Boeing and Airbus – Different Visions, Different Aircrafts

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Introduction

Boeing and airbus have a difference in opinion on the future of commercial airlines. In 1997, Boeing decided to pull out of building a new plane code named 747-400. The plane would have carried a total of 550 passengers. The reason for the pull out was due to the lack of orders. Only two airlines British airways and Singapore had expressed their interest in the super jumbo. However, these two airlines had not made any firm orders. Boeing also pulled out because they were concerned about flying large numbers in one plane. Airbus on the other hand decided to go ahead with their project of building a new plane carrying 550 passengers. Unlike Boeing, Airbus received orders for their new planes. This made Boeing to reconsider their decision to pull out of the super jumbo program.

Airbus expected the costs of developing the new plane to be about 11 billion dollars. Moreover, it offered 49% more room than the Boeing sonic cruiser. The costs of development are also 20% cheaper than Boeing’s. Boeing had previously estimated the cost of developing the sonic cruiser at 2 billion dollars basing this figure on the existing technology of the 747 (Bass, 2010). However, the costs of the jumbo rose to 7 billion dollars. Therefore, Boeing said that the new Airbus plane could not compete with the sonic since they expected the costs of developing to rise to about 12 billion dollars. According to Boeing, the only way that airbus would compete with the jumbo was by accepting government subsidies. Airbus rebuffed these claims saying that they were trying to establish industrial partnership with Japan to help them meet the costs of developing the mew A350 plane. Japanese aerospace group was already cooperating with Boeing. Therefore, airbus was planning to use the same strategy.

In the year 2001, Boeing unveiled their alternative project, the sonic cruiser and reaffirmed their decision of pulling out of the 747-400. However, the sonic cruiser project was abandoned in 2002 after Boeing received negative feedbacks from airlines. After deciding against the sonic cruiser, Boeing concentrated on a new plane codenamed 787 Dreamliner. This plane could hold a capacity of 218 and burned less fuel by 20%. The plane was 10% cheaper to operate than similar jets in the market. The plane cost of developing the plane was initially 4.5 billion. The downside for the 787 was that it would only travel at 80% of the speed of the sonic cruiser.. Boeing estimated the market for the 787 to be 3500 over the next 20 years

After the release of the Dreamliner, Airbus threatened to unveil a new plane A350 to compete with the sonic cruiser. This move led to a huge row between the United States and the European Union over the amount of subsidies the two parties were getting. Boeing received 23 billion dollars as subsidies while airbus received over 15 billion. Boeing feared that this money would be used to develop the A350 that would compete with the sonic cruiser. The United States together with Boeing argued that airbus is already a profitable business and no longer needed state subsidies. Airbus plans to spend 2 billion dollars to make a new plane A350. The new plane is based on the success of the previous version the A330. Therefore, the new plane is bound to be cheaper than the Dreamliner and will have longer travelling range. The performance of the A330 would be better for the case of a bigger plane carrying 270 passengers.

Nevertheless, the plane is not expected to hit the market until 2013.

In response to claims that Airbus would release a plane to compete with 787 Boeing said that they could not. Boeing believes that market for larger planes will shrink while the market for midsized planes would gain popularity. Therefore, the planes would gain market share from 18% to 21%.

Factors Influencing Investment Decisions

Factors that influence decision-making can be either internal or external. These factors are usually variable from one organization to another. Sometimes, these factors may affect one organization while the other is free from its effects. The factors that affect an organization from within are therefore known as internal factors. Internal factors are usually specific and might only be affecting the organization in question (Scott and Kesten, 2007). The factors may also be coming from outside the organization. Therefore, they are known as external factors. External factors usually originate from the market and may affect more than one organization (Scott and Kesten, 2007). Investment decision making is crucial since it affects the returns that a company will receive. Boeing and airbus have different factors in play. These factors affect the investment decision making and thus the difference between the companies. The factors that affect each company may be either external or internal. This paper discusses both the internal and external factors that led to the difference in decision making between Boeing and Airbus

Internal Factors Affecting Decision Making

Management Outlook

Management outlook is process that management use to determine whether to invest or not. Management outlook involves a number of procedures and processes that will enable management to decide the viability of a decision. Some of the processes involved in management outlook are research, analysis of financial information and market analysis. Boeing abandoned the production of the 747-400 after they realized that there were no orders. Only two airlines had shown interest out of the multiple airlines in existence in the market. The management outlook came to play after this information. Boeing managers saw the future of producing Boeing 747-400 as non-profitable. Data from the market had indicated that the planes launch would not be very successful in the market. Therefore, management had to make a decision on whether to continue manufacture and risk the uncertainty. In the long run, Boeing decided to pull the plug on the 747-400. Boeing management believed they were in a bear market and would make a loss if they implemented the project. On the other hand, their outlook of their competitors was very different. The managers of airbus believed they were in a stag market. They went ahead and built their 555-seater plane codenamed A380. The plane surprisingly got orders. This led Boeing to have doubts in their decision to pull out of the project in the first place even though they did not build the 747-400.

The general economic assumption is that Boeing management failed to see the opportunity in investing in a product that was unproven in the market. They pulled out believing they were in a stag market. Their competitors on the other hand were risk takers. They saw the opportunity in the market (Jago, 2002). In fact, Airbus used some of the market hype created by Boeing to profit. The decision of Boeing to pull out eliminated competition thus creating conducive market conditions for airbus to operate as a monopoly. Another reason behind airbus success might have been the establishment of a brand. Airbus might have established a better brand name and were therefore sure they would succeed if they launched the large aircraft. Therefore when management made their decision they knew they were not risking a since they already had a loyal customer base. This is supported by the fact that Boeing and the united state were arguing that Airbus was already making profits and did not require government aid. This clearly tells us that Airbus had already established a market share. Therefore, when management was making an investment decision they took this market share into account.

Cash Flow Budget

A cash flow budget shows the projected cycle of funds flowing in and out of the company. Analysis of a cash flow statement will determine how whether a company will have the available cash to undertake different ventures. The cash flow budget would also show the timing of fund influx in a company (James, 2010). Knowing the time of fund influxes would determine when and how to implement decisions. Boeing and Airbus definitely have different cash flow budgets both in term of figures and in terms of timing of influx. This difference in timing and figures would definitely explain the difference in investment decisions of the companies. An argument had ensued between the Boeing and the airbus in terms of the cash flow. Boeing was accusing Airbus of being dependent on government subsidies and aid in order to compete. However, airbus had rebuffed these allegations and claimed that they were seeking partnership with Japanese aerospace groups. The difference in the cash flow budget of thee two competitors made them make different and conflicting decisions. It can be said that, in the case of the A380 plane made by airbus against the market analysis that it might be unsuccessful, was a typical case of difference in cash flow. Airbus directors and managers felt hat the influx of funds into the company could handle losses if any occurred. Therefore, they ventured into making a plane that might have been unsuccessful. An obvious fact is that most profit making organizations make decisions basing them on speculation of profit and their ability to handle losses. Therefore, airbus management could not have made the decision if they were of the opinion that the company could not handle the losses. This could only be determined by observing the cash flow budget. On the other hand, Boeing made the opposite decision. They abandoned a project of making 747-400 since the market analysis had indicated it would be unsuccessful. The logical explanation for this situation is that, Boeing managers had analyzed their cash flow budget and concluded that flow of funds might not have been able to handle the losses at that time. Therefore, the logical decision in this case would have been to abandon the project and cut their losses before it was too late.

External Factors Affecting Investment Decision Making

Competitor’s Strategy

Companies usually study the habits of their competitors. The manner in which the competitors use their resources will usually determine the strategy the other competitor uses to invest. Competitors usually use invest capital in different manners in order to ensure they can differentiate their products from the other (Brand, 1998). Differentiation is usually a marketing strategy approved by Lavidge and Steiner model (Linzalone, 2008). By using differentiation, the company is able to establish a unique product that has its own market share (Barth, 1999). Boeing and airbus are competitors therefore; they each have their own strategies of differentiating their products from the other. Thereof it can be seen that once Boeing made a decision to pull out of making a 550-seater plane, airbus made the decision of making the 555-seater plane. Airbus saw the opportunity of differentiating their product once Boeing pulled out. Both Boeing and Airbus are both trying to differentiate their product for marketing purposes. Differentiation leads to establishment of a brand and a brand leads to a loyal market share of consumers. Boeing and airbus are both trying to establish loyal consumers by applying different investment strategies.

Boeing decided against the investing on the 747-400 once Airbus had established a good percentage of the market share instead they opted to make a smaller plane, 218-seater codenamed Dreamliner. The capacity made this plane different from that Airbus, 555-seater, plane. Each of these competitors is using a unique product to capture the market. Therefore, in order to succeed in successfully differentiating their products, the companies must employ different investing decisions (Bennett and Gabriel, 1999).

Market Forecast

Market forecast both short term and long term would determine how an organization makes an investment decision (Stolba, 1990). Management of any company has to do no an analysis on the market trends first (Davies & Strycharz, 1990). This will enable the managers to be able to forecast the short and the long-term situation of the market (Ferber, 1973). Boeing did a market forecast when they wanted to build 747-400. The market showed that they only had two interested customers who had not even made orders. Therefore the market forecast for Boeing showed that the airplane was not worth investing in. on the other hand Airbus decided to build a large plane even though Boeing’s forecast had indicated otherwise. This means that Airbus had done a market analysis and the forecast had shown that the project was viable. Therefore, the market forecast for each of the two made them make different investment decision. Market forecast also made Boeing build the 787 and abandon the sonic cruise project. This is because the market had indicated that they would prefer a cost saving plane rather than a faster plane. Boeing took this forecast to make the Dreamliner and beat its competitor (Davila and Wouters, 2004). The investment decision in this case was different from that of its competitor because of the research. Market forecast is an important function in investment decision-making (Leitner and Warden, 2004). It provides the knowledge a manager requires to make the final decision on investment. Most companies depend on market forecast in decision-making since availability of a market indicates profits prospects for the company (Revay, 1989).

Risks

Market Risk

This is the risk that the value of an investment will reduce due to market risk factors such as interest rates, exchange rates, and commodity prices (Hutto, 2009). Both Boeing and Airbus are faced with market risks since they are both investing under uncertain conditions. It is not easy for manufacturers to forecast changes in all of the market risk factors (Borodzicz, 2005). Therefore investments may be undertaken without taking into consideration of the risks involved (Gorrod, 2004). Boeing and Airbus are bound to be faced with the market risk factor irrespective of their locations and strategies. Some of the market risk factors are:

Interest rate risks: This is the risk that exists when a company obtains an interest bearing capital investment (Altemeyer, 2004). For example, loan, bonds, debentures and hire purchase. Generally the interest rates fall and rise depending on the total market conditions (Alexander and Sheedy, 2005). A rise or fall in the interest rates would either mean a loss or profit to the concerned organization. Economists have established a means of calculating the interest rate risk. These calculations enable managers to form a provision for the risk factor and avoid losses.

Currency risks: This is the risk that arises due to changes in exchange rates. Since Boeing and Airbus trade, they cannot avoid the exchange rate risks (Hubbard, 2009). Any loans obtained in foreign currencies will be affected by the exchange rate and would definitely lead to losses or profits. The fact that there exists a risk in the foreign exchange rate lead to a requirement for a provision (Kahn, 2006). Foreign exchange risks are of two basic types. Transaction risk is the risk that the exchange rate of foreign currency will change unfavorably with time. Translation risk is the risk that an asset held by a company in foreign currency may render reports inaccurate.
Commodity risks: Some commodities are usually necessary for normal operations of a company (Andreas, 2010). Any changes in prices of such commodities may lead to losses by a company. Boeing and Airbus are dependent on commodities such metal, electricity and fuel. Changes in prices of metal or electricity. It may lead to losses in the airplane industry due to increase in cost of production (Ruffin, 2002).

Operational Risk

These are risks that arise from execution of a business. Operation risk is broad concept and encompasses risks arising from human factors and processes of operation. Operation risks also include risks such as fraud and legal risks. Boeing and Airbus both experience operation risks while operating. Human factors such as errors might lead to losses in accompany. A good example is the case where Boeing managers decided to pull out of the super jumbo project. This decision was a wrong decision due to human shortcomings. The fact that Boeing managers did not recognize opportunity in the 747 super jumbo is a human error. This risk that human cannot identify all opportunities is a risk that all organizations must take. Another good example of risks being faced by both organizations is the legal risk. The companies may be affected by government legislation and other legislation set by the aviation air safety body. These bodies may require changes that may lead to losses in the industry of manufacturing planes.

The main objective of risk management is to identify the risk and to eliminate the risk. Risk management has the purpose of adding sustainability to all the activities that a company undertakes. Risk management increases the probability of success and reduces the chances of failure in an organization. There are several approaches that can be used to manage risks. Different managers can use different methods manage risks. In case of market risks, management will approach the risk depending on the type of risk involved. Interest risks are managed by calculating the risk factor. The analysis of the risk factor is usually done through simulating shifts in one or more yield curve. After calculating the risk factor, management can provide for the risk and ensure that the company can be able to pay up for any losses due to interest rate changes.

Boeing experienced operational risk in the course of its operations. The error of abandoning plans to build 747-400 was human error. This error was rectified by the company in their next project; building the sonic cruiser. They conducted sufficient research before rolling the sonic cruiser into the market. The feedback they got was that the sonic was not the most desired plane in the market since it was not cost effective. Boeing therefore abandoned the sonic program to build the 787 which as highly successful. Boeing in this case managed the operation risk by introducing research to combat the problem that arose when they pulled out of developing the 747-400. Boeing also faced the commodity risk when building the 787 plane. Their initial estimation of developing the plane was 2 billion but it rose to seven billion shillings. The rise in costs might have been due to commodity the risk. The company managed the risk by having extra funds to carter for the changes in cost of development.

Airbus on the other hand is also faced by commodity risks. In the quest of building their new aircraft (A350), airbus is bound to be affected by the changing prices of components that are required to develop the plane. Airbus is managing this risk by setting a provision for the expected changes in commodity prices. Airbus has estimated a cost of approximately 2 billion to develop the plane. This figure represents an estimate meaning the company has the knowledge on how much they can set aside to provide for commodity risks that may arise. Risk management is a continuous process and requires constant managerial attention.

Stakeholder’s Analysis

The main stakeholders in this case are the United States, the European Union, Boeing and airbus. These stakeholders have each been affected differently by the completion that exists between them. The United States for example has to issue subsidies to Boeing in order to ensure the company can manufacture planes at an affordable price. It has been estimated that Boeing receives up to 23 billion dollars in subsidies. On the other hand, the European Union is also affected with the same challenge. The EU issues an excess of 15 billion dollars as subsidies to support Airbus in manufacturing the planes. Airbus and Boeing are both stakeholders in this case. The completion between the two companies has led to the companies experiencing risks while in the process of manufacturing. Boeing for example experience operational risks.

The management of was challenged after they had withdrawn from building the super jumbo. Management corrected this mistake by embarking on research before undertaking new projects (Quayle, 2010). This strategy led to Boeing coming up with a viable project that was highly successful in the market. Airbus in the other hand as stakeholders is faced with the challenge of completion from Boeing. Airbus has to compete with Boeing’s innovation and therefore is burdened with the task of being equally innovative. To compete with Boeing’s Dreamliner innovation, Airbus decided to invest 2 billion dollars in developing a plane to rival Boeing’s Dreamliner. It is expected that by 2013 Airbus will unveil their new plane that will rival the Dreamliner.

Financial Appraisal

An appraisal is the process of valuing a project a business or an antique with the aim of determining the viability of the project (Markku, 2001). Appraisals are typically used to assist in taxation but sometimes an appraisal is used in assisting in decision making (Andriessen, 2004). In the case of Boeing, the function of the appraisal is to determine the viability of the project. If the project is viable then managers can use the appraisal in making investment decisions (Krugman and Maurice, 2003). Appraisals can be done using a cash flow statement or using the income and expenditure statement. In this paper the income and expenditure has been used to appraise the Boeing project.

Overview

Boeing embarked on a project to build a cost effective aircraft as required by the market. In building the plane, Boeing incurred costs of production and development. Boeing incurred the costs of research when they were seeking the market’s opinion on the aircraft development. They also incurred material costs and labor costs to develop the Dreamliner. Taking these costs into account is the first step of an appraisal of the Dreamliner effects to Boeing

Costs of development

The costs of producing a single Dreamliner airplane should also be taken into account this cost should be separated from the cost of development for appraisal purposes. However, the total costs of development of the Dream liner have been estimated to be 7 billion dollars. Assuming here are no maintenance costs that Boeing has to take into account then the only costs to be taken in the case of the dream liner are the costs of production and development.

Market forecast

Boeing has forecasted the sales of the Dreamliner to be about 3500 planes in over the next 20 years. Another focus is that the medium sized planes like the Boeing 787 codenamed Dreamliner are going to gain a market share of three percent. Therefore, the forecasted number of planes sold should be adjusted by the expected gain in market share. In adjusting for the gain, Boeing will gain 3% increase in sales. 3% of 3500 will give a rise of sales by 105 planes in the next 20 years.

Overall financial viability in terms of income versus expenditure

Boeing has already had a total of 876 orders from 53 separate customers. Each of the new planes is sold at the price of 150 million dollars. Therefore, the total sales by mid 2010 are given by multiplying the total number of planes sold to the cost of each plane. The total sales by mid 2010 were 131.4 billion dollars. Assuming Boeing had a profit margin in the sale it can clearly be stated that they had recovered their costs of developing the Dreamliner. Boeing has estimated the total number of planes to be sold in the next 20 years to 3500 plus the three percent increase in sales number. Therefore assuming the forecast to be true the total numbers of planes to be sold in the next 20 years will be 3605. Having already sold 876 planes the remaining number of planes that will be sold over the next 20 years will be 2729 planes. Assuming the prices of the plane are not going to change within the next twenty years, Boeing is expected to have a total of 4.0935 trillion dollars in sales in the next 20 years. This figure can be matched against the costs incurred to produce the plane the other costs incurred to put the plane in the market. Taking into account all costs and all the incomes from the 747, the impact of the Dreamliner can clearly be mapped.

Conclusion

Factors that influence decision-making can be either internal or external. These factors are usually variable from one organization to another. Sometimes, these factors may affect one organization while the other is free from its effects. The factors that affect an organization from within are therefore known as internal factors. In the course of their operations, both companies are faced with risks. Market risk is the risk that the value of an investment will reduce due to market risk factors such as interest rates, exchange rates, and commodity prices. Operation risk is risks that arise from execution of business processes. Operation risk is broad concept and encompasses risks arising from human factors and processes of operation. An appraisal is the process of valuing a project a business or an antique with the aim of determining the viability of the project.

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