Airbus A3XX:Developing the World’s LargestCommercial Jet

Group 1

111 Rakshit Jhunjunwala

115 Ankitesh Mathur

211 Manu Shrivastava

301 Balagopal Padmakumar

402 Rishi Bajaj

Airline Industry – An Overview

Highly competitive

Capital and Labor intensive

Seasonal industry – increased revenues in 2nd and 3rd quarters

Sensitive – Fuel Prices, Price of airfares and customer demand

Industry Trends

YTD (2004 over 2000)

RPK Growth

ASK Growth

PLF FTK Growth

ATK Growth

Africa 17.00% 13.60% 1.9 11.50% 4.00%

Asia Pacific 11.70% 14.90% -2.0 25.30% 21.80%

Europe 1.80% -0.20% 2.6 6.90% 3.00%

Middle East 48.40% 43.20% 2.6 53.50% 51.20%

North America 4.10% -0.50% 3.4 2.00% 3,20%

South America 11.70% 7.60% 2.7 13.90% 18.80%

Industry 8.10% 7.20% 0.6 15.90% 11.80%

• Growth in the industry

Where RPK : Revenue per Passenger Kilometer ASK : Available Seat Kilometers PLF : Passenger Load Factor FTK : Freight Ton Kilometer ATK : Available Ton KilometerSource : www.iata.org

Dynamics of Airline IndustryCompetitiveness of an Airline depends on two factors:

1. Revenue - ability of a firm to fill the seats in an airplaneBreak Even Load Factor (BLF) which measures the percentage of capacity needed on a plane to cover its costs. BLF for profitable airlines has generally fluctuated between 60% and 65%.

2. Costs – mostly uncontrollable• Labour – Competitive Wage Structure

• Fuel

• Maintenance

Costs are also attributed to flight time, flight distance, landing fees, en-route charges, handling, administrative costs and opportunity costs of not flying.

Dominant Business Models

Currently 2 dominant business models in the airline industry

Hub and Spoke Model –

used by traditional / dominant airlines who concentrate their long haul and international flights at a hub while branching out short haul services to other cities.

A long haul flight out of the hub typically waits for passengers from connecting flights to board. Since the volume of passengers is significantly higher, there is a need for Very Large Aircrafts.

Point to Point Model –

used by regional or budget airlines who deploy their aircrafts on a specific route between 2 airports

the airplane typically does not need to wait for connecting flights; which results in a faster turnaround time as compared to the 1st model

Washington DC

London

Atlanta

The Boeing Company

Founded in 1916.

Forefront of Civil Aviation for almost a century

From B17s and B29s during World War II,

B52 during Cold War to Boeing787.

Is into sales of:- Commercial Aircrafts Military Aircrafts Missiles Space System Controls

Revenues:-US$ 64.306 billion (2010)

Commercial Aircraft -2/3 Military Aircraft ,missiles, space systems- 1/3

Boeing unique importance for US

It Supplies:-

F-15 fighter aircraft to Air Force One Space Shuttle to support its political strength

Largest contributor to the US BOP in terms of exports

Boeing fleet consists of 14 models

Flagship of Boeing fleet :-747-400, held 420 passengers in the standard three-class configuration.

B747 bought for its range and not its capacity

AIRBUS INDUSTRIES Founded in 1970 by consortium of principle

agencies:

• DASA—Germany• BAE Systems—England• Aerospatiale Matra –France• CASA—Spain

Later become simplified joint-stock company in 2001, owned by EADS (80%) and BAE Systems (20%). 

Employs around 57,000 people

Revenue: €27.45 billion (FY 2008) 

Known for producing and marketing:-

First commercially viable ’fly-by-wire’ airliner, the Airbus A320, and

World's largest airliner, the A380.

A3XX is estimated to cost $13 billion to launch

Uncertainty in demand => more risky

Highly capital intensive project

Chances of failure could lead to diverse effects on the entire

company (Failure of prominent companies while

attempting to launch new planes)

Ultimate success : ability to break-even and future demands

Investment Total

R&D $11 billion

Capital Expenditure $1 billion

Working Capital $1 billion

Why is Airbus interested in building the A3XX?

Enter new segment – VLA

An optimistic outlook at receiving orders for VLA aircraft owing to its capture of more than half of the VLA market by terms of orders (in 1999)

Market research – potential and increased demand

Growing economies in Asia like China

Increasing point to point route frequency is not a solution as it leads to congestion

Cont.

Large range of travel without any stopovers - key point in purchase decision making

Better operating economy – 12 % more to operate as compared to 747s but has 35% more space

More customer satisfaction, comfort

Higher number of premium flyers

Cont.

4 engines per aircraft as compared to the usual 2 engines increase the safety factor

Would be the King of the air and any premium airline would feel the need to have it

More sources of revenue due to increased space

Commercial aviation sector leader

What are its objectives

Ascertain the need

Secure as many orders

Build a new product that could match the requirements of the industry over the next 20 years

Meet the standards and norms for building very large aircrafts according to the U.S Federal Aviation Administration (FAA)

Cont.

Secure cheap source of financing with risk mitigation of the project

Create a product that would be the highest level of luxury and thus would be imperative for any premium airline brand to purchase to drive up revenues from its high yield business class flyers

Increase sales of its product and capture majority of the commercial airline industry to become a leading player (ahead of the current leader Boeing)

Economies of Large Projects

ELEMENTS

Land and site development

Buildings and civil works

Plant and machinery

Know how and engineering

Expenses on foreign technicians and trainings

Miscellaneous fixed assets

Pre-operative expenses

Contingencies

Preliminary and capital issue related expenses

margin money

Benefits of large scale projects

Setting cost:Project cost of new capacity =

(Project cost of old capacity) * (New

capacity/Old capacity)n

Where “n” ranges from .5 to .9 (usually its around .7)

Example

Say old capacity is 100 TPD and cost is 1000 crore. Now the new capacity is 200 now the cost calculation.

= 1000 * (200/100).7

= 1624.5 Crore

Thus instead of expected proportional cost of 2000 crore we are saving 376 crore.

Higher Debt to equity ratio

D/E ratio

Less than 500 crore

1.5:1

More than 10000 crore

4:1

Benefits

Projects finance–

SPV benefits

Economies of scale.

Benefits given by Governm

ent

ADVANTAGES

Cheap credit.

Bargaining power for interest rates.

Efficient use of capital equipments.

Bargaining power in buying and selling.

Benefits of R&D.

Utilization of byproducts.

Lower advertisement cost per unit.

DISADVANTAGES

Restrictions by lenders.

Time and cost over run.

Large payback period

possible changes in policy, tax rates, technology etc.

CONTD...

Lenders

Advantages

Less borrowers-

easy to manage

Easy monitori

ng

Lenders can afford to

spend more in reports etc.

Disadvantages

High riskProject

financing – limited

recourse.

Airbus economics In general for large projects

Cost 13 Bn. Usually very high over 1 Billion

Cost overrun 2 Bn. Cost overrun can be a problem, in most of the cases it takes place, because of many issues ranging from political issues to design problem.

Operating margins 15%-20% Are good but also the interest rates are high to adjust.

Effective tax rate 38% Depends upon the country.

Inflation 2% Depends upon the country and other factors.

Production capacity 48 planes per year

High

Limited Optionality

On the decision making process, Airbus has limited optionality with respect to the fact that it does not have a product in the Very Large Aircraft (VLA) category that is therefore dominated by rival Boeing and its 747 series of aircraft.

If it fails to take the decision of going ahead, there is no other option for the aircraft operators but to purchase VLAs from Boeing.

Cont.

In Finance, Optionality: The value of additional optional investment opportunities available only after having made an initial investment.

The investment decision itself involves considerable optionality (to ramp up, abandon, change, etc.)

It is important to recognize that there is limited optionality here.

For example, the value resulting from an ability to stage investment is less in this case because one does not learn much about demand during the construction process—most of the demand will not materialize until several years hence.

Cont.

A decision to wait before committing to industrial launch has limited benefit for the same reason, as the demand cannot be ascertained in a short period of time.

It will be a trade off if they decide to hold on until sufficient demand rises at the risk of not being able to fulfill the orders in a timely manner.

Finally, the highly specialized nature of the assets and development research implies that abandonment has little value.

The investments put into the development and construction of the final product cannot fetch a sizeable percentage of the initial value.

Thank you