The Global Commercial Aircraft Industry - Research Paper Example

The case study of Airbus strategic analysis is focusing on the impact of current global financial crisis on the growth and development of commercial aircraft manufacturing industry. Commercial aircraft industry is a capital intensive industry in which manufacturers require huge amount of financial resources. The economic crisis existing in the global economy is not ensuring adequate sources of financial resources. In these conditions it will be interesting to identify the impact of economic crisis on the growth and profitability of the capital intensive industry of aircrafts. The aircraft industry is characterised by intense government support and control by way of subsidies and grant and regulations. As a global industry there are no geographical boundaries for the operations of the players in the industry. It leads to global competition of competent manufacturers. The impact of global competition and government regulations on the operations of commercial aircraft industry will be helpful for finding out a suitable marketing strategy for the Airbus. As a part of analysing strategies relevant for Airbus in the intense competitive commercial aircraft industry, present conditions in the global commercial aircraft industry are analyzed through the PESTEL model. Through the Porter’s five force analysis, the major forces in the industry that affecting the strategies are identified and analysed. 1.1. Short background of the aircraft industry: 1.1.1. Market overview: Aircraft manufacturing industry involves the manufacturing of both commercial and defence aircraft. The commercial aircraft manufacturing segment of the industry can be divided into two markets. Regionally focused narrow body aircrafts and internationally focused wide body aircrafts. The level of competition in these two divisions is highly differentiated. The commercial aircraft manufacturing industry is a global industry and there is no geographical boundary that restricts the operations of the players in the industry. Thus for profitable long term existence, manufactures required to adopt adequate global production and marketing strategies. The approximate size of the global commercial aircraft industry is $ 76 billion. (Aircraft Manufacturing Industry. 2008). In the industry, there is only limited number of manufacturers exists profitably. The Airbus and Boeing are the leaders in the industry. Since 1970s, outsourcing of operations is emerged in the industry and this leads to the growth of the component /subsidiary aircraft -product market. Since 1990s, the two market leaders in the industry, Boeing and Airbus adopted contracting of production process in order to reduce the operating costs and ensuring advanced quality products. They adopted foreign suppliers especially in their newly emerging global markets. (Xu and Chan 2008). It is estimated that 8% of the world’s gross domestic product is contributed by the global civil aviation industry. It is approximately for an amount of $ 3. 5trillion. Due to the impact of economic crisis over the global market, it is estimated that the orders for new aircrafts should be go down severely. In case of Airbus it is about 1400 and for Boeing it is 1000. Current down warding trend in the global equity market leads to higher reduction in aircraft value. This will affect the procurement of financial resources for the aircraft industry from the stock market badly. The globalisation of the industry generates challenges to the players in the industry. (Commercial Aviation Panel: Demand is Strong but Consolidation Global Competition and Infrastructure Cloud the Horizon. 2008). The commercial aircraft manufacturing industry is highly affected by the global financial crisis. Manufacturers are forced to adopt uneconomical sources of finance for their operations due to their lower value in the stock market. Subsequent competition can be seen within each segment of the aircraft manufacturing industry. Direct competition over models and price between the market dominants bring forth highly efficient and cost effective aircraft models in the market. (Melo 2000). “Airline industry group IATA said recently it expects the industry to lose 2.5 billion dollars in 2009 due to the economic crisis after losses of some 5.0 billion dollars in 2008. Demand for flights has fallen sharply as recession bites in many leading economies.” (Airbus Warns of Horrible Year Ahead, Sees Orders Halved. 2006). Prevailing global economic crisis strongly affected the aircraft industry through reduced demand for product and demand for advanced aircraft to operate in a cost effective manner. It forced the companies to spend more on acquisition of advanced technology. Due to the much tighter credit conditions in the market, the fund availability for research and development is reduced and this affects the development of advanced products that meet the customer needs and interests. Sales orders to the companies are highly reduced and as a result the turn over from the business is highly reduced. “In the aircraft industry orders for new aircrafts are falling, as illustrated by the order cancellations announced by the EADS (France) and Boeing (USA).” (UNCTAD 2009, p.11). The current challenging financial and market environment have forced airline companies to become much more capital efficient in order to overcome the reduction in turn over. Thus most of the airline companies are adopting leasing of aircrafts on a long term basis instead of buying them. It is expected that the aircraft industry should hardly affect by the financial crisis. (Airlines Opting to Lease Aircraft Amid Financial Crisis. 2008). 1.1.2. Industry structure types: The term industry structure types refers to the number and size distribution of firms in the industry. In the commercial aircraft manufacturing industry, there is only limited number of players exist profitably. A major portion of the total market share of the industry is under the control of Airbus and Boeing. In order to identify the full structure of an industry, the whole backward and forward channels of the industry have to be identified and analyzed. Each of the components of the aircraft industry is described below; 1. Suppliers: The aircraft industry needed many parts for which the suppliers are only limited. In case of plane tires the major suppliers are Good Year, Bridgestone and Michelin. In case of high tech components, Siemens and Honeywell are the major suppliers. The major suppliers of components of the aircraft are Rolls Royce and General Electric Company. The manufacturers of aircraft are required to contract with these suppliers for developing new planes. A long term strategic alliance is required to build up by each manufacturing firm with these suppliers. (Lacher, Roth and Graber 2004). 2. Manufacturers: The commercial aircraft industry is a capital intensive industry in which huge amount of long term investment is required. Due to the requirements of sophisticated innovative high technology and enormous economies of scale, only limited number of profitable firms is exist in the industry. In the global aircraft industry the duopoly of the market leaders Boeing Company and the Airbus is dominating and they have greater influential power over the industry. The growth and development of the industry in controlled by the dominating companies Airbus and Boeing. 3. Buyers: In the industry, the buyers are mainly airline companies. It is with the intention to assess the effect of current economic conditions on the aircraft industry. Individual buyers are also present in the industry. The aircraft product market is cyclical in nature which depends on the demand from the buyers. In the period of uncertain economy, the demand from the airliners are highly fluctuated which affect the profitability of the manufacturing companies. 4. Competition: The level of competition in the industry is very higher. The competition is concentrated in between Airbus and Boeing. In the present conditions individual firms are not able to balance the risks and exploit benefits from developing activities in a broad range of aerospace business. Thus most of the small scale firms are integrated with large one in order to avoid competition. Procurement of efficient and skilled labour force suitable for the industry is crucial for the profitable operations of the manufacturing companies. Thus in the labour market and technological innovation intense competition is exist in between the rival firms. (The European Aerospace Industry Meeting the Global Challenge. 1997). 1.1.3. Impact of dominating companies in the industry: The commercial aircraft manufacturing industry is characterized by intense rivalry between the major firms of Airbus and Boeing. The competitiveness and commercial success of companies in the industry depends on the integration capabilities of inter-related aerospace disciplines in a broad range. The commercial aerospace products market is a global market in which only large scale manufacturers exist profitably. In the world aerospace market, a majority share of the market for a long time (over 70% in 1994) are held by the European companies. Rapidly increasing competition from Canadian, Brazilian and Asian producers combined with the acquisition of smaller firms by giants has resulted in a significant reduction in European market share. (The European Aerospace Industry Meeting the Global Challenge. 1997). The impact of dominating firms in the industry can be seen in the financial market as well as in the labour market. Large sums of capital are required to be raised by the entrepreneurs through financial markets. In general conditions, firms are not able to procure necessary financial resources relevant for their operations from the market. Thus the financial aid of government in the industry is a major factor that determines the financial competency of the manufactures. In the labour market intense competition is exist between the market leaders. It leads to the increasing of labour costs in the industry. Technological innovation is continuously carried on the industry in order to attain technological competency against rival firms. It results in development of advanced aircraft models supporting lower fuel consumption aircrafts. In the product markets, higher level designing and engineering innovation are required in order to meet the demands of the buyers. 1.2. PESTEL Analysis: The PESTEL analysis is effective for identifying the opportunities and threats associated with the external environment of the aircraft industry. Political environment: In the aircraft industry involvement of government is in higher level. Financial support from the government is a major factor that determines the profitable existence of the manufacturing companies. Government support to Airbus helped them to enter in the global market profitably. As a result of the trade agreement between the US and the European Union, the financial aid that offered by the government to the national firms, is limited to 33 % of development costs. Prohibited production subsidies and limited sales supports to the large aircraft sector as a result of the mutual understanding between the EU and the US affected the Airbus as they are restricting form receiving more than 33% of the production cost. Formerly it was up to 100%. (Hayward and Fraest 2005). Economic Environment: The global economic environment characterised by financial crisis affected the aircraft industry badly by reduced demand and financial tightness. Flexible management of the business is needed in the dynamic and challenging market conditions. Due to the impact of down turn economy and resulted credit crunch, aircraft companies have faced increasing order backlogs. It leads to a number of cancellations of plane orders and t affect the proper functioning of the aircraft industry. (Trelfa 2009). Sociological Environment: Scarcity of experienced, competent and skilled labour force is a serious problem in the aircraft industry. Intense competition exists in between the rival firms in order to acquire skilled labour force. This leads to increasing of the labour cost. Highly competitive market conditions in the industry necessitate flexible reaction to the changing needs. There exist huge potential for the European aerospace industry as it occupies over 370000 direct employees and its many times indirect employees. It creates high quality employment opportunities in the society. It assists in developing critical and pervasive technologies that supports the development of many other related industries. In the European aircraft industry around 700 small scale manufacturing firms are operating with an estimated 70 000 suppliers in all Member States in the Union. Technological environment: Technological innovations are continuously carried on in the aircraft industry. Innovation is mainly focusing on reducing the fuel consumption and lowering the air and noise pollution. Advanced technologies in the field of design and manufacture are prevalent in the industry. . (Pritchard and Macoherson 2005). System integration mode of production is adopted by companies through which the key components and subassemblies are designed and manufactured by external companies. It helped the companies to get advanced aircraft components. The European aerospace industry is occupying diverse production capability suitable for all aerospace applications. The engines and equipment facilities occupied by the aerospace industry is able to compete in financial and technological terms with attractive commercial programmes. The European aerospace industry is intending to strongly defence against the US monopoly in the aerospace business. (The European Aerospace Industry Meeting the Global Challenge. 1997). Environmental factors: The aircraft industry is now better considering the environmental factors such as reduction in pollution and destruction of environment. Technological innovations are carried on in the industry with the intention to reduce the oil consumption rate of aircrafts. In order to attain maximum efficiency, existing aircrafts are refitted with new technology enhanced aircrafts. To achieve sustainable growth in the industry companies are trying on develop eco-friendly emission free aircraft systems. (Global Commercial Aviation Industry Looks to More Electric Aircraft in Quest for Effective and Environment Friendly Aircraft. 2008). Legal environment: Aggressive industry laws are controlling the global commercial aircraft industry. Environmental laws relating to the industry demanded reduction of noise and air pollution by the aircrafts at a greater level. The emergence of the Airbus Boeing duopoly in the industry leads to the tie up of US and EU in terms of the financial support to larger commercial aircrafts. This affects the financial competency of the firms in the industry. 1.3. Porter’s Five Force Analysis: Porters five force analysis is intended to identify the existing conditions in the product market in terms of competition and profitability. 1. The threat of entry: In the aircraft industry the threat of entry is not exist due to the requirements of huge initial capital investment and strong research and development support. The buying decisions in the industry mainly related to long term contract and trust over the producers. It is difficult for a new entry firm to acquire market share by competing with the existing firms. The long term experience and technological competency of the existing firms reduces the threat of entry in the industry. 2. The power of buyers: The power of buyer can be seen more intense in market where there exists large number of producers and the switching cost between suppliers will be lower. In the commercial aircraft industry, the customers are the airliners. The power of buyers in the aircraft industry are not so strong due to high switching costs, limited number of aircraft companies and requirements of large capital expenditure for the purchase of aircraft. Aircraft suppliers should enjoy bargaining power over the airline companies. (The Airline Industry). 3. The power of suppliers: In the aircraft industry, suppliers are a major factor that determines the innovation in the product development of manufacturing firms. Most of the manufacturing firms are entering in to contract with the suppliers for supply of component products. In order to develop advanced aircrafts products, long term contract with the component manufacturers is essential. Thus it can see that suppliers have strong power in the aircraft industry. 4. The threat of substitutes: Threats of substitutes in the aircraft industry in not exist due to the huge cost and technological requirements in the industry. 5. Competitive rivalry: In the global aircraft industry, strong competitive rivalry exists between Airbus and Boeing. The duopoly of these two companies imposes challenges to both of them to acquire and sustain market share by competing each other. 2. Airbus Analysis 2.1. Airbus Company Profile: Airbus is a subsidiary of European Aeronautic Defence and Space Agency (EADS). It is the largest manufacturer of commercial aircrafts in the world, with a capacity range of 100 to 500 seats. By the end of 2005, Airbus had delivered 4130 aircrafts to 225 customer world wide. It had a healthy order look of 2177 aircrafts to be delivered during 2005-2008. Its headquarters is located in Blagnac, Cedex, France. It employed 57000 people as in Dec. 2007. It is a global company with design and manufacturing facilities in France, Germany, U.K and Spain. It has subsidiaries in U.S, China and Japan. (Airbus S.A.S SWOT Analysis. 2008). The company recorded revenue of €25216 million in the financial year 2007, increase of 0.1% over 2005. The company recorded an operating ---- of €881 million in 2007 compared to the €572 million in 2006. Since Airbus is a subsidiary of EADS, it is not releasing its finances. (Airbus S.A.S SWOT Analysis and Company Profile. 2009). In spite of the recession and the economic melt down, Airbus is preparing to meet the future challenges of greener, cleaner and smarter aircrafts with improved efficiency and reduced emersions. The company has plans to trim the man power in the wake of postponement of deliveries at the request of customers due to drop in tourism traffic. To economize production, outsourcing is resorted to on large scale. The Airbus Fly Your Ideas Challenge is a global competition to encourage innovative thinkers to develop ideas that can shape the future of aviation by delivering further reductions in the industry’s impact on the environment. (Fly Your Ideas Airbus). 2.2. Value Chain Analysis: The term “Value Chain” was coined by Michael Porter in 1985 in his famous book – Competitive Advantage. It is useful to separate the business system into a series of value generating activities referred to as value chain. Porter's Generic Value Chain Inbound Logistics > Operations > Outbound Logistics > Marketing & Sales > Service > M A R G I N Firm Infrastructure HR Management Technology Development Procurement   (The Value Chain: Porter’s Generic Value Chain. 2007). The role of these activities is to offer the customer a level of value that exceeds the cost of the activities resulting in a profit margin. Input logistics: Receiving and warehousing of raw materials. Operation: Converts input into finished goods. Outbound Logistics: Warehousing and distribution of finished goods. Marketing and Sales: Identification of customer needs and generation of sales. Service: Support to customers after the products and services are sold to them. To maintain the above supply chain, following support system is required. Infrastructures: Organizational structure, control, company culture. HRM: Employee recruitment, hiring, training and compensation. Technical Development: Technologies to support value creating activities. Procurement: Purchasing materials such as materials, supplier and equipment. One of the Airbus’ key objectives is to continuously improve its supply chain by mastering the supplier approval and the supervision of their manufacturing capabilities. . To achieve that goal, Airbus has developed a strategy based upon the Quality Management System and their special processes by external bodies along with the use of international standards. Special processes are those where the resulting output cannot be verified by subsequent monitoring and measurement. “Airbus is introducing Radio Frequency Identification (RFID) technology to its supply of aircraft spare parts. This follows the successful introduction of the technology to its aircraft tools supply chain four years ago. RFID technology allows the storage and modification of data on a microchip and the exchange of data with PC or EDP systems.” (Airbus Applied RFID Technology to Supply of Aircrafts Spare Parts. 2003). With an increasing amount of airlines activity being outsourced to strategic partners, supply chain management is the key to drive the growth strategy and to ensure that the company continues deliver its customer target. With in last 12 months such activities have increased by 70%. To meet the threat of global recession, outsourcing to developing countries of China and India is a must because such countries are affected minimum due to adequate domestic demand. 2.3. Financial Ratio analysis: Consolidated Income Statements (IFRS) For the years ended 31st December 2007, 2006 and 2005 (in €m) 2007 2006 2005         Revenues 39,123 39,434 34,206 Cost of sales (34,802) (34,722) (27,530) Gross margin 4,321 4,712 6,676 Selling expenses (864) (914) (832) Administrative expenses (1,314) (1,360) (1,351) Research and development expenses (2,608) (2,458) (2,075) Other income 233 297 222 Other expenses (97) (188) (153) Share of profit from associates accounted for under the equity method 210 152 210 Other income from investments 86 37 15 Profit (loss) before finance costs and income taxes (33) 278 2,712 Interest income 502 454 423 Interest expenses (701) (575) (578) Other financial result (538) (123) (22) Total finance costs (737) (244) (177) Income taxes 333 81 (825) Profit (loss) for the period (437) 115 1,710 Attributable to:       Equity holders of the parent (Net income (loss)) (446) 99 1,676 Minority interests 9 16 34         Earnings (losses) per share € € €         Basic (0.56) 0.12 2.11 Diluted (0.55) 0.12 2.09 (Consolidated Financial Statements (IFRS). 2007, p.1). The most important ratio is profitability, which is profit (loss) / sales that has been gradually going down from 2005 (5.00%), to 2006 (0.29), to 2007 (-1.12%). The second important ratio is earnings/share which is also showing a downward trend (2005: 2.11, 2006: 0.12, and 2007: -56). This downward trend of profitability and earnings / share is an indicator of the forth coming economic recession. The revenue has increased from €34,206 million to €39,434 million during 2005 to 2006, an increase of 15.28%. But it decreased from 2006 to 2007 – from €39,434 million to €39,123 million – the decrease of 0.79%. The profit of Airbus has steadily come down from €1710 million in 2005 to €115 million in 2006 and to loss region (€-437 million) in 2007. Why the profit has come down from 1710 million to 115 million during 2005 -06 in spite of increasing sale of 15.28% during the same period need further scrutiny. While the revenue has increased by 15.28%, the cost of sales has grown up by 26.23% results in erosion of profit during 2005 – 06. During 2007 to 08 the growth is assumed to be negative because of the economic melt down. It is a paradox that in spite of a limited monopoly in the market, Airbus is unable to make substantial profit. This is because the airline industry is having severe competition unlike the airline manufacturing industry. 2.4. SWOT Analysis: SWOT Analysis is a tool for auditing an organization and its environment. It is a first stage of planning and helps marketers to focus on key issues. SWOT stands for Strength, Weakness, Opportunities and Threats. Strength and Weakness are internal factors and Opportunities and Threats are external factors. Strength could be 1) Specialist marketing expertise 2) Innovative product Weakness could be 1) Location 2) Pure reputation Opportunities could be 1) Joint ventures / Strategic alliance 2) New international market Threat could be 1) A new competitor 2) Introduction of taxes on the product “In terms of product strategy the strength of the one is the weakness of the other: Boeing found no real answer on the A380 as mega-jumbo, but is highly successful with its B787 in the mid-size, long-range segment, where Airbus is lagging behind with its try to catch up through the A350.” (Mayer 2007). The biggest strength of the Airbus over Boeing is its innovative design. Boeing which enjoyed the status of the market leader up to 2003 was pushed to 2nd place by Airbus with the introduction of A380. Now Airbus is the world leader in civil aircraft manufacturing. “Although it may be difficult for an organisation to acknowledge its weaknesses it is best to handle the bitter reality without procrastination.” (SWOT Analysis: Weakness). The weakness of Airbus is its narrow product range and limit diversification. Boeing has a wide range of aircrafts catering to the military operations and space research. The biggest opportunity of Airbus is the growing demand for long haul commercial aircrafts for which the annual growth will be 5% for the next ten years. The immediate threat for Airbus is the sharp price increase of Aluminium and Titanium which are used for the aircraft body. Hence A350 will be made out of Carbon Fiber Reinforced plastics instead of Aluminium. As indicated in the financial ratio analysis, the cost of sales has been growing at a faster pace than the revenue income growth rate leading to erosion of profit. This is mainly due to the increased cost of raw materials like aluminium and titanium. And hence there is urgent necessity to replace these materials by carbon fiber reinforced plastics. 3. Recommendations for future strategic direction and decisions for Airbus Before the financial crisis of 2008, the aviation industry was poised for a growth of 5% P.A. for passenger and cargo traffic. While the recession will definitely affect the aviation industry the impact will be offset to some degree by lower fuel prices. So the overall impact of the recession is likely to be less severe in the long run. Terrorist attacks on civil aviation are on the increase. Hence airlines have to build additional safety gadgets in the aircrafts to meet high jacking and other type of terrorist attacks. Already many people have lost job in airline industry. This is the best-time to go back to school get upgraded skills and return with greater vigour when the market will boom up again. (Chandler 2009). “With the financial tsunami that happened on Wall Street and Washington the last two to three months, it affected all capital markets. Airplanes are purchased with discretionary funds, on the most part, and that kind of spending is just not taking place today.” – says John Eagleton, North Star President and CEO. (Kelleher 2008). Aircrafts are usually ordered years before they are built and the financing is often not finalized until a few months before delivery, according to aviation executives. This raises doubt rather some aircrafts ordered at the height of a three year order boom that peaked in 2007, will be delivered to the original customers over leave the factories which no buyer. The French Govt. plans to inject 5 billion Euros (6.5 billion pounds) into the banks with the aim of financing airplane purchase. (Willard and Hepher 2009). Airbus has been asked to help door makers Latecoure, one of the sub contractors with the above funds. The recommendations are summarized below. 1) Follow supply chain management vigorously and ensure maximum outsourcing at the optimum price and quality. 2) Postpone production of non-profitable aircrafts such as Single Aisle A320 aircrafts. 3) Utilise the funds provided by the govt. for credit financing the airlines to purchase the ordered aircrafts. 4) The utilize company’s cash resources to support sub contractors like Latecoure to tide over the recession crisis. 5) Rehabilitation of the retrenched employees and up gradation of their skills during the lean period. 6) Establish more manufacturing units in developing countries like India and China. Bibliography Airbus Applies RFID Technology to Supply of Aircrafts Spare Parts. (2003). [online]. Press Center: Press Releases. Last accessed 10 February 2009 at: http://www.airbus.com/en/presscentre/pressreleases/pressreleases_items/09_18_03_RFID_technology.html Aircraft Manufacturing Industry. (2008). [online]. CheatHouse.com. 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