Emerging markets and greater airline profits have caused demand to exceed supply at an historical rate.
By: Eduard Batash
In mid-2016, Qatar Airways canceled 4 Airbus aircraft orders that were months overdue. In regards to this cancellation, the airline’s CEO, Akbar Al Baker, commented that “It [overdue production] is making a huge impact on my bottom line. We are quite frankly, screaming.” Mr. Baker’s comments underscore airline “bottom lines’,” or revenues’, heightening dependence on ordered aircraft production timetables. In the last 10-15 years, additional wealth creation in the Asia-Pacific and in Mr. Al Baker’s Middle East has spiked global travel demand which consequently, has increased global airline revenues four fold. To accommodate these growths, Qatar Airways and other airlines requested numerous plane orders from the two largest global commercial aircraft manufacturers, European-based Airbus, and its competitor, American-based Boeing, within the said time period. However, both have struggled to deliver the due aircraft on schedule, and have amassed unprecedented backlog numbers. A 2016 Deloitte report on the commercial aviation industry’s current state suggests that persistent delivery delays and inefficiencies due to bloated order calls and large backlogs may enable future market entrants to compete with Airbus and Boeing and break the aircraft market duopoly.
More Passengers and More Planes
According to the Deloitte report, the global airline industry’s cumulative global operating incomes have increased by approximately $300 billion, or by 12%, since 2002. Despite airfares 46% drop on a CPI-adjusted level since 1990, additional sources of revenue such as checked bags, food and premium seating have bolstered the 12% cumulative revenue growth. Moreover, passenger enplanements (passenger boardings) experienced about a 30% increase between 2002-2015, while load factors, measurements of aircraft capacity utilization, were at all-time highs. To account for, and help facilitate this growth, global airlines added, on average, between 2.5% and 4.5% of new aircraft to existing fleets each year between 2005 and 2014. In 2015 alone, aircraft retirements plus new aircraft additions equated to a 5.7% increase in global seat capacity from 2014.
Additionally, aircraft manufacturers’ backlogs, any aircraft orders that are either behind production schedules or are have overdue delivery dates, by region consisted of: 4,041 Asian-Pacific obligations, the highest number of backlogs and 1,112 Middle East obligations, the 4th highest number of backlogs behind North American and European backlogs, but ahead of Latin American and Caribbean backlogs. The large backlog numbers from Asia and the Middle East present these regions’ strong presence in not only demanding new aircraft, but also in aggregate wealth. Higher airline revenues due to rising travel demand have increased Boeing’s and Airbus’ profits in the past 15 years, but have also contributed to potentially overwhelming backlog numbers.
Backlogs Examined: What they now entail
Once commercial airlines, or defense ministries, place order calls, Boeing and Airbus do not begin assembling those ordered aircraft right away. Although popular aircrafts, such as the single aisle Boeing 737 series and Airbus 320 series are typical 2-year productions, both companies keep many orders in backlog, and have long-term programs that require minimum numbers of built aircraft before shipment and sale. The firms receive the majority of revenues upon shipment and can then pay for built-up inventory costs.
However, commercial aircraft backlogs have increased dramatically since 2004. According to Deloitte, total commercial backlogs in 2004 amounted to 2,569 aircraft from 2 market participants, Boeing and Airbus. Boeing accounted for 56.9% of the total backlog and Airbus, the remainder. The normal level of backlog production, which firms determine based on the number of aircraft finished per month, amounted to between 2 and 5 years from 2004 to 2009. By the end of 2015, total commercial backlogs increased to 13,467 aircrafts among all 5 manufacturers. Boeing and Airbus constituted 93% of total unit backlogs- with Boeing accounting for 5,758 aircrafts in backlog, or 42.8 % of total market backlogs, while Airbus accounted 6,774 aircrafts in backlog, or 50.3% of total market backlogs. The normal level of backlog production increased to between 6 and 10 years.
Two periods of unusual high net order demand spikes drove this unprecedented backlog increase. In reference to the earlier Boeing v. Airbus comparison chart, net order calls for both firms spiked around 2002, decreased substantially in 2008 and 2009 due to the global financial crisis, spiked up again in 2011 and have decreased and maintained steady levels from 2016 until now. This data do not entail that Boeing and Airbus have production inefficiencies, but rather highlight the surging growth in global air travel demand, emerging market wealth creation and the aerospace industry’s boom/bust order call cycles. Moreover, they suggest that for the industry to absorb future order calls, it may require other significant market participants.
What Current Levels of Aircraft Backlogs Mean for Future Travel Supply and Demand:
The commercial aircraft manufacturing industry operates as a duopoly; That is, 2 firms (Boeing and Airbus which constitute approximately 93% of market share) supply the good (aircraft) and a small number of buyers (airlines and governments-owned airlines) demand said good. The narrow-body, or single-aisle jet is typically the most popular product relative to total orders and deliveries for both firms. Furthermore, longstanding contracts between airlines and both firms and their high-quality products have historically restricted new and rising firm market entry.
Deloitte estimates that only 6% of the world’s total population flew on airplanes in 2015. Given this untapped future demand and present backlog strain, immediate market entry opportunities may arise for firms that are not subject to traditional entry barriers. For example, in November 2015, COMAC, a Chinese-state-sponsored commercial aircraft manufacturer unveiled its first passenger jetliner, the C919. It can seat 168 passengers and is meant to compete with the single-aisle B-737s and A-320s. Because COMAC has large capital sponsorship and contacts through the Chinese government, it has the ability to establish contracts with state-sponsored airlines (specifically in the Asia-Pacific and Middle East) and directly compete with Boeing and Airbus. When asked whether he would buy aircraft from COMAC, Mr. Al Baker responded, “no hesitation at all in buying Chinese airplanes” and that “ I think it would be good for this monopoly to be broken.” However, he also added that in terms of reputation, COMAC aircraft would have to be made in the standard that he wanted.
Deloitte also forecasts that global aircraft manufacturers will need produce an additional 34,000 aircraft from 2017-2034, or an estimated 684 more aircraft produced per year by 2034 to supply the increase in travel demand. Another net order call surge may be on the horizon because airlines may desire more fuel efficient planes to combat higher oil prices. These forecasts again suggest that in addition to handling (or losing) high backlogs, Boeing and Airbus may over-expand supply chains and labor forces. This overexertion may lead to idle capacity in the future when the travel boom dies down.
Perhaps the movement towards a monopolistic competitive market with more aircraft manufacturers, such as Russian Irkut’s MC-21, Canadian Bombardier’s C-Series, Japan Mitsubishi’s MRJ and Brazil Embraer’s E-Jet E2, will lead to increased efficiencies and provide the airline sector the resources it needs to fly people to their destinations.
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