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2007: A Critical Year for Airbus

By Thomas Lifson

If Queen Elizabeth II were to describe the year 2006 for Airbus, she would surely call it an annus horribilis. To recover its momentum in the civil airliner business it will have to overcome many serious challenges in 2007. Customers, unions, governments, and its archrival Boeing all present pitfalls, and must be dealt with artfully for Airbus to regain its footing.

The year that was

The embarrassment of multiple delays in the scheduled delivery of its 380 super-jumbo jet was exacerbated by the serious financial consequences in terms of penalty payments and financial concessions to aggrieved airline customers. Suppliers have gone through the financial wringer, unable to deliver and get paid for components already booked, in-process or even manufactured. Instead of collecting cash upon delivery of A 380s, it is spending extra money in a feverish effort to move the metal.

Airbus' next generation aircraft in the midsize range, the A350 was a critical bungle. Boeing correctly judged that the midsize new technology segment of the market is where the growth lies. Boeing's new generation long range, medium-size, ultra-fuel efficient model, the B787 Dreamliner has had the best product introduction in Boeing's history, and is set for delivery in May 2008. The halfway measure A350, really an upgrade of the existing A330, was so badly received that it had to be pulled from the market.

The most critical market segment

Mid-size wide body aircraft are both popular and traditionally more profitable than narrow body craft, like the B737 and A320 series. Airbus has successful entries at this level, but they are aging. Airbus has promised its customers the A350XWB, an all-new craft made mostly out of composites. Airbus boasts a wider fuselage and promises lower costs than its competitor. But the larger the diameter of the fuselage, the trickier to manufacture. Originally Airbus planned to use a compromise structure, but just last week, Airbus announced it was abandoning its plan to use composite panels on an aluminum frame.

As a result, the aircraft's first entry into service has been pushed back to at least 2014. Composites are tricky to manufacture and there are undoubtedly experience curve effects enabling Boeing to lower its costs faster than Airbus, as it is off to a fast start with high volumes.

In effect, Airbus is conceding to Boeing an exclusive hold on the market for fuel efficient midsize craft for perhaps six years, probably the biggest segment of the market. While Boeing is dominating the most lucrative business segment, lowering costs at a certain rate with each doubling of volume, Airbus will be scrambling to fund the $15 billion development cost of the A350XWB. In 2014 Airbus will be at the top of its experience curve, and actual manufacturing costs will probably exceed what it receives in revenue. As accumulated production volume grows, costs will decline. With a mature product in the 787, Boeing may be in a position to play hardball on price, offer various improvements and derivatives, and will have locked in many potential customers to the family or aircraft. They will be difficult to persuade to jump ship to Airbus and incur excess training and other switchover costs.

On top of its technical and competitive difficulties, Airbus is located in the euro zone, with far too many expenses payable in valuable euros, while delivery prices for its products are denominated in dollars, which have substantially declined in value. Airbus' was able to hedge against currency fluctuations in the forward markets, but those hedges have largely expired, and the company is exposed to severe financial pressure due to its foreign exchange exposure. Euro-based costs are simply too high in much of Airbus' procurement and manufacturing actrivity.

While Boeing yesterday reported its profits doubled in 2006, beating Wall Street expectations, Airbus has acknowledged that it would report an operating loss for 2006, although the extent of the loss is not yet known.

During Airbus' horrible year, Boeing grabbed a decisive lead in new airplane orders, topping Airbus by a margin of 1044 to 780. Airbus did barely manage to beat Boeing in terms of deliveries of aircraft in 2006, in both numbers and total value, but that reflects orders received in previous years, and the margin was sharply down. With its order book behind Boeing for the past two years, future deliveries and revenues will fall behind Boeing.

Management turmoil was the final ingredient in the debacle that was 2006 for Airbus. The company hired and then fired a new chief executive, Christian Streiff. The man he replaced is under investigation for possible crimes related to insider trading. During his brief tenure, Streiff outlined the sort of cost saving measures that will be necessary to return Airbus to a profitable basis for operations, measures distinctly unpopular with unions and others who would bear the brunt of downsizing and outsourcing. His lack of diplomatic skill in persuading parties too accept the unpalatable was said to be a reason behind his departure.

Behind the Power 8-ball

It appears that successor to the era of Streiff, Louis Gallois, a French veteran of the state railways and other establishmentarian posts, continues to embrace most of the cost saving measures imagined by him. They and others presumably dreamed up more recently are now known as the "Power 8" plan. Perhaps Gallois' polish will help sell the plan to all its constituencies, but there is every reason to believe it will be a tough slog. The next few weeks will see the preliminary skirmishes breaking out.

At this stage it is impossible to know how effectively the Power 8 Program will be implemented. Unions in Germany and elsewhere may raise political hell, or they may not, aware that painful cuts are the price of viability.

Even if Airbus is able to cut costs, it will need a lot of financial resources to pay for the new program. The A320 narrow body program continues to prosper, with manufacturing being shifted around, including some to China. But narrow body jets are a not as profitable as wide bodies, and face competition from below, out of the commuter airliner industry, including a significant participant Embarer, in Brazil.

Airbus will play politics any way it can. On the one hand it may tell unions that brutal Anglo-Saxon market forces are at fault in its ruthless drive for efficiency, and urge following the advice of Milton Friedman. But it may be forced to seek funds from national or regional governments in Germany and elsewhere, so Airbus will face pressures to keep certain facilities open, no matter what the opportunities for creative destruction.

Airbus will also be forced to play politics in establishing a facility in Alabama, if it obtains a contract for supply of tankers to the United States Air Force, in a joint project with Northrop. This will be all the more awkward if jobs in the EU countries falter.

The world needs at least two major airliner manufacturers, so even Americans have a stake in then continued viability of Airbus. It is doubtful that France and Germany in particular will allow it to fail. But such indulgence may encourage foolish moves. And a well-funded foolish competitor is considered dangerous for others in the market.

Boeing may look to be in the far stronger position for now. But history can be fickle when it comes to the fast-changing aviation world. It is worth keeping in mind that for a couple of decades Douglas Aircraft was the mightiest name in airliner production. Like Fokker, Lockheed, and many other storied names, Douglas has vanished from the airliner marketplace. It could happen to any private company.

Thomas Lifson is the editor and publisher of American Thinker.

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