Gaining Altitude

TOULOUSE, France â€”  The challenger is gaining on the champ. Airbus Industrie, the European commercial airplane producer that is owned by companies from four nations, wrote up nearly as many aircraft orders last year as perennial world leader Boeing Co.

It was an impressive demonstration that Airbus has more than withstood a competitive full-court press by Boeing in the 1990s, notably including the 1997 acquisition of the only other real competitor in the plane-building business, McDonnell Douglas.

That dramatic move figured to cement the Seattle company’s dominance of commercial aerospace. But the opposite has occurred.

Airbus has made inroads with longtime Boeing customers, such as American and United Airlines, British Airways, All Nippon Airways and Korean Air Lines. It is currently battling for an order from Scandinavia’s SAS, a longtime Boeing client.

And Airbus has set its sights even higher. The company hopes to seize global leadership in commercial aircraft by launching the next big jumbo jet sometime in the coming decade--a bold bid to supplant Boeing’s venerable but aging 747.

Industry experts give the Europeans a good chance.

“One thing is clear: Airbus is here to stay,� said Pierre Chao, aerospace analyst at the Morgan Stanley investment company. “It is run by smart, energetic guys. It makes good products. It is willing to take the right risks, and it has won the respect of the airlines.�

The envisioned new jumbo aircraft, a 555-seat machine currently dubbed the A-3XX, would be the first of an entirely new family of airplanes for Airbus, said John Leahy, Airbus senior vice president and head of airliner sales.

Launch of the 3XX has been pushed back because there is no market for such a large plane today, but engineering and planning are continuing. And Airbus is signing agreements with aircraft subcontractors worldwide, such as Japan’s Mitsubishi Heavy Industries, to invest in the plane’s development, which could cost more than $12 billion.

Executives in Toulouse see historic possibilities. If the 3XX comes to pass, Airbus could displace Boeing as the prime contractor in global air transport--empowered to hand out export- and job-creating contracts in technologically advanced industries around the world. Boeing seized that valuable leadership role from Douglas Aircraft back in the 1950s with its launch of the 707, the first commercial jetliner.

Meanwhile, Airbus’ order backlog is hefty, and the consortium is coming off a year in which--although it lost money as a consortium--it actually made money for its French, German, British and Spanish partners on some $13 billion in revenue.

“We’ve arrived,� declared Leahy, reflecting the general optimism at Airbus’ glass-walled headquarters near the Toulouse airport in southwestern France.

Of course, Boeing isn’t exactly going away.

As it announced last week, the giant company, which last year had $55 billion in revenue, is launching a broad-based effort to get all its aircraft programs back to profitability after production stumbles and losses in recent years.

Those difficulties can be traced directly to Boeing’s aggressive push in the mid-1990s to head off Airbus and snare 75% to 80% of the world’s aircraft orders.

But Airbus pushed back, and one result has been a fire-sale environment, analysts say--price cuts of as much as 35% to 40% per aircraft. That means planes such as the Airbus A-320 or the Boeing 737, with list prices of about $35 million each, have been going for less than $25 million.

There can be little profit in such sales, as was confirmed last weekin a report that Airbus Industrie had lost $200 million last year because of price-cutting. The disclosure was issued by British Aerospace, the aircraft-manufacturing partner that owns 20% of Airbus and supplies the wings for its airplanes.

The other partners are DaimlerChrysler Aerospace of Germany and the French-government-owned defense company Aerospatiale, each of which owns 37.9% of the Airbus consortium; and Construcciones Aeronauticas, or CASA, of Spain, which owns 4.2%.

The structure of Airbus is as complex as its history.

It was founded in 1970 as a government-backed effort to preserve a European aerospace industry, after the commercial failure of the Concorde, the British-French supersonic aircraft. And the consortium remains a unique public-private hybrid, even as it today seeks a more conventional, investor-owned corporate structure.

Airbus’ first model, the 250-passenger A-300, was heavily supported by initial sales to the French and German state airlines. Airbus made a breakthrough to the U.S. market with a subsidized sale to the old Eastern Airlines in 1975 and won orders from more than 80 airlines worldwide after that.

In the process, it devised a production system that is admired to this day: Wings are made in Britain, fuselage sections are made in Germany and France, and other parts are made in Spain. These are all flown in large transports to Toulouse for final assembly. Airbus has 37,000 employees among its four partners.

Throughout its existence, Airbus has been attacked as an unfair competitor because of its government subsidies. With some justification, Boeing continues to object that it is competing not with an investor-owned company like itself, but with an entity that can borrow at low interest rates because of its government connections and can run up losses as long as it keeps workers employed in its supplier countries.

Boeing brings its objections to the U.S. government, which is currently pressing an inquiry into how Airbus is financing an upgrade of the A-340, a competitor of the Boeing 777. At issue in the inquiry, by the U.S. trade representative’s office, is whether Airbus is using government subsidies to pay for more than 30% of the cost of the A-340 upgrade.

One of the ironies of the Airbus-Boeing competition is that Airbus is allowed government subsidies of up to 30% of the cost of developing a plane under a 1992 agreement between the United States and the European Union. The agreement is a tacit U.S. admission that U.S. defense spending has in effect been a subsidy for Boeing, McDonnell Douglas and other aerospace companies.

The agreement averted a trade war at the time, but tensions are rising again. Last week, the U.S. cited Airbus as a frequent offender in offering bribes to sell airplanes in international markets.

Full Privatization Ahead?

Airbus responds to such allegations with slaps at Boeing--�Boeing is always denying that we have a right to compete,� Leahy remarks--and explanations that its programs are carried out with loans from its partners that it must repay. And the company must earn a return on capital like anyone else, according to Leahy, an American who joined Airbus in 1985 and who headed North American sales efforts before becoming head of global sales in 1994.

To end the subsidies issue, Airbus has been trying to change its structure from consortium to single private company. But that has been repeatedly put off because of disagreements between the French government partner, Aerospatiale, and the German and British partners.

“They’ve been saying they’re going private since 1996,� said aerospace analyst Nicholas Heymann of Prudential Securities in New York, “but they may never get there.�

Still, Heymann and other analysts agree that arguments over Airbus’ structure won’t do Boeing much good. “They’ll have to compete with Airbus as it is,� Heymann said.

And Airbus is a formidable competitor because it doesn’t behave like the stereotypical government company.

Possibly because it didn’t have to answer to Wall Street demands for quarterly earnings increases, Airbus has invested to develop significant aviation technology. Its electronically controlled flight system, an advance over electromechanical controls, has now been adopted by Boeing for the 777, something Airbus officials never fail to point out.

Airbus understood early on that to compete with Boeing it had to offer a family of airplanes. So in the 1980s it developed the 150-passenger A-320 to compete with Boeing’s 737 and the A-340 to offer airlines a smaller version of the 747 and to compete with the 777.

The consortium gained market share, mostly at the expense of the fading McDonnell Douglas. On several occasions, discussions about cooperative ventures between Airbus and McDonnell were begun, but the two sides could never quite agree on terms.

And then came the 1990s, a period that began with the Gulf War upsetting aircraft industry patterns by causing a decline in air travel. Orders for planes first dried up, then came back in a rush as airlines saw rising prosperity. At one point early in the decade, Boeing and McDonnell were short of capacity to meet demand; Airbus orders increased almost by default.

Boeing “didn’t want that to happen,� said a company spokesman, so it decided to greatly expand production capacity in order to get as many orders as it could. The intent, analysts say, was to starve Airbus, perhaps drive it out of business.

But it was an unrealistic hope for many reasons, one being that the world’s airlines don’t want a monopoly supplier.

“Our policies want to have two manufacturers of airplanes, not one supplier,� said Yang-Ho Cho, president of Korean Air Lines, speaking for all airline managements. Cho’s company, like many others, has spread the business around, ordering one range of aircraft from Airbus, another from Boeing.

In recent years, they have been able to negotiate good prices, Cho said. But he doesn’t feel sorry for the aircraft makers: “Airline fares are ridiculously low; why shouldn’t manufacturers’ prices be too?�

As Boeing pressed its campaign, Airbus was hurting in 1993. Orders fell to 38 planes from 136 the year before, when Boeing took orders for 217. But then Airbus did something that is rare for European companies, not to mention government-connected ones: It cut personnel by consolidating production in its German operations, and reduced costs through early retirements in the French operations.

It reorganized the production system and the relationship of Toulouse assembly to the partners, introducing a production software system that consultants praise as one that Boeing could learn from.

And Airbus aggressively went out and got orders, raising its total to 460 aircraft in 1997 and 556 last year.

Lean Years Ahead for Industry

Boeing, meanwhile, was running into problems with its expanded production schedules. The result was losses, embarrassments and, last fall, a replacement of top management in the commercial airplane division.

Europeans are feeling vindicated these days.

“They underestimated European industrial and political will,� crows a veteran European aerospace expert.

But in truth there is little reason for either side to celebrate in the aerospace business today. Both Boeing and Airbus, thanks to their price-cutting competition, have failed to profit from a boom cycle in aircraft orders. Now they face a downturn as recession-bound countries in Asia and Latin America continue to cancel existing aircraft orders and put off airline expansion plans.

The next few years will be lean ones, predicts analyst Heymann, who sees the next “up cycle� beginning in 2003.

So Airbus and Boeing alike are now retreating from their expensive campaigns of pressing for market share. That’s why Boeing announced last week that it is going to get its costs in line.

And Airbus will be doing the same, because it will have to fully privatize to succeed in the new Europe. For whatever subsidies and taxpayer support existed three decades ago to found the company, times are changing here too. Companies are expected to earn their keep these days.

In that, Airbus is fortunate, because Chief Executive Noel Forgeard, a veteran of French defense industry and government posts who was appointed to Airbus’ top job last April, “runs the company as if it is already private,� said Pierre Sparaco, a longtime aerospace correspondent who now covers Europe for Aviation Week magazine.

So there will be a quiet period in the competition. But after the carnage of the 1990s, the world of commercial aviation will never be the same. Airbus has made its point.

Analyst Chao calls it “a Boeing and Airbus world.� And if Boeing isn’t careful, one day that order of things will be reversed.

James Flanigan can be reached by e-mail at [email protected].

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Flying Closer

A decade of data reflects Airbus Industrie’s staying power. Airbus’ 1998 jetliner orders almost matched those for Boeing--556 for the challenger versus 656 for the leader. Still, in terms of value of aircraft delivered in ‘98, Airbus, with 25.5% of the total, has only about one-third of Boeing’s share.*

Aircraft Orders (1998)

Boeing: 656

Airbus: 556

****

Value of Aircraft Delivered (1998)

Percentage share of total value of aircraft delivered:

Boeing: 74.5%

Airbus: 25.5%

McDonnell Douglas: 0%*

* Boeing’s acquisition of McDonnell Douglas in 1997 increased its share of deliveries.

Sources: Airbus, Boeing and Teal Group

Airbus at a Glance

* Name: Airbus Industrie, a consortium owned by DaimlerChrysler Aerospace of Germany, Aerospatiale of France, British Aerospace of Britain and Construcciones Aeronauticas of Spain

* Business: Commercial aircraft

* Headquarters: Toulouse, France

* Employees: 37,000

* 1998 revenue: $13.3 billion

* 1998 earnings: $200-million loss