Break-Even Point of Industry Essay
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1. Airbus’ Interests & Objectives
First of all, the large and cost-efficient A3XX would be popular with significant growth in the air transportation industry. Worldwide passenger traffic would almost triple in volume by 2019, with fuel price rising in the future. Creating large and cost-efficient aircrafts, rather than increasing frequencies and building new routes, would be the long-term solutions to the problem of growing demand. Therefore, this project will be strategically significant. Secondly, Airbus wants to gain market shares in the VLA market and break up the monopoly of the 747, but it didn’t have a product to compete with Boeing’s 747.
Compared to the 747, the A3XX provides more advantageous features which would attract passengers especially on the longer routes, such as more space per seat, four-engine plane, etc. The combination of increased capacity and reduced costs would provide superior economics. Airbus felt confident that capacity increases would eventually prevail. As we stated above, Airbus’s objectives are to break up the monopoly of the 747, to increase its market share in the VLA market, to gain enormous financial success and to be an industry leader.
2. Break-Even Point & Market Demand
Production will be able to reach full capacity from 2008, with order and delivery assumed on a stable level. During this period, the capital expenditure will be offset by depreciation in calculation of free cash flow, and R&D will be included in the operating margin. The company, as assumed, will produce and deliver 22 aircrafts for the airlines which have ordered, with 6 in 2006 and 16 in 2007. Since $700 million would have already been spent before the decision, this amount of investment should be treated as sunk cost, therefore irrelevant to the NPV analysis. To break even, with assumed operating margin of 18%, Airbus should produce and sell about 40 VLAs every year since 2008, or 495 in total before 2019. Taking the estimated margin from Lehman Brothers and CS First Boston into consideration, total orders needed for break-even can range from 306 to 509 in 20 years.
From the view of Airbus, the market demand for VLA, 1550 in years, is large enough to take this project. And it is pretty safe to launch the development since, even with lowest estimated margin, 38% of total market share will guarantee a break-even. However, Boeing gives a totally different perspective and a much lower forecast on potential market demand. Under this estimation, A3XX development will have little chance to make a profit. Airbus should take at least half a market on VLA to make that project fruitful.
3. Boeing’s Response
Based on the analysis before, the VLA market is so promising that Airbus is very likely to launch the A3XX. Facing with this threat, the most important move for Boeing is to prevent Airbus from dominating the VLA market. Therefore, Boeing can cut the price of existing 747 product lines and produce 747 stretch as response to Airbus. Producing 747 stretch which may contain 550+ passengers won’t be too costly for Boeing since is a modification over the current model, and that can powerfully compete with A3XX in the VLA market.
Before the stretch version is market available, Boeing can offer a price cutting of the existing 747 which can not only divert sales away from A3XX, but also make A3XX project less attractive. Other alternatives might not fit. Firstly, fighting the A3XX on legal grounds (improper subsidies) will probably induce the revenge complain from Airbus, making Boeing itself to pay a large penalty. Secondly, to develop its own super jumbo jet is costly and maybe not profitable. What’s worse, in 1997 Boeing faced the first loss in more than 50 years, it’s better for Boeing to have a prudent stable strategy than an aggressive investing.
4. The Threshold To Launch
We think Airbus should commit to build A3XX. The Annual Sales and Orders as of 1999 show that Airbus currently faces a disadvantage in competition with Boeing on almost every size of passenger aircraft. Worse is that, while Boeing pockets the market for VLA, Airbus even has no product to compete. Breaking the monopoly on this market becomes critical for Airbus, which is aiming to lead the industry. Strategic significance of A3XX makes this project worth an effort. Compared with the situation when Boeing launched its 747 development with 25 initial orders, the current 22 orders, with other 34 probable, is not a negative sign to commit the project. However, there would also be great risk in the new aircraft development. The possible poor market demand will make the project unprofitable. More important is that new A3XX should be sold quickly in early years to exploit learning curve effect on manufactory and seize market before Boeing reacts.