Boeing called the improved models the 737NG, for “Next Generation.” In many, if not most, of the ways that affect an aircraft’s operating costs, this improved 737 was a new airplane, one that has done very well in the market, at times as well as the A320, and at moments better. (Actually, the 737 has outsold all other passenger jet aircraft by a wide margin. As of the start of 2006, it had logged more than 6,000 orders, whereas the second-place aircraft—Boeing’s 727—booked 1,831 orders in its day. Still, the 737 is a 1960s design and has gradually conveyed a sense of being old wine in new bottles.)
Airbus had dodged a bullet. Given Boeing’s dominance at the time in every segment of the airline market, a newly minted 737 could have all but buried the A320, as Airbus people like to point out. Instead, the two companies treated the airline market to the sort of competition it craves. The airlines have since grown accustomed to the contesting claims of Airbus and Boeing about the operating costs of the A320 and the 737. The validity of these claims lies in the eye of the beholder. They can be used to prove whatever case the parties want to make to the airlines. One airplane may be portrayed as having lower operating costs at six-hundred-mile stage lengths, whereas the other may appear to do better at fifteen-hundred-mile segments in the same airline’s route structure.
Deciding whether to build or not to build new aircraft is always confusing, rarely more so than in the early 1990s. At that time Airbus still lay deep in Boeing’s shadow. McDonnell Douglas was still in play. the U.S. airline industry was unavailingly trying to cope with the worst financial crisis of the post-deregulation era.
Fifteen or so years later, John Leahy would say, “This industry operates in ten-year cycles. It found the bottom in the early 1980s. It reached a peak in the later 1980s, and it fell off a cliff in the early 1990s. It was reacting to the cyclical effects in the world economy.”36
Dean Thornton took a simpler view: “It’s all traceable to a time when we made and they bought too many airplanes,” he said.37
THE HIGH-STAKES affair between Boeing and Airbus has had no more interested audience than the big three engine makers: GE, Pratt & Whitney, and Rolls-Royce. The struggle for the engine business matches the intensity of the Boeing-Airbus jousting. And like Boeing and Airbus, the big engine makers have been trading places. A short history of their ups and downs over the past thirty-five or so years would go like this:
First, Pratt & Whitney, a division of United Technologies, began taking for granted its tight grip on the airline engine business. In 1970, Pratt had a 90 percent market share of this trade and a corporate ego to match. Like Boeing, Pratt made reliable, top-of-the-line products; and as with Boeing, a mix of arrogance and a series of misjudgments by management allowed the competition to close the gap and then forge far ahead. In 1970, Pratt had one president and four vice presidents. By the late 1980s, it had five presidents and fifty-seven vice presidents, and the company’s market share had fallen to roughly 15 percent.
Back in the 1970s and 1980s, when the first wide-bodied aircraft were developed, Rolls-Royce ran a poor third to Pratt and GE. Gradually, Rolls-Royce closed the gap and, in the mid-1990s, could match or even outperform the other two in various big markets. Good products, hardheaded management, and aggressive price discounts had to be there, but Rolls-Royce also got a strong assist from HMG (Her Majesty’s Government) in the form of launch aid that between 1998 and 2003 amounted to £450 million.*1
Its competitors—GE and Pratt—contend that this assistance enables Rolls to spend far less of its own funds on research and development and, in effect, to “buy” market share.38 Probably more important, however, is the golden share in Rolls-Royce held by HMG, in theory to prevent some foreign company from buying this crown jewel. Actually, the golden share serves to assure the financial community that Rolls-Royce is a reasonably secure investment and protected against financial failure. And then, Prime Minister Tony Blair provides another strong assist. He was seen by GE and Pratt as a supersalesman for Rolls-Royce engines. Blair attached as much—and probably even more—importance to the commercial aircraft industry as Bill Clinton did.
Pratt has seen itself becoming less able to compete, thanks in part to Rolls-Royce’s privileged relationship with its government and, at least as important, to what could be called GE’s larger toolbox. “We don’t have to go to the U.S. embassy somewhere to arrange a meeting with the top people there with one of our senior guys,” says a GE executive. “Our top guy in that country can arrange those meetings. Also, we have a banking operation, and that can do a lot for a country.”39 He could also have mentioned GECAS, the GE leasing company and one of the world’s two largest buyers of passenger airplanes.
And he could have noted some very large advantages that GE brought to the engine competition: they all involved the CFM56, which is not just the company’s most successful engine but the most successful commercial engine of the jet era. First, although the CFM56 involves a fifty-fifty partnership, the French company, Snecma, contributed most of the research and development funds for it. Second, under the terms of the GE-Snecma deal, the revenue stream from the engine is divided fifty-fifty, but the costs are split in a way that favors GE. Third, GE was able to contribute the high-technology, high-value part of the engine—the “hot section”—which originally powered the B-1 bomber. (This is an example of the flow of technology between the U.S. defense and commercial sectors that Airbus grumbles about.)
Like Boeing and Airbus, the engine makers must take seat-of-the-pants decisions on where the airline market may be headed within the life of any new product. Between the 1970s and the early 1990s, Pratt badly misread the tea leaves. In its procession of mistakes, Pratt’s biggest was betting on the wrong Boeing airplane. The company saw little future for Boeing’s improved 737, even though it supplied an engine for the early version. Pratt tried instead to sell engines to airlines that had ordered the 757, an airplane the market never warmed to and one for which for which Pratt lacked an engine of the right size.
The 737NG, although not the best of breed, did, as noted, become a vastly successful airplane. Pratt had the right engine for it. So did GE—the CFM56. But with Pratt not stepping up, Boeing granted GE exclusivity on the 737NG; the airplane with that engine would be sold as a package. GE and Snecma have since delivered more than fifteen thousand CFM56 engines, of which roughly two-thirds were for 737’s.
This was an unusual move on all sides. Engines are normally sold separately, and there is normally a choice of two, sometimes three engines. As with the airframes, the carriers want to be able to play the suppliers off against one another. The 737’s rival, the A320, is sold with two engines: the CFM56 and the V2500, the latter of which is widely judged a somewhat better engine because it has more advanced technology. The V2500 is referred to as the “company engine,” because an alliance of seven companies, of which Pratt and Rolls-Royce are the main members, sponsored it. That engine and its success have kept Pratt’s commercial division alive. (Pratt currently relies mainly on its large and prosperous military business.)
Each of the three engine companies has made serious mistakes, although none perhaps as serious as Pratt’s rejection of the 737. GE, for example, refused a tempting offer from Jean Pierson in 1997 to put an engine on the extended-range version of Airbus’s A340. The decision was made by Jack Welch, GE’s supreme boss, who insisted on having no competitors for that airplane’s engines. Pierson recalls him saying, “I put money on the table, and I want exclusivity. But I said, ‘I will never put myself in yours or anyone’s hands.’”40 (In fact, Pierson later granted Rolls-Royce exclusivity on that airplane.)
“Airbus was very angry,” says one GE executive. He added that James McNerney, Boeing’s new chief, had just taken over GE’s engine group. “Jim’s first big job with us,” he said, “was to rebuild our relations with Airbus. And he did.”41
It is a media event when a major airline orders new airplanes and the engines for them. The size of the purchases assures pr
ominent coverage. But the exact details of a given transaction—the contractual arrangements that can mean the difference between winning or losing the deal—are normally treated by the seller and the buyer as proprietary information. The seller usually tries to conceal or at least obscure them from other potential customers, the more so since many airlines attempt to obtain, often successfully, what the industry calls “most favored nations” clauses. These have the same meaning—what is available to one is available to others—in the commercial aircraft business as in trading arrangements between nations.42
The engine side is a confusing business—as tricky as selling the airframes but a little less risky and less straightforward. What an airline pays for an engine doesn’t affect the price it may be paying to Boeing or Airbus for a new airplane, even though engines are 25 to 30 percent of the total value. The process begins with the purchase by Boeing or Airbus of an engine that it has selected for one of its airplanes. That engine is then sold to an airline. But the engine company will already have steered matters in its direction by offering discounts directly to the airline, along with other incentives.
Engine makers can be even more creative than the airframe manufacturers in finding ways for financially strapped airlines to purchase their wares. “We don’t sell engines, we make concessions,” says a key figure at GE. “We say, ‘Here is the price, and if you pick us we’ll pay some of your development costs.’ We might also say, ‘Here is what we can do for you—provide you with ten years of spare parts and some extra engines.’”43
Engines are normally the chief source of tension between the airlines and their suppliers. They are expensive, complex, and vulnerable. The frequency-of-repair rate on engines is much higher than on other parts; they require a far greater degree of after-sales service. Engines burn at very high temperatures and consume two or three times their value in spare parts over their lifetime. Engine suppliers earn much more money from sales of spare parts than the airframe companies do.44 That allows the engine makers to offer huge discounts to their airline customers. The airframe, by comparison, generates less than 10 percent of its value in spare parts.
Some engine company people describe what they do as selling “at a measured loss.” They can, they know, more than make up for their loss through maintenance and sales of spare parts. “It’s a razor/razor-blade industry,” they like to say. “We give the razors away and make money on the blades.” More than half of what an airline spends on equipment goes to the engine suppliers.
The three companies operate in much the same way, although for a time—during the mid-1980s and early 1990s—Pratt did so more aggressively than its competitors. In the early 1980s, engine discounts averaged about 30 percent of selling price. But by 1991, with Pratt allegedly showing the way, the companies were giving up to 80 percent, and average discounts were hovering at about 50 percent. In effect, all three players were losing money—certainly not making any—on the engines they were sending out the door, but recovering it on sales of spare parts.
By 1995, Rolls-Royce apparently decided to hike its market share sharply by becoming at least as aggressive as the competition and, indeed, even more so. In 1997, for example, Rolls offered a remarkably high discount on engines purchased by Singapore Airlines (SIA) for the first extended-range version of Boeing’s 777. Over the years, SIA bought eighty-three of them, all with Rolls-Royce engines, although Pratt had been the airline’s regular engine supplier. Pratt was told by SIA that Rolls had “offered a deal we could not refuse,” according to a former Pratt executive who was closely involved. “It had to be close to a hundred percent,” he says, “because we lost and we were north of eighty-five percent.”45
More recently, GE had a similar experience. All Nippon Airways (ANA), the launch customer for Boeing’s 787, was a reliable GE customer and expected to remain one. Instead, ANA surprised all sides—shocked GE—by selecting a Rolls engine for its 787’s. No one doubts that this transaction also involved an offer that couldn’t be refused. According to a GE executive, “ANA came to us and said, ‘This is what Rolls is offering. What can you do?’ We walked away.”46
Rolls had begun selling an approach called “total care,” offering to include within the engine price several years of free maintenance. GE and Pratt proposed similar deals. However, Rolls, unlike its competitors, was also capitalizing research and development costs instead of expensing them. The costs would not show up on the profit-and-loss statement, only on the balance sheet.
In recent years, some airlines started buying new equipment not because they may have needed it but strictly in order to receive the huge checks reflecting the discounts on offer. More often than not, these airlines use the money to pay operating expenses.
AN AIRLINE’S CONTRACT with Boeing or Airbus guarantees certain performance characteristics of the engines, such as the amount of fuel they consume. The airline and the engine supplier sign a separate agreement that covers such matters as the cost of spare parts and the period of time, typically three thousand hours, during which the engines must perform reliably.
“You are pushing the envelope with each engine,” says a very experienced Pratt executive. “You never know whether it will work until you begin testing—whether, for example, the EPA [Environmental Protection Agency] will frown on the emissions. There are two key emissions. One is nitrous oxide, known as NOX. The other is CO2. But as you push one of them down in order to comply with standards, you push the other one up. It’s very tough to get around that trade-off. There is also the problem of noise level going up as you keep emissions down. You have to operate in accordance with the internationally agreed standards on noise.”47
The interplay of the engine and airframe makers lacks rules and predictability; it can be chaotic. Boeing or Airbus will present a new airplane that is intended to carry, say, three hundred passengers for seven thousand miles. The company will guarantee a fuel consumption—fuel burn, as it’s known—of no more than X. An engine company will see no difficulty in meeting the thrust requirement, but meeting a fuel-burn guaranty is always tough. Boeing and Airbus normally offer the airframe and engine guaranties to airlines as a single package, along with penalties to be imposed if the guaranties are not fulfilled.
If an engine falls short of its guaranteed specifications, the airframe maker—Boeing or Airbus—will inform the airline that its new plane will be able to go the full seven-thousand-mile distance but will be burning more than the agreed-upon amount of fuel. What will have happened is that the airplane just got heavier, as new planes usually do. And the additional weight dictates more engine thrust, hence a bigger fuel burn.
The ensuing penalties to be paid to airlines cost both engine and airframe makers, heavily in most cases. To avoid being burned with penalties, engine makers tend to hedge by adding margins to the specifications. But if the airframe doesn’t stray from its specifications, the engine designed to carry 300 people 7,000 miles will be able to do that much and a bit more. Actually, the designers determined long ago that their engines always need another 10–15 percent more thrust. In short, engines are designed for aircraft growth. One GE executive says, “If you are dealing with a one-million-pound airplane and the airframe guys miss the specified weight by one percent, the engine will need a lot more thrust to carry that weight.”48
THIS SYSTEM PROMOTES continuing strife between the airline and engine companies, who tend to blame each other when problems develop. Occasionally, the strife triangulates to include the airframe maker, as it did in July 1989, when a United Airlines DC-10 lost its center engine about an hour after taking off from Denver. The failure was caused by a crack in the front fan disc, which holds the fan blades. The aircraft’s hydraulic lines ruptured, and the plane lost hydraulic power; it was not controllable. It crashed near Sioux City, Iowa. Some inspired maneuvering by the flight crew allowed a crash landing, causing 111 deaths. However, 172 of the passengers, although injured, survived, and 12 were uninjured.
Three months l
ater, an engine part found in a field showed that the failure was caused by a crack in the disc’s titanium. Investigators then learned that as part of United’s inspection procedure the crack had been coated with a fluorescent dye. A fluorescent light is used to scan such parts and look for flaws that ought to show up. United had followed this procedure four months earlier, but had not detected the crack.
GE was sued for the disc failure and United for failing to discover the crack. McDonnell Douglas was sued for “faulty” placement of its hydraulic lines. The cases were all settled with “contributions” from each of the three parties—United, GE, and McDonnell Douglas. The level of acrimony ran very high. United has not bought an engine from GE since the event.
Although passenger aircraft and their engines are constantly improving and becoming more reliable, the companies still find plenty to quarrel about. Most often it is a carrier complaining that the costs of flying an airplane are unreasonably high. Its manufacturer then censures the engine for having too little thrust or consuming too much fuel. But the engine supplier almost certainly will blame the aircraft’s designers for having allowed too much drag. Engine makers see the aircraft as just a great quantity of aluminum wrapped around the vehicle’s only technological marvel, its propulsion system.49 (And there is something to that, although a little less than contended.) Over the years, these disputes, although routine, have become steadily more hard-edged, as the importance of restricting fuel consumption drives the entire industry.
Boeing Versus Airbus Page 13