Airbus A3XX: Developing the World’s Largest Commercial Jet (A) (9-201-028 HBR) Contents: Introduction to the Case, Industry • Why is Airbus interested in building the A3XX? • What are the objectives? • What are the basic economies of large projects? • Limited optionality Done by- 111 Rakshit Jhunjunwala 115 Ankitesh Mathur 211 Manu Shrivastava 301 Balagopal Padmakumar 402 Rishi Bajaj

1. Airbus A3XX:
Developing the World’s Largest
Commercial Jet
Group 1
111 Rakshit Jhunjunwala
115 Ankitesh Mathur
211 Manu Shrivastava
301 Balagopal Padmakumar
402 Rishi Bajaj

2. 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

3. Industry Trends
• Growth in the industry
YTD (2004 over RPK ASK PLF FTK ATK
2000) Growth Growth Growth 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%
Where RPK : Revenue per Passenger Kilometer
ASK : Available Seat Kilometers
PLF : Passenger Load Factor
FTK : Freight Ton Kilometer
ATK : Available Ton Kilometer
Source : www.iata.org

4. Dynamics of Airline Industry
Competitiveness of an Airline depends on two factors:
1. Revenue - ability of a firm to fill the seats in an airplane
Break 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.

5. 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

7. Washington DC
London
Atlanta

8. 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

9.  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

10.  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

11. 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%).

12.  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.

13.  A3XX is estimated to cost $13 billion to launch
Investment Total
R&D $11 billion
Capital Expenditure $1 billion
Working Capital $1 billion
 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

14. 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

15. 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

16. 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

17. 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)

18. 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)

19. Economies of Large Projects

21. 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)

22. 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.

23. Higher Debt to equity ratio
D/E ratio
More than
Less than
10000
500 crore
crore
1.5:1 4:1

24. Benefits
Projects Benefits
Economies
finance– SPV given by
of scale.
benefits Government

25. CONTD...
ADVANTAGES DISADVANTAGES
Cheap credit.
Restrictions by lenders.
Bargaining power for interest
rates.
Efficient use of capital
equipments. Time and cost over run.
Bargaining power in buying and
selling.
Benefits of R&D. Large payback period
Utilization of byproducts.
possible changes in policy, tax
Lower advertisement cost per rates, technology etc.
unit.

26. Easy
monitoring
Less Lenders can
borrowers- afford to
easy to spend more in
manage reports etc.
Advantages
Lenders
Project
financing –
High risk limited
recourse.
Disadvantages

27. 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 High
per year

28. 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.

29. 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.

30. 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.

31. Thank you