their eyes, was roughly even and they were

determined to stay in it, with government subsidies if necessary.6

In spite of Hills’ decision, the Bush administration pushed ahead with a GATT consultation

regarding the German exchange-rate protection measure.7 Though the EC had approved theGerman scheme, the US argued that it amounted to an illegal “export subsidy” according to

the GATT Subsidies Code.8 The Europeans worried that an American “victory” in the GATTaction would embolden the Bush administration to widen its GATT consultation, targetingAirbus’ cheap-loan subsidies as an unfair trade tactic. Their fear had softened the European

negotiating position. Moreover, it appeared that the other Airbus partners had also questionedthe GATT-legality of the German scheme, which they felt had dragged the consortium into a

transatlantic dispute that should have been avoided.9

Though presenting a united front to the US, the German dispute was a sign of the internaltensions that continued to dog consortium members. Additional factors influenced theEuropean position: 1) they were worried that the Airbus dispute was adversely impacting the

broader tenor of the EC-US relationship during a time of dangerous instability in EasternEurope and the Soviet Union, 2) the commercial success of AI lessened the perceived need of direct subsidies to continue. These considerations strengthened the hand of the British within

the consortium, who had long argued that Airbus should evolve towards a more purelycommercial operation as a way to improve the efficiency of AI. Many free traders in theReagan administration hoped that the consortium would take this course; that way, trade

5 Steven McGuire, Airbus Industrie: Conflict and Cooperation in US-EC Relations, St. Anthony’s, 1996, p.

113-116.

6 McGuire, op. cit., p. 37-38.

7 John Zaraocostas, “Deal on Airbus Kept EC off US Trade Hit List,” Journal of Commerce, 5 July, 1989, p.5A.

8 McGuire, op. cit., pp. 149-150.

9 Ibid., p. 154.

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high, an additional constraint that many suspected Boeing was seeking to impose on AI.)13 AImember-company loan repayments had already begun, purportedly with $600 million in 1991,$700 the next year, and annual paydowns of about $900 million each year thereafter until

reaching a total of approximately $10 billion; no further subsidies were planned.14

For the Europeans, the gains had been twofold: 1) the US formally recognized the legitimacyof the European initiative and, in particular, accepted the principle of government

involvement in the form of direct subsidies; 2) indirect subsidies, even as they interfaced withnational defense industries, became an explicit part of the US-EU agenda. In other words, theagreement appeared to have set the parameters of competition between the American

companies and the European consortium with some government involvement. Certainobservers also interpreted the Accord as a recipe for tacit collusion, in which competitors

would refrain from engaging in overly aggressive price competition.15

The 1992 Accord was completed during a severe recession. Combined with the post-Gulf War drop in international travel, the aircraft industry was hit with a double demand dip, its

worst slump in decades.16 With dropping fares, civil airlines worldwide lost an estimatedtotal of $15.6 billion between 1990 and the end of 1994, making them less able to order new

aircraft.17 They preferred to let their current fleets age, deploying them more efficiently andrepairing rather than replacing them. This led to a rash of order cancellations, during whichmany of the paper gains of the late 1980s boom were lost. To shore up its sagging revenues,

McDonnell Douglas concentrated on retrofitting the existing aircraft it had manufactured.18

Financial considerations - cost-cutting, operational efficiencies, and highly advantageousfunding in the form of aircraft leases - began to drive the market, adding to the downward

pressure on prices; innovation and new technologies became a secondary consideration. In asignificant turnaround, American aircraft manufacturers could no longer count on air carriercompanies to finance large chunks of the development of new models. It was a buyers’

market, and longstanding relationships between Aircraft manufacturers and passenger air

carriers deteriorated. This opened significant new opportunities for Airbus.19

13 McGuire, op. cit., p. 147.

14 “Put Away Childish Things: It Is Time for Europe’s 25-Year-Old Airbus Consortium to Be Turned Into aFull-Grown Public Company,” Economist, 8 July, 1995. No byline.

15 Lynn, op. cit., p. 156.

16 “Puzzle in the Skies: Airlines Are Not Buying Jets,” Economist, 11 Feb., 1995. No byline.

17 Carole A. Shifrin, “New Jumbos, SSTs, Face Tough Hurdles,” Aviation Week and Space Technology, 21Nov., 1994, p. 42.

18 Dori Jones Yang, “The Hint of an Updraft,” Business Week, 20 June, 1994, pp. 66-68.

19 Paul Betts, “Preparing for Tomorrow Today: The Worst May Be Over for the Beleaguered AircraftIndustry,” Financial Times, 2 Sept., 1994.

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Boeing Ups the Ante I: Reengineering

To Bill Clinton, the Democratic Presidential Candidate, the state of the economy - and the role

of government to nurture and protect national industries - became a potent weapon to promotehis politics of “change” in the 1992 elections. Throughout the previous decade, it had becomefashionable to bemoan the economic decline of the US, whose institutions and businessesseemed powerless before the inexorable rise of “Japan, Inc.” and the “Asian tigers.” Some

observers, among them Lester C. Thurow, began to train their attention on Western Europe aswell: with the Maastricht Treaty, its march toward unity seemed to presage an economic

renaissance of sorts.20

Not surprisingly, the newly elected President Clinton turned his attention toward Airbus,initiating a new era of competition in spite of the laboriously negotiated Accord of 1992. “Alot of layoffs at Boeing would not have been announced,” Clinton said in a speech at a Boeing

factory, “had it not been for the $26 billion that the US sat by and let Europe plow into Airbus

over the last several years. So we’re going to change the game.”21 Though President Clintonsoftened his rhetoric a few days later at the behest of Boeing and McDonnell Douglas, he

started to intervene in a number of sales deals involving the American companies, directlycontacting heads of state on their behalf. Clinton was credited, for example, with clinching a$6 billion deal with Saudi Arabia for Boeing and McDonnell Douglas in 1993, an “intensely

personal” competition that eventually involved President Mitterrand of France, Prime Minister

Kohl of Germany, and even Prince Charles.22 The French also accused Clinton of having

secretly “linked” the re-scheduling of Saudi Arabia’s military debt with the deal. Nonetheless,the signal was unmistakable: the Americans were ready to fight in the style that their

competitors had adopted; there were even suggestions of renegotiating the 1992 Accord.23

Though 1993 was one of the most difficult years on Airbus’ record - the consortium had soldonly 38 aircraft, down from 136 the year before - its strategy of creating a family of aircraftwas beginning to pay off. In the rapidly expanding markets of Asia, Airbus made important

inroads in 1994, topping Boeing in the total number of aircraft ordered worldwide for the firsttime, at 125 over 120, though apparently not in sales revenues. This cemented AI’s place asthe world’s second largest aircraft manufacturer, well ahead of the faltering McDonnell

Douglas, which was competing in the passenger jet market as a niche manufacturer rather than

with a family of complementary aircraft.24 After an estimated loss of $8 billion in its first 23

years of operation, according to a Lehman Brothers study, the consortium appeared on theverge of profitability; by 2003, its pre-tax profits were predicted to be around $10 billion.25

20 See Head to Head: The Coming Economic Battle Among Japan, Europe, and America, Morrow, 1992.

21 As cited in Robert Guttman, “Aircraft Builders of the Future: Boeing and Airbus Go Head to Head—AnInterview with Airbus N.A. Vice Chairman Alan Boyd,” Europe, May 1993, p. 10.

22 Lynn, op. cit., pp. 1-10.

23 David Buchan, “French Attack Clinton on Aircraft Sales,” Financial Times, 2 March, 1994.

24 Paul Betts, “Airbus Sees 13.7% rise in Turnover,” Financial Times, 7 Jan., 1994.

25 Stanley Holmes, “Airbus at CrossRoads,” Seattle Times, 27 June, 1997.

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Moreover, the goal of the consortium remained above all to expand its market share until

Airbus became the number one seller of passenger aircraft; charging higher prices for greaterprofit - an imperative for a publicly traded company like Boeing - was thus a subordinate goal

for AI.26

Boeing responded by cutting itself to the bone. Through several rounds of brutal re-engineering, including the firing or early retirement of 28,000 employees during 1993 and

1994, the company reduced overall production costs by about 25%. Investing heavily in newcomputers and automated manufacturing techniques, Boeing also shortened the order-to-delivery time of widebody aircraft from 18 to 11 months, which it planned to further reduce to

6 months during the coming decade.27 The design of the 777 was touted as an example of Boeing’s future. Aided by Dassault’s Computer Assisted three-dimensional InteractiveAnalysis (Catia), the 777 became Boeing’s first commercial aircraft designed entirely on the

computer, which eliminated millions of paper drawings and innumerable physical prototypes,allowing it to be built in record time. (Dassault, a private French company not a member

company of AI.)28

In addition, with the 777, Boeing initiated a new strategy of design and production, sharingdevelopment costs with subcontracting partners, such as the Japanese Aircraft DevelopmentCorporation, a subsidiary of the Ministry of International Trade and Industry (MITI). To

develop the fuselage and center wing of the 777 - 21% of the new aircraft - three majorJapanese companies pooled resources in a research consortium; the arrangement also limitedthe involvement of Airbus in their avionics programs, a key Boeing goal. Though many

American observers feared that the arrangement would transfer key technologies and

industrial know-how to a future competitor,29 the end result appeared to significantly boostthe cost-competitiveness of Boeing’s operations; managers believed it would prove far moredifficult for the AI consortium to achieve similar production cost cuts under the subsidy

constraints of the 1992 Accord.30 As Boeing launched the 777 series in 1995, its orders

surged, with huge new deals in Asia, including by Singapore Airlines for 77 Boeing 777s andby Air China for 15. In terms of orders and options contracts, it was one of the best years thatBoeing had ever known. Despite these results, the company eliminated an additional 12,000

employees during 1995. Airbus orders, meanwhile, dropped behind those of McDonnell

Douglas in 1995; it was the first time since 1988 that AI was number three.31

26 Jonathan Ford and Alexander Nicoll, “The Sum of Its Parts,” Financial Times, 27 Aug., 1998.

27 Stanley Holmes, op. cit., 27 June, 1997..

28 Claudia H. Deutsch, “3D Programs Turn Design on Prototypical Ear,” New York Times, 31 March, 1997.

29 “Industry Coalition Advances Airplane Manufacturing Goals,” Aviation Week and Space Technology, 29July, 1991, p. 56. No byline.

30 Laura D’Andrea Tyson, Who’s Bashing Whom: Trade Conflict in High-Technology Industries, Institute forInternational Economics, 1992, p. 192.

31 See Michael Skapinker, Financial Times, “Boeing Soars to Top of Orders List,” 2 Aug., 1995; “Boeing Wins$12 Billion Singapore Order: Deal is Blow to Airbus,” 15 Nov., 1995.

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Throughout 1996, demand for passenger aircraft recovered even more briskly than during the

previous boom period. Driving this trend were: 1) the pent-up demand of US air carriers,25% of whose fleets were over twenty years old; 2) the impending “stage 2 noise” deadlines, a

new regulatory requirement for civil aircraft; and 3) the continuing hunger of the Asian tigersfor passenger aircraft. Order backlogs for both Boeing and AI rose in 1996 to unprecedentedlevels, as they sold 505 and 288 passenger aircraft, respectively. Only McDonnell Douglassuffered a decline in sales, shrinking by nearly two-thirds to only 43 orders. In exchange for

price breaks, Boeing was also beginning to negotiate exclusive supplier contracts - to buyonly Boeing - with a number of large carrier groups, including a 20-year $6.6 billion deal withAmerican Airlines for 630 airplanes; similar contracts were soon signed with Delta and

Continental.32

Boeing Ups the Ante II: the Merger with McDonnell Douglas

With the end of the Cold War in 1991, East-West military tensions eased and defense budgetswere cut in half. As demand for arms and military aircraft plummeted in the West, militarycontractors scrambled to find new markets for conventional weapons in the developing world.

But by 1993, it was clear that the military industry would never recapture the lost demand: inexchange for their purchases, arms buyers in the third world demanded co-production

agreements and the transfer of manufacturing technologies to their home countries.33 Later

that year, US Secretary of Defense Les Aspin called together top US executives from acrossthe aerospace and defense industries, explaining to them that it would be “impossible for all of

them to survive” independently. Over the next four years, Aspin’s message, which came to beknown as “the last supper,” sparked the largest push for consolidation that the industry hadever seen, a $40 billion “rationalization” of some 32 defense businesses. The consolidation

resulted in three dominant groups: Raytheon, Lockheed-Martin - and Boeing.34

Though AI had been discussing a merger with McDonnell Douglas since 1988, it took Boeingonly three years to cement a $13.3 billion merger with the St. Louis-based aircraft

manufacturer. Announced in December of 1996, it was the tenth largest merger in US history;only five months earlier, Boeing had purchased Rockwell International’s military and spacedivision for $3.2 billion. With these two deals, Boeing became a huge defense industry firm as

well as the largest manufacturer of aircraft in the world. Taken together, the new Boeing

would have orders on its books for $100 billion, with projected revenues of $48 billion andminimal debt.35

32 James P. Woolsey, “Riding the ’96 Buying Binge,” Air Transport World, Jan. 1997, pp. 33-5.

33 Harry J. Van Buren, III, “Arm in Arm:The Political Economy of the Global Arms Trade,” InternationalJournal of Organizational Analysis, July 1996, pp. 311-4.

34 Michael Skapinker, “Europe Ready for Takeoff But Without a Flight Plan: Aerospace and DefenseContractors Agree on Need for Restructuring, Financial Times, 27 March, 1998.

35 Adam Bryant, “Boeing, McDonnell Douglas Announce $13.3 Billion Merger,” New York Times, 16 Dec.,1996.

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The advisory committee of the European Commission’s merger task force immediately

denounced the deal, threatening trade war and the imposition of sanctions for up to 10% of

Boeing’s turnover. 36 Though the merger took place between two US companies, the

committee argued, its jurisdiction extended to all companies with business dealings in Europeregardless of national origin.37 The European Commission (EC) mounted a number of objections, including:

• Should Boeing enter the military market as a major player, its civil aircraft operationswould gain access to the indirect aid of Pentagon R&D, a violation of terms that would kill

1992 Accord.

• While the market share of McDonnell Douglas in new civil aircraft had fallen to only 4%,

the larger Boeing would still have manufactured 90% of the operating aircraft worldwide;because Boeing could link pricing to the supply of spare parts, the EC argued, its new sizecould cripple the ability of Airbus to introduce directly competing models.

• Boeing’s “exclusive agreements” with American Airlines, Delta, and Continental were

unfair in light of the merger.38

Boeing, of course, viewed things somewhat differently. The spillovers promised to cross bothsegments of the aircraft industry, perhaps multiple times: the expertise in composite materialsdeveloped for the B-2 bomber, for example, found their way into the tail wing of the 777,

which also came to be applied in Boeing’s Joint Strike Fighter proposal. Moreover, entry intothe defense industry would stabilize Boeing’s revenues against the cyclical downturns of the

civilian air industry. An additional financial incentive, as the Europeans had noted, was theservicing and spare parts requirements for existing aircraft, which represented an enormousreservoir of potential profit. Finally, though two rather than three civil aircraft manufacturersmight mean less price competition, Boeing argued that its operations were projected to save

up to $1 billion per year, making it a more efficient manufacturer.39 To avoid a trade war,intensive negotiations followed, involving heads of state from both sides of the Atlantic, the

EC, US trade representatives, the US Department of State, and Boeing.

On July 23, 1997, less than 24 hours before it was scheduled to rule on the merger; theEuropean Commission announced its approval “in principal” of the deal. While Boeing

hailed the EC’s approval announcement as a “happy day” for the company, its executives were

privately annoyed about the concessions they had been forced to make. First, Boeing wouldshare the technology “spillover bonus” from government-funded defense contracts and

research, both in “nonexclusive, royalty-only” licenses to commercial aircraft manufacturersand in an annual report on unexpired patents from “nonclassified projects.” Second, Boeing

36 Vago Muradian, “White House Lobbies EU for Approval of Boeing-MDC Merger,” Defense Daily, 23 July,

1997.

37 Vago Muradian, “Europe Rejects Boeing-MDC Merger, White House Mulls Response” Defense Daily, 17July, 1997.

38 Philip Butterworth-Hayes, “Boeing Casts Shadow Over Europe,” Aerospace America, Aug. 1997, p. 4.

39 Bryant, loc. cit.

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would refrain from “unduly” interfering with supplier-manufacturer relationships. This

meant, for example, that the company would not use its new relationship with McDonnellDouglas to link spare parts pricing to future aircraft sales. Finally, and most importantly,

during the final hours of negotiation Boeing had agreed to cancel the “exclusive supplier”provisions from its contracts with American, Delta, and Continental airlines, even though the

company viewed them as a separate issue from the merger.40

The only sour note that day was struck by Karel Van Miert, the EU CompetitionCommissioner, who objected to the Americans’ lobbying campaign. “Boeing is a private

company,” he complained, “but it seems to behave as if it were a public one.”41 Nonetheless,

the new agreement represented one more attempt to set the terms of competition betweenindustrial titans who were now operating on a continental scale.

The Airbus Reformers

Airbus officials and EU politicians hoped that the Boeing-McDonnell Douglas merger wouldspeed AI’s internal negotiations between the French, German, Spanish, and British membercompanies and their governments. Though they had debated a string of consolidation and

restructuring plans during the previous year, they had been stunned at the swiftness withwhich the Boeing-McDonnell Douglas deal had been sealed. Now the various factions - the

“reformers” and the “consolidators” - in the debate had begun to regroup.42

The reformers championed a more strictly commercial Airbus Industrie, an internalrestructuring that would re-cast the company into a “single corporate entity.” By replacing thecumbersome consortium structure, the reformers argued, Airbus could become as cost-

effective and lean as Boeing, a modern global corporation that could stand virtually withoutgovernment support (and interference). AI’s structure and legal personality had, theyacknowledged, offered significant advantages during the 20 years of its “infant industry”

phase. As a Groupement d’Intérêt Economique (GIE) - a French marketing and serviceorganization owned by four stakeholding partner-companies - AI had functioned successfullyas a catalyst to pool European resources, farming out research, design, and manufacturing

among members who retained their national independence.43 Close government relations hadtranslated into soft, low-interest loans to consortium members; its finances were under no

obligation to be reported publicly; the group paid no corporate taxes under French law, whichAI partners paid to their respective national governments.44

40 John D. Morrocco, “Boeing, EU Resolve Dispute Over Merger,” Aviation Week and Space Technology,

28.7.97, p. 22

41 As cited in Morrocco, ibid., p. 22.42 Kevin O’Toole, “Europe’s Denouement,” Flight International, 14.12.97, p. 3.43 MIT Commission on Industrial Productivity, Made In American: Regaining the Productive Edge, MIT Press,

1989, p. 212. Deutsche Airbus owns 37.9%, France’s Aerospatial 37.9%; British Aerospace 20%; and CASA

of Spain 4.2%.44 “Dissecting Airbus,” Economist, 16 Feb. 1991, pp. 51-52. No byline.

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However, as Airbus evolved toward a mature, profitmaking enterprise, reformers believed, it

was becoming clear that the GIE system was antiquated, perhaps fatally. The division of laborbetween member companies had become an inefficient and costly porkbarrel partition of

subcontracts according to each shareholder’s stake. Because national shareholders bid high inorder to keep profits for themselves, cost controls were crippled and efficiency sacrificed;parts were often manufactured in one country, refinished in another, then flown back for

reassembly back to the first.45 Moreover, the GIE loosened the consortium’s grip onsuppliers, spare parts manufacturers, and maintenance support, cost factors that together werecrucial to the consortium’s long-term viability. Instead, member companies acted as if they

were entitled to subcontract fixed portions of each AI aircraft and governments oversaw theirportions as if they were employment guarantees rather than the profitmaking operations of aglobal enterprise. Airbus had to contend with restrictions on seeking lower cost suppliers

outside of the shareholder group.46

Finally, the reformers posited, the decisionmaking process of AI was extremely time-consuming and cumbersome. Though the group had a strong and charismatic managing

director in Jean Pierson, most of its decisions were made by committee. This meant that everynew program was a complex balancing act to reach consensus between the interests of thepartners, with lengthy political negotiations on design, launch strategies, and possible

alliances. For example, discussions on the A3XX had gone on for years without concrete

result.47 In addition, given the four member companies, there was much duplication of effort

in such areas as sales forecasting and engineering design. Airbus headquarters, it wasreported, was not even privy to the precise figures of profitability and cost structures of its

individual member companies.48 And, reformers concluded, it was all at taxpayers’ expense -

perhaps as much as $26 billion according to one estimate. Airbus, they concluded, shouldbecome a single, publicly traded company as soon as possible.49

The Airbus Consolidators

In contrast, the consolidators feared that Airbus might not be ready to radically restructureitself. For the time being, they believed, AI should stick to its successful organizational

formula while forging ahead with new programs. The Airbus strategy, in their view, shouldfirst round out its family of commercial jets, which would enable the consortium to betterexploit its significant accomplishments, moving into the spare parts market as well as

competing with Boeing’s jumbo jet. In their view, the consortium structure worked just fine.

45 Holmes, loc. cit.

46 Kevin O’Toole, “Europe’s Denouement,” Flight International, 14 May, 1997, p. 3.

47 Thor Vladmanis, “Airbust?” Financial World, 8 July 1996, p 38-9.

48 Michael Skapinker, “Delayed Departure to a Different World: Airbus Industrie Has Come a Long Way But

Restructuring the Consortium Will Be a Slow Process,” Financial Times, 16 April, 1995.49 Holmes, loc. cit. The estimate comes from the US Dept. of Commerce.

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First, consolidators observed, Airbus had long planned to mount a direct challenge to the 747

series. In the words of Adam Brown, head of Airbus planning, AI hoped to catch Boeing in a“pincher movement,” with the A340 competing from below and the superjumbo from

above.50 Though somewhat smaller, drawingboard variations of the Airbus A340 projectedcarrying capacities of almost 400 passengers over ranges of approximately 7,000 miles - bothstandards within a hair’s breadth of the smaller 747 models. The A3XX superjumbo, whose

release was planned for some time early in the next millennium, promised to fly morepassengers farther at about 17% below Boeing’s cost. Though designs varied, the A3XXmight fly as a triple-decker that would carry 800 or more passengers, complete with fast food

restaurants, movie theaters, and hotel suites. Given its financial requirements of $10 billion or

higher, the original AI structure, they believed, was better suited to develop the A3XX.51

Second, consolidators argued, Airbus was developing a substantial base of customers. This

offered AI the opportunity, for the first time, to profit from the secondary markets of spareparts and servicing. Though less widely discussed than the sale or lease of newly mintedaircraft, this market was crucial to the profitability of many subcontracting manufacturers

from airframes and jet engines to lower software subsystems. In the aircraft engine industry,for example, the US company Pratt & Whitney routinely raised the price of spare parts 15%per year, which was purported to result in revenues 1.5 to 2 times greater than the purchase

price.52 The enlarged Boeing was reported to be shifting resources into similar secondarymarkets; according to one estimate, the company expected $4 billion in revenues from this

area alone by the year 2000.53 This base, consolidators believed, could hold the keys to AI’sfinancial future.

Third, consolidators pointed out, the politics behind any radical reorganization wereimpossibly complex, even ideologically charged. France, with the world’s number twoaerospace industry, was the principal sticking point in this regard; the communist members of its newly elected Socialist government, headed by Lionel Jospin, opposed the privatization of

the country’s defense industry. This represented a critical stumbling block to AI

consolidation.54

Furthermore, the transition to a single corporate entity required a “valuation” of the shares that

each member company would own, which promised to decisively influence their voting powerwithin the consortium. For the French, the crucial factor was the proper valuation of member-company Aerospatiale’s bureau of design, whose “brain power and experience” supposedly

contributed far greater value than the 37.9% stake of Airbus assigned to the company. But thetwo other major stakeholders, Germany and Britain, had different ideas regarding the

50 As cited in Lynn, op. cit., pp. 225-6.

51 McGuire, op. cit., p. 140.

52 “Power Plant Pricing Polemics,” Air Transport World, Nov. 1992, p. 55. No byline.

53 Seanna Browder, “Boeing At Your Service: After the Merger, It May Maintain 77% of All Airliners,”Business Week, 14 July, 1997, p. 32.

54 Olivier Provost, “Les Francais Planchent Sur Une Evolution Progressive d’Airbus,” La Tribune, 5 May,1998.

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valuation. One concern was the impact of the voluntarily reimbursable national loans: while

the French and British member companies had paid back over 50% of them during 1992-1996, Germany’s Daimler-Benz Aerospace - the largest debtor and least profitable firm of the

consortium - had decided to delay repayment until 2002, at which time it planned to do soaccording to its own calculations regarding the “health” of the consortium.55 Nonetheless, theGerman government and member company argued that this cash resource should be

considered as a net asset in the valuation process. For their part, the British argued that thefinancial performance of their aircraft wing-manufacturing factories should be the principal

criterion for their valuation. The French objected strenuously to both of these notions.56

Finally, while France preferred to proceed with the privatization on a case-by-case basis,starting with civil aviation and moving to missiles and helicopters, the Germans and theBritish argued that “global fusion” should occur all at once, in a “big bang.” Not surprisingly,

the negotiating position of each group reflected the “advantages” associated with theirstrategic attributes. On the one hand, a slower approach would allow the French to emphasizenational strengths in design. French managers also feared the dislocation and chaos of a major

reorganization, and advocated a more pragmatic process in which problems could be resolvedas they arose. On the other hand, the quicker, “top down” approach of Britain and Germanywould tilt valuation in favor of existing financial assets. These concerns were leading

Germany and Britain to bind themselves in a coalition, which threatened to marginalise

France as a minority shareholder, effectively removing it from future decisionmaking.57

Finally, European wrangling extended to the location of the re-made Airbus headquarters - inBrussels as a “symbol of Europe” or elsewhere - and the harmonization of salaries and other

administrative regimes.58

Despite these problems, a new consensus was beginning to emerge within the consortium:while reformers accepted the need to expand the Airbus family, the consolidators werecoming to understand the necessity of internal organizational reform. In March of 1997,

Airbus members finally agreed, in a memorandum of understanding, to form a singlecorporate entity: design, production, and procurement would be under the direct control of AI;the private company would be listed on the stock market; and the governments of the member

companies would avoid interference with its decision making process. The only question was,

how it would all be done?59 Airbus, like Boeing, was attempting to bid up the competitiveante.

55 Olivier Provost, “Aerospatiale Va Creer une Filiale ‘Airbus France’ en 1998,” La Tribune, 10 Dec., 1997.

56 Christophe Jakubyszyn, “Scenario pour l’Europe de l’Aeronautique et de la Defense,” Le Monde, 3 March,1998.

57 Alain Cadix, “Aeronautique Europeene: Fusion ou Rapprochements par Metier?” Les Echos, 27 May, 1998.

58 Patrick Haas, “Airbus: Zone de Turbulences,” Figaro-Economie, 25 May, 1998.

59 John Tagiabue, “Airbus Partners Agree to Firm Independent Corporation,” New York Times, 14 Jan., 1997.

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AI Competitive Positioning

Throughout 1997, despite record-breaking commercial success - at $10 billion in annual sales

the consortium represented Europe’s biggest business - Airbus still had to contend with thenew American behemoth. Boeing continued to enjoy the 747-series monopoly, had a far largerbase of operations in existing aircraft, and its private-sector character continued to confercosts advantages on it that were far more difficult to negotiate within Airbus’ GIE structure.

First, the 747 models continued to lock AI into the lower end of passenger aircraft markets,

creating a ceiling beyond which the consortium could not expand. The 747 was credited withpropelling Boeing into its position as the world’s number-one aircraft manufacturer. Thoughthe development cost of the 747 in the mid 1960s had put the entire company at risk -at

approximately $1.2 billion, it represented three times Boeing’s total capitalization at that

time60 - the 747 eventually became one of the most profitable civil aircraft ever developed.

By driving down ticket prices and opening up new routes, the 747 created the first mass

market for long-distance travel, the must-have passenger carrier for many airlines.61

According to some estimates, in the 1990s each sale generated $45 million in profits for

Boeing, making it the only consistently profitable civil aircraft manufacturer during the last 25

years.62 At the end of the decade, the 747 accounted for 25 to 30% of the world aircraft

demand, and was a particular favorite in the Asian markets, which were projected to be the

largest into the 21st century.63

Though the A3XX was being designed to end Boeing’s last monopoly bastion, there were

problems with the superjumbo concept as well. For starters, it was far from certain how big

the market for a superjumbo would be. Demand estimates varied from a few hundred to over1,200. Was there room, many asked, for a new superjumbo? If not, the A3XX could turn out

to be a colossal failure, the greatest white elephant in the history of civil aviation. (Thebreakeven point, where development costs were fully covered, was estimated to be at around

600 aircraft.)64 Furthermore, it was unclear whether airports would buy into the infrastructureinvestment requirements that the A3XX might impose, including: 1) the greater weight,wingspan, and wheel bases, which would overtax runways as they were currently constructed;

2) safety concerns that required changes in aircraft evacuation procedures as well as new data-link technologies to evaluate critical aircraft systems; and 3) enhanced demands on airportfacilities to accommodate the sudden appearance of 550 to 800 passengers as they

disembarked.65

60 Tyson, op. cit., p. 167. Due to lack of demand for the 747, Tyson reports (p. 186) that Boeing reduced its

employees from 101,000 in 1969 to 37,000 in 1972.

61 Lynn, op. cit., pp. 157-8.

62 Tyson, op. cit., p. 185.

63 “Reach for the Sky,” Economist, 7 Sept., 1996, p. 68.

64 J.A. Donoghue, “Airbus: Alone at the Top,” Air Transport World, Apr. 1997, pp. 38-41.

65 Shifrin, loc. cit.

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In addition, under the constraints of the 1992 Accord, Airbus had to somehow come up with a

$8 to 15 billion financing package to develop the A3XX. This could involve traditionalAirbus subsidies from national governments, along with reinvestment of AI member company

profits, for 60% of development costs; the remaining 40% would fall to development partnerswilling to share in the risk, commercial loans, and even issuing IPOs as a private

corporation.66 Airbus had even entertained the notion of developing the superjumbo with

Boeing throughout 1993, though Pierson had come to regret this episode as an underhanded

attempt by their rival to delay the A3XX.67 “This program is cost, cost, cost, and cost,”

Pierson said. “We have lost one year, minimum.”68

Finally, as Boeing continued its reorganization, the American company provided anunappetizing example of what might be in store for Airbus should it go ahead with its

restructuring: worker dislocation and submission to the pressures of globalization. Not only

would the multi-year effort to adopt Toyota’s “lean manufacturing” methods force Boeingemployees to work longer hours by recasting and consolidating their jobs,69 but the

incorporation of McDonnell Douglas into Boeing required a massive rationalization of thecompany. Boeing planned to cut an additional 12% of its labor force of 238,000, whichwould involve up to 28,000 layoffs, and shift the manufacturing of military aircraft and the

popular 737 aircraft series to separate facilities, forcing workers to move or lose their jobs. Anumber of Boeing groups would also be spun off as separate companies, which would enablethe company to accept competing bids from supplier subcontractors overseas. Boeing claimed

these moves would allow it to respond more quickly to customer needs as well as generate

higher profits.70 Within the constraints of its evolving structure and mission, Airbus would

have to formulate a response. Was the A3XX part of the answer?

Epilogue

Boeing found the road to its ambitious reorganization plans a bit rockier than anticipated. In

1997, for the first time in 50 years, the company lost money - a $178 million net loss. Thereasons included:

• The new price competition, which cut into profits as a way to offer less expensive aircraft.Boeing had to deeply discount its commercial aircraft, sometimes by as much as 35%.

• Unanticipated production bottlenecks. Due in large part to its an overzealous reengineeringcampaign in the mid 1990s, remaining employees had been unprepared for the surge in

66 Economist, 7 Sept., 1996, loc. cit.

67 “The Flying Monopolists,” Economist, 19 June, 1993. No byline.

68 As cited in Thor Vladmanis, “Airbust?” Financial World, 8 July 1996, p 38-9.

69 Stanley Holmes, “Boeing Production Aims to Be Lean Machine,” Seattle Times, 16 Aug., 1998.

70 Stanley Holmes, “Boeing Sets Realignment,” Seattle Times, 13 Aug., 1998.

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orders; they required far more training and work experience, which significantly reduced

their productivity.

From riding high with its acquisitions and record projected revenues, Boeing suddenlyappeared to be a beleaguered, sprawling giant unable to consolidate and coordinate its

operations, which now ranged from the 777 to Minuteman missiles and cutting-edgecommunications satellites. Though it was too early to judge Boeing CEO Phil Condit’s plansfor re-tooling the company, he found himself having to repeatedly deny that the board was

seeking to oust him.71 It also appeared that Boeing would not go forward with the stretched747, at least for the time being. The demand, Boeing maintained, simply wasn’t there. In

addition, the stretched 747 would in many ways be incompatible with preceding models -pilots would have to be retrained and a new set of safety guarantees would have to be

satisfied, which greatly added to projected costs. 72 Finally, despite having racked up the

largest order backlog in the company’s history, Boeing’s shareholders seemed deeplydisappointed in its performance: its stock price began a long, steep decline.73

Airbus’ march toward privatization continued. Fearing to be left behind by its German and

British Airbus partners, the French finally agreed on a plan to merge the state-owned

Aerospatiale with Matra, the defense business interests of the private group Lagardere.74 The

French decision removed one of the most significant obstacles to merging the membercompanies into a new, private AI. The issue had moved, it seemed, to the practical difficultiesof forging a new corporate culture from the disparate entities that made up Airbus. Though

Pierson planned to step down in March, 1998, Boeing executives knew they were facing a

determined and hungry competitor with a long-term vision.75

The 1997 Asian economic crisis threatened the gains in the orders of both Boeing and Airbus.

As the Asian economies shriveled, so did air travel, significantly depressing demand. Notonly did the manufacturers face delays in both delivery dates and payments, but outrightcancellations as well. Almost 65% of Boeing’s current orders for 747s and 777s came from

Asia.76 The demand for a new superjumbo - with a price tag or nearly one quarter of a billion- appeared more uncertain than ever.

71 Ibid.

72 Polly Lane, “Plans Dropped for Giant 747 Jets,” Seattle Times, 21 Jan., 1997.

73 Polly Lane, “Boeing Profits Disappoint Investors,” Seattle Times, 28 Apr., 1997.

74 Alexander Nicoll and David Owen, “France in Policy Change with Aerospatiale Merger,” Financial Times,23 July, 1998.

75 Alexander Nicoll, Robert Graham, and David Owen, “France Bites a Bullet,” Financial Times, 24 July, 1998.

76 Stanley Holmes, “Growing Pains, Part 1: Boeing’s Toughest Test Yet,” Seattle Times, 1 Feb., 1998.

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Exhibit 1

Order market Shares evolution, 1976-1998*

0

10

20

30

40

50

60

70

80

90

100

1 9 7 6

1 9 7 7

1 9 7 8

1 9 7 9

1 9 8 0

1 9 8 1

1 9 8 2

1 9 8 3

1 9 8 4

1 9 8 5

1 9 8 6

1 9 8 7

1 9 8 8

1 9 8 9

1 9 9 0

1 9 9 1

1 9 9 2

1 9 9 3

1 9 9 4

1 9 9 5

1 9 9 6

1 9 9 7

1 9 9 8

1 9 9 9

2 0 0 0

Boeing

AirbusMDC

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Exhibit 2

Cumulative orders*, 1970-98

A300/A310

A320

A321

A330/A340

A319

0

400

800

1200

1600

2000

2400

2800

1 9 7 0

1 9 7 2

1 9 7 4

1 9 7 6

1 9 7 8

1 9 8 0

1 9 8 2

1 9 8 4

1 9 8 6

1 9 8 8

1 9 9 0

1 9 9 2

1 9 9 4

1 9 9 6

1 s t q

u a r t e r

1 9 9

8

*in number of aircraft

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Reinventing Airbus

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Transcript of Reinventing Airbus