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:: October 2013 Letter ::

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Dear Fellow North Pacific Watchers,

Two Northeast Asia market disasters for Boeing in just two weeks. Behind that headline are two different meanings. The F-15’s loss in South Korea in late September was not Boeing’s fault at all (see my September letter). Japan Airlines’ A350XWB order this month was, in fact, Boeing’s fault. Here are the issues and consequences surrounding JAL’s 31-aircraft (18 -900s, 13 -1000s) buy.

First, the JAL decision is about hedging against risk. Boeing management has provided ample reasons for Japanese carriers to do this. In the aftermath of the 787 program disaster, airlines are understandably wary about relying on Boeing. This post-787 concern would have been manageable, since the 777-X and 787-10 look like extremely promising designs. What made the risk worse was that Boeing dragged its feet on the 777-X and 787-10, even implying that the schedule was far from firm. In fact, focusing on 787 fallout merely exonerates Boeing management from recent mistakes.

Jetmakers often forget that airlines are low-margin operations. Given high fuel prices, if an airline goes against a competitor that has a jet with 10% lower fuel burn, they’ll lose both market share and profit. JAL, understandably, didn’t want to risk a competitor getting a new generation plane five years before it did. Similarly, for ANA, relying on Boeing for 777-Xs means running the risk that JAL, their direct competitor, will get their A350s as 777 replacements years before ANA does. Therefore, an ANA A350 order is likely. And, now that Japan has hedged its bets, everyone else in the region will likely hedge too. Airbus sales executives should have some busy and lucrative months ahead.

It isn’t just Boeing. It’s Airbus and the A350. While Boeing was floundering around over the past few years, Airbus was making tremendous improvements. The bad old days of management by deranged political hacks and of impossibly dumb program launches are over. Instead, Airbus is a far more focused company with solid management, and it seems to be executing well on a promising new widebody. All Boeing can do now is look back longingly to the days Airbus was run by Noël Forgeard and launched planes like the A380. For more, see my January 2013 letter.

The 777-X has a very bright future ahead. It’s starting life as a lost opportunity. The 777-X looks set to be launched at the Dubai Air Show with hundreds of orders from several key carriers. That’s great. If the 777-X had been launched six months ago, Boeing could have kept IAG. If it had been launched in 2012, Cathay Pacific could have been retained too. In other words, Boeing hit the snooze bar on the alarm clock twice before the JAL loss. And they had ample warnings that Japan was at risk too; Bloomberg reported in May that Airbus was holding talks with Japanese carriers about an A350 buy. (For more on this, see www.forbes.com/sites/richardaboulafia/2013/05/24/787-delays-continue-to-boost-airbus/.)

On a related note, Japan was never an all-Boeing island, but the 777-X should have made it one. Japanese carriers have bought scores of Airbus, Douglas, and Lockheed widebodies. JAS had over 30 A300s, which JAL inherited when they merged with JAS in 2006. But then again, given the large industrial opportunities associated with a manufacturing role on the 777-X, and given that the 777-X family and 787-10 look ideal for Japanese needs, the A350XWB shouldn’t have been able to get its nose under the tent at all. Japan was also the last market left in the world (including the US) where Boeing had any kind of inherent advantage.

Boeing needs widebody dominance, which is now at risk. BCA’s story for years has been, “Don’t worry about single aisles. We dominate the twin aisle market.” But that dominance is looking shaky in the aftermath of JAL. With A320Neo and 737MAX sales apparently stuck at 60%-40% in Airbus’s favor, this is a worrying development for Boeing.

Japan’s vertical structure may be ending. That’s both bad and good for Boeing. Japan’s approach to aerospace has involved coordination between airlines, industry, and government. This meant a remarkable (and anachronistic) vertical structure where airlines buy planes that are partly built by national industry and partly funded by the government. But JAL, post-bankruptcy, no longer has the luxury of caring about anything more than buying the right planes for its needs (and avoiding risk). That’s bad for Boeing, since they can’t entice Japanese customers on the basis of industry content.

But, on the positive side, just because Boeing lost JAL (and probably ANA) doesn’t mean they’ll lose Japanese industry. The real prize in Japan is accessing risk-sharing investments from Mitsubishi, Kawasaki, and Fuji Heavy Industries (with Japanese Government help). Boeing won’t refuse to deal with these companies just because they’ve lost the JAL order; that would be cutting off their own nose to spite their face. However, these key sales losses definitely affect the terms offered by Japanese industry to Boeing. Japan Inc. may be less aggressive about paying large sums for 777-X workshares.

For Boeing, this is a good time for contrition, not arrogance and complacency. A few months ago Boeing flamboyantly told suppliers, “We have no-fly lists across the company,” implying that anyone who doesn’t meet Boeing’s aggressive terms will be frozen out. A better approach: “We apologize to our suppliers for the financial pain associated with the 787 delays. Please partner with us on the 777-X; it will be a rewarding experience.” Similarly, both the 787-10 and 777-X have the unusual distinction of being launched by customer orders, not by a Boeing launch. “This is what we may build one day,” Boeing effectively said, “No guarantees about timing, but these planes are so good that when we do customers the favor of launching them, airlines will sign up.” Boeing needs to return to a more proactive approach to jetliner launches.

These two North Pacific losses illustrate Boeing’s two different sides. BDSS has aging aircraft kept viable by smart and effective management. The Korea loss shows the limits to that approach. BCA has modern, competitive, second-to-none jets hobbled by dubious management. The JAL loss shows the limits to that approach. BCA’s fundamentals are quite strong. But Japan was Boeing’s market to lose. Somehow, management found a way to lose it.

October Teal Aircraft updates include the C-5, MS-21, KC-390, OH-1, CL-415, and Caravan. There are also updates of the Engine appendix and Military Aircraft Fleet appendix. Have a great Halloween.

Yours, ‘Til JAL Orders COMAC 929s,
Richard Aboulafia
 

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  ~  Last updated on January 08, 2006