MIAMI — According to Boeing Commercial Airplanes Chief Executive Ray Conner, the company is embarking on a new cost-cutting program due to competitive pressure. The planned cost cuts, announced during a webcast to all employees on Wednesday morning, will include layoffs and more minute pruning measures such as no longer providing water bottles to employees. The planned job cuts would be a mixture of voluntary retirements from the International Association of Machinists and Aerospace Workers (IAM) and job cuts of employees across the organization, starting with management.
Airbus pressures Boeing with the A330neo, weak Euro
Part of what is driving Boeing to reduce headcount, particularly on the 787 program, is the increased pricing pressure from rival European manufacturer Airbus. The value of the Euro has declined by nearly 20% since the end of 2014, giving Airbus an advantage in exporting its aircraft around the world. Since Airbus accrues most of its expenses with a weakened Euro, and prices and receives payments for its aircraft in U.S. dollars, Airbus is able to lower the dollar list price of its aircraft sharply, thus exerting pressure on Boeing.
This problem manifests most clearly with the 787, where Airbus’ rival A330neo was developed for just $2 billion (versus 787’s $28.5 billion and counting) and features a fully paid off production set up. Thanks to these elements and the weak Euro, Airbus is selling the A330neo for as low as $90 million while Boeing can’t go below $120 or $130 million on the 787-9, conferring a huge advantage on the Airbus widebody.
Despite the cash operating cost advantages conferred by the 787, the A330neo is highly competitive on direct operating cost thanks to pricing. This puts Boeing in a position where it needs to take extraordinary steps beyond the existing planned reduction of 787 costs (which is more about achieving scale on 787 production).
The MoM might have to be a MAX
One spillover effect of the price pressure could be on how Boeing plans for a new Middle-of-Market (MoM) airplane to compete with the Airbus A321neo. Thanks to the A321neo’s naked superiority over the Boeing 737 MAX 9, Boeing needs a new MoM option as soon as possible to regain parity in the narrowbody space.
Most of the MoM indications to date (and our preference) is to pursue a clean-sheet design with significant innovation. The problem is that such a strategy would be very expensive, incurring development costs of $15-20 billion. Thanks to financial pressure, Boeing might instead opt for yet another 737 MAX variation, which would comprise a new wing for a stretched variant of the 737 MAX 9 and new engines, with an expected launch date in the mid 2020s. Such an option might be combated by Airbus with an accompanying A322neo, but would limit development expenditures.
SEC probe into 747 and 787 accounting more bark than bite
Thursday morning brought more bad news for Boeing in the form of a newly launched probe from the Securities and Exchange Commission (SEC) into the company’s accounting for the 787 and 747-8 programs. Boeing’s deferred accounting system, which spread the $28.5 billion in 787 development costs across an accounting block of 1,200 airplanes (the Dreamliner has won 1,143 orders to date) and spread 747-8 costs across an accounting block with 35 aircraft yet to be sold allowed the company to record profits in the late 2000s and early 2010s despite the huge development expenses incurred on those programs.
Setting aside the specifics of Boeing’s figures for a second, it is important to note that deferred accounting is a very valid expense (and can be thought of as the inverse of depreciation of assets). The startup expenses incurred by Boeing in researching, developing, and launching production of the 787 will pay off for the entire lifetime of the 787 program, and thus it is totally valid to account for those expenses across some number of Dreamliner deliveries. The same applies for the 747-8 program.
Where there might be a quibble is with the specific figures chosen by Boeing, which some might argue are unrealistic given that there are no 747-8 orders on the horizon in the foreseeable future and that the 787 still hasn’t broken even on a cash basis (given +/- 770 787s in the backlog, Boeing needs to make a profit of more than $30 million on each Dreamliner just to recoup these costs). But nothing Boeing did was improper, it was just acting on the best information available to it at the time (who would have predicted that the air cargo market would fall off a cliff back in 2007?).
Even if Boeing is forced to revise those accounting blocks by the SEC, at worst, the company will be forced to take a loss on paper (remember that the cash has already been spent) – there is no real justification here for penalties. Still, the SEC probe is yet another unwelcome distraction from the very real internal and external challenges faced by Boeing in today’s aerospace marketplace.