Airbus A3xx: Developing the World's Largest Commercial Jet
Harvard Business School Case No.: 201-028; Teaching Note: 5-201-040
Posted: 30 Jan 2001
Date Written: November 2000
SUBJECT AREAS: project finance, product development, valuation, demand analysis, capital budgeting, competitive strategy CASE SETTING: July 2000, commercial aviation, $13 billion investment
In July 2000, Airbus Industrie's Supervisory Board was on the verge of approving a $13 billion investment to develop the A3XX, a new super jumbo jet that would seat from 550 to 1000 passengers and have a list price of $216 million. Having secured firm orders for 22 jets, the Board must decide if there is sufficient long-term demand to justify the investment.
At the time, Airbus was predicting that the market for very large aircraft (VLA) would exceed 1500 aircraft over the next 20 years and would generate sales in excess of $350 billion. According to Airbus, it needed to sell 250 aircraft to break even on an un-discounted cash flow basis, and could sell as many as 750 aircraft over the next 20 years. Boeing, however, was predicting that the VLA market would be less than 400 aircraft over the next 20 years. The difference stems from fundamentally different perspectives on the industry's likely evolution: Airbus is predicting an increase in "hub to hub" travel and the need for larger planes to service key hubs. In contrast, Boeing is predicting an increase in "fragmentation" and the expansion of point-to-point service. The case explores the two sets of forecasts, and asks students whether they would proceed with the launch given the size of the investment and the uncertainty in long-term demand. It also analyzes the competitive interaction between Airbus and Boeing in the battle over the VLA market.
This case presents one of the most interesting "high stakes" gambles of the current era. From a finance perspective, it illustrates the basic economics of large projects. They involve small, relatively uncertain future cash flows to pay back large, up-front costs. More importantly, unlike venture capital, most of the development cost must be spent prior to selling a single product. In other words, it cannot be staged nor can it be salvaged with much value.
In terms of analysis, students must estimate the breakeven number of planes and decide how likely it is that Airbus will sell that many planes. This analysis shows how difficult it is to estimate even top-line demand for a product with a useful life of up to 50 years. The answer, of course, depends on market growth rates and assumptions about Boeing's likely response. Here, the case merges strategy and finance by exploring the competitive dynamics between a monopolist and a potential entrant in a market with entry costs in excess of $10 billion. An important yet unknown determinant of the outcome will be the role of government intervention-governments play a role on both sides as customers, investors, and interested parties. For this reason, the case is appropriate for finance, strategy, and general management courses.
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