© 2006, I.P.L. Png 1Airbus v. BoeingUntil 2001, Airbus was a marketing consortium established under French law asa “Groupe d’Intérêt Economique”. The four shareholders – Aerospatiale–Matra(37.9%), British Aerospace (20%), Construcciones Aeronauticas (4.2%) andDaimler Aerospace (37.9%) – performed dual roles as owners and industrialcontractors.Most major decisions required unanimous approval of the shareholders. Airbuswas obliged to distribute production work among its shareholders according topolitical as well as economic considerations.Then, Airbus was re-organized into a single fully integrated limited company.The objective was to streamline operations across national boundaries, reducecosts, and speed production.The re-organization coincided with a consolidation of Airbus market position. AsFigure 1 shows, from 31% in 1996, Airbus had steadily increased its share of themarket to 57% in 1999, but then dipped sharply to 47% in 2000. Following there-organization, Airbus recovered and maintained its share in the mid- to high50s until 2005.In April 2004, Boeing launched the new 7E7 Dreamliner jet with a firm order for50 aircraft from All Nippon Airways of Japan. The deal was worth about US$6billion at list prices, with deliveries scheduled to begin in 2008.Eight months later, in December 2004, following considerable speculation, Airbusannounced that it would develop the A350. This would compete with the Boeing7E7 in the market segment of twin-engine medium to long range jets withcapacity of 200-300 passengers. Airbus Chief Commercial Officer John Leahypredicted that the A350 would attract a substantial number of Boeing customersand “put a hole in Boeing's Christmas stocking”.1Boeing subsequently renamed 7E7 as the 787. It is a completely new design,with development cost estimated to be $8-10 billion. By contrast, the A350 is aderivative of the existing A330, enhanced with a new wing, more fuel-efficientengines, and other new technologies. The development cost would be just 4billion Euros (equivalent to $5.3 billion).Besides the development cost, aircraft manufacturers also incur substantial coststo manufacture the aircraft. The manufacturing cost is driven by an “experiencecurve”. As engineers and workers gain experience in production, they devisenew processes to reduce cost. As Figure 2 shows, the experience curve inaircraft manufacturing flattens out once cumulative production reaches thehundreds of units.Airbus and Boeing must set prices for aircraft based on projections of unit costs.Owing to the experience curve, these projections depend critically on forecast

sales. If the sales fall short of target, unit costs will be higher than planned, andthe manufacturer may incur a substantial loss on the plane.By December 2004, Boeing had secured 52 firm orders for the 787 (7E7), farbelow its target of 200 by that time. Richard Aboulafia of industry consultant Teal1 “A350: Airbus's counter-attack”, Flight International, January 25, 2005.Group remarked that Airbus had succeeded in its goal of “disrupt[ing] thebusiness case for the 7E7”. Northwest Airlines is one of the world’s largest airlines. However, since 2000,the airline has consistently incurred losses. In 2004, Northwest’s operating losswas $505 million and net loss was $862 million. Yet in May 2005, it placed a firmorder for 18 Boeing 787s, worth approximately $2.2 billion at list prices, plusoptions for 50 additional planes. The first planes would be delivered in August2008, with 6 planes delivered in each of 2008, 2009, and 2010.A sharp and sustained increase in oil prices has hurt Northwest and otherairlines. Yet, amidst continuing losses, Northwest is buying new planes. Why?Investment decisions are forward-looking. Current losses are sunk costs.Airlines believe that higher oil prices will persist, so it is important to buy morefuel-efficient aircraft for future operations.Table 1 shows that, while Northwest and United operate a mix of Airbus andBoeing aircraft, American and Delta concentrate on buying Boeing planes.Why? One reason is economies of scope in maintenance, repair, and training.An airline can reduce these costs by concentrating its fleet with onemanufacturer, but not across manufacturers.Airbus has emphasized that the high degree of commonality among its variousmodels provides airlines with substantial savings in crew training anddeployment. Chief Commercial Officer John Leahy remarked, “The A350 goesup on the ramp in 2010, and you’ll see pilots walking over from 330s without anytraining and flying it, walking over from 340s with just a very short transitioncourse lasting a couple of days ... It fits right into the Airbus family.”32 “Airbus pushes ahead with rival to 7E7”, Seattle Post-Intelligencer, December 11,2004.3 “AF&NM interview: John Leahy, chief commercial officer, Airbus”, Airline Fleet &Network Management, November/December 2005, 62-65.© 2006, I.P.L. Png 4Discussion Questions1. Suppose that there is demand for 500 units of the Airbus A350-Boeing787 type of aircraft, and that the selling price of each plane is $110 million.Assume that if Airbus manufactures the A350 and Boeing manufacturesthe B787, then each will sell 250 units, while if only one manufacturer

enters the market, it would sell 500 units. Further, assume that there is noexperience curve and that the manufacturing cost is fixed at $85 millionper aircraft. Use a game in strategic form to identify the pure-strategyequilibrium(ia).2. Is this a situation of first-mover advantage? Please explain your answer.3. How does the experience curve affect the strategic situation? Pleaseexplain in qualitative terms.